Central Asia May Be Key to Gas Cost Deal

With oil trading below $60 per barrel, eyes are turning to see what will happen to gas export prices as Gazprom begins the now-annual ritual of haggling with its customers to the West ahead of the winter heating season.

The outcome will hinge on talks with Central Asian producers, who supply a large percentage of the gas that Russia sells on to Europe, and the removal of a contentious intermediary. The likely result, analysts said, is that Europe will be paying less for its gas next year while Ukraine is facing a price hike.

"It's still unclear whether the price [in Ukraine] will be based on market conditions or some other considerations," said Denis Shauruk, an oil and gas analyst at Alfa Capital in Kiev. "Prices in Central Asia have not yet been announced."

In May, Gazprom agreed to pay Kazakhstan, Uzbekistan and Turkmenistan "European market prices" for their gas, meaning that Russia's neighbors, who still receive the fuel at below-market rates, will have to bear the burden of the increase.

Last month, Prime Ministers Vladimir Putin and Yulia Tymoshenko agreed to a three-year period for Ukraine to "transition to market" prices. On Tuesday, Gazprom said it had agreed to supply a minimum of 55 billion cubic meters to Ukraine next year and that the sides had made "significant progress" on a long-term contract.

Gazprom's negotiations with Ukraine and Belarus, which both still pay far below market rates, are closely watched by European customers, who have seen supply interruptions because of disputes upstream.

RosUkrEnergo, a trading company half owned by Gazprom, currently buys gas at the Russian border with Kazakhstan and transports it to the Ukrainian border. From there, the trader sells it to Ukrainian state-owned energy company Naftogaz Ukrainy and to European countries, who pay an additional transport fee and much higher rates.

But from Jan. 1, 2009, RosUkrEnergo is expected to be ousted, a key goal of Tymoshenko. Under the new arrangement, Gazprom would buy Central Asian gas directly and sell it to Ukraine.

"The [pricing] formula is not going to be different," said Jonathan Stern, head of gas research at the Oxford Institute for Energy Studies. "The question is what the price is going to be in January. ... I don't think Gazprom is going to be prepared to make a loss."

As of August, Gazprom was paying Turkmenistan $160 per 1,000 cubic meters, according to company figures. That same gas fetched $500 in Western Europe last month, while Ukraine was paying just $179.50. Stern said he expected Central Asian gas to become $40 to $100 more expensive as of Jan. 1.

Gazprom has raised Ukraine's rates by about 35 percent in recent years. Peter Keller, an oil and gas analyst at Troika Dialog in Kiev, said Ukraine might pay up to $250 or $260 per 1,000 cubic meters next year.

Alexei Miller, Gazprom's CEO, said Wednesday that Europe could expect lower prices next year, although experts said the price lag from oil's fall would outlast the winter.

"We won't see the decline in European gas prices until probably the second quarter of next year," Stern said.