Russia and the Gas Cartel, Part III: The Doha Meeting

As the leading natural gas producers prepare to meet for their summit meeting in Doha on Monday and Tuesday, I thought it was time to revisit the gas cartel topic. Although it is long overdue, I suppose this will be the third installment in a series – see Part I and Part II.


Russia’s Critical Gas Markets – visit BBC for interactive features

It seems that no matter how many times various energy analysts discard the possibility of an OPEC-like cartel of natural gas exporters, the specter of gasfinger, as we affectionately refer to it (credit to the FT), seems to pop up again and again. Whenever these reports, rumors, and warnings come forward, Russia is almost always portrayed as the cartel protagonist, especially given its politically activist state-owned energy firms, Gazprom and Rosneft, and the Kremlin’s uniquely integral role in the management of the companies (as a Hungarian opposition official recently commented: “Gazprom is a state, not a commercial company”). So why does gasfinger continue to itch? I can think of at least three reasons why the cartel talk is growing and will continue to grow: 1) geopolitical instability is causing many import dependent states, especially in Europe, to panic over security of supply, 2) gas exporters have discovered that talking about cartels is an appealing way to exercise leverage in other areas of international relations, and 3) there are actually very real and legitimate concerns to be addressed in regards to gas exporters developing closer business relations – although the nature of the problem is largely misunderstood. Stop the panic? The gas OPEC has not gone unmentioned among importers, and for good reason. Given that on average most EU states import 73% of their gas from Russia (Baltic member states and Slovakia import close to 100%). The infamous debacle of Russia’s supply cutoffs to Ukraine and Belarus, supply “disruptions” to Georgia and Lithuania, combined with the hostile swipes at Yukos, Shell, BP, and Total contributed significantly to energy paranoia, coalescing into a perfect storm with the uncertainties created by the American’s misadventures in Iraq and ever mushrooming predictions of Europe’s dependence on gas imports. The United States, though not dependent on Russian gas, has also registered its concern. Given these events, the gas cartel talk has been abundant: Samuel Bodman, US Secretary of Energy – “Initiatives, new or old, to take control of the delivery of energy to the markets or to limit the role of the market in setting prices all contradict the long-term interests of both suppliers and consumers.” Ileana Ros-Lehtinen, US Congresswoman on House Foreign Affairs Committee – “The creation of this cartel would pose a major and long-term threat to the world’s energy supply. We must vigorously oppose the establishment of this global extortion racket.” Adris Pielbags, EU Energy Commissioner – “The context of these meetings between Russia and Algeria makes us nervous.” “Our worries are the development of the contacts between Russia and Algeria … they could create a kind of cartel.” “I can’t exclude at this stage that there won’t be moves to establish a gas cartel.” Claude Mandil, Executive Director of International Energy Agency – “If there is much ado about the creation of the gas cartel, I might think that gas consuming countries will devote their effort to become less dependent on gas.” Nikos Tsafos, a gas analyst at PFC Energy – “Gas exporters really want a greater say in how gas markets are changing.” Rakesh Shankar, an economist at Moody’s Economy.com – “The three players you absolutely need to make this work are Russia, Iran and Qatar. Between them, they cover 57% of global reserves and 26% of global-gas production.” Paolo Scaroni, CEO of ENI (comments made last April before signing Gazprom’s largest deal in history) – “We are increasingly dependent on a small number of suppliers … an alliance of the top three or four gas exporters would be more effective than Opec.


Mr. Putin’s People

Stoking the fire Although there have been numerous denials by government representatives and a plethora of articles seeking to ease concerns over coordination between exporters, unfortunately this line has not been consistent. The fact that the idea of gasfinger provokes such visible agitation among the West, the concept has been successfully captured for use as a blunt instrument in diplomatic exchanges. These sporadic and opportunistically timed comments on the gas cartel coming from countries facing international pressure on other unrelated issues cannot fully be trusted as reliable indications of future energy policy decisions. (Indeed, RA energy expert/guest blogger Derek Brower believes that the cartel is largely a bluff – an unattractive proposal for exporters). Nonetheless, the gas exporters have been making constructively disturbing statements about it: Vladimir Putin: “A gas OPEC is an interesting idea. We will think about it. … We do not reject the idea of creating a gas cartel. … Who told you that we turned down an offer to create a cartel? Quite the opposite, in fact. I said that it was an interesting suggestion!” Ayatollah Ali Khamenei: “The two countries [re Russia] through mutual cooperation can establish an organization of gas exporting countries like OPEC.” Abdelaziz Bouteflika, president of Algeria – “The Iranian suggestion is completely in line with trends introduced by globalisation, which leads producers to get together to defend their interests. The idea shouldn’t be rejected out of hand. It merits examination and discussion by interested parties.” Rafael Ramirez, Minister of Energy and Petroleum of Venezuela – “Caracas supports the idea of a gas OPEC that will supplement OPEC and that will be a excellent mechanism of regulating the two main commodities on the energy market.


