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Russia: Cheap Gas Fuels Debate

A World Bank report has raised doubts about European demands for higher natural gas prices in Russia on the eve of what appears to be a new government push for gas sector reforms. The outcome of the debate could affect Russia's entry into the World Trade Organization, as well as the course of the economy and consumer costs.

Boston, 12 March 2003 (RFE/RL) -- Despite demands that Russia must raise its gas prices to world market levels, a World Bank report suggests that Moscow may have sound economic reasons for keeping rates low, the London-based "Financial Times" reported this week.

A World Bank study, which the paper said had been "suppressed," seems likely to spark more debate on the pace of Russia's reforms and terms for its membership in the World Trade Organization.

The European Union has stalled Russia's application to the WTO for the past year with demands that it stop subsidizing its domestic gas market by charging five times more for the gas it exports. The EU relies on Russia for one-fourth of its gas.

Russian officials have bounced between optimistic and pessimistic accounts of their WTO talks, but the negotiations keep coming back to the same thing. The EU wants Russia to raise its domestic gas prices dramatically, and Russia refuses to budge. EU officials have repeatedly cited a study by the Organization for Economic Cooperation and Development (OECD) stating that low energy prices have subsidized Russian industries by nearly $5 billion per year.

This month, Russian negotiator Maksim Medvedkov noted progress in the WTO talks on services and agriculture, the RIA Novosti news agency reported. But the core demand on energy still seems to be stuck.

Medvedkov said, "A compromise is not really possible in this area." One reason is that most Russian consumers and industries cannot afford EU-level tariffs. Another is that tariff hikes have already made it hard to keep inflation in check.

But the unpublished World Bank report may give Russia new ammunition for its argument with the EU. The "Financial Times" said "A decision to suppress the conclusion is believed to have been taken at the top of the organization, partly out of fears of damaging relations between the World Bank and [European Union] member states."

The paper quoted Julian Schweitzer, head of the World Bank's Moscow office, as saying that the issue "is still being discussed and debated within the bank."

The reason is that the report endorses a rationale for gas prices that would be less than half of what the EU would like. The report says that Russian prices have already risen close to "long-term marginal costs" or, in other words, the cost of replacing the gas in the future, including the investment it would require.

The argument appears to mean that the Russian government could raise prices to cover the costs of the Gazprom monopoly, and it probably should. But it would not have to raise them to EU levels to erase what the EU sees as a massive subsidy.

The World Bank study estimated that Russia's long-term marginal cost for gas is $40 per thousand cubic meters. The figure compares with current Gazprom tariffs of $20 and 40 cents, according to the Prime-TASS news agency. In other words, tariffs should be roughly doubled instead of raised fivefold to EU levels of $100 or more. Last month, Gazprom deputy chief executive Aleksandr Ryazanov said that 60 percent of gas prices are due to transport costs, making the argument that Russia's prices for the EU must be higher because it is farther away.

Russia's current domestic tariff already includes a 20-percent increase approved by the government for this year. Gazprom sought a 37-percent hike, which was ruled out by inflation concerns. The company estimates it will lose $157 million this year on domestic sales, but the amount pales in comparison to the OECD subsidy claim.

News of the World Bank report comes as the government prepares to consider a reform plan for the gas sector this week. While Gazprom has pressed for higher tariffs, it has also resisted a split into production and distribution units, a move that critics see as essential for opening the market to competition. Gazprom has targeted a tariff of $35 per thousand cubic meters in 2006, a figure unlikely to satisfy the EU demands.

The government has recognized the need for higher tariffs. The question is how much and how fast. Gazprom has proposed a free market for gas only between 2008 and 2010.

Foreign investors are expecting big changes, particularly in the liberalization of trading in Gazprom shares. This week, Russian and foreign media jumped at a Gazprom announcement that the state and its affiliates now control 51 percent of the company, a move seen as a prelude to allowing direct foreign buying of Gazprom stock on the Russian market.

It is unclear that the news merited the sudden attention that it got, since President Vladimir Putin made the same announcement on 14 February, as reported by the Interfax news agency. But the government now seems more likely to move ahead with gas sector reforms than at any time in the past year. Even so, the tariff issue may remain a stubborn one because of its vast entanglements.

The question is crucial not only for Russia's trade within the WTO but also for the economy and the future of power-sector reforms. The Unified Energy Systems (EES) electricity monopoly depends on gas for 67 percent of its fuel, according to chief executive Anatoly Chubais. Sharply higher gas prices could raise power costs and devastate potential profits, also endangering the EES restructuring plan.