11.01 Analytics

The Triumph of Herostratus: How Russia lost the energy war and permanently forfeited its leading position in the global gas market

Russia has lost the energy war on which the Kremlin had pinned great hopes at the beginning of the full-scale invasion. Europe has successfully restructured its energy market, largely substituting Russian gas, prices have fallen, and Gazprom, once the flagship of the Russian economy, has found itself trapped with its 'energy weapon' in Putin's geopolitical trap. The company's 2023 revenues have fallen by 40% and taxes paid have roughly halved. The company's capitalisation has fallen six times to the levels of the mid-2000s. The established transport infrastructure, in which more than €27 billion has been invested in the last 20 years alone, remains largely inactive. 

While the Soviet leadership depoliticised gas trade with Europe in the late 1960s, Putin set out to repoliticise it, leading to the collapse of 50 years of gas cooperation and Gazprom's dominance of the most premium market. Meanwhile, talk of redirecting Russian gas eastwards remains empty.The limitations of their own investment resources, lack of access to international capital markets, sanctions, geopolitical uncertainty, and the ambiguity of long-term prospects for the gas market in the energy transition will allow redirecting, at best, a smaller or insignificant part of the gas released — and this will take at least five to six years.

The end of the feast

2023 marked the beginning of the long-term degradation of the Russian gas industry and its flagship company Gazprom. Two years of war in Ukraine have been enough to destroy the economically most successful part of the USSR's legacy, which was inherited by the new Russia and continued to develop in the post-Soviet period. 

Gazprom's apparently irreversible loss of European markets became apparent in early 2023, when Europe managed to survive the winter without the majority of Gazprom's gas. However, at that time, this had little impact on the gas giant's financial performance. The decrease in exports did not worsen the company's financial performance and even led to the growth of some indicators due to abnormal gas prices in the global market. In March 2022, they exceeded $3800 per 1,000 cubic metres, which is ten times higher than the average price in recent years. As a result, in 2022, the company's revenue grew by 14%, reaching 11.67 trillion rubles, and the pre-tax profit (EBITDA) remained at the previous year's level (3.6 trillion rubles). As the company’s head Alexey Miller boasted: 'Yes, we have a decrease in gas supplies to Europe by several tens of percent. Only prices have increased not by tens of percent, but several times. So if I say that we are not offended, I am not being dishonest’.

However, the following year, Gazprom faced serious problems. In 2023, prices returned to the level of $350-400 per 1,000 cubic metres, and now the company's management expects its revenue to drop by 37% to 7.4 billion rubles, and EBITDA will decrease by 39% to 2.2 trillion rubles. The company did not provide a profit forecast, but in the first half of the year it fell eightfold, from 2.5 trillion to 296.2 billion rubles. At the same time, in 2022, Gazprom paid a record 5.38 trillion rubles in taxes to the budget, making the company the largest taxpayer in the country. And, in 2023, they are expected to pay half as much: according to management estimates, their tax payments will drop to 2.5 trillion rubles.

The fall in prices and, consequently, in Gazprom's financial performance reflects a fundamental event — the restructuring of Europe's gas markets. It took just over a year to reduce Russia to the status of a minority supplier. While in the 'pre-Covid' year 2019 Russia accounted for more than 60% of all EU pipeline gas imports, that share is now less than 17%. Pipeline gas supplies from Russia to the EU from January to November 2023 decreased by 2.5 times (24 billion cubic metres) compared to the same 11 months of 2022, according to the monthly report of the Gas Exporting Countries Forum (GECF). In 2023, Russia supplied an average of 2.2 billion cubic metres of gas per month to the EU, compared to 5.5 billion cubic metres in 2022 and 12.4 billion cubic metres in 2019–2021, according to the GECF report.

Sources of pipeline gas supplies to the EU, 2019-2023, billion cubic metres

The largest suppliers of pipeline gas to Europe have become Norway and Algeria, which together supplied less gas than Gazprom alone until 2022. Norway now accounts for 53.5% of pipeline gas supplies (about 7 billion cubic metres per month), while Algeria accounts for 19.7% (2.5 billion cubic metres per month). In addition, European countries have managed to almost completely replace the shortfall in Russian pipeline gas with liquefied natural gas (LNG). Europe has increased its LNG purchases by 65% (from 79 to 131 billion cubic metres) and has become its largest consumer, surpassing previous leaders such as China, Japan, and South Korea. For January–November 2023, LNG deliveries to Europe increased by another 3.9%, reaching almost 120 billion cubic metres for the 11 months (data from Gas Infrastructure Europe, the Association of European Gas Storage Operators). However, this increase in LNG purchases was not accompanied by a rise in prices. Finally, in 2022, the European Union reduced gas consumption by 13%, according to the International Energy Agency's estimate, and in 2023, it decreased its consumption by an additional 3%, to approximately 350 billion cubic metres.

