Gazprom Has Uber Problems

Published June 5, 2015

Gazprom, the Russian state-owned energy giant, has traditionally used its position as the second-largest exporter of natural gas to the European Union (EU) (Norway is the largest) as a means of flexing its political muscle, especially under the leadership of Russian President Vladimir Putin. But it appears Russia’s days as the energy bully may be coming to an end, as years of using energy as a blunt political instrument to advance the Kremlin’s agenda and disruptive new technologies for oil and natural gas extraction threaten Gazprom’s bottom line much like Uber and other innovative ride sharing companies have usurped market share from traditional cab companies.

The new technologies upending the geopolitics of energy production are the combination of horizontal drilling, hydraulic fracturing, along with sophisticated seismic monitors that can detect oil and natural gas deposits thousands of feet below the surface. These technologies, frequently lumped together under with the term “fracking,” are the Uber of the energy production world.

The fracking revolution in the United States was not ushered in by big oil, but by small companies using innovative new fracking technologies pioneered by George Mitchell in the Barnett Shale of east Texas in the 1990s, democratizing oil and natural gas production in the United States. By 2009, fracking was unlocking ever-increasing quantities of oil and natural gas from immense formations once thought too costly to develop. By 2014, the wildcatters, a name often assigned to the independent fracking companies, had increased oil and natural gas production by 80 percent and 40 percent, respectively, helping the United States usurp the title of the world’s largest producer of natural gas from Russia and the gas titan, Gazprom.

The American fracking revolution has not been lost on Gazprom, or Vladimir Putin, the shirtless wonder of the world, because in Russia, the relationship between Gazprom and the state goes for beyond ownership; it is a network of mutual support. According to the Energy Information Administration, 50 percent of Russia’s federal budget revenue in 2013 came from mineral extraction taxes and export customs duties on oil and natural gas, and oil and gas accounted for 68 percent of Russia’s total export revenues in 2013.

Because Russia depends on oil and natural gas exports for such a large extent of its revenue, it is desperate to keep these American technologies from spreading in the United States and Europe. Russia has been linked to American anti-fracking movements, much like traditional cab companies have attempted to stem the growth of Uber.

In some ways, Gazprom and traditional cab companies are very similar. They are large, bureaucratic organizations that have relied largely on political favoritism and lack of competition rather than dynamic business models, innovative ideas, or improved customer service for their survival. In many areas, the number of taxis on the road is limited by unions to keep wages for drivers — and cab fares — artificially high. As a result, wait times are long and arrival times uncertain.

“Gazprom is regarded as a reliable supplier, albeit one that is not autonomous of government intervention,” said Adnan Vatansever, a lecturer at King’s College in London, who did a study on Gazprom’s long-term gas contracts. This government intervention is the reason Russia is being charged with hindering competition and artificially inflating the cost of the natural gas it sells certain eastern European countries, including Bulgaria, Estonia, Latvia, Lithuania, and Poland, by European commissioner for competition, Margrethe Vestager. These countries have been charged 40 percent more for their gas than Russia charges other European nations. These practices are designed to keep money flowing to the Kremlin’s coffers.

Consumers will only tolerate poor service for so long, and they are quick to jump to better alternatives when given the opportunity. The factors contributing to Gazprom’s power may have ultimately sown the seeds to its own demise. For years, Gazprom has relied on its sheer size, captive markets, and the backing of the Russian government to maximize its influence in European geopolitics. However, its bureaucratic nature has left it flat footed as new technologies, such as hydraulic fracturing and LNG exports, have disrupted the traditional energy supply chain, much the same way Uber, has fundamentally changed the way consumers get rides.

As European energy consumers gain access to more choices, whether it be from LNG imports from Qatar, Egypt, or eventually, the United States, building pipelines to access natural gas from Central Asian countries, or developing their own energy resources using hydraulic fracturing, they will be less likely to tolerate what are perceived as Gazprom’s abusive business practices, leading to a decline in revenue for the world’s largest-natural gas producing company, similar to the way traditional taxi cabs have experienced a 20 to 30 percent decline in cab traffic.

Even though many of these energy alternatives are still years away, Gazprom’s revenues have already begun to fall, largely due to the Kremlin’s strong-arm tactics. Partially in response to the events Russia’s actions in Crimea, European consumers cut their demand for Russian gas by 8.5 percent, and former Soviet nations cut their demand by nearly 20 percent in 2014. Additionally, western sanctions placed on Russia have impeded Gazprom’s ability to get long-term loans in the international market.

These problems are compounded by the fact that Russian natural gas prices are linked to the price of oil, and largely because fracking has nearly doubled U.S. crude oil production, oil prices have plummeted to multi-year lows, reducing the price Gazprom can fetch for natural gas exports through its pipeline infrastructure. “Oil is much more important than gas for the Russian budget. In terms of hydrocarbon revenues for the budget, nearly 90 percent is oil and the rest gas,” Mr. Vatansever added.

While Russia still provides roughly one-third of European gas imports for the short term, the clock is ticking, as new technologies being perfected in America threaten to overthrow the established order and level the playing field, resulting in superior products and better service for consumers. This maxim holds true whether the Uber is decentralizing car rides or fracking is decentralizing energy production: innovation will always win.

[Originally published at the American Spectator]