Chart from wsj.com

Critical Juncture or Failure to Launch? While it is far too early to tell whether the term “cartel” is an appropriate description of the agreements that will be taking place on Monday and Tuesday, some analysts have already identified a critical juncture in the development of this new group: the signing in August 2006 of a memorandum of understanding between Gazprom and Sonatrach. From Hakim Darbouche in a report published by the Centre for European Policy Studies:

It was not until early August 2006 that concerns, European mostly, were voiced over the possible cartelisation of the gas market. These came as a reaction to a Memorandum of Understanding (MoU) signed between Gazprom and Sonatrach, which between them account for nearly 40% of Europe’s gas supplies (26% from Russia and 12% from Algeria).6 It was the discretion and the opacity surrounding the conclusion of the agreement which sparked this anxiety, particularly on the part of the European countries heavily dependent on either source, led by Italy which, more than anyone else, depends on both (69% of its gas comes from Algeria and Russia). Indeed, Romano Prodi was the first to react by requesting that the Commission look deeper into the matter and seek clarifications from both parties as to the content of the agreement. Instead, it was NATO’s economic committee which produced a confidential study warning that Moscow may be pushing for an OPEC for gas that would strengthen its leverage over Europe. Since then, the Russian-Algerian rapprochement has been locked into Brussels’ radar which picked up further activity in January/February 2007: in Algiers, another and arguably more substantial MoU was signed between Russian and Algerian energy firms; from Tehran, Khamenei openly endorsed the idea of a gas OPEC; in Moscow, Putin warmed to the idea of a producers’ alliance and promised to ‘think about it’; and from Doha where Putin discussed the idea with the leaders of one of the world’s top LNG exporters.

This is precisely how Gazprom and its Kremlin operators achieved the near impossible task of turning a world class energy firm like ENI into a mere instrument with which to commit larceny. ENI, as I have said before, is the first victim of the new gas OPEC, or whatever title you wish to give the group manipulated by Russia. There have been numerous naysayers who wholly reject any possibility of a gas exporter’s cartel, and their arguments are sound and strong (see Russia and the Gas Cartel Part II). Most analysts point out the following factors which make natural gas unsuitable for an OPEC-like organization: 1) The high degree of long term contracts for natural gas create a debilitating market rigidity, 2) The heavy use of pipelines means that gas is a regional commodity – no global market, 3) Too many different policy agendas and fear of sanctions from importers, and 4) Gas export infrastructure is really, really expensive. Lew Watts, Chief Executive of PFC Energy (and therefore not an impartial observer), wrote in the FT this week: “importers should not worry about “gas weapons” – the current market structure for gas largely protects them from such machinations and, after all, prospective members are also competitors.” Similarly, the Economist also rejects the plausibility of a gas OPEC, arguing that Putin is only using it to leverage Europe into committing to some new contracts: “By entertaining the prospect of a gas cartel, Mr Putin hopes to give a prod to those states wavering over whether to commit to buying more gas from Russia in the future.” A Misunderstood Threat So after all this background information, I come to my main issue with this debate: we are missing the point by concentrating only on prices, short-term impact, and a perception of collective interests on behalf of the exporters. The potential threat of the gas cartel is not on its immediate ability to influence prices – the analysts are 100% correct on this one – it has much more to do with a situation of coordination, creating a rapidly diminishing environment for competition bordering on market failure. Agreements between the top three to five gas exporters is already leading to a carve up of the markets. Call it what you want, but it is already happening. The cartel doubters also place an inordinate amount of attention on the short term (remember how weak OPEC looked in 1949, when some clever Venezuela engineers cracked the code of the foreign companies’ accounting books). Today’s Wall Street Journal article points out the possibility of the future development of a global spot market of LNG tankers, which would give a future gas OPEC far greater powers:

A major aim of the forum is to gain firmer control over the fast-growing market for liquefied natural gas, or LNG, said a top negotiator for one of the largest producers in the group. The world gas business amounts to a patchwork of regional markets, because gas is mainly distributed through pipelines confined to individual big markets such as the U.S. LNG, a super-chilled form of gas that is loaded on tankers, has the potential to change the market because it can be shipped around the world, making it a truly global commodity like oil. But that tradability also makes LNG more susceptible to price swings, prompting the producers to start thinking about a cartel. … The urge to get a grip on the nascent market comes as LNG is going through a major growth spurt. Global gas consumption was 2.75 trillion cubic meters in 2005, of which only 6.9% was delivered in the form of LNG and 19% by international pipeline shipments, according to the BP Statistical Review, an industry bible. But global LNG capacity is expected to rise to 476 billion cubic meters by 2010 from 246 billion cubic meters a year in 2005, according to the International Energy Agency, the industrialized world’s energy watchdog. The trading of LNG is fast maturing as well, providing a possible opening for a cartel. LNG has been sold almost entirely in long-term contracts between a supplier and a buyer, leaving little room for a cartel to meddle. As recently as 2000, LNG, in contrast to oil, had only a negligible spot market, where commodities are bought and sold for immediate delivery. By 2005, 12.4% of LNG was delivered under short-term contracts of less than two years, according to Andy Flower, an LNG consultant in London and former head of BP PLC’s liquefied natural gas activity. That is expected to grow to 30% by 2020.

And lastly, we would be mistaken to assume that Russia, by far the group’s largest member in terms of reserves, wouldn’t be able to throw its weight around (hint: it already is). These arguments about coordinating foreign policy agendas, and the inability to reach agreement on production are not convincing, and it is problematic to think about the gas cartel in terms of the “collective interests” of the group. At the end of the day, it is each and every member for itself, and given the recent troubling pattern of Russian energy policy and its confrontation with the West, it is not unreasonable to assume that a variety of tactics could be employed to instrumentalize the cartel toward supporting Russia’s foreign policy objectives. An early indication of Russia’s potential aggressive role in the cartel can be seen in regards to the near total absence of discussion of exports from Central Asian producers – for which Russia is seeking to be an arbiter. It is also likely to continue to use any additional influence (whether a gas OPEC or nuclear support) it can hold over Iran to make sure their plentiful supplies do not come into competition with Russia’s customers/energy hostages. As Vladimir Milov, a former Russian deputy minister of energy told the Wall Street Journal, “This is viewed exclusively as a political idea…as a way to show strength to the West.” A show of strength, I fear, seems only to be the beginning.