The Russian natural gas industry has its origins in the 1950s, when the first pipeline was built from Saratov to Moscow. It expanded rapidly after the discovery in the 1960s of large reserves of natural gas in the Yamal-Nenets region of Western Siberia.

After the dissolution of the Soviet Union, the oil and coal industries were restructured into several regional enterprises, many of which are now in private hands. By contrast, the natural gas industry (including production, refining, transportation and sales), remains largely the business of state-controlled Gazprom. Gazprom is the monopoly owner/operator of the UGSS. Moreover, Gazprom accounted for approximately 85.0 per cent. of Russian gas production in 2005, with the balance coming from integrated oil and gas companies and independent gas companies.

Gazprom’s major producing fields have either reached peak production or are already suffering from declining production. At the same time, demand for Russian gas, both domestically and from Western Europe, already exceeds supply. Aggregate domestic and international demand for Russian gas in 2005 was approximately 661.0bcm, which exceeded Gazprom’s production of approximately 547.0bcm and exceeded total Russian production of approximately 641.0bcm, as a result of which Gazprom had to purchase and transit gas from Central Asia in order to meet its supply commitments.

Source: Jonathan Stern, The Future of Russian Gas and Gazprom, October 2005

This gas supply deficit is unlikely to abate, and could widen, in the medium term. The next major fields being developed by Gazprom, such as the Barents Sea Shtockman field, are technologically challenging and, accordingly, the Company believes that Gazprom may be unable to bring them into production, as currently scheduled, in 2011. Meanwhile, aggregate domestic and international demand for Russian gas is estimated to have risen to 710.0bcm in 2006 and, according to UBS projections, is expected to rise even further to 779.0bcm in 2010 and 866.0bcm in 2015. It is expected that Gazprom will continue to buy gas from Central Asia to meet its supply commitments.

The gas supply deficit is expected to lead to an increase in unregulated prices for Russian gas. In addition, the gas supply deficit has led the Russian government to acknowledge that an increase in domestic regulated gas tariffs is required to stimulate increased supply, contain demand and promote energy efficiency. Accordingly, the Russian government proposed a series of regulated price increases which, if adopted, would result in Netback Parity (to Western European prices) for regulated industrial consumer gas tariffs by 2011. The Company believes that any such increase in regulated gas prices will have a knock-on effect of boosting unregulated gas prices.

These market and regulatory trends combine to create opportunities for independent gas exploration and production companies that can bring new Russian gas fields into production and bring the gas to market.