Russia will just be one of many gas producers competing for European and Asian export share. At no stage will Moscow be setting the price or volumes of global gas supplies. Anybody left paying oil indexed prices in Europe can expect to go bust.
It’s been coming for a long time, but Gazprom has finally canned its 3.9tcm Shtokman gas development in the Barents Sea. France’s Total and Norway’s Statoil can breathe a collective sigh of relief as Gazprom’s triumvirate partners, ducking out of an increasingly expensive $20bn Arctic development. But as far as Russian Inc. is concerned, this is a strategic shocker. Far from dictating global LNG dynamics as the ‘swing producer’, Moscow is going to be kicked from pillar to post trying to set prices in Europe, and far more importantly, in Asia. That applies not only to liquid molecules, but pipeline gas as well. The reality of this hasn’t fully dawned on President Putin yet. When it does, expect the Kremlin to go for the quickest political fix it has to hand: The 63bcm South Stream pipeline specifically designed to stitch up South East European markets as the target of choice. Pathetic politics, but a sure sign of where Russia’s limited regional ambitions now rest.
In Shtokman’s defence, the numbers never added up. They looked tight before the international shale explosion and downright disastrous after – especially when you consider that North West Russian fields were designed to supply a ‘burgeoning’ U.S. LNG market in the early 2000s. Once inconclusive final investment decisions got pushed back to 30th June 2012, Statoil bit the bullet in mid-August, writing off its $336.2m investment, safe in the knowledge that it could find cheaper and easy access to international gas plays. Icy extremes vs. American pie? Statoil knows which side its bread is buttered, especially without major oil and tax breaks to improve Shtokman economics. Concessions incidentally, that Rosneft has been able to offer for Arctic oil plays as the Kremlin’s new toy of hydrocarbon choice. Any residual hopes that major international players would replace Statoil in Shtokman, were dashed when Royal Dutch Shell (with a barely concealed tongue in London’s mouth) offered to help Gazprom expand its Sakhalin II LNG ambitions. The irony of this won’t be lost on Gazprom, nor will Novatek’s coup to develop relatively quick and easy Yamal LNG projects in West Siberia. Highly attractive fiscal terms from the Kremlin have certainly helped in this effort, but Putin’s very old and very tedious game of hydrocarbon divide and rule amongst domestic players, has massively missed the strategic resonance of Shtokman for Russia.
Given that everything Gazprom has done over the past decade has been ‘out of the money’ (Nordstream is barely mentioned in polite conversion in Europe these days), Shtokman is the one loss-leader that would actually have made long term sense for Russia. Not only are Shtokman reserves far larger than the entire Norwegian continental shelf, Russia has had a serious depletion problem since 2001. Its existing onshore gas production peaked at 513bcm of gas in 2011, having touched 556bcm in 2006. Like it or not; Gazprom’s 35trcm of reserves are mostly in hard to reach, and environmentally challenging locations spanning the Yamal Pensinsular, Far East, Eastern Siberia and the Arctic shelf. The days of easy gas has gone. ‘Strategic Shtokman gas’ should have been the way of the future, and especially for Russian LNG plays.
To put things into context, despite sitting on over 30% of global gas supplies, Russian LNG production accounts for less than 5% of global share. Moscow is basically a fringe LNG player in a global gas world. A lamentable statement when you consider Russia is the gas equivalent of Saudi Arabia in the oil world. Had Gazprom been nearly as good at producing LNG as it has been talking about it over the past decade (I’ve had multiple tongue lashings in Europe on this subject), it would be in a far better position to dictate gas fundamentals across its key markets. Combine Shtokman and Sakhalin fields, and you get around 62 million tonnes of LNG, volumes that would go an enormous way to reinforcing Russian price preferences across the globe.
But forget it. Russia is far happier sitting tight and pushing the idea that mothballing upstream investments will reduce volumes in order to put gas prices firmly back on oil indexed fundamentals. That might have some credence if it wasn’t for the fact that up to 250mt/y of LNG is expected to come on-stream from every point of the compass over the next decade. West Africa, East Africa, North America, the Middle East or Australasia, you name it. Russia will just be one of many gas producers competing for European and Asian export share. At no stage will Moscow be setting the price or volumes of global gas supplies. Anybody left paying oil indexed prices in Europe can expect to go bust (and please, please, do). Chinese players aren’t nearly so stupid. If Russia can’t dictate LNG dynamics to underpin spot prices, there is no way Beijing will sign up to 70bcm of expensive Gazprom supply contracts currently on the table. Russia’s Eastern Gas programme will fall flat on its face, not to mention Moscow’s inherent arbitrage potential by simultaneously feeding Eastern and Western markets. Market maker becomes perennial market taker.
So assuming Russia is becoming another bog standard gas producer, where do they go from here? One option is to cross subsidise gas plays with highly lucrative Arctic oil concessions to enhance production. If Exxon (et al.) wants in on Russia oil, be sure to support Russian gas. It’s hard to see other IOCs taking the plunger otherwise (irrespective of the terms involved). The other, more credible option is to make domestic gas sales more attractive through price reforms. Local energy prices tend to be around a third (or less) than prevailing market rates in Russia. Putin either has to free up domestic prices to let Gazprom fulfil its broader ambitions, or follow through on serious upstream privatisation for the likes of Novatek to take on Alexi Miller’s export monopoly. Right now, he’s doing neither.
If anything, the form book suggests that Putin will bottle things, and go for the easier political option of promoting European pipeline projects to monopolise local supply and rents. That’s already happened on Nord Stream feeding Western Europe markets, with the South Stream (€16bn pipeline) as the low hanging fruit to pipe 63bcm of gas to South East European markets. The fact that Russia has flopped on the global gas scene won’t matter if the ‘Muscovite street’ can see Putin strutting his stuff in adjacent SE European states. Competing European pipeline projects would be blown out of the water. It would give Russia total gas control over South East Europe, and inherent hegemony over Ukraine given that Kiev would lose its current role as a European transit state. Russia would not only hold the keys to its rediscovered ‘post-Soviet’ space, it could exert serious political presence in Turkey, and even dictate terms in the Caspian region given its limited export routes.
All ‘impressive stuff’, until you realise that Russia has relegated itself to a regional gas player rather than global giant. To play the big boy role, Shtokman had to go ahead to dictate terms over new gas players in the Middle East, Australasia and Africa – not to mention setting the stage for a serious approach towards a gas cartel as the logical conclusion of independent global gas prices. Unfortunately for Russia, Mr. Putin is still on the back foot. He spends most his time moaning about European market designs and U.S. shale gas developments that have broken the Russia supply model, consistently failing to grasp that Russia has to ‘up its game’ to meet the global shale challenge. Bottom line; Shtokman gas will remain stuck under the ice long after Mr. Putin has gone (circa 2018) and beyond. A tragedy for Russia, but good news for everybody else…