The dissolution of the Soviet Union in 1991 and its replacement by the Commonwealth of Independent States (CIS), prominent among which was the Russian Federation, was a welcome event around the world. However, the subsequent development of Russian resources – particularly natural gas – has been disappointing. And the future of the Russian gas sector could be even worse. Contrary to widely-held beliefs, if current trends continue, Russia will have a severe natural gas shortfall by 2010. This prediction is astonishing given that Russia has more gas reserves than any other country, and one of the largest reserves-to-production ratios.

The reason for the looming gas shortfall is simple. Over the past several years, Gazprom, Russia’s state-owned natural gas monopoly, has not invested sufficiently, and lacks the technology to develop new gas fields to replace its rapidly depleting ones. From a Western point of view, the solution is simple: the Russian government should terminate Gazprom’s natural gas monopoly, and involve foreign oil companies and independent Russian ones in natural gas exploration, production, and transportation. However, it has no intention of doing so – at least not in the near future. And in typical fashion, Gazprom announced recently that it will not share the development of its huge Shtokman gas fields with outside companies.

There are complicated reasons behind the current state of Russia’s natural gas industry. A thorough understanding of the industry and its history is required before we can discuss its future.

This article examines Russia’s natural gas reserves, production, and transportation, with particular attention given to recent geopolitical events. The Russian gas industry’s problems – and possible solutions – will also be discussed.

The Resource Base

Russia has the world’s largest proven natural gas reserves, estimated at 1,680 trillion cubic feet (Tcf), about double those of Iran, the next largest. Russia is also the largest gas producer and exporter. For 2004, Russia’s gas production exceeded 22.4 Tcf and exports totaled 7.1 Tcf. In addition, the gas industry plays a significant role in the Russian economy, contributing about 26 percent of total GDP in 2004.

Figure 1: Top 20 countries in the world, ranked by
gas reserves (in Tcf – Source: EIA)

Figure 1 compares Russian gas reserves with those of the other major gas producing countries. And Table 1 lists the 13 largest gas fields in the world. As is shown, Russia owns two-thirds of them.

Table 1: World’s largest gas fields (in Tcf) ranked by
current reserves estimates (Source: EIA)

Gazprom, tracing its origins to the Soviet Gas Ministry, is the dominant and monopolistic gas company in Russia. Figure 2 shows Russia’s total gas production and consumption, and Gazprom’s contribution from 2000 to 2005, which accounts for about 80 percent. Gazprom is not only Russia’s largest gas producer, it also owns the entire gas pipeline infrastructure in Russia – all 155,000 kilometers of it, along with the compressor stations. In addition, Gazprom controls the sole means of getting gas to domestic and export markets.

Figure 2: Russia’s total gas production and consumption,
and Gazprom’s gas production, from 2000 to 2005
(Sources: EIA, Interfax, Gazprom)

The professed reason that Russia has given Gazprom monopoly control over its natural gas is the so-called “social obligation.” Through Gazprom, the Russian government subsidizes its inefficient domestic industries with low-priced natural gas. Gazprom sells most of its gas to domestic customers at a considerable discount. The wholesale price of 1,000 cubic meters of gas for a Russian household is around $15.90 (about $0.45 per Mscf). For industrial users, gas costs around $24.20 ($0.69 per Mscf). By comparison, in the E.U., household tariffs range from Finland’s $159 ($4.50 per Mscf) to Denmark’s $735 ($20.82 per Mscf). Clearly, Gazprom is losing large amounts of money on domestic sales, and must rely on export revenues for the difference.

Gazprom’s major challenge is the aging of all its major producing gas fields. Production from these fields is declining and studies project steep declines in Russia’s overall natural gas output between 2008 and 2020. According to Russia’s own projections, which ET published in December 2006, Russia will face a gas shortfall of about 100 billion cubic meters by 2010. Considering that Russia owns the largest gas reserves in the world, and one of the largest reserves-to-production ratios (81.5, compared to Algeria’s 55.4 and Canada’s 8.8, for example), this fact should be worrisome for energy officials from Beijing to Bonn. The only conclusion to be drawn is that something is fundamentally wrong in Russia’s gas industry. However, before discussing this, analytical information on the country’s natural gas reserves, production, and transportation, and recent geopolitical events involving Russian natural gas, should be considered.

Russian Natural Gas Reserves

Among other things, table 1 shows the eight largest Russian gas fields and comparisons among their reserves (some of their locations are shown in the map on pg. 18). Of these, we will discuss Urengoy and Shtokman in detail, as well as the Yamal peninsula, and another important site, Sakhalin Island. While Sakhalin’s 2.7 trillion cubic meters is just a fraction of Russia’s overall reserves, its location and the involvement of some of the largest multinational companies make Sakhalin an important focus for Russia’s natural gas industry.

