Gazprom vs. Shale Gas – Institute for the Study of Conflict, Ideology and Policy

Gazprom vs. shale gas: The best laid plans of titans and men

Russian Federation Energy Politics by Creelea Henderson

When energy prices peaked in July 2008, Russia’s ascendance to energy superpower status was pronounced a fait accompli, thanks to its national champion, the state gas monopoly Gazprom, which that year achieved unmatched output accounting for around 17 percent of total world gas production. (1) During the past decade, Gazprom emerged as a titan among multinational energy majors by seizing a commanding share of the international gas trade concentrated mainly between Russia and Europe, an export strategy that the company has sought to expand through its recent efforts to gain a foothold in dynamic markets farther afield. Among other prospective customers, Gazprom targeted US markets for Russian liquefied natural gas (LNG) shipments and, in 2006, the company announced its intention to supply ten percent of US gas needs by 2010. (2) That ambition failed to materialize. Instead, in 2009, the US overtook Russia to become the world’s leading gas producer, thanks to new drilling technologies that have transformed US natural gas production in the past five years, raising the country’s proven reserves by around 40 percent. (3)

The shift in US production has been quite literally tectonic, as new methods of extraction access natural gas deposits trapped in dense beds of shale rock miles underground. Hydraulic fracturing technology, which uses an emulsion of water, sand and chemicals to crack shale rock, marks an advance in gas production that is being hailed as “the biggest energy innovation of the decade,” by Daniel Yergin, chairman of the Cambridge consulting group, who marvels at the fact that the industry missed the eureka moment of the new technology: “there was no grand opening ceremony for it. It just snuck up.” (5)

Despite its quiet arrival, shale gas already has had a significant impact on the international gas trade. Around 20 percent of US natural gas production is attributed to shale gas, representing an overall increase in supply that has saturated the national energy market. While the US domestic market eventually will absorb the majority of new supply, there are signs that the gas glut is spreading to global energy markets, as LNG shipments originally destined for the US divert their cargoes to other ports. European countries have become prime destinations for these additional gas supplies, because they have the infrastructure to convert LNG for domestic use. Thus, it is in Europe, where successive years of reduced demand in the recessionary period, coupled with the recent abundance of LNG deliveries, that a gas glut has emerged on a magnitude capable of jeopardizing Gazprom’s position as a leading energy supplier to regional markets. (6) Among Gazprom’s key customers, the glut is pushing spot prices for LNG far below the price of Russian gas, pegged to crude oil prices. (7) European consumers operating under long-term supply contracts with Gazprom have begun to tamp down their use of comparatively more expensive Russian gas, in order to take advantage of the recent influx of cheap energy. (8)

One tantalizing possibility raised by the advent of shale gas is the promise of energy independence it holds for Poland. The country presently gets over 70 percent of its gas supplies from Gazprom, yet customers in Poland harbor deep mistrust for the gas giant that they regard as a coercive arm of the Kremlin. (9) Poland’s leaders, eager to recreate an American-style shale gas bonanza in Eastern Europe, have welcomed US cooperation in what they hope will become a transformative energy initiative. “Production of shale gas in Europe can change its energy paradigm,” Polish Foreign Minister Radoslaw Sikorski told US envoys. (10) This spring, US energy majors began exploratory drilling in Poland’s shale beds, where they hope to confirm estimates that put Polish shale gas reserves at three trillion cubic meters, an amount equal to 200 years’ of domestic supply. (11) Such a significant find would give Poland the resources it needs to replace its primarily coal-burning power plants with gas-powered plants, enabling the country to reduce its CO2 emissions, and may even present an opportunity for Poland to become a net gas exporter to its European neighbors.

As an incidental matter, the advent of shale gas production has raised the profile of the international LNG trade and highlighted the capacity of LNG exporters to respond to abrupt shifts in the global gas market. Whereas consumers who receive gas deliveries via pipelines are constrained from taking advantage of the current resource oversupply and attendant fall in commodity prices by fixed, oil-indexed contracts, the exporters and importers who trade in LNG volumes meet short-term needs on spot markets where the price of gas, uncoupled from the price of oil, offers a fair reflection of prevailing global market conditions. Of course, the high degree of flexibility that characterizes the LNG trade could give leading gas exporters the leeway they need to form an OPEC-like cartel that seeks to drive up global energy prices. Algeria raised the idea of coordinating production levels as a means of solving the global supply glut and stabilizing weak gas prices at a recent meeting of the Gas Exporting Countries Forum, a group of the world’s biggest gas producers, but the proposal was nixed by other members, including Russia’s Energy Minister Sergei Shmatko, who dismissed the idea of cutting pipeline deliveries or LNG supplies as impossible. (12)

