Speech by Alexey Miller at the meeting devoted to the General Scheme for the gas industry development until 2030 under the chairmanship of the Russian Federation Prime Minister Vladimir Putin

Novy Urengoy

Esteemed Mr. Putin! Esteemed meeting participants!

I think that one of the main conclusions resulting from the review of the General Scheme for the Russian gas industry development is that the domestic market is becoming a priority for us in the gas industry. Thus, the main emerging competitor for our export markets is represented not by other export markets, but by the domestic market of Russia. In this respect, I would like to dwell on the features of the existing gas market, on the gas prices and the prospects we are expecting and forecasting in the nearest future.

It is well known that in spite of the market principles applied in the domestic economy, the prices for gas – the main fuel product – are set in a directive manner. This practice has some serious adverse effect. In particular, it is specific with no interfuel competition, transformation of gas into a monofuel resource and above all – absence of the market signals to consumers concerning the commodity price.

Over a long period of time Gazprom has been financing its investment program through the export incomes that have virtually been the only source of finance for our investment program until lately. Recent crisis developments showed this income structure bears immense and real economic risks. We actually have no other way, but to use the domestic gas market economy in order to provide reliability and safety of gas supply in Russia, as well as to use the Russian gas market economy to meet our international obligations.

Domestic prices for industrial consumers currently reach some USD 82 which is on average 5 to 6 times lower versus those set for the European consumers. The price for the population is around USD 62 – 9 to 10 times lower than the same prices for European consumers.

In this regard, I would like to note that the existing level of domestic prices doesn’t offset all the expenses required for the development of gas production, transmission and distribution infrastructure particularly for the domestic market needs. We finance our domestic infrastructure at the expense of the export market.

The Russian Federation Government has already adopted a resolution on the transition to the equally profitable prices and I will dwell on it later. If the gas industry had had equal profitability with the export market over the past decade, Gazprom could have earned RUB 1.5 trillion of additional income or more than USD 50 billion. This natural resource rent has been redistributed to the Russian industry over the decade.

The Resolution No.333 of the Russian Federation Government dated May, 2007 has undoubtedly become an important stage in the Russian gas market streamlining. A decision was taken to apply new pricing approaches based on the equal profitability principle for gas sales on the domestic and foreign markets using a market-based price formula. At the same time, we all understand and know perfectly well that the domestic price, the price for Russian industrial consumers, will always be lower than the one on the European market. This price will always be some 40 per cent lower since it doesn’t contain the export duty and the significant costs for transportation to the European markets.

The Federal Tariff Service (FTS) is currently publishing information about the level of formula-based equally profitable prices on its official website to inform the market participants about equally profitable prices. This information is available to absolutely all the industrial gas consumers and they certainly have to act with reference to equally profitable gas prices in the medium term.

Speaking about the comparative analysis of the regulated and the existing formula-based prices, it shows that the gap remains quite significant, almost twofold. That was the reason for the Russian Government decision to postpone the transition to equally profitable prices for industrial consumers initially planned for January 1, 2011. After multiple consultations with the Ministry of Energy, the Ministry of Economic Development and the FTS the Government finally endorsed a resolution on the appropriate issue envisaging a 2011–2013 transition period to mitigate the price bulge effect. To prevent a sharp increase in the formula-based wholesale prices the transition period stipulates discounts that will be annually specified by the FTS as part of the price formula. At the same time, the discount will be at the level determined by the forecast for Russia’s socioeconomic development in the coming year. I am confident that over the transition period we will reach equal profitability by January 1, 2014.

It is worth noticing that in the course of the gas market liberalization the proposed formula-based pricing and the equal profitability principle will have nothing to do with the gas supply to population since the state is envisaged to set the gas prices for it. The gas supply to the population will remain state determined and will be driven by the inflation trend.

According to Gazprom, transition to market based prices will not have a large-scale adverse impact on the economics of the industrial enterprises and personal income. Thus, we estimate that a 15 per cent growth in gas prices in 2011 would lead to an appropriate increase in the commercial product price to a mere 1 per cent. On our part, we should remember that extra costs within Gazprom’s investment program materially impact the related industries: domestic products nowadays cover more than 90 per cent of supplies for the Company’s investment program. Gazprom’s investment program creates in the order of 500 thousand jobs in related industries.

At present, the General Scheme demonstrates that the domestic market accounts for nearly 60 per cent in natural gas sales, but it will be in 2010 when domestic gas sales will yield profit for the first time in the past years. This profit will serve as an additional source of capital investment. We can see from the 2010 outcomes that in the area of self-financing of the domestic gas market infrastructure we will possibly reach the level of nearly 67 per cent.

On the other hand, however, after such decisions have been taken by the Russian Government, we can see that other trends are still evolving as well. This involves, for instance, the increase in the tax burden on the gas industry and after the decisions on the transition period had been taken, it was resolved to considerably elevate the severance tax – by 61 per cent from January 1, which will result in an additional load of RUB 48 billion in 2011. The most important thing I would like to highlight is the initiatives by the Ministry of Finance that are taking effect right now concerning the need to impose in 2012–2013 the corporate property tax for the companies owning transmission assets. They propose a 1.1 per cent rate in 2012 and a 2.2 per cent rate in 2013. The issue hasn’t been decided upon yet, but the additional load will be substantial anyway. It will account for RUB 29 billion in 2012 and RUB 57 billion in 2013. In this way, the additional burden for Gazprom will total nearly RUB 200 billion over three years.

I am raising this issue, first of all, because I view the decisions on exemption of natural gas produced in Yamal from the severance tax, i.e. imposition of the zero rate on it, as well-timed and expedient. It seems to me, when the Eastern Siberian fields are concerned, as well as the Far East and the offshore areas, we should speak both of the zero severance tax and the export duty reduction for natural gas produced in these regions.

As for Gazprom itself, the Company is raising internal resources. I would like to say that over the last two years, 2009 and 2010, regarded as the crisis and the post-crisis years, the Company has established a tough system of economizing measures and elaborated a fixed schedule, and this really takes effect. In 2010 the prime cost of gas production will hover around 8 per cent below the 2009 level, while the prime cost of gas transmission will remain in 2010 at the level of 2009. If we touch upon the statement made about high transmission costs especially in Europe, the strategy we are implementing within the South Stream project particularly consists in setting up joint ventures in European transiting countries, in which we receive 50 per cent of the gas transit tariff for pumping natural gas across these countries. Therefore, this project and these JVs created in some countries and expected to be created in others, serve as means of boosting Russian gas competitiveness in Europe.

As far as the European market is concerned, I would like to underline some figures in this regard. By now, we have 172 billion cubic meters of natural gas sold on the “take-or-pay” terms until 2015. 216 billion cubic meters of natural gas is an aggregate annual contracted volume, the maximum that we can supply. Our purchasers may not off-take less than 172 billion cubic meters. If they fall short of this minimum, they will simply have to pay.

The identical level of gas supplies to Europe has been retained by Gazprom under the signed contracts until 2030. We have 214 billion cubic meters of aggregate annual contracted volumes and 170 billion cubic meters – on “take-or-pay” terms for 2030. All these gas volumes have already been contracted. As you know, the Company operates according to the principle that “natural gas should be sold first and then produced”. Now, all these gas volumes have been sold. And all these volumes have been sold under the price formula fixed in the contracts. Therefore, there can and may be no negotiations with our European purchasers relevant to selling terms and conditions for these gas volumes all the more so that European consumers give priority to stable gas supplies over a long period of time, rather than to the absolute value or the absolute price of gas. And this is what makes them cooperate under the conditions contained in the long-term contract that are the “take-or-pay” terms. In gas transmission this principle is called “ship-or-pay” accordingly.

No doubt, the proposed measures on streamlining the formula-based gas pricing will allow shaping gas prices during the transition period in a way that would be manageable for the government and absolutely transparent with minimum impacts on industrial consumers. And the most important thing is that these measures, according to our estimates, will bring about an absolutely insignificant inflation growth – only 0.2 per cent per annum and will naturally make a substantial contribution to decreasing the gas- and energy-intensity of the Russian Gross Domestic Product.

I propose to support and adopt the General Scheme for the Russian gas industry development, to address and support the draft Russian Government Directive on streamlining the gas pricing submitted to the Russian FTS, and to introduce the price formula with discounts according to the principles already agreed on with the ministries.

I wish to reiterate my proposal on the decisions already taken: imposition of the zero severance tax in Yamal; the identical decisions should be applied to Eastern Siberia, the Far East and the shelf. It would also be reasonable to consider the possibility of abolishing or rather slightly reducing the export duty similarly to the oil industry.

Thank you for your attention!