This entry is the second installment in a series of posts addressing the realities of the formation of a potential natural gas cartel. The first installment can be viewed here. Since the Financial Times broke the big story about the NATO report warning Europe to be wary of a possible gas cartel led by Russia, numerous media have rushed forward with reports and editorials arguing the absurdity of such a notion. But to what extent are these arguments valid? What are the real possibilities of a Russia-led gas OPEC, and how will coordination among exporters impact prices and geopolitics in the short, medium, and long term? Here are the arguments of the debate in broad stroke: A natural gas cartel is unlikely because… 1) the different agendas of exporters will make production quotas impossible to agree upon. 2) too many long-term contracts for a cartel to control prices 3) producers know that consumer countries could react negatively with sanctions 4) gas exporters have an overwhelming need for foreign investment and technology to extract In my opinion, a natural case cartel is indeed a future possibility that we must prepare for because… 1) there is a very high degree of market concentration. 2) some gas exporters like Russia have a history of breaking contracts, and there are significant investments to move into LNG in a big way, which may dramatically increase the amount of gas sold on the spot market. 3) consumers have already demonstrated a high tolerance for anti-competitive policies in the energy sector, and exporters have already learned how to break their collective bargaining position. 4) finance and technology can be obtained through minority joint ventures in which the foreign partner has no control over the executive. Also, sources of finance act do not always act in concert with sources of technology. Now let’s address the arguments of the cartel critics point by point. To begin with, we have had numerous statements from the horse’s mouth that Russia is not only planning to coordinate prices with other natural gas exporters, but they are already well advanced in this strategy. For example, a big part of the gas cartel story has been the aggressive rhetoric of Valery Yazev, head of the Duma’s energy committee. On Oct. 30, made the following comments during an address to the Russian Gas Union industry group:
“It is necessary to form a gas alliance, which could be joined by Turkmenistan, Kazakhstan, Uzbekistan, Russia, Ukraine and Belarus. Tomorrow, with the removal of the problem of Iran’s nuclear programme, I would also see Iran in this alliance. … In the EU we have a very clearly formed cartel of customers of Russian gas, which is imposing on us the ratification of the Energy Charter, which does not meet Russian interests.”
Back in June, President Vladimir Putin himself expressed a similar sentiment at the Shanghai Cooperation Organization (SCO) summit:
“I believe that creating an SCO energy club is a pressing issue, as is more intensive cooperation in transport and communications. Russia will consider financing some projects in the economic area.”
This was followed by comments from Iranian President Mahmoud Ahmadinejad that SCO nations could help “prevent the threats of domineering powers and their aggressive interference in global affairs,” and said that Russian-Iranian energy cooperation “could be even more productive if we cooperated in pricing gas and forming the main gas routes.” The cartel deniers also say that the differing political agendas of gas exporters would prevent successful price coordination. However, it is clear that even countries with so-called “ethical” foreign policies such as Norway have already demonstrated that they would sacrifice a great deal of their principles for exploration deals in Russia, and furthermore, the cartel really only needs a few members to put the squeeze on Europe. Enno Harks, an expert at the Science and Policy Foundation in Germany, pointed out that the coordination between suppliers is already at an advanced stage in a Nov. 15 interview with Vremya Novostei:
“If such plans were destined to be realized, a Russian-Algerian cartel would have grave consequences for the European Union. On that point, I’ll just cite two figures. There’s an official indicator that says 24% of gas consumed in the EU comes from Russia. But that figure can easily be misleading. If we consider 30 West European countries, including a major producer like Norway, then it turns out that this region gets 70% of its gas imports from Russia and 20% from Algeria. Any form of cartel agreement between Russia and Algeria has the potential to be a disaster for European consumers of natural gas. The West must prevent that from happening.”
