Gazprom looks to regain gas buyers with greater pricing flexibility

Gazprom is adapting to a slump in European gas demand and the encroach of LNG into its traditional key market by becoming more flexible with its customers and turning to spot market pricing.

After three decades of supplying gas under long term oil-indexed contracts to its biggest buyers, Gazprom is looking to include reference to the spot market in its pricing mechanism. Its hand is being forced after European sales fell 12% in 2009, with buyers adding insult to injury by also turning to a spot market flooded with LNG from suppliers such as Qatar.

Unicredit Securities Oil and Gas analyst, Artyom Konchin, says the contracts Gazprom has in place with European customers gives them some scope to go to the spot market when it is cheaper, leading Gazprom to do the same.

“There’s a flexible part in every contract Gazprom has in Europe which allows customers not to take out a 100 % of the contracted volume, but a certain share. This is assumed to be at around 15-20 %. Customers in Europe are taking out the required volume and then they buy the difference on the spot market. So instead of just abandoning this remainder Gazprom wants to sell it at a spot market price.”

Customers have repeatedly criticized Gazprom for its lack of price flexibility and its focus on long term contracts, and particularly its ‘take or pay’ policy regarding contracted volumes. When the demand supply balance was tight they gave Gazprom the whip hand in dealing with customers – they could pay the price or Gazprom could sell it elsewhere. But when supply outstrips demand that means those same customers are looking for savings and the biggest savings are coming from buying as much gas on the spot market as they can, rather than under one of the Russian gas export monopoly’s contracts.

Gazprom has made some concessions already. Price adjustments are likely to come into effect for almost all European contracts. Some buyers have already been granted concessions, such as Germany's E.ON Ruhrgas.

Just last week Deputy Prime Minister Igor Sechin added that Gazprom would also relax the ‘take or pay’ contract for Turkey. Dmitry Lyutyagin, Chief analyst at Veles Capital, says this is part of negotiations on the South Stream project.

“Russia considers Turkey as a partner in the South Stream project. To somehow encourage Turkey to allow building the pipeline through its waters Russia is offering gas at spot market prices which is cheaper than the long-term contract.”

Gazprom says it’s not going to destroy the long-term contracts system. But analysts say greater flexibility is the way for Gazprom to regain its market share.