Russia and Shale Gas: Friend or Foe?

Governing is choosing. Choosing political and economic orientations and choosing the path to reach them. In the world of public policies, prospects and scenarios are made, and ranged according to their likelihood to happen. Actions can then be aligned to get to the desired outcome. Yet, it is not rare that unplanned and sometimes unwanted events disturb the course of smoothly planned scenarios. In any case, these scenarios are also contradicted to by other players’ scenarios and strategy. So “frictions” obviously appear and adaptation is needed.

In the sphere of energy policies, earthquakes happen and shake policies. These earthquakes shake scenarios and prospects and force them to react and adapt. A recent one happened and it has a name: unconventional gas. This “earthquake” occurred at a time when another physical disaster was also impacted the course of things (the Fukushima nuclear incident), but the point here is more about the former than the latter.

Yet, they have in common the damages they cause. The Fukushima nuclear incident was and still is a real drama for human life and nature. Occurring on the other side of the world, its impacts went on to shake public policies in some European Member states that decided to close the door to nuclear energy. That means that energy produced by these plants has to be replaced.

The “unconventional gas earthquake” impacted the energy sphere in general, in particular by introducing a new pattern in the way this industry works (i.e. low cost gas[1]). For some it raised the hope of cheap gas (good news in a time of crisis), and less reliance on Russian gas supplies. But some others are being forced to reconsider their plans, Russians in particular. A very concrete and negative impact for them of the shale revolution is that the Shtokman project is now in a coma that it may never get out of.

And still, uncertainties remain over the real impact of this “shale gas earthquake.” At the moment, many chose to follow the “shale gas stream.” But some facts (for example: different geology between states, differences in mineral rights, economic viability of unconventional gas) lead some to think that the infatuation for unconventional gas should be relativized and that the “shale revolution” should be taken with care.

A careful position is exactly the one adopted by Russia. Moscow closely monitors shale gas development but does not fall for it. Above all, it may not need to fall for it. As a matter of fact, Russia holds the world biggest natural gas reserves. If its unconventional gas resources were to be added, it would mean an additional 680bcm [2]. Why use expensive and environmentally damaging techniques when one has enough gas to meet its current contractual obligation (and potential future ones) and its own growing internal demand? That would make no sense.

At first sight, Russia seems to be negatively affected by the development of unconventional gas. First, the US overtook her as the top world gas producer and more shale gas on the market means more competition and in principle low prices. And on the topic of low prices, Russia is also witnessing a change in pricing-patterns it may not agree with. Gas pricing seems now to be driven by the US. New gas producers are likely to adopt the spot pricing system, based on supply and demand. For instance, Mozambique's contracts are executed on the Henry Hub indexation.

Further, in showing less flexibility than its competitors, Russia lost its position last year as primary supplier to Europe[3] in favour of Norway that included more spot prices in its contract (it seems that Statoil went with 55% of spot indexation, while Russia had with only 7% spot indexation). But this situation could be resolved. Russia lost its position not because it does not have the reserves, or because it does not have the transport capacity but because its gas is, currently, too expensive. And buyers are simply making the rational choice of buying the cheapest gas.[4]

Second, shale gas exports projects from the US are competing with other projects for financing. Bankers now turn their back to capital intensive and technologically complex projects (such as Shtokman) that are less profitable than these new projects.

Consequently, with plenty of resources located worldwide, the problem is no longer the quantity of gas left underground, but about money and the financing of projects. And with the logic of getting as much profit as possible in the shortest amount time, it's logical to turn towards quickly drilled wells and quick profit as well.

The US, with its peculiar geology, its vast landscapes, mineral rights regime where subsoil is privately owned, and the experience of its oil and gas companies, found itself under favourable conditions to develop its unconventional resources. Having gas underground though is no longer enough.

More cheap gas is a problem for Russia that relies heavily on hydrocarbon exports for its federal budget. The current time seems to design a new pattern for gas industry that seems unfavourable to Russia. It has to find new customers in a more competitive market.

The market in Asia is becoming more challenging, due to prospects of cheap shale gas exports from the US.  Japan, as an example, imports Russian gas but finds it too expensive and is looking for cheaper gas. At the beginning of this month, the Japanese Trade Minister, Toshimitsu Motegi, called for a quick approval for US LNG exports to his country. He further emphasized the “merits of approving LNG exports to Japan and other Asian economies: “The high natural gas price is the main cause for Japan to experience a trade deficit for the first time in 31 years. This price in Japan is four or five times higher than in the U.S.” “If LNG can be imported from the U.S., with growing production of shale gas, it will make a lot of difference to Japan to be able to diversify its fuel-supply sources [Japan imports LNG from Russia and is currently considering a 5bn$ gas pipeline from Eastern Siberia]  and shrink the price gap”. “A new flow of LNG supply from the U.S. to Asia would be an essential game changer that would contribute to energy security as well as economic and geopolitical stability in Asia”.[5]

US shale gas would is also in competition with Russia when it comes to Pakistan. Indeed, last October, Dr. Asim Hussain (Advisor to the Prime Minister on Petroleum and Natural Resources) revealed that the government is interested in buying a field of unconventional gas in the US, with the view of securing a cheap sources of energy to meet the country’s rising needs[6].

Further competition with Russian gas in the Asia-Pacific region is also likely to be for supplying China’s growing appetite for the blue fuel. When it comes to Chinese supplies, there are various options ranging from their own shale gas reserves (estimated as being twice bigger than those of the US) to supplies from East Africa.

This looks very much like a shaky time for Russia, especially at a time when Russia’s Gazprom is already challenged on the European market. From every angle, the picture does not look good for Russia, and shale gas seem to be more a “foe” than a “friend.”

Here comes the 'but'...