Russian gas is no longer needed by Europe. European consumers paid a heavy price in 2022 and early 2023, but now it is the turn of the Russian state and Russian citizens to pay, deprived of export revenues that sometimes reached $20-30 billion a year. The Russian gas industry is facing an 'existential threat,' according to Skoltech’s report 'The Transformation of Russia's Gas Export Strategy'. In 2022, the country's gas production fell 11.7% to 673.8 billion cubic metres, while Gazprom's production fell 20% to 412.6 billion cubic metres. In the first half of 2023, the company further reduced production by almost 25%.

From depoliticisation to repoliticisation: a strategy of collapse

The export pipeline infrastructure for supplying Russian gas to Europe existed for over 50 years, when the 'deal of the century' between the USSR and West Germany, called 'gas for pipes', was concluded. The breakthrough nature of the deal was determined by the fact that the mutual benefits of gas co-operation proved to be a more important factor than political tensions between the USSR and Western countries. Germany, and later other European countries, invested in the development of Soviet gas fields and transportation infrastructure in exchange for long-term (almost 30-year) contracts for gas supply to Europe. As a result, a network of pipelines was built through Ukraine and Belarus. Gas trade was not questioned even after the Soviet invasion of Afghanistan, when relations between the USSR and the West escalated to breaking point, and for decades,it was considered the foundation of mutual interest between Russia and Europe in cooperation and interaction. Pipeline gas remained one of the few depoliticised commodities.

Upon coming to power in 2000, Putin also pinned his hopes on the 'gas umbilical cord' of Russian-European relations. He swiftly replaced people in the leadership of Gazprom who had emerged from its ranks and developed the company over the previous decades, with his ally Alexey Miller, who had no prior connection to the gas industry, and consolidated Gazprom's monopoly on gas exports from Russia. In relations with the EU, Putin promoted the concept of long-term gas supply contracts at stable prices and Gazprom's participation in European gas distribution networks. The company's leadership convinced itself and others that the prospects for liquefied natural gas trading and shale oil production were limited, and that pipeline gas was therefore indispensable. However, Europe adopted an energy development strategy aimed at long-term diversification of supplies and increasing competitiveness in the energy market.

At the same time, across the post-Soviet space, the company transformed into a political tool: maintaining low gas prices for post-Soviet countries was made dependent on their loyalty to Moscow's interests and participation in Russian integration projects. This was the cause of the acute conflict between Russia and Ukraine and two gas crises in 2005-2006 and 2009, when gas transit through Ukraine was reduced or suspended. Gas, once an instrument of depoliticising relations, as it was during the Cold War, was increasingly turned into an instrument of their politicisation.

In response to the Ukrainian crises, Russia began constructing new gas pipelines to bypass Ukraine. The Blue Stream pipeline under the Black Sea to Turkey cost $3.2 billion, the Turkish Stream pipeline (one line to Turkey, the second to Europe) cost €7 billion, and the two pipelines under the Baltic Sea to Germany — Nord Stream-1 and Nord Stream-2 — cost €7.4 billion and €9.5 billion, respectively. Thus, approximately €27 billion has been spent on these four pipelines over the past 20 years (construction contracts were mostly awarded to oligarchs close to Gazprom and Putin, including Gennady Timchenko and Arkady Rotenberg). However, only the two Black Sea projects are now operational, and Nord Stream-2 has never been put into commercial operation. 

Even after the full-scale invasion of Ukraine, no European sanctions were imposed against Russian pipeline gas and Gazprom itself (unlike for oil and major oil companies). Moscow began cutting its exports to Europe as early as 2021 to prevent European consumers from filling gas storage facilities before winter and to put pressure on Europe once the invasion began. And after the start of the war and the imposition of financial sanctions, Russia demanded payment for gas supplies in rubles, forcing European consumers to violate these very sanctions. However, after two years, Russia has lost the energy war with Europe, the 50-year 'gas romance' is over, and the transport infrastructure created for it is mostly inactive.

Today, supplies to the EU are still channelled through the Ukrainian gas transit corridor and the second line of Turkish Stream. According to Skoltech analysts, supplies through these two pipelines amount to approximately 90 million cubic metres per day, which has led to a drop in supplies to the European market (including Moldova) to 28-30 billion cubic metres in 2023. Thanks to the gas-for-pipes deal, Russia became the world's largest gas exporter as early as 1978 and held that position until 2022, when it was overtaken by the United States. Russia is also likely to have been overtaken by Qatar in 2023, and Russian export volumes are expected to return to the levels of thirty years ago.

Gas supply volumes by key exporting countries, 1970-2023, million cubic metres

In 2006, Gazprom was the third largest company in the world in terms of capitalisation, at about $250 billion. Its management declared its intention to lead the company to the top position and eventually reach a capitalisation value of $1 trillion. By the end of the second year of the war in Ukraine, Gazprom's value on the Moscow Exchange had fallen to 3.85 trillion rubles, or $42 billion. Putin and Miller have managed to almost completely destroy the most profitable part of the Soviet and Yeltsin-era gas legacy.

