COMMENT: Gas-OPEC - a very interesting idea

By bne IntelliNews April 6, 2007

Chris Weafer of Alfa Bank -

Executive Summary

The administration of Russian President Vladimir Putin has been very consistent about its key long-term goals for the economy. The government is seeking a diversified economic base that can sustain predictable growth and which also generates greater wealth distribution. Increasingly that means greater integration with the global economy.

To date, energy cooperation has meant supply deals and a strict avoidance of taking part in any price control mechanisms.

Next week's meeting in Qatar has a formal proposal for an OPEC-style price control structure on the agenda. It is being promoted by Iran and Venezuela with a clear political agenda.

Russia has not dismissed the idea of a more active gas body, because if the political agenda can be avoided, such a structure could help develop important areas of cooperation in the cross-border gas market, including technology and investment.

Consumer countries view the prospect of a Gas-OPEC as a threat, however. While the current structure of the cross-border gas market does not lend itself to an effective cartel arrangement, the word OPEC is more often associated with the events of 1973 and the constant threat of a repeat.

As Putin's government pursues its long-term economic goals, an important priority for 2007 is to conclude a new Partnership & Cooperation Agreement with the EU. Energy is a key part of that deal. Holding out the prospect of a Gas-OPEC provides a not-unhelpful backdrop to those talks.

Actively engaging in such a price-fixing cartel would at minimum severely delay Russia's economic development and change the expected parameters of the investment case. The economy would evolve more like Saudi Arabia or Iran than Norway. That is inconsistent with Putin's stated goals.

The cross-border gas market is now relatively small in global energy and mainly based on the Russia-EU pipelines. But LNG will change that, and in the future the gas market will take on more of the characteristics of the oil market. Many of the major projects are Russia based. An effective gas price cartel cannot work without the active involvement of Russia.

In the past Russia has given "moral" support to OPEC, but never any active cooperation as it pursued global economic integration. Countries like Venezuela and Iran will, however, make sitting on the fence less comfortable than in the past.

Investment theme: independent gas

It is expected that awareness of the investment potential from the expected growth in cross-border gas trade, particularly as liquefied natural gas (LNG) projects are developed, will result from issues such as the proposed Gas-OPEC. That, along with a greater emphasis on developing and broadening Russia's domestic gas industry, is already highlighting the gas-producing companies as attractive long-term investment targets.

Russia's energy sector, or rather the state's priority for developing the industry, is at an important crossroads. Ever since the end of the Soviet-era in 1991, there has been very little emphasis on developing new resources as first the private sector engaged in asset accumulation and latterly the state engaged in re-establishing its control structures. But now there is a realistic expectation that this long period of "pass-the-parcel" between state, private owners and back to the state is ending, and the focus is about to shift to the development of new resources and industry broadening.

2007 is an important transition year, as the state is engaged in "tidying-up" the remaining structures - ie. broadening its direct and indirect control – and hopes to complete major international trade deals based on enhanced energy cooperation.

This is particularly the case for the gas industry. Russia is facing a shortage of gas for the domestic market and also has no spare gas, based on existing producing assets, to supply export markets with additional exports. Russia does, however, have enough gas in identified deposits to both supply incremental gas to the domestic market and satisfy export growth expectations. Currently, Russia's gas reserves are confirmed (by, for example, the 2006 BP Statistical Review of World Energy) at 48 trillion cubic meters (cm), or 27% of known world reserves. But the US Energy Department late last year reported that new deposits not yet included in the BP review will bring that reserve figure up to 65 trillion cm, or about 35% of the world total. Deposits in the Arctic, increasingly becoming accessible because of the global warming effect on the ice shelf, and in Sakhalin are already known to contain amongst the largest gas deposits on the planet.

Therefore, once the priorities of 2007 are achieved, we can expect to see a substantial emphasis on developing these projects (Shtokman, Kovykta, Sakhalin, etc.) and also the involvement of gas producers in addition to Gazprom. While the government is publicly supportive of a doubling of the domestic price by 2010, it has of course stopped short of signing off on higher increases than budgeted for 2007 because of the negative election implications. In 2008, we can expect to see that position change and the expected acceleration of price increase growth to start.

