Update: Russia and Poland Agrees on Gas Price Reduction

Russian gas giant Gazprom and the Polish state-controlled gas company PGNiG, have come to an agreement on a long simmering dispute on the price of natural gas by agreeing to introduce a special annex to the Yamal Contract.

An agreement revising the terms of natural gas deliveries to Poland was signed in Warsaw between Gazprom Deputy CEO Alexander Medvedev and the head of Poland’s PGNiG, Grazyna Piotrowska-Oliwa. The pricing negotiations have been under way since April 2011.

The change is of a vital importance for the PGNiG, especially in the wake of expected gradual gas market liberalization in Poland and because of ambitious shale gas exploration plans.

“The strategic state company, owing to billions of zlotys savings, will regain profitability and will be able to increase investments in gas exploring and producing,” Polish Treasury Minister Mikolaj Budzanowski wrote in the special press release quoted by the Polish media.

Poland was reported to be seeking a 20 percent discount from Gazprom. PGNiG, the state-controlled monopoly currently buys approximately two third’s of the nation’s gas requirements from Gazprom, paying around $550 USD per 1,000 cu m.

Last June, Polish Economy Minister Waldemar Pawlak said that Poland should receive the same pricing as Gazprom's German customers, which was about $450 per 1,000 cu m.

PGNiG, which presently sells Russian gas at a loss in the regulated domestic market, said the change to the pricing formula would add from 2.5 bln to 3 bln PLN (780 – 935 mln USD) to its 2012 gross EBITDA, when applied retroactively to the 2011-2012 trading period.

“We’re looking forward to the perspective of market opening and incoming competition with much more calm,”  PGNiG CEO Grazyna Piotrowska – Oliwa declared.

Details confidential

Both PGNiG and Gazprom representatives stressed that the changes to contracts are confidential, with neither side revealing the exact scale of the price reduction.

“The price reduction puts us on a par with other very large importers,” said Piotrowska-Oliwa.

“This is an important step to restoring the competitiveness of PGNiG's long-term contracts,” Alexander Medvedev agreed in a statement.

Gazprom outlined that “new terms of the Yamal contract reflect changes that have taken place on the European gas market in the last few years.”

Pressed for the exact amount of the gas price reduction, the PGNiG CEO pointed to the “more than 10%” number, while according to the Treasury Minister Budzanowski, who spoke to CNBC television, the cut is greater than 15%.

Oil Indexation

The oil-indexed pricing formula in the present contract is to be altered to partly reflect current prices of gas by introducing some elements of future market price.

Medvedev said that the two sides have “found a mutually acceptable mechanism of correcting prices for Russian gas that would give us flexibility in reacting to the recent changes in the gas markets in Poland and Europe.”

The Gazprom statement indicated: “The price of raw materials agreed through negotiations takes into account current market prices of gas and petroleum products. At the same time, the deal does not question the fundamental principles of natural gas trade: long-term contracts, ‘take or pay’ principles, and also the peg to petroleum product prices.”

“The spot component, taking into account realities of the Polish market, will not be directly introduced into the contract.” Gazprom underlined in its press release.

Asked to comment, Rafal Dudzinski, the deputy CEO of PGNG said that the altered formula contains an indexation to a forward curve and not to spot prices directly.

The general conditions of the long-term contract, expiring in 2022 and take-or-pay principle, remain intact.

Stockholm case closed

The resolution of the dispute results in PGNiG dropping its case against Gazprom before the Stockholm Arbitration Tribunal.  Dudzinski said that the Arbitrator had been already notified on withdrawal of the motion against Gazprom, which was filed a year ago.

PGNiG had sought arbitration, claiming that gas prices indicated by the existing long term contract were disproportionally above the spot prices.

According to the Polish company executives, the arbitration process would not have guaranteed a better outcome than reached in bilateral agreement.

Piotrowska-Oliwa, said the agreement “changed the pricing formula” of their 2010 agreement by linking the cost of the gas to market prices. The price reduction by more than 10 percent, effective immediately “brings Poland in line with other major gas-importers in Europe,” she added.

“Our expectations have been met”- said the CEO of PGNiG Grazyna Piotrowska Oliwa, explaining that that “analyses pointed to the desirable and possible level of price reduction”.

Retail price reduction

PGNiG provides 98% of Poland's 14 bcm/year of gas supply, two thirds of this volume, or 9 bcm of gas purchased from Russia, under the Yamal Contract with take or pay formula and price several times higher than domestic gas production costs.

The high prices of Russian gas and the reluctance of the regulator URE (Urzad Regulacji Energetyki) to approve higher tariffs, caused losses on gas trading for the PGNiG, which is effectively subsidizing the Russian gas with much cheaper domestic production.

Contrary to what the majority of experts expect, the company promised that retail prices of gas will be consequently reduced. The firm says it will file for a price reduction to URE in mid-November.

“From the 1st of January, with the URE chairman’s authorization, lower price will be introduced,” Grazyna Piotrowska Oliwa said, adding that a “significant” reduction may be expected.

“Polish households will pay the lowest gas bills in the region,” commented Minister Budzanowski adding, that the reduction scale may reach 7%.

Win – win

After series of price reductions for Russian gas importers in Europe, Poland had been paying one of the highest prices in Europe

Piotrowska Oliwa said that “the agreement shows that Gazprom and PGNiG are capable of finding, through business negotiations, a win –win solution, satisfying both parties”.

Shares of PGNiG in Warsaw gained over 9%. Major industrial consumers will strongly benefit, with Police chemical company rising over 6% Tuesday.

Who wins more?

Poland dependence on Russian gas imports has led to apush for alternatives including the building of an LNG import terminal in Swinoujscie, near German border. Poland has been also supporting international and domestic companies exploring for shale gas. Over 110 concessions have been issued by the Ministry of Environment for the last six years.

In inital reactions, industry experts note that the deal is another sign showing that Gazprom is slowly adapting to market realities although, according to some commentators, the Russian company still provides no answer the general question of price uncompetitiveness of long-term, oil-indexed contracts in the slow-growth European economy.

The Russian firm has already agreed to price adjustments with importers buying gas for Germany, Italy, France, but also Turkey, Greece and Poland’s southern neighbor Slovakia.

At the same time the EU is investigating whether the Russian giant is abusing its dominant position in Poland and other countries in the Central Europe region.

Some commentators in Poland also expressed doubt, that despite comments, whether the price reduction will lead to a significant retail price cut.

Skeptics also suspect that the agreement is a result of a behind the scenes negotiations between Polish and Russian governments and may be a part of a wider accord, with some additional concessions made by the Polish side.

As for facts, the deputy CEO of PGNiG Radoslaw Dudzinski was quoted by Polish media said that Gazprom may invest in energy projects in Poland and both companies can re-launch negotiations on construction of the second leg of Yamal-Europe pipeline.