Unnatural Monopoly: The Endless Wait for Gas Sector Reform in Russia

Abstract

THE NATURAL GAS INDUSTRY is probably the least marketised major sector in Russia. The transitional institutions and structures created in 1992 have proved highly resistant to change, and attempts to increase the role of market forces in the sector have had little success. It is increasingly clear, however, that lack of reform represents a threat to the sector’s long-term development and, by extension, to Russia’s longterm growth. 1 This article examines the state of the gas industry today, as well as options for reform. The first section describes the structure of the sector and its role in the Russian economy. This is followed by an analysis of the domestic market. These two sections highlight the anomalous position of the vertically integrated gas monopoly OAO Gazprom. Though constituted as a joint-stock company, Gazprom operates in many ways as an arm of the state, combining commercial and regulatory functions, and maintaining tight control over the sector’s infrastructure and over information flows within it. Gazprom’s control over information is particularly important, as it renders opaque much of what happens in the sector. The third section considers the major sources of pressure for change, chief among which is the need to stimulate investment in gas production in order to sustain output over the long term. Proposals for reform are considered in the final section. There is an urgent need to increase transparency in the sector and transfer many of the regulatory functions now performed by Gazprom to the state. There is also a longer-term need for much more fundamental restructuring, involving a considerable degree of unbundling of Gazprom. In particular, it would be desirable to remove control of the sector’s transport infrastructure from the company and to revise the arrangements governing gas exports to non-CIS states, which are currently monopolised by Gazprom. At the same time, recent increases in domestic gas tariffs must continue until internal gas prices rise above full, long-term cost recovery levels. Cost-reflective pricing of gas on the domestic market will be crucial to securing the industry’s future. Overview of the sector It is hard to exaggerate the significance—national and international—of Russia’s natural gas sector. The Russian Federation accounts for around 27% of the world’s proven reserves of natural gas, with roughly 47 trillion cubic metres in explored