The event

On April 9, Qatar will host a regular meeting of the Forum of Gas Exporting Countries in Doha. This is not a new organization; it was formed in 2001 and has met regularly since then to discuss industry trends, etc. Currently the members of this organization account for about a 75% share of the world's known gas reserves.

The reason this particular meeting is grabbing the headlines is because Iran has tabled a motion that the organization extend its mandate to move closer to an OPEC-style structure that is also engaged in price control and supply management. That motion has been strongly supported by Venezuela and to a lesser extent by Algeria.

The countries that have said they will attend the session to discuss the idea of Gas-OPEC are Russia, Iran, Qatar, Venezuela and Algeria. In aggregate these countries account for a 61% share of proven gas reserves in the world (using the BP data) and a 31% share of current production. If the Central Asian states were to join, as they almost certainly would if the formal structure is established, then the share of known global reserves would rise to 66%.

Why a Gas-OPEC now?

The motivation is political as Iran, in particular, is looking to raise the stakes in its dispute with the UN as well as Western energy importer countries. Venezuela has also been pushing OPEC to take a much more aggressive role in the oil market and to use its position to push oil prices higher.

Venezuela recently held a meeting of gas producing countries in Latin America with the aim of forming a structure to coordinate industry development and regional pricing. This meeting was attended by Bolivia and Argentina, and smaller countries such as Trinidad & Tobago have since indicated interest. Of course, right now none of the countries in this block have any significant export business or even export potential. It is mainly a political statement and part of Venezuela's efforts to use the "energy-threat" weapon in its war of words with the US.

Nothing new

The idea of a Gas-OPEC is not new. The idea for such a structure to influence prices was first mooted by the Shan of Iran in the early 1970s. At that time he pushed the idea with Russia, but after a series of meetings Russia pursued its own path with an energy deal with Europe.

Some 35 years later, not a lot has changed in political terms. And for those 35 years, Russia has been a reliable energy supplier to Europe with the exception of the blips caused as it "restructured" its transit arrangements with Ukraine and Belarus.

Russia's position

Initially Russia's position, as stated by the energy minister, was not supportive of a Gas-OPEC style structure. But quite quickly President Putin declared the idea to be "interesting" and would send a high level delegation to the Doha meeting.

That said, both Qatar and Russia, the world's two biggest exporters of gas, have stopped well short of adopting the position taken by Iran and Venezuela, and both countries have emphasized the aim of greater cooperation in developing the global gas industry rather than maximizing pricing power.

Why the hesitation?

The reason why is a mixture of industrial, economic and political considerations – partly because of concern over the future availability of crude oil, partly because of environmental concerns and partly because of major gas discoveries in the Artic region (it is expected that demand for gas will increase significantly in the coming decades). For the industry to develop efficiently and speedily to match expected demand growth, there has to be substantial improvements in technology. Deposits such as the Shtokman field require complex technology to extract the gas from the sea bed and LNG processing plants are also being upgraded.

Cooperating in developing these technologies and creating new industry methodologies and standards simply makes sense if the global industry is to match expectations. This type of gas forum, ie. more active than it has been over the past five years, can provide the mechanism to coordinate these developments.

There is also an economic angle – the price of gas is now mainly linked to that of crude oil but with a time lag. While stopping short of using price "threat" mechanisms, there is logic in looking at a price mechanism that is not just the by-product of oil. Putin has talked about this aspect several times in relation to gas as well as the variable discount that exists between the prices of Urals crude and benchmark Brent. Getting a fairer price for exported energy is a declared priority for the government.

The most important reason why Putin has declared this an interesting idea is because it provides a very useful backdrop to current negotiations with the EU on a bilateral trade and investment deal for which Russia is bartering future energy flows.

Europe is looking for energy security, and that means Russia agreeing to open up projects like Shtokman for development, accommodating international (ie. European mainly) partners in the joint venture and the product being exported to the EU to satisfy the expected growth in energy demand in that region. Even if Europe were to move alternative energy projects along quite speedily, it is still faced with a period of up to 10 years when there will be a need for extra energy imports.

