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By John Helmer in Moscow

Anti-Russian allies fail to cook on hot air.

Russia demonstrated on Tuesday that it retains the backing of the major Central Asian gas producers and exporters to Europe – despite public calls from UK Prime Minister Gordon Brown and American figures that alternative, non-Russian supplies of Europe’s gas should be developed swiftly.

In a ceremony in Tashkent on Tuesday, Prime Minister Vladimir Putin and Uzbek President, Islam Karimov, agreed that Gazprom, Russia’s largest enterprise, will buy gas from Uzbekistan at European prices, and build a new gas pipeline from Central Asia, transiting Russia, in order to boost gas purchases from Uzbekistan and Turkmenistan. For lack of available gas-feed, the Tashkent deal dooms the Nabucco alternative pipeline, proposed by the NATO alliance to cross Georgian territory, and under the Black Sea to Austria.

In March, Gazprom had agreed with Kazakhstan, Uzbekistan and Turkmenistan over gas purchases starting in 2009 at European prices that have already reached $400 per thousand cubic metres (tcm); this is 50% to 100% higher than the current purchase prices of Central Asian gas.

The first impacts of the new gas price will be the allies against Russia in the recent Ossetian war, Georgia and Ukraine, which are currently paying around $230 and $180 per tcm, respectively.
Before Georgia began deploying its US and Israel-supplied heavy artillery for the attack on Tskhinvali, triggering last month’s war, Gazprom had been briefing European gas consumers and energy strategists on the implications that crude oil price volatility was having on the future of gas pricing. In July, Gazprom chief executive Alexei Miller issued the public forecast that the price of crude oil might go to $250 next year. In the small print, Miller was also predicting something equally, if not more dramatic – that gas prices are following oil upwards, but may stay up, even if oil retreats. If the oil and gas prices decouple, Miller pointed out, leaving oil to move up and down in roller-coaster fashion, gas is likely to move ahead into uncharted premium territory.

Liquefied natural gas (LNG), according to market reports, is already close to parity with crude oil. When LNG cargoes sell for $20 a million cubic feet, as has been happening this year, this is the energy equivalent of about $124 per barrel of crude. In a year’s time, LNG market reports are forecasting that LNG may fetch a premium over crude oil.

“The oil price that I predicted is not surprising,” Miller has said. “The global energy consumption has been growing at a breakneck pace and looks almost price-insensitive. The last 10 years (1997-2007) saw the Chinese energy consumption almost double and the Indian one grow over 1.5-fold. It can be contributed not only to their industrial growth, but to a principal shift in the lifestyles of their populations. Asia has replaced bikes with scooters. What about the next step to cars?”

He then took issue with the idea that decoupling the gas price from crude oil would produce bargain gas pricing. “The proponents of gas-oil price decoupling mistakenly assume that free-floating gas prices would be lower than oil-pegged prices. But reality doesn’t substantiate the idea of lowering gas prices by this decoupling in the foreseeable future. When converted to BTU, the pipeline gas supplied from Russia to Europe under various long-term contracts in May [2008] was 11% cheaper than fuel oil and much more advantageous in terms of environmental and customer friendliness. If we consider other markets, the picture will be even more illustrative. In the UK the gas price is not pegged to the oil basket and in May was 50% higher than the average price of our supplies to continental Europe. And currently the oil price rose to almost 140 dollars per barrel. So where are the advantages of free-floating gas prices?”

Igor Tomberg, an independent Moscow energy analyst, told Mineweb that Miller isn’t jawboning the price of oil upwards. “He is trying to warn that growth of gas prices can go faster than oil price growth. He is also warning that, if an international gas market exchange is established, this “would be very advantageous for Gazprom.”

Konstantin Simonov, general director of the Fund for National Energy Security in Moscow, believes that “decoupling is advantageous for Russia, as gas reserves are structured differently from oil. The main [gas] players here are Russia, Iran and Qatar. What is said about a gas OPEC is nothing but bogeyman tales. What is true is that if there will be decoupling, different players will come to the table. What we are talking about here that within 20 years gas may substitute for oil as the main global energy resource. If this role of gas will be growing, then why should the gas price be defined by connection with oil?”