Gas in a trap

Russia has largely lost the energy war on which the Kremlin had pinned high hopes at the beginning of the invasion of Ukraine. Gazprom, with its 'energy weapon', has found itself trapped in Putin's geopolitical mousetrap.

Russia remains the country with the largest gas reserves in the world (ranging from 37.4 trillion cubic metres, according to British BP estimates, to 73 trillion cubic metres across all categories, according to Rosnedra). As Re:Russia has previously discussed, Russia holds 23% of the world's gas reserves and before the war, it represented 17% of global gas exports; this share will now be at least halved. Some of the newly freed-up huge reserves can be utilised domestically, but it is practically impossible to break the trend of degrading production capacities without significant export alternatives. Gas production in the USSR/Russia developed with the available export markets in mind. According to the Skoltech report, Gazprom has already had to mothball wells due to a significant decline in production in 2022-2023. To find new consumers for 150 billion cubic metres, it will be necessary to invest tens of billions of dollars, recreating transportation and logistics infrastructure – new gas pipelines and LNG plants.

Statements by Russian officials, including Vladimir Putin, that gas exports could be redirected eastwards are irresponsible. Only a fraction of the available gas volume can be diverted to the most obvious direction — China. The Power of Siberia gas pipeline, through which Gazprom was to supply 22 billion cubic metres in 2023, will reach its design capacity of 38 billion cubic metres by 2025. Moscow has not yet managed to reach an agreement with Beijing on the construction of a second pipeline, Power of Siberia-2, with a capacity of up to 50 billion cubic metres, despite nearly 20 years of talks. This gas pipeline, which will deliver gas from Yamal (previously exported to Europe), should be almost twice as long as the existing one (3550 kilometres versus 2150 kilometres) and 1.3 times more powerful. According to independent analyst Sergei Vakulenko, it could cost twice as much as the first pipeline, amounting to $34 billion. This is almost as much as was spent during Putin's tenure on the construction of gas pipelines to Europe, which are now largely inactive.

However, revenues from exports through the second Chinese pipeline will only amount to between $2.5 billion and $4.3 billion a year, which is significantly less than what Gazprom earned from selling gas to Europe ($20 billion), notes Vakulenko in his review for Carnegie Politika. As the sole alternative buyer on this route, China already pays about 60% of the European price for gas, according to Reuters, citing a document from the Russian government. Thus, the price of gas for sale in the EU and Turkey in 2023 was $501.6 per thousand cubic metres, in 2024 it is expected to fall to $481.7, and for China these figures are expected to fall from $297.3 to $271.6. But, according to Vakulenko’s estimate, the cost of gas for China will be even lower and will not exceed $170 per thousand cubic metres (35% of the European price). Deducting the cost of production and delivery, the netback will be about $53 per cubic metre. In other words, this project will begin to pay off (taking into account construction expenses) around 15 years after launch, i.e. in the mid-2040s.

This raises questions about the feasibility of the project. While it appears profitable and advantageous in many respects (utilising domestic production capacities), it carries two significant risks, Vakulenko writes. First, dependence on a single consumer, which will not only dictate the terms of the contract, but also demand that they be changed in the future. However, the even more serious problem is the uncertainty about the prospects of gas demand. Forecasts for China's energy development suggest that demand will continue to grow until 2040, and then, after a period of stability, it will begin to decline, with gas trade between Russia and China ceasing by 2060. But, if Beijing accelerates its transition to renewables, which is highly likely given the development of new technologies, this trajectory may be even shorter. Vakulenko notes that this is a fundamental difference from the situation in the 1960s and 1980s, when the prospects for gas demand growth looked limitless. It is for this reason that China is demonstrating a lack of interest in financing the construction of the gas pipeline.

As an alternative to the Chinese market, Skoltech analysts consider the possibility of gas supplies to South Asian countries, primarily India and Pakistan, via Kazakhstan and Uzbekistan (by putting the Central Asia-Centre gas pipeline system into reverse mode). According to a conservative forecast by the International Energy Agency, the share of natural gas in India's energy mix is expected to increase from the current 66 billion cubic metres to 115 billion cubic metres by 2030. Meanwhile, Indian officials say that demand may grow up to 200 billion cubic metres per year. Skoltech experts believe that this is a real opportunity for Russia to redirect significant volumes of gas from the European market to a new region. But taking into account the long-announced TAPI gas pipeline from Turkmenistan to Afghanistan, Pakistan and India, deliveries may not exceed 30-40 billion cubic metres per year.

In addition, any of the projects to supply gas from Russia to China or South Asia, as well as plans to build liquefaction plants, will face a new reality — international sanctions and limited external and internal sources of financing. Amid a sharp drop in its own revenues, Gazprom approved a 20% cut in its investment programme for 2024, down to 1.57 trillion rubles (about $17.7 billion), at the very end of 2023. The costs of the war are putting a significant strain on the Russian budget, and Russia has no access to international capital markets. In this situation, financing from potential future consumers will be very expensive, and the continuing uncertainty about the future of both Russia and the global gas market makes such long-term investments particularly unattractive.