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Gazprom Looks to China Amid Ukraine Crisis

As the crisis in Ukraine continues to escalate, Europe remains under pressure to reduce dependence on Russian gas. Last year, Russia accounted for 30% of Europe's overall gas demand. Indeed, Europe relies heavily on Russia for its energy needs. However, Gazprom (NASDAQOTH: OGZPY  ) , the Russian gas monopoly, also relies heavily on Europe. It's not surprising, then, that as the crisis in Ukraine has isolated Russia, Gazprom is looking to diversify its customer base.

Europe's dependence on Russian gas
In an annual meeting with investors back in March, Gazprom had said that it expects Europe to become even more dependent on its gas supplies. The comments from Gazprom came amid the crisis in Ukraine. The Russian gas giant certainly has a point. Russia accounted for 30% of Europe's total gas imports in 2013, compared to 25.6% in 2012.

Growing dependence on Russian gas is a major concern for European policymakers, especially as Russia has now threatened to cut Ukraine's gas supplies. More than half of the gas supplied by Russia to Europe in 2013 passed through Ukraine. If supplies to Ukraine are cut, European gas supplies are also likely to be disrupted, although the continent is more prepared this time than it was in 2009 when Russia last cut gas supplies to Ukraine. Still, it's important for Europe to cut its dependence on Russia.

Europe's options, however, are limited. Since the crisis in Ukraine began, there have been growing calls for the U.S. to come to Europe's rescue. The shale gas boom in the U.S. means that the country is now in a position to export gas. However, under current regulations, the U.S. can export natural gas only to those countries that have free trade agreements with it. None of the countries in the European Union, or EU, have such an agreement in place. Exporting to countries that do not have a free trade agreement requires approval from the Department of Energy, or DOE. So far, the Obama administration has approved only a handful of applications to export natural gas. The escalation of the crisis has put pressure on the U.S. to expedite approvals.

However, even if the U.S. accelerates project approvals, building LNG export terminals takes years. The only LNG facility to have all the required approvals is Cheniere Energy's (NYSEMKT: LNG  ) Sabine Pass terminal in Louisiana. But even Cheniere's facility is scheduled to start shipments in late 2015. Recently, Cheniere's CEO Charif Souki noted that the ability of U.S. gas to save Europe from its dependence on Russian supplies is overstated. Souki, though, added that U.S. exports could still make a significant difference.

LNG exports from the U.S., however, is a long-term solution. And that will happen only if the U.S. approves several projects. In the near term, Europe faces significant challenges to secure its energy needs. Its available options are limited, which means that the continent will struggle to significantly cut its dependence on Russia. While that is good news for Gazprom, the company itself needs to reduce its dependence on Europe.

Gazprom looks to China
While Gazprom has threatened to cut Ukraine's gas supplies, the company is not in a position to lose revenue from Europe. In 2013, Gazprom's revenue stood at 5.25 trillion rubles. Gas sales to Europe and Turkey accounted for 32% of the total revenue. While Europe is expected to remain a key market for Gazprom, the company is looking to China and other Asian markets to reduce some of its dependence on Europe. Indeed, it is even more important for Gazprom to reduce its dependence on Europe. In a presentation last week, Gazprom said that, while it is aiming to expand in Europe, it sees diversification to the Asian market as a priority this year.

In fact, last week, Gazprom and China National Petroleum Corporation, or CNPC, the parent company of PetroChina (NYSE: PTR  ) , discussed the terms of a 30-year deal to supply pipeline gas to China. While Gazprom and China have been in talks for more than a decade, they have failed to reach an agreement about price. However, the crisis in Ukraine has forced Gazprom to push for a deal. At the same time, China is looking to increase the share of natural gas in its energy mix. Gazprom and CNPC expect to sign a contract as early as this month.

While a deal with China will help Gazprom diversify its revenue sources, Europe will remain its most important market. The Russian government's policy of using Gazprom to serve its geopolitical interests will end up hurting the company in the long term.

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Varun Chandan

I have a Master in Finance degree from IE Business School in Madrid. I use the top-down approach when it comes to investing. I like to analyze macroeconomic factors and how they impact individual companies.

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