The Gazprom chief executive warns the international gas market that it faces a devil’s bargain. On the one hand, “at present the BTU-adjusted gas price doesn’t exceed 70% of the current oil price. This is due to greater flexibility and consumer attributes of oil. But the development of liquefied natural gas brings the market qualities of oil and gas ever closer, specifically as gas is capable of becoming a universal motor fuel. All this strengthens the long-term gas/oil link.”

And on the other: “If the gas price oil peg is replaced by the supply and demand pricing principle, the gas market will lose its immunity to the influence of major suppliers.” With Russia and Gazprom in control of about 27% of world gas reserves – double those of Iran and Qatar, and with these three together, 60% — the geography of influence over energy pricing would shift to a far narrower axis than the current map of oil reserves allows.

According to Simonov, the Russian interest probably favours decoupling. “There is a nuance here, of course. For a long time, gas was viewed as a substitute for oil. But this raises the question – should it be viewed like this? Coal, for example is also a hydrocarbon fuel, but it is not viewed as a simple substitute of oil.”

Simonov concedes there is a downside for Russia, and Gazprom, in decoupling. “Russia has long-term contracts for up to 30 years with its consumers – like Germany, Austria, Italy and France. If the price would be decoupled, this would impact on the contracts, since they use an oil-linked formula for the price. Still, let’s be clear about the fundamental stability of demand, which is driving the pricing formula in future. The prognosis of European experts is that Europe would need an additional 140bcm to 2015. Suppose Norway provides 30bcm, North Africa, 50bcm. Where would another 60bcm come from? It’s nonsense to say from LNG, because all the LNG is contracted already. Thus, I consider that there will be growing demand for Russian gas in Europe at least for the next 20 years.”

Tomberg sees decoupling as inevitable. “Everything goes in that direction. Among the reasons there is the volatility of oil prices. Gas is slowly becoming one of the world’s commodities; it will be independently traded on the exchanges.”

For Gazprom, the global shift in energy demand towards China and India is another vector changing the way gas supplies should be priced. This is ironic, if to recall the way the Anglo-American market preached market liberalization to Russia’s state-dominated economy for the past eighteen years. Miller told Le Figaro recently: “the more liberal market does not necessarily mean lower prices for gas”. For the more liberal the market intermediation – without cartel structures, government-to-government undertakings, domestic price controls, export quotas, and the like – the more supply-demand conditions will expand Gazprom’s influence. The fact is that, nowadays, these also undermine the bidding power of Europe and North America, compared to Asia.

A source close to Gazprom points out that Qatar has already declared its intention to redirect spot deliveries of LNG from the European market to Asia, where the bidding premium is more advantageous. The view from Gazprom’s skyscraper in the south of Moscow is that the litany of free market competition, which the western powers brought to the capital after the collapse of communism in 1991, is no longer what the western powers want to accept themselves. They are now promoting market and investment controls in an effort to limit Gazprom’s access to their markets, and play one source of gas supply off against another.

The macro-economic shifts within the energy exporting countries are also favouring those gas producers, which can replenish their reserves faster than growth in domestic demand consumes them; and those which are politically stable enough to deliver on contract. On both counts Gazprom looks the safer bet. In Miller’s recent round of interviews, he claims that by 2010, the volume of Gazprom’s gas production will reach 570 bcm; in 2015, about 615 bcm; in 2010, between 650 and 670 bcm. The capex for this is estimated at more than $3 billion per annum. By the enbd of next decade, it is anticipated that roughly half of all Gazprom’s output will originate from new deposits – on the Arctic shelf, the Yamal peninsula, and in eastern Siberia.

If that’s the good news, what about the bad — the attempts to bet against Gazprom’s intention, or capacity, or what Russians call the Caspian paradox? A source at Gazprom explains: “We constantly hear the calls from the Caspian countries and elsewhere to create new gas-transport routes bypassing Russia. The argument is that this increases competition of supply, and thus favours the bargaining position of European consumers of energy. What is happening, however, is the opposite of the intention. The new gas hasn’t appeared in Europe yet, but the competition to buy has started up in the Caspian region. The first effect – prices have gone up. As that has happened, the advantage of Gazprom’s supplies and delivery routes looks plainer than before”.

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