These very concrete impacts of unconventional gas development are the reason for Russia to carefully monitor it though one may wonder why only monitor when actions should be taken. For instance, why no more spot prices in its pricing formula? Actually, this careful monitoring seems to be a wise position. Indeed, there are still many question marks at the moment as to what will happen next and it may turn to be in favour of Russia.

If Asian countries are expecting low priced LNG from North America, if Europeans are still dreaming of having a shale revolution of their own and even of importing US LNG (see for instance the commercial agreement between US-based Cheniere and Centrica of the UK); facts are still uncertain (even the amount of US shale gas to be exported is uncertain). And all can happen.

Not rushing into action has shown to be a winning strategy for Russia when it found itself in bad situation. In has happened that Russia won with a retreat-and-see strategy. Russia won over the French Napoleon’s Great Army mainly because of Napoleon’s miscalculation. The French Emperor had been too keen to embark on this expedition to achieve his blocus against England, but numerous mistakes led him to a defeat[7]. During the expedition to Russia, Napoleon lost every day between five thousands and six thousands of his soldiers, and met nobody to fight with.

Well the situation could be the same: while the world is getting all over enthusiastic about new gas discoveries, new pricing formula; Russia just does not fight back by rushing to agree on everything with the fear of losing its position as a supplier. And the final outcome may not be that bad.

Let’s try to see it from a Russian perspective. The US production of unconventional gas is now linear; its curve no longer goes up. How much will be exported is still a big question. The shale gas revolution actually led to a re-industrialisation, with companies moving back as the energy was cheap. The US manufacturers are probably happy to have indigenous resources at low price, especially in time of economic crisis. And people (who are also voters) are probably happy to keep their job and not to see manufacturing plants closing down.

So the quantity of North American unconventional gas that would actually reach European shores may be fairly low. Plus, US companies may be more interested in sending their LNG to Asia where the prices are higher and where the demand is rising (and the enlargement of the Panama Canal is happening at the right time). So US unconventional gas may not compete that much with Russian gas on the European market. Regarding the competition in Asia, it will depend on how much gas is actually exported, and the actual demand there.

Additionally, on the “Asian front”, China seems to have huge shale gas reserves but may not be able to get the best out of it. The US shale gas revolution is not to be reproduced everywhere as conditions (geological, political, legal) are not the same. Progress in the shale gas sector in China are currently fairly slow, with only 60 wells drilled over the past two years (60 is the number of new wells drilled every ten days in North Dakota…).

Furthermore, some of the Chinese shale deposits are located in area where water supply is an issue (and hydraulic fracturing requires a lot of water). “Most of China’s areas are facing water challenges, either shortages or pollution,” said Ma Jun, director of Beijing’s Institute of Public and Environmental Affairs. “We don’t want this issue to be further exacerbated.” The Tarim River, he notes, used to drain into a large inland lake, which dried up completely in the 1960s. Large parts of the river, also used to irrigate cotton fields, have run dry too.[8]

The Chinese administrative system is also an important hurdle and its infrastructure is not developed like it is in the US.

Moreover, US companies are much more experienced than Chinese companies in the shale gas business. China’s hunt for know-how is facing resistance. Thus, contracts between North American companies and Chinese companies are being carefully drafted. “There is every reason for the government to develop more shale resources,” said Zhou, of IHS CERA. “The more we look at it, the more unique we realize North America is.”[9]

This last comment is interesting and Europeans should think about it. The possibility to have a shale revolution in its populated territory is to be questioned. Actually the expected revolution is turning low. Poland is still looking for its sweet spot. In the United Kingdom, comments and analysis are becoming more cautious. A study by the Commons Energy and Climate Change Committee concluded: "It is by no means certain that prices will fall as a result of foreign or domestic shale gas development." “Tim Yeo, chairman of the committee, said: "Ministers should be careful not to base energy policy on an assumption that gas prices will fall in future as a result of shale gas production. Rising global demand for gas, particularly from Asia, could limit any potential price reductions.[10]"

Figures are being revised about how much shale gas could actually be revolutionary in Europe, and it seems that it could cover only two to three percent of European needs. It seems worth to metion what sounded like a wise comment made by a Member of the European Parliament one week ago at a Brussels event: “Just recently, Commission Oettinger said there was a possibility of shale gas supplying 10-15% of Europe’s energy needs in future, yet yesterday’s figures from the International Energy Agency, quoted by Werner Zittel, put that figure at 2-3%, significantly lower than Commission estimates,” she said. “The evidence we heard from two experts (David Hughes and Werner Zittel) strongly challenged the hype surrounding shale gas as a genuine option for Europe’s much-desired energy security,” said Ms Harkin. “It poses serious questions as to why any energy policy mix should include this new and expensive technology if there is not a reasonable return of gas supply.[11]

So with a worldwide revolution that is actually only happening in North America, Russia’s stance on unconventional resources is a choice that does more than wise. Just like during the Napoleonic war, there is no rush to embark on actions while the situation is too uncertain. But one thing is almost certain: Europeans are very likely to wake up with a hangover. Once they understand that they do actually need Russian gas, it may already be when Russia is in the nice position of being a swing supplier between Europe and China.

There were some laughs in Brussels at a conference two years ago on Russia’s possible arbitration between sending gas to the EU and sending it to China. It was said that this will not happen in so far as China would get gas from Eastern Siberia while Europe gets gas from Western Siberia. Europeans should wake up quickly because there is actually no certainty at all about Eastern Siberian gas reserves…

So yes, the gas that is to be sent to China is likely to come from Western Siberia. Maybe it’s time for Brussels to take into consideration its Russian partners concerns and limit the impact of its coming hangover. After all, shale gas may be an ally for Russia. This latter is just waiting for its time.

Yasmina Sahraoui is based in Moscow and comments on natural gas developments