The Shale Gas Boom: How Scared is the Kremlin?

Gazprom should be scared. The US has overtaken Russia as the largest producer of natural gas courtesy of the fracking revolution, the EU suddenly feels bold enough to rebel, and Moscow could very soon lose its grip on its European gas markets.

By some accounts, the Kremlin is quaking in its cupola, but other accounts-mostly Gazprom's-it's simply biding its time until the gas prices rise again.

In mathematical terms, the EU has rather belatedly decided that things aren't adding up and that Europeans are paying too high a price for Russian gas and not benefitting at all from the natural gas boom in the US, which has boosted supplies and caused prices to drop significantly. While Russia is selling its gas for about $10 a unit, the US is selling the same for about $3.

Another variable has also surfaced: The US has become self-sufficient in natural gas and this has led other countries to shift exports of LNG destined for the US market to the European market. The prices of this non-Russian LNG is about half of what Gazprom is charging. This has somewhat worked to force Gazprom to cut prices in Western Europe, but it retains its stranglehold on Eastern Europe. 

Here is some more math: While Gazprom is the world's single largest producer of natural gas, recording $44 billion in profits in 2011 alone, the company is in trouble. In September, Gazprom announced it was scrapping plans to develop a new arctic gas field, being short on funds, and its latest financial report shows a 25% drop in profits. (Incidentally, Gazprom was also recently wrong-footed by Pakistan, which decided not to go with the Russian giant for the construction of a gas pipeline from Iran to India through Pakistan. Putin responded by cancelling a state visit to Pakistan).

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Gazprom is attempting to make up for these shortcomings by looking eastward, to markets in