Urengoy
The Urengoy gas field is the world’s second largest, and originally had nearly 10 trillion cubic meters (about 350 Tcf) of reserves (for years it was the largest until the North Dome was discovered). It lies in the Yamalo-Nenets Autonomous Okrug in the Tyumen Oblast, just south of the Arctic Circle, and is named after the settlement of Urengoy. Discovered in June 1966 (the first discovery well hit gas on July 6, 1966), the field started producing in 1978. In February 1981, Urengoy had already produced its first hundred billion cubic meters of natural gas. Gas from the field began to be exported to western Europe in January 1984. It continues to produce over two hundred billion cubic meters of gas per year. Urengoygazprom, a subsidiary of Gazprom, manages the production.

Shtokman
Shtokman is one of Russia’s super-giant offshore gas fields, located under the Barents Sea. The estimated reserves stand at about 200 Tcf. The original destination of Shtokman gas was to be the west coast of the United States, with the gas transported as LNG. However, with deteriorating relations between the U.S. and Russia, Gazprom (the sole owner of Shtokman) now plans to export the gas via the Baltic seabed pipeline (the North Europe Gas Pipeline, or NEGP) to Europe. The major recipient of Shtokman gas would be Germany.

Recent announcements in Russia suggest that production won’t begin until 2012 and foreign companies will not be allowed to participate.

Yamal
Gazprom estimates it will invest $69 billion in the development of the Yamal peninsula over the next 20 years. The combined reserves of Yamal’s fields are estimated at 850 Tcf of gas with 459 Tcf of proven reserves. It is one of the most promising gas-bearing formations in western Siberia. However, compared to other Russian gas fields, production costs will be much greater in Yamal. Gazprom will need solid government backing to tap into its reserves, assuming that foreign investment continues to be discouraged.

Sakhalin
Sakhalin Island, a former penal colony located off Russia’s eastern shore, is home to five oil and gas projects, each operated by a separate international consortium. Oil reserves in the area are estimated at around 14 billion barrels, in addition to natural gas reserves of approximately 96 Tcf.

Even though each consortium has extensive export plans (including to the United States) via LNG terminals and export pipelines to the mainland, there has been little progress except for the first two projects, Sakhalin 1 and Sakhalin 2. The five projects are currently in different stages of development, but Sakhalin 1 and 2 are supposed to bring oil and natural gas production online in the near term. Both projects have targeted Asian markets.

However, problems have arisen. Russian politics have caused delays, and considerable anxiety exists among the major players that the Russian government will renege on existing contracts or place obstacles in their way. This is particularly significant given that huge amounts of additional capital will be required to develop and transport Sakhalin’s gas to the market.

Figure 3: Russia’s natural gas production (including
estimates to 2008) and consumption (Source: EIA)

Russian Natural Gas Production

Gazprom, often referred to as a “state within a state,” holds about one-third of the world’s natural gas reserves and produces about 80 percent of Russia’s natural gas. The remaining percentage comes from independent producers. The company operates 90,000 miles of natural gas pipeline and 43 compressor stations. As the world’s largest producer and exporter, Russia is also a huge consumer of natural gas. The country produces an annual 21 Tcf, consuming 14.5 Tcf and exporting the rest (2002 numbers). Despite the country’s huge reserves, natural gas production has remained essentially flat over the past several years, with a mild production increase (1.3 percent) forecast for 2008. In contrast, oil production has flourished, especially during the Yukos years.

The immediate future of natural gas production in Russia does not allow for much optimism. The overall production decline forecast for Gazprom is quite steep, as shown in Figure 4.

Figure 4: Decline in gas production for the
combined production of selected Gazprom fields
(forecast to 2020 – Source:
Institute of Energy Policy, 2006)

Considering that Russia’s domestic consumption is increasing by 2.5 percent annually, the current demand in Europe, Turkey, and the C.I.S. for up to 325 billion cubic meters, and China’s demand for 38 billion cubic meters, it’s clear that additional sources of natural gas must be found if Russia wants to play a major role in the natural gas market. It’s equally clear that the problem of Russia’s looming gas shortage can only be solved by optimizing existing fields and through the rapid development and production of major fields such as Yamal, Shtokman, and Sakhalin. Obviously, implementing these solutions will require a substantial investment that Gazprom is unable to raise. Making matters worse, the state-owned company indirectly contributes to a continued production decrease by precipitating further government regulations and difficulties for independent producers. These obstacles include:

- Insinuated takeover threats by Gazprom;
- Increased government transportation tariffs; and
- Independent producers’ lack of access to the gas transportation system.

The only real solution to Russia’s looming financial deficit is foreign investment in Gazprom, but this would strike at the heart of its monopoly, and the Putin government does not want that. It is clear that gas production in Russia might have looked very different had the government encouraged independent producers and investors to get involved with Gazprom. One scenario for the potential contribution of independent producers shows a net increase of 100 billion cubic meters per year by 2010.

Investment from foreign companies could, by 2020, help increase production from fields such as Yamal (180 to 190 Bcm per year), the Nadym-pur-Tazovsky area (440 to 445 Bcm per year), and Kovyktinskoye (16 Bcm per year). For Shtokman, foreign investment could allow production to reach 10 Bcm per year by 2010. If this were the case, an optimistic forecast of natural gas production could be as shown in Figure 5.