Both the EU and Russia fully understand the others' position and their vulnerability. The EU can talk about alternative supplies from Central Asia, but the reality is that the infrastructure is very problematic and supplies uncertain. An export source out of that region, a region in which China is already pricing aggressively for supplies, would not solve the energy security issue.

Equally, of course, Russia can talk about alternative markets in China and India, but again the reality is that the infrastructure does not exist to allow that shift and would take considerable resources and time to put it in place. Critically, however, is the fact that the declared long-term ambition of the government is to create a more diversified economy in Russia by opening up access to the EU, US and other global markets. The main barter Russia has to achieve that is energy.

But the threat of an aggressive Gas-OPEC and diverting future supplies elsewhere is a useful backdrop in 2007.

Gas-OPEC: so what?

Right now, an OPEC-type structure means very little. Exported gas forms only a small percentage of the cross-border trade in energy, and very few countries, other than Russia, Qatar and Algeria, have any significant export volumes. In addition, most gas is exported by means of fixed pipelines between producer and customer and based on long-term supply contracts.

Neither Iran nor Venezuela has any export business worth mentioning. Hence even if the members of a Gas-OPEC structure were to declare a more aggressive stance on pricing, in effect it would mean very little for quite a long time. Russia, for example, could not take gas out of the pipeline to Europe and sell it elsewhere because unlike the oil business, there is no alternative infrastructure to deliver that gas, even if there was a willing customer.

But…there be Dragons out there

The problem with agreeing the sort of structure proposed by Iran and Venezuela is that while Russia and Qatar may see this as no more than a useful forum for advancing technology cooperation and cross-country investment, there is always the danger that it can evolve into something more political. In that instance, Russia might get carried along whether it likes it or not, and even if a more price hawkish stance works against its broader economic goals.

OPEC was formed in the early 1960s, and for 10 years it was no more than a forum for oil producers. The events of 1973 changed all that. Today, the image immediately created in the mind of energy consumers is to associate even the idea of an OPEC-style structure with the consequences of the six-fold price hike in oil in 1973 and the politically motivated supply disruption.

Throughout Putin's presidency, Russia has been lucky in that it managed to stay balanced on the fence between OPEC and the G7. To a large extent that was because of the trend in the oil market that allowed Russia to always maximize its production and export growth while benefiting from higher prices. It had observer status with OPEC, but was never part of any price control procedures. That allowed for the backdrop of using energy barter to secure its more important long-term goal of global economic integration with the G7 and the EU.

Given Russia's absolute dominance in the gas market, it would never be able to hold that neutral ground stance if there was a conflict on price and supply between the consumer and producer countries. Even if that was avoided, the inevitably hawkish comments and proposals from Iran and Venezuela would mean that previously comfortable "fence-sitting" would be a lot less so in the future.

Russia's role in global energy

Cross-border trade in oil and gas is approximately 44m barrels of oil equivalent (boe) per day – Russia accounts for almost one-fifth of that.

Russia is the biggest producer of global energy and the biggest exporter of oil and gas in boe terms. In 2006, the aggregate volume of oil (crude and products) and gas exported was equivalent to 8.2m barrels per day, or almost 19% of the net amount of hydrocarbons supplied to the global market by the net export countries. Saudi Arabia, bigger in terms of crude but smaller in gas exports, was second with an 18.1% share of the net export market.

In boe terms, Russia's vast reserves of natural gas, conservatively estimated at 26.7% of the proven world total, added to proven oil reserves means that Russia's hydrocarbon base is the largest in the world. Its boe reserves account for 16.3% of the proven total compared with 13.2% for Saudi Arabia.

Russia currently has a dominant role in the gas export market with a market share of 31% of net exports. Canada is next with a 15.5% share, Norway has a 10.8% share and Algeria accounts for 10.1% of net gas exports. Geological evidence strongly supports the view that there are several more Shtokman-size gas deposits in the Arctic Sea, and the head of the state agency in charge of natural resources recently said that his agency believes that gas reserves now total 68 trillion cm, up from 48 trillion cm. That is equal to an extra 125bn barrels of oil in boe terms.

Chris Weafer is chief strategist of Alfa Bank in Moscow

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