We also frequently hear the argument that a gas cartel is not possible because of the exporter’s needs for foreign investment and technology. There is no doubt that significant investments are needed in this area in the short term, but it is wrong to assume that the formation of a cartel – or any abusive conduct in regards to pricing on behalf of the Russians – is sufficient to dissuade investors and foreign oil and gas multinationals from pouring the money and technology in. Following the theft of Yukos, the Ukraine fiasco, the North European Gas Pipeline deal, the IPO of Rosneft, and, most recently, the attacks on foreign firms working in Sakhalin – we have not seen even a slight diminishment in energy investment. According to RIA, FDI during the first six months of 2006 shot up 41.9% to $23.4 billion, and public-private partnerships – which in the energy sector must be majority state-owned – are booming. By controlling 51% of a natural gas development project, the Kremlin retains as much opacity as they desire while at the same time enjoying a steady flow of capital and technology to develop and mobilize their gas assets. Even the most discouraging aspect to foreign investors – the burdensome Gas Law of 1999 and other regulatory hurdles that limit Gazprom’s ability to sell gas at market value domestically – may be lifting soon. There is also the argument that cooperation among natural gas exporters wouldn’t be able to influence prices because too much natural gas is locked up in long-term pipeline contracts. First of all, Russia has showed a habit of breaking contracts that no longer suit them to renegotiate at higher prices, and two, there is a real possibility that their LNG export capacity could jump up dramatically in the future. By the looking Gazprom’s recent midstream asset spending spree, the Russians are showing a clear desire to diversify their customer base. The recent announcement regarding the assignment of the Shtokman gas to Europe instead of LNG development was nothing more than a political ruse blindly gobbled up a gullible media – anyone who thinks otherwise should start asking Petro-Canada some tougher questions. While a global spot market is not likely to develop for many years, the very fact that natural gas prices are set on a regional rather than global market basis gives Russia considerable clout as a cartel leader. It is already a monopoly supplier to many countries, and is able and willing to raise prices when it wants (this week Russia is close to gaining control over a Belarussian pipeline to solve a price dispute). Even if the gas cartel only consisted of Russia and Algeria (together controlling 34% of Europe’s gas), in a few short years they would already control more supply to Europe than OPEC. The West should also be very concerned about Gazprom’s impressive ability to cooperate and coordinate with other suppliers. In addition the Algeria relationship, Russia has had important contact with Egypt, which although smaller, is an important supplier to Europe through its two LNG terminals, and could play a pivotal role in building new trains to bring the Arab gas pipeline up to Europe. Exporter’s influence on price can also increase with the growth in the trade of liquefied natural gas. According to a thorough Simmons & Company report, LNG consumption is set to skyrocket at 12% annually through 2010 – and you can bet that the Russians will not miss out on the lucrative markets of the Atlantic basin, nor fail to maximize LNG exports out of Sakhalin. Make no mistake that Russia has a LONG way to go before becoming a real influential LNG player (the Oil Drum has an excellent survey on the future of LNG), And while they are still relative newcomers, they have increasingly become fast friends with Algeria. Sonatrach is an LNG monster, making Algeria the second largest LNG exporter in the world, and a competent partner to help Russia develop this technology. The biggest LNG supplier in the world is of course Qatar – which has the potential to become the ultimate swing supplier – the Saudis of the gas market. The common wisdom among the analysts is that neither Qatar nor Norway is likely to immediately participate in an aggressive cartel, and while I’m not inclined to disagree, it is important to note that Qatar is already experimenting with the market forces by shutting down production at the North Field, and driving LNG prices through the roof. At the same time we have seen an increase in ownership of upstream LNG projects by national oil companies, and the producers are undoubtedly thrilled to see these new infrastructure projects proceed slowly while prices rise. While the spot market for gas remains very small, the continuing supply tightness and declining production in other areas like Indonesia mean that prices may become increasingly correlated with crude indexes as well as commodity futures – which means that a small group of exporters such as Russia, Algeria, Iran, and Qatar could enjoy significant influence over global prices with production quotas even if countries like Norway and Trinidad refused to play. The Gas Exporting Countries Forum may only be a debate club – but it is certainly poised to facilitate some mutual back scratching, if not something much more formal in the future. My entire point here is that too many analysts are over-reacting to the James-Bond-like conspiracy theory of “Gasfinger” and failing to address the fundamental issues at stake – which is that Gazprom is already actively engaged in anti-competitive policies to pre-empt, disaggregate, and coordinate the energy market. You can call it a cartel if you want, or an industry association, or even just a multinational memorandum of understanding, but the truth is that this is nothing more than a debate over semantics, and Europe, the United States, and Asia should be doing everything possible to prepare for the possible future of a natural gas cartel – despite the evident challenges to its formation.