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. Last Updated: 07/27/2016

Gazprom Follows Path Laid By West

While government officials were in the throes of hammering out a still-secret plan to liberalize Gazprom shares, a young deputy minister held court over a hushed audience.

"I will briefly say something about our plans to reform Gazprom. They will start in the second half of this year," Andrei Sharonov, deputy economic development and trade minister, said at a recent conference on natural monopolies at the President Hotel.

Sharonov elaborated further, saying Gazprom will lose control of its 150,000-kilometer pipeline system.

After that, he didn't have anything new to say.

The Kremlin says reforming Gazprom, the country's largest company and biggest taxpayer, is a top priority. The appointment of a new CEO appears to be the only concrete measure that has been made toward that reform, while other plans such as share liberalization and the redivision of assets like pipelines remain on the drawing board.

But to be fair, Russia's laborious task of trying to grab Gazprom by the horns is not that much different from the grapple every other major Western gas-producing country has had to make. Those countries all had natural gas monopolies at one time or another that went through drawn-out and controversial reforms.

In Europe, Britain was the first country to fully deregulate its gas markets, a process that started in 1986 with the privatization of British Gas and then the breakup of its monopoly on gas transmission and distribution.

Other European nations — such as The Netherlands and Belgium — have followed suit, even though they haven't gone as far.

However, the pace of deregulation has stepped up since the European Union in 1998 passed a gas directive whose main objectives are to increase competition and create an open market.

The United States deregulated its market in the late 1970s.

If the United States and Britain could do it, and if the rest of Europe is about to do it, why is Russia falling behind? And, more importantly, why does Gazprom appear to be balking?

At first glance, the reasons seem to be obvious. In America and Britain, free markets have led to shorter supply contracts and the creation of spot markets, similar to those that already exist for oil trading. According to former Gazprom CEO Rem Vyakhirev, Gazprom has little incentive to produce gas in inhospitable climates if it has no guarantee that it will receive a high enough price for that gas.

"You should see the cold we have to deal with, the frost layer we have to drill through," Vyakhirev told a group of European businessmen earlier this year. "We don't have the fortune of living in a European climate. We have Siberia instead."

But this is what all producers say, said Jonathan Stern, a long-time Russia watcher and gas expert at the London-based Royal Institute for International Affairs. Such an argument didn't keep other governments from forging ahead with reform, he said.

Gazprom has an unusual sway with the government that can be explained by two things. First, taxes levied on Gazprom account for about one-fourth of regional and federal budget receipts. Second, by providing heat and power to most of central Russia, the gas giant acts as a lifeline to small settlements that have no access to alternative energy sources.

"We must be careful about how we tread," said Sharonov, the deputy minister. "This is the budget we are talking about."

Not only does Gazprom contribute a relatively larger amount to federal coffers than its European counterparts, the monopoly is more entrenched vertically and horizontally. This means that Gazprom has numerous subsidiaries not directly involved in the gas industry but, at the same time, has ironclad ownership links throughout the gas chain.

Stern pointed out that while British Gas had a monopoly mostly on transmission and distribution, Gazprom dominates both transmission and gas production itself. In this case, transmission occurs through high-pressure trunk lines over long distances; distribution is getting the gas from these pipelines to homeowners and power plants.

Deregulating transportation is a relatively simple task: Open up the routes to third-party access and put them under independent regulatory control. Russia's oil industry has operated this way since 1993, when a government resolution created the export pipeline monopoly Transneft after dismantling the Oil Ministry. Even though oil executives sometimes like to accuse Transneft of favoritism, they are in a better position than the few independent gas producers that hold little sway over Gazprom.

But if the government sincerely intends to break up Gazprom's production segments into several operators, it will have to do so more or less arbitrarily, analysts said. How do you split up a complex of fields that stretch across the country? And how do you decide who gets what?

When the Russian government began the privatization of Gazprom through closed subscription sales in the early 1990s, a State Property Ministry official noted that "Gazprom has its own particular privatization, under which enterprises forming part of the unified gas supply system are not privatized independently."

At the time, it was a priority to keep Gazprom's production and transmission capacities whole for what the state said were strategic reasons. If Gazprom follows through with what analysts call Britain's mistake — reforming after privatization takes place — then Gazprom shareholders may see the value of their shares diluted just as British Gas shareholders did in the late 1990s.

The "strategic" argument has also lost currency with European policymakers who now believe that "the short- and long-term security of gas supply is sustained through diversification," according to a report on gas reform released by the International Energy Agency last year. As one market observer put it: "It's safer to have 20 suppliers and 20 buyers than one supplier and one buyer."

Now that Europe is well on its way to market liberalization — to the extent that it won't sign any more long-term contracts with Gazprom — where does that leave the Russian gas giant?

If Europe finds gas cheaper than Gazprom's through liberalization, Gazprom will be forced to stop subsidizing domestic consumers through exports. And if Gazprom is broken up, which "baby" Gazprom would be responsible for providing heat to users that don't pay?

"Gazprom decided that it couldn't make a certain group of customers pay for political reasons," Stern said. "The profitable customers who can pay will pay, and they will also be snapped up by the competitors."

After the upheaval at British Gas, prices did go down, but the customers to suffer most were those who couldn't afford any services, Stern said.

What are you going to do with them? he said. Leave them out in the cold?

In England, that might be unpleasant. In Russia, it could be fatal.

Sharonov's recent statements about reform aren't the first time the specter of Gazprom reform has been evoked. Perhaps nothing will happen with Gazprom until an infrastructure or supply crisis inspires the government to grapple with monopoly reform — the way the power crisis last winter in the Primorye region put electricity reform front and center.

"They've been talking about reform for as long as I can remember," Stern said. "There's been a ton of words but no action. I want to see people get on with something. I want to see dates and a real timetable."