Unsurprisingly, the reaction of Gazprom officials to the advent of shale gas production has been decidedly wary. Gazprom Deputy CEO Alexander Medvedev has attacked shale gas projects as “dangerous” and found it “unimaginable” that Europe would permit shale gas production, which, he suggested, might contaminate drinking water. (13) In a different vein, Medvedev tried to put a brave face on current events by predicting that gas prices will rebound on a rising economy in 2012. Although most industry experts do not see the gas glut drying up anytime before 2015 and do not endorse his rosy prognosis, Medvedev announced company plans to boost Gazprom’s output to record levels year-on-year for the next three years, in anticipation of a complete turnaround of European markets. (14) Behind the bully forecast, Gazprom has been quietly adjusting its strategy to uncertain market conditions, renegotiating agreements to phase out imports of Turkmen gas, and postponing several major new gas field projects, including the long-anticipated development of the Shtokman and Bovanenkovo gas fields, that Gazprom will soon depend upon to meet its supply commitments in coming years. (15) The company’s decision to defer investment in new gas field development, in order to finance and build a new pipeline that it will use to deliver gas to established markets with relatively inelastic demand, as it has done with its recently-launched Nord Stream pipeline to Western Europe, suggests that Gazprom’s attention is focused on securing long-term delivery commitments with European customers, rather that scanning the horizon for new markets to conquer. For energy industry observers who came to know Gazprom as an indomitable industry titan in former years, the company today seems somehow diminished, even less inclined to rattle its neighbors. Perhaps the company is mirroring the depressed natural gas market, or simply consoling itself for its failure to anticipate the shale gas phenomenon that has cost it a potential new market and allowed US producers to challenge its global standing.

Source Notes:
(1) “Security of Supply and Related Investments,” Gazprom website, 5-9 Oct 09 via (http://gazprom.com/press/miller/speeches/24WGC/).
(2) “Gazprom set to reveal partners for giant gas field,” Financial Times, 24 Apr 06 via (http://www.ft.com/cms/s/0/204df5be-d32e-11da-828e-0000779e2340.html).
(3) “Should Gazprom fear the shale gas revolution?” BBC News, 8 Apr 10 via (http://news.bbc.co.uk/go/pr/fr/-/2/hi/business/8609131.stm).
(4) “New Way to Tap Gas May Expand Global Supplies,” The New York Times, 9 Oct 09 via (http://www.nytimes.com/2009/10/10/business/energy-environment/10gas.html).
(5) “Recent commodity market developments: trends and challenges,” Note by the UNCTAD secretariat, 3-5 Mar 09 via (cimem2d2_en.pdf).
(6) “Gazprom upbeat on demand despite rival shale gas,” Reuters, 14 Apr 10 via (http://www.reuters.com/article/idUSLDE63D1E120100414).
(7) “European Energy Giants Seek Lower Prices from Gazprom,” The New York Times, 24 Feb 10 via (http://www.nytimes.com/2010/02/25/business/global/25gas.html)
(8) Ibid.
(9) “US Giants Bet on Shale Gas in Poland,” The Wall Street Journal, 8 Apr 10 via (http://blogs.wsj.com/new-europe/2010/04/08/us-giants-bet-on-shale-gas-in-poland/).
(10) “US Giants Bet on Shale Gas in Poland,” The Wall Street Journal, 8 Apr 10 via (http://blogs.wsj.com/new-europe/2010/04/08/us-giants-bet-on-shale-gas-in-poland/).
(11) “US Giants Bet on Shale Gas in Poland,” The Wall Street Journal, 8 Apr 10 via (http://blogs.wsj.com/new-europe/2010/04/08/us-giants-bet-on-shale-gas-in-poland/).
(12) “Natural-Gas Cuts Likely Off the Table,” The Wall Street Journal, B6, 17-18 Apr 10.
(13) “Gazprom scorns shale gas as ‘danger to drinking water,” Telegraph.co.uk, 9 Feb 10 via (http://www.telegraph.co.uk/finance/newsbysector/energy/oilandgas/7199259/Gazprom-scorns-shale-gas-as-danger-to-drinking-water.html).
(14) “Gazprom Says ‘Abnormal’ Gas-Price Cap to Undermine Investment,” BusinessWeek, 14 Apr 10 via (http://www.businessweek.com/news/2010-04-14/gazprom-says-abnormal-gas-price-gap-to-undermine-investment.html).
(15) Ibid.