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A Brief Perspective on Russian Natural Gas

Professor Ferdinand E. Banks
March 10th, 2010

In the wake of the ‘Georgia Incident’ that began around the opening of the 2008 Olympics, it initially appeared that there could be a pilgrimage back to Cold War days, since many questions were asked about Russian geopolitical intentions, and at the same time some bizarre opinions about the availability or non-availability of Russian energy resources were put into circulation. For instance, a short article appeared in Newsweek claiming that oil and gas passing through Georgia was supposed to “free Europe from Russia” but, according to its author, “NOT ANYMORE”. How anyone could believe that the prevailing gas superpower, Russia, was capable of having its ambitions thwarted by a few pipelines from the interior of central Asia, is something that deserves the attention of psychologists or psychiatrists and not readers of an important weekly news publication.

There were probably many items in my gas book (1987) that prevented it from becoming the favourite bed-time reading of various experts, but almost certainly one of them was the contention that there should be more cooperation between the producers and consumers of energy resources, to include Russia and OPEC, and not just because an important axiom of conventional game theory maintains that when cooperation is possible between actual or potential antagonists, it should be attempted. The reason I am thinking of is because in the medium to long run there could be a serious global shortage of gas (and oil), and it is important to everybody if what is left of these resources is used to smooth out the transition to a new global energy economy – probably one emphasizing renewables and various alternatives, but also nuclear.

A gentleman who apparently had some difficulty grasping the mechanics of the gas market was former U.S. president Ronald Reagan, as well as his advisors, because instead of buying gas from the Soviet Union, they thought that some effort should be made by European consumers to obtain the supplies they required from e.g. Africa and Argentina, arguing that by doing so it would weaken the Soviet economy. The correct strategy at that time – and perhaps now – was to contract for the largest possible quantities that could be obtained from the Soviet Union/Russia, and to encourage that country to invest in (and fill) the largest possible pipelines. The basic issue was not merely safeguarding and expanding Western Europe’s supplies of gas in the years to come, but increasing the general accessibility of all energy materials, to include those purchased by the United States (and its friends and allies) from any supplier.

Twenty years ago, when I pointed out the advantages of doing business with the Soviet Union in a talk at Cambridge University, and in addition suggested toning down Cold War rhetoric, a number of observers – to include the founder of the influential publication Geopolitics of Energy, Melvin A. Conant – assured me and everyone else within earshot that although the ideological commitment of the Soviet Politburo was ostensibly to Marx and Lenin, it held an equally high regard for dollars and deutschmarks, which made Soviet gas industry executives prone to discharge their business obligations in a civilized manner. In the Newsweek article referred to above, as an aside, it was stated that European gas buyers have excellent relations with Russia and do not fear greater dependence. In addition, Germany is supposed to be building its own pipeline through the Baltic Sea to guarantee its supply of Russian gas.

I know a great deal about this pipeline, and believe that persons interested in it should pay extremely close attention to certain details. There has been some delay with this conduit that is at partially due to strange ideas in e.g. Sweden as to the ulterior purposes of the Russians, when the most likely agenda of those good ex-communists turns on collecting as much money as possible, and sooner rather than later.

According to Jeffrey Michel, an MIT engineering graduate living in Germany, this underwater pipeline would allow Russian vessels to avoid a complicated sea passage, and in addition would mean that possible disputes between Russia and Baltic states will not lead to a reduction in gas contracted for by Germany and perhaps other countries, or even another Cold-War burlesque. A further observation has been made by the important petroleum consultant Herman Franssen, who notes that Russia is not only an energy powerhouse, but also possesses an enormous amount of unused and underused agricultural land. Buttering up to Russia, to include supplying them experts, might lead to the efficient exploitation of this land, which eventually could be essential for feeding hundreds of millions or even several billions of persons outside Russia.

