Shale surge poses threat to Gazprom When Gazprom last month finally launched its new flagship project, the Bovanenkovo gasfield far above the Arctic Circle, it should have been a triumphant moment: the field contains enough gas to supply Europe's needs for decades to come. But instead, the launch of the field - after years of delays and more than $44bn in capital expenditure - was overshadowed by a warning as Vladimir Putin called on the state gas company to pay more attention to the shale gas boom in the United States. The shale revolution that is revolutionising global gas markets is also threatening to undermine Gazprom's export position in Europe, where it accounts for 25 per cent of gas sales, and to relegate projects like Bovanenkovo to relics of the past. "Politicians, experts and businesses are talking about a real shale revolution," Mr Putin said. We are simply obligated to take these trends into consideration, to clearly imagine how the situation will develop not just in the next two to three years, but throughout the coming decade. After years of denial about the importance of shale, Gazprom is coming under increasing fire as it faces growing competition in global markets and a European Commission antitrust probe. At home, too, it is facing the rise of Rosneft, which snapped up a big new domestic supply contract soon after agreeing to buy TNK-BP in a transformative $55bn deal. The shale gas boom in the United States and the arrival of new supplies of liquefied natural gas to Europe are posing the biggest threat to Gazprom since its creation in 1989 as a state monopoly carved out of the Soviet Ministry of Gas. To make matters worse, its export revenues are predicated on long-term contracts that peg the amount its European customers must pay to the price of oil. But alternative supplies, which are sold at cheaper "spot" prices, are threatening this business model - all at a time when it is making record investments. Supplies governed by the cheaper spot prices have now climbed to near 50 per cent of total sales in Europe, making Russia's continued insistence on the long term oil linked contracts increasingly untenable, analysts and industry players say. The fundamentals of the gas industry have totally changed. It has become increasingly impossible to say the price should be linked to the oil price," says Jonathan Stern, director of gas research at the Oxford Institute of Energy Studies. There is no longer any doubt that there is a new reality. But with the company's investment programme expected to amount to $31bn this year, having hit a record $55bn in 2011, "gradually the time will come when Gazprom will have to be broken up" to separate its pipelines production, Alexander Ryazanov, the gas giant's former deputy chief executive, says. This could happen in the next five years. A launch of a European Commission antitrust probe this September into whether Gazprom is abusing its dominant market position in central and eastern Europe is also ratcheting up the pressure on the oil-linked contracts. "It may well be that the Gazprom antitrust case . . . will turn out to be the landmark antitrust case of this decade, as Microsoft was of the last decade," wrote Alan Riley, professor at City Law School, in a recent paper. In the process, the European gas market. [is] likely to be transformed. Gazprom has already begun making concessions to several customers in western Europe. It agreed to reduce the price of contracts for this year to bring them nearer to spot prices in a move that cost it $4.5bn in the first half of the year. But it has refused to relinquish the oil price tie - and is offering the revisions for only one year. It will have to cede more ground if it wants to keep customers, analysts say. The company "is in an extremely complicated position because investment costs are growing at the same time as there is a very serious fall in its markets. They will have to either lower prices or lose contracts," says Vladimir Milov, the former deputy energy minister who is now an opposition leader. For now, Gazprom is still making enough money to have a great deal of wiggle room on price cuts and maintain profitability; net income was more than $16bn in the first half. But once investments have been piled into expensive new pipeline projects, then it could become increasingly difficult for the company to provide discounts, according to Mikhail Korchemkin, an independent commentator on the gas industry. According to Mr Korchemkin's calculations, Gazprom needs to export gas at a price of about $14 per mmbtu by 2020 to afford the investments in its pipelines. But the current average spot price in Europe is already about $10 per mmbtu, while sales in the US are even cheaper at $3.50 per mmbtu. "They would reach a point of no return," he says. Gazprom could reach a time when it's permanently in the red and that's when we expect a break-up of Gazprom. Gazprom's spokesman Sergei Kupriyanov says there is no logic to such calculations, adding that all of Gazprom's investments were made according to strict business plans for generating returns. Investors are also increasingly concerned about growing inefficiency; the group has consistently spent more than it said it would in recent years. This year it announced an additional Rbs150bn of investment in pipelines, an area that critics say is plagued by a lack of transparency and high costs. "Gazprom has two main problems," Mr Ryazanov says. One of them is that investment costs are very high. It's clear that many objects are built on a not very competitive basis because the tenders are very closed and only a very close circle of companies win. "Secondly, it has always been inflexible on export policies," he says.