On May 23, Italian energy company Eni signed a deal with Gazprom in which, for the first time, Gazprom allowed the price to be determined by the spot market for natural gas instead of being linked to oil prices. Russia has long fought to keep the price formulation linked to oil prices, as that arrangement is more lucrative. While Italy is the first country for which Moscow had to give up this pricing mechanism, it certainly will not be the last.
Unlike oil markets, natural gas markets have long been regionalized. Transporting natural gas over long distances requires either that the gas be liquefied, an expensive process, or a long pipeline be built, which does not have the flexibility of liquefied natural gas since the buyers or sellers are always those parties on either end of the pipeline. Historically natural gas was effectively a byproduct of oil production, and most gas was burned off at the source instead of sold to the market. When it was sold, it was unclear how to price it because of the lack of competition. As a result, in many contracts natural gas was indexed to the price of oil based on its energy content, roughly a fifth of crude oil's. This system has lasted more than 50 years in Russia and many other natural gas markets, including Asia. As more pipelines were built in North America, and to a lesser extent Western Europe, companies began to compete, and the competitive price of natural gas was not always the same as oil.
Natural gas supplies have boomed over the past decade and likely will continue to grow. Oil production, however, has stagnated, and as the two markets have moved away from one another so has the disparity between gas-on-gas and gas-on-oil pricing mechanisms. Traditional natural gas exporting countries like Russia and Qatar will continue to hold out as long as possible, but will have to give in eventually to the more market-oriented price formulation. But even with new supplies coming online, Russia's market share will not be threatened, though Moscow's ability to use natural gas prices and supplies as a political tool will diminish over time, particularly in countries outside its immediate borders.