Figure 5: Forecast of gas production increase,
should Russia choose to encourage
independent producers (top); additional combined
production from Gazprom and
independent producers (bottom)

Russian Natural Gas Transportation

After production, Russian natural gas is put into mainline gas pipelines, which form Russia’s unified gas transportation system (UGS). UGS is the world’s largest gas transportation system, a unique technological chain of facilities in charge of gas extraction, processing, transportation, storage, and dispatch. UGS is supposed to ensure a steady supply of gas from the well to the end-consumer.

Gazprom has been implementing a comprehensive reconstruction and technological retooling program for its gas transporting facilities, spanning 2002 to 2006. Reconstruction and upgrading of gas pipelines mean no more bottlenecks for future gas flows, less energy consumption during gas transportation, and better reliability and safety. The following summary discusses some of the most important pipeline projects either under construction or in the planning stages.

Yamal-Europe-II Pipeline
The original Yamal-Europe natural gas pipeline connected natural gas fields on the Yamal peninsula, in Russia, with Poland and Germany via Belarus, and had the capacity of about 1 Tcf per year. Gazprom and Poland currently disagree on how the second branch will travel through Poland; Gazprom seeks a route via southeastern Poland to Slovakia and on to Central Europe, while Poland wants the branch to travel through its own country and then on to Germany.

Blue Stream Pipeline
The Blue Stream natural gas pipeline connects the Russian system to Turkey through a 750-mile pipeline, 246 miles of which extends underneath the Black Sea. Natural gas began flowing through the pipeline in December 2002, under an initial schedule of 71 Bcf per year. By 2010, thanks to capacity increases, the pipeline could be delivering 570 Bcf per year.

North European Gas Pipeline
The North European Gas Pipeline, extending over 2,000 miles from Russia to Finland and the United Kingdom via the Baltic Sea, was proposed in June 2003 by Russia and the U.K. About 700 miles of the pipeline will pass under the Baltic Sea while 570 miles crosses Russian land. The unique aspect of this route is that there are no transit countries; hence, transit costs and risks are expected to be low. In theory, this pipeline will ensure a reliable gas supply to western Europe. The European Union is particularly interested in this project’s development. However, there is no definite consortium developing the pipeline at this time.

Kovykta to China Pipeline
The construction of oil and gas pipelines from Russia to China is currently being discussed. But there are still key issues to be resolved, such as the exact route, terms, and stages of construction. The most probable field to supply this pipeline is the Kovykta field in eastern Siberia, because of its proximity to China and Japan. However, the Kovykta field’s development has been jeopardized by Gazprom’s refusal to provide pipeline capacity. Throughout 2006 there were moves by Gazprom to purchase stakes in TNK-BP, the Russian-British joint venture and Kovykta’s license owner. If the purchase occurs, pipeline capacity would certainly be provided to Kovykta. Such a development would expedite construction of the Kovykta-China gas pipeline.

Russia’s Pipeline Transport Problems
- According to Vladimir S. Katrenko, head of the Committee for Energy Transport and Communications of the State Duma, “Pipeline transport is the nervous system of the Russian fuel and power complex.” His statement delineates the importance of pipeline transport in Russia.
- Despite the Russian oil and gas sector’s strong potential for generating great returns on investment, there is no investment boom. The major reason for this is the absence of an organized structure and a legal framework to govern pipeline transportation. Issues concerning pipeline transport are highly regulated and based on capricious government dictates. A new Duma committee is supposed to oversee attractive investment portfolios while retaining governmental control and the pipeline monopoly, a formidable task.
- According to the article “Truboprovodny transport Rossii (1946-91)” published at www.transneft.ru, the dissolution of the Soviet Union in 1991 led to a cessation of new trunk pipeline construction. In 2000, Russian capital assets deterioration was 60 percent in the oil extraction sector, 80 percent in the oil refinery sector, and 55 percent in the power industry. The coal industry continues to be in permanent crisis. Gas companies resort to reduced recovery because the most profitable fields are running low.
- Production sharing agreements (PSAs), intended to attract oil and gas investments in Russia, often contain stipulations that have harsh effects on investors. For example, one PSA regulation states that no more than 30 percent of the exploited reserve can be developed. This tough margin automatically eliminates reserves of less than 10 billion cubic meters, and narrows the field of potential investors.
- There is also imminent pipeline danger due to old and aging pipes. According to Katrenko of the Duma, one-fourth of the trunk pipeline length has been in operation over 30 years, and yet another one-third has been operating for over 20 years. It is widely understood that the Russian fuel and power complex (FPC) urgently needs large investments, up to $30 billion a year.
- Another gas transportation problem is that UGS is currently operating at capacity. In 2005 the UGS transported 699.7 billion cubic meters of natural gas, which Gazprom acknowledges is above its designed capacity. The UGS is also in need of massive investments to prevent the shortfall discussed above.

The first four authors are students of Prof. Michael J. Economides at the University of Houston.