It seems the shoe is on the other foot for a change, making for some interesting developments here in Moscow.
It's the sixth time in as many years that I've been invited to give a briefing during the annual policy meetings held by the Ministry of Energy. This trip, however, is not like all the rest.
Instead of the usual certainty, there is a noticeable indecision in where Moscow plans to move next.
As an Oil & Energy Investor reader, you probably know the reason. It's unconventional crude, and it's completely changing the global landscape.
Here's why that has the Kremlin worried...
Believe Me, Shale Gas Is No "Flash in the Pan"
You see, traditionally Russia has been able to obtain a certain amount of leverage from being the largest non-OPEC producer of conventional oil. The authorities simply parlay OPEC supply quotas to improve their export pricing and undercut OPEC members in selected global regions when Russian companies can improve market penetration by providing additional volume.
These days, however, that leverage is in jeopardy, and the culprit is the same factor that is moving the U.S. market to the top of the production list. Unconventional oil is growing so fast, American oil production this year will come in at a higher level than at any point since the late 1970s, with the prospects of becoming the world's largest supplier a possible near-term reality.
What's more, Russia's earlier campaign against shale gas (claiming it is a "flash in the pan," unsustainable, causes earthquakes, etc.) has fallen flat as more and more unconventional gas is found worldwide and interest grows for its development.
Gazprom, Russia's biggest enterprise and the largest gas company on earth, simply miscalculated on that one. While Gazprom has begun serious development of coal bed methane (another major source of unconventional gas), it has steadfastly maintained shale gas will come and go quickly, being mainly confined to the United States and Canada.
Unfortunately, for Russian intentions, nobody else in the world is buying that argument -especially in light of the latest reserve figures.
The first global estimate of recoverable shale gas was issued in 2011. But this June, the first revision of those figures was released, a study that also included the initial projections of tight oil.
Both of these projections were much higher than anybody had anticipated.
That is bad news for the Kremlin because Russian policy has always emphasized long-term, take or pay, pipeline contracts with the cost of gas based on a basket of crude oil and oil product pricing.
Yet with the advent of new unconventional availability, combined with an acceleration of liquefied natural gas (LNG) exports, the Russian preeminence in the availability of hydrocarbons is now under threat.
Both shale gas and LNG are providing new opportunities for local spot gas markets to form in places that used to be dependent on Russian pipelined product. As these localized markets begin to have assured volume, the spot nature of the transactions are undercutting the price needed by Russian companies to make a profit on their exports.
The Problem with "Take or Pay" Contracts
It happens this way...
The contracts signed with Gazprom or Rosneft are usually for 20 years. However, the take or pay provision requires the end user to agree to import a certain amount or pay as if they had (this is usually 75% or more of the monthly contracted amount).
On top of that, with gas prices pegged to that of oil, the rise in Brent crude prices in London (now in excess of $110 a barrel) has caused the price for Russian gas to climb. Ordinarily, that would be gravy for Moscow except for one noticeable change in the situation.
Thanks to the emergence of shale gas and LNG, they are no longer the only game in town.
In the immediate term, the shale gas extracted elsewhere will impact market prices in Europe and Asia as LNG exports begin to ramp up. In a few years, however, domestically produced unconventional volume will also come on the scene.
The combination of imported LNG and rising local shale production will make matters very difficult for Gazprom...and the central government back in Moscow that relies on the export revenues.
As a result, Gazprom is belatedly moving as quickly as it can into LNG exports as a way of offsetting this challenge. But the truth is they are well behind the curve.
Even More Problems for Moscow
The same change is now appearing on the oil side.
Once again, it is the presence of unconventional production that is creating the angst. This matter has been the agenda for our conversations for months. But more recently, a new concern also materialized.
The possible agreement to relax sanctions against Iranian oil exports is now acting like a double whammy on what are becoming the most interesting of these annual policy meetings in years.
As I noted last week, it remains too early to tell whether an accord is actually coming, since all of the main hurdles on the Iranian nuclear agenda have yet to be confronted.
But Russia is already seeing the writing on the wall. They did sign off on the accord. They cannot assume it will fail or that the other factors laying siege to their traditional control over export venues will simply evaporate.
That has led to a quite unfamiliar posture in Moscow - indecision. It has also led to another unanticipated wrinkle.
My major presentation is scheduled for later today (I am writing this early in the morning Moscow time - nine hours ahead of East Coast U.S. time). And last evening, they asked if I could change the focus of my comments to include all of these new elements.
I have willingly agreed. As regular readers of Oil & Energy Investor are well aware, I have been addressing the changing dimensions of the new energy balance for some time now. So I do have an approach that I'm ready to suggest to them.
The good news is that it's one we can make some money on. So stay tuned.
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