Several years ago the kingpins of the European Union (EU) held a meeting at which the availability of Russian natural gas and oil was discussed at length, and the Financial Times (March 23, 2006) suggested that the sale of Russian gas to China and Japan might have a negative effect on the energy prospects of Europe, which relies on Russia for perhaps 40% of its gas. By extension, in the long run, this could have a negative effect on North America, because the global gas scene has started to take on some of the features of a mainstream textbook market, due (among other things) to the ability of huge liquefied natural gas vessels to deliver ‘spot’ cargoes. But in referring to a “textbook market” I specifically mean a market with more flexibility than a conventional LNG market. For instance, instead of a portfolio of long-term contracts in which gas carriers are locked into predetermined routes, British Gas (BG) now tries to structure its operations so that gas can be diverted to buyers that are willing to pay premium prices.

According to the Newsweek article mentioned above, a recent Rice University Energy Program modelling exercise found that Russian efforts to deprive Germany of gas would likely be futile, as market deregulation would allow other suppliers to fill the gap. What this odd conclusion missed is that, ceteris paribus, there are no other suppliers in the short-run, nor perhaps inexpensive exporters to Europe in the long-run, which is a reason why Finland chose nuclear instead of Russian or Norwegian gas. On the other hand, Russia can always rush to completion any pipelines that they are constructing in the direction of China, in which case Germany, perhaps other European countries, and unless ‘shale gas’ lives up to its publicity, the United States might someday find themselves bidding for progressively larger increments of imported gas.

The running mate of presidential candidate John McCain, Governor Palin, was apparently very positive to larger investments in Alaskan (and perhaps Canadian) natural gas, which would eventually find its way to the U.S. Midwest. This scheme was being discussed in some detail twenty years ago, and the cost was (mistakenly) considered excessive at that time. At the present time the estimated cost may be much larger than the 10 billion that several Russian pipelines toward Asia will ostensibly cost. The truth is that Russia’s position with regard to alternative export markets is so enviable that its government does not have to be concerned with the future of underwater or any other kind of pipeline carrying natural gas in the westward direction.

One of the editors of the Financial Times, Martin Wolf, sometimes likes to offer opinions in energy matters. He suggested that Russian “elites” should be punished because Russia overreacted in the Georgian incident. When I was informed of this proposition, I informed his energy staff that the only kind of punishment I could imagine for those ladies and gentlemen was to prohibit them from enjoying the marvellous skiing in places like Courchevel and St Moritz for a season or two . Of course, the French and Swiss governments would have to agree to this, which is unlikely.

Something else that we do not hear much about is a possible participation of the Russians in the growing liquefied natural gas (LNG) market, although that option has been raised by some observers. There has also been some talk about Russian gas exports from the new Sakhalin LNG scheme gaining access to Asia-Pacific markets, which could include utilizing any terminals that might open in India, and also taking advantage of the fact that Indonesia’s gas fields are ageing, and consequently are less attractive to potential customers. It is also interesting to note that the Russians have decided to develop the giant gas field Shtokman without foreign help, and possibly switch it from a source of LNG for the U.S. to a pipeline venture whose gas is destined for Europe.

In theory there should be a place for Russian LNG just about everywhere, because while LNG accounts for only about 2% of the gas used by the U.S. at the present time, the United States Department of Energy (USDOE) has suggested that it could amount to 30% by 2025, with the total demand for gas in the U.S. amounting to about 30 trillion cubic feet. If shale gas does not live up to its promise, it might be useful to remember a statement by an important American energy executive (Mark Papa) several years ago. “Right now, on the supply side, LNG is the only lever we have to pull.”

One more observation can be offered here. The demand for oil appears to have stagnated to a certain extent, but the price is slowly increasing. This is because OPEC today is a genuine cartel that understands how to play the oil game. They are capable of playing it the way that you and I would play it if given the opportunity! At one time it was believed by certain oil market insiders that Russia would be allowed to join this club, but that did not happen because both OPEC and Russia considered this unnecessary. But there is also talk of a possible GASPEC, in which Russia would play a leading role. There is an excess of hype in the shale gas ecstasy that seems to be sweeping North America, but even so I will offer a prediction: this GASPEC is a certainty if e.g. the presence of (real or imagined) shale gas puts a strong downward pressure on gas prices.

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Professor Ferdinand E. Banks
March 10th, 2010

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