The traditional Achilles heel of the world gas business has been aligning supplies with markets. This month, in honor of our special supplement on the Russian petroleum industry, I asked our friends at Wood Mackenzie to explain how Gazprom is changing the balance of power in the European energy market. Woodmac's Tim Lambert shares his views below.

Over the next 2 decades, one company could end up holding the balance of power in the European energy market: Gazprom, the Russian gas giant, an increasingly significant natural gas provider to most EU countries. The rise to strategic prominence of Russian natural gas, and of Gazprom in particular, is explored in unprecedented detail in Wood Mackenzie's definitive study: Time to step on the gas: will Russia realize its potential? The study provides a comprehensive assessment of Russia's gas sector. It examines the Russian gas market and the outlook for reform, as well as assessing the "western" call on Russian and Central Asian gas and its implications. Wood Mackenzie also analyzes the strategy of the key player, Gazprom, and its ability to finance the investment needed in the future.

The challenge is immense, but Russia has the potential

The call on Russian gas is growing, but Russia has ample reserves. Demand for Russian and Central Asian gas will grow from just under 24 Tcf (680 Bcm) today to 35 Tcf (945 Bcm) in 2020. However, Russia's supply potential is not in doubt, with ample reserves to sustain production at current levels for around 85 years and significant exploration upside.

Meeting this increased call implies huge investments, largely resting with one company - Gazprom. This scale of growth will require a total capital expenditure requirement in fields and pipelines of around US $240 billion (2004 real) over the 2004 to 2020 period. As it dominates the Russian gas sector, much of this burden will fall to Gazprom.

Reform of the Russian market continues, but Gazprom will still dominate the entire gas value chain. We believe that reform will continue at a gradual pace. The price increases achieved in the domestic market will enable producers to make returns on upstream investments in Russia. However, the congruence of interests between Gazprom and the state will mean that Gazprom's dominance, especially of the export channel, will continue for the foreseeable future.

However, major uncertainties remain

There are uncertainties around future production levels and the role of non-Gazprom producers. Although production is increasing, there are questions around the decline rate of Gazprom's three main producing fields, gas re-injection projects in Kazakhstan and Turkmenistan's ability to fulfil its ambitions. Also, the high level of control exerted by Gazprom limits opportunities for Russian Oil Companies (ROCs), International Oil Companies (IOCs) and independents to niche positions.

Russia's dependence on Gazprom, and Europe's dependence on Russia, will continue. The government's increasing dependence on oil and gas revenues (and hence Gazprom) exposes it to a volatile oil market. It needs to diversify Russia's economic base and ensure that the oil price windfall it is now enjoying is used to the benefit of other value-creating sectors. Similarly, we expect Europe's dependence on Russian gas imports to increase from 25% today to around 38% by 2020, placing increased importance on the political relationship with Russia. Gazprom has ambitious plans for the future. It aims to increase its control over the Russian market and to develop positions in liquefied natural gas, gas-to-liquid (GTL) and power in addition to expanding internationally. Given the broad range of this activity, we see challenges ahead in retaining focus and potential complications with tightening margins post 2015.

Overall, the Russian gas market continues to move forward, although reform will be slow. This will not provide dramatic opportunities for IOCs - although there have been some openings. Gazprom will be able to continue with the required investments under a profitable framework at least through 2010. The key question hanging in the balance is the fate of European customers as they face increased dependency on Russia and Gazprom in an environment of potentially higher gas prices post 2015. This, coupled with the reality that the Russian government will maintain a heavy hand in the domestic gas market, particularly as its dependency on Gazprom revenues grows, provides the foundations for a complex pan EuroRussian gas market between now and 2020.

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