Streetwise Professor

The most common defense of Russia’s/Gazprom’s increasing the price of gas to Ukraine, Belarus, Azerbaijan and others is to deny that the motive is political, and to claim instead that these consumers are now being charged the same market price as the Western Europeans. There is a kernel of truth to this, but it obscures the crucial question: just what kind of market is this?

Some markets are competitive. Some markets are not. The market for Russian and most Central Asian gas falls squarely under “not.” Gazprom has a state enforced monopoly on the transit of gas across Russian territory. Moreover, the Russian government is aggressively playing the “Great Game” in Central Asia and the Caucasus to stymie development of any alternative transport routes. For instance, Russia used its overwhelming leverage against Armenia to get that impoverished nation to limit the size of a gas pipeline from Iran, thereby ensuring that the pipe could not be used to transport Iranian gas into Europe.

Russia’s central geographic position, and its heretofore successful efforts to impede development of alternative transportation routes gives the transit monopoly Gazprom great market power. It is effectively a monopsonist upstream, and can exploit this monopsony power to depress the purchase price of gas from Turkmenistan and other “independent” suppliers. Moreover, because the supply of gas into Europe from non-Russian sources is constrained (and will continue to be so unless and until Europe invests in substantial LNG capacity), Russia faces a downward sloping demand for its gas in Europe, which gives it some monopoly power. Indeed, Eastern and Central Europe have even fewer alternatives to Russian gas, and are even more vulnerable to the exercise of market power.

This combination of monopoly and monopsony power is reflected in the chasm between the purchase price of gas from Turkmenistan and Kazakhstan–about $45-$65 per mcm for years, lately raised to $100 per mcm–and the price in Europe–upwards of $230 per mcm. Based on a price of $230 to Germany, and a price in Turkmenistan of $65, this translates to a price difference between consumer and producer of about 3.5 cents per mcm per kilometer. This represents a markup over the Turkmenistan price of about 63 percent per 1000 kilometers. (Even at the now higher Turkmenistan price of $100, the shadow price of transportation is about 2.8 cents per mcm per kilometer, and the markup is 42 percent per 1000 kilometers.)

To put things in perspective, the basis (i.e., the price difference) between the price of gas in Chicago, and the price of gas at the AECO hub in Alberta, a distant Canadian gas supply location, averaged a little over 1 cent per mcm per kilometer from November 2003-January 2007. The markup is about 5.5 percent per 1000 kilometers. Examining the AECO-Iroquois route (Iroquois is a gas hub in New York state), the average basis worked out to about 1.5 cents per mcm per kilometer in 2003-2007, and the markup was about 7.5 percent of the AECO price per 1000 clicks. Iroquois is often quite congested, especially during the winter, so it tends to exhibit a wide basis compared to other locations in North America. Nonetheless, the Europe-Turkmenistan basis dwarfs the Iroquois-AECO basis, and dwarfs the Chicago City Gate-AECO basis even more.

Now, some of the disparity arises because of Gazprom’s inefficiency. (If the exercise of market power doesn’t bother them, global warming worriers should fret about the massive amounts of methane–a greenhouse gas much more potent than CO2–that leaks from Gazprom’s pipes.) But a healthy chunk reflects a market power rent that exists in the no-entry Russian market but does not exist in the much more competitive North American gas transportation market.

The Europeans have importuned Russia to open its gas transportation system. Sorry, not going to happen. This arrangement is too lucrative for the Russian government and the various hogs that feed at the Gazprom trough. This market is not competitive, and is unlikely to become so any time soon.

So let’s call a spade a spade. Let’s not pretend that the price of gas in Europe is a competitive market price. It’s not. It’s a monopoly market price, supported by a state-enforced entry barrier. It deserves no deference from supporters of free markets. The subsidized prices that once prevailed in Ukraine and Belarus don’t deserve deference either; nor does the highly subsidized domestic Russian price.

But two wrongs don’t add up to a right. This has long been a dysfunctional market supported by the dysfunctional exercise of government power. The old dysfunction was to subsidize the consumption of energy by inefficient manufacturing enterprises. The new dysfunction is to extract monopoly and monopsony rents. Prices were too low before. They are too high now (for consumers–still too low for producers).

So, the next time I hear someone repeat the mantra that Gazprom is just charging “the market price,” I will be tempted to sing a few bars from the Minor Threat song “I don’t wanna hear it”:

I don’t want to hear it
‘Cause I know that none of it’s true
I don’t want to hear it
Sick and tired of all your lies
I don’t want to hear it
When are you gonna realize…

That I don’t want to hear it
Know you’re full of ****

Except, I’ll probably fill in the ellipses. ‘Cuz I am–The Streetwise Professor.

Big hat tip to former students Monika and Samir for bird-dogging the data for me. Mucho obligo.