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The gas sector remains almost wholly unreformed
The reform of Russia’s crucial and highly monopolised gas sector has repeatedly been postponed, and it is not clear that any substantial reform will be undertaken in the foreseeable future. Despite its enormous importance, the natural gas industry is perhaps the least reformed major sector in Russia. Most gas continues to be sold at regulated prices that are below full cost-recovery levels, although regulated tariffs for all consumers except households are now rapidly approaching cost-recovery levels. Both the up- and down-stream sectors are dominated by a state-controlled, vertically integrated monopolist, OAO Gazprom. Though organised as a joint-stock company, Gazprom in some respects operates as an arm of the state. It combines commercial and regulatory functions, and maintains tight control over the sector’s infrastructure and over information flows within it. Gazprom’s control over information is particularly problematic, as it renders opaque much of what happens in the sector.
Underlying all of this regulation and rationing is the unsustainable under-pricing of natural gas, which constitutes a subsidy from the gas sector to the rest of the economy. While there is a good deal of debate about what the ‘true’ cost-reflective price of gas production in Russia might be, there is general agreement that regulated natural gas tariffs in Russia are still below full cost- recovery levels. This is particularly true of gas supplied to the household sector. While gas tariffshave risen rapidly since 2000, outpacing both consumer- and producer-price inflation, they still have some way to go to reach long-term sustainable levels.
Continued lack of reform would threaten the future development of this crucial sector
The inefficiencies inherent in the sector’s architecture would, on their own, constitute compelling arguments for reform: an economy as dependent on its resource sectors as Russia’s can ill afford such inefficiencies in what is arguably its most important resource industry. However, the case for reform is even more compelling in view of the need to raise investment and output very substantially over the coming years in order to meet rising domestic demand and growing export commitments. The natural gas sector as it is currently constituted is highly unlikely to be able to sustain sufficient output growth to satisfy internal and external demand over the long term. Given that the importance of gas exports to Russian growth is likely to grow over the medium term, this is a particularly serious concern.
Both Gazprom and the government acknowledge that non-Gazprom production must grow rapidly if the gas industry is to develop successfully, but Gazprom’s current position within the sector constitutes a significant impediment to such growth, restricting both small producers’ access to the market and consumers’ freedom to choose their suppliers. There is significant potential for accelerating the growth of non-Gazprom production and making gas supply in Russia more competitive. This potential cannot be realised until Gazprom’s domestic rivals can be assured of equal treatment, which is impossible as long as Gazprom controls both the information flows and the infrastructure.
Gazprom denies that it exploits its control over the gas industry’s infrastructure and information flows to put other producers at a disadvantage. Certainly, Gazprom has now incentive to exclude them from the market altogether; on the contrary, it wishes to see their role in supplying domestic consumers increase. However, Gazprom’s position gives it considerable scope to ensure that the smaller producers market their gas on terms that suit Gazprom: regardless of the rights and wrongs of particular conflicts between Gazprom and its rivals, the fact remains that the monopolist can discriminate against other producers and that it has incentives to do so. The establishment of an effective regulated third-party access regime for the sector’s infrastructure is likely to be absolutely crucial to the outlook for investment by non-Gazprom producers.
An overhaul of the sector’s regulatory structure is needed, as is some unbundling of Gazprom itself
More generally, there is thus an immediate need to increase transparency in the sector and also to transfer what are essentially regulatory functions from Gazprom to the state. The need for rationing regulated-price gas supplies should in any case disappear as domestic tariffs rise. In the interim, however, it would be preferable for the state to take over the allocation of quotas for regulated-price gas from Gazprom. Whoever actually rations the gas sold at regulated prices, there needs to be greater transparency and less scope for arbitrary action than at present. Clear rules and principles governing the allocation and administration of these quotas should be formulated and implemented. Once set, moreover, quotas should be binding, so as to give greater predictability to consumers. Over the medium-to-long term, Gazprom’s natural monopoly/infrastructure provision functions should be separated from its potentially competitive activities. In particular, this will necessitate unbundling Gazprom’s transport and dispatch operations into separate entities. This will be a long and complex process, which should not be executed in haste; it is therefore important that restructuring be planned and started soon.
Tariff policy needs to be made more transparent and consistent
Finally, tariff policy needs to be both more transparent and more consistent. The government is committed to raising tariffs to cost-recovery levels and has made considerable progress in doing so already. However, it is understandably reluctant to risk lower growth and higher inflation by raising tariffs too rapidly. A big-bang approach to raising gas tariffs would hit households and industry extremely hard. Both need time to adjust. However, the need for a more gradual approach makes it all the more important that the authorities commit credibly to a price path for regulated tariffs and to clear, transparent methodologies for calculating them. This would, inter alia, make it easier to introduce longer-term contracts into the sector. At present, tariffs are adjusted once or even twice a year, and the increases often look somewhat ad hoc, the product of bargaining between the government and Gazprom. Various drafts of the government’s energy strategy and other official documents have outlined medium-term targets for gas prices, but price increases to date have consistently been smaller than these targets would imply. The targets for gas price increases included May 2004 agreement with the EU on WTO entry should therefore be seen as an important step forward, for they represent a binding commitment undertaken by the government in an international agreement.
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Economic Policy Reforms: Going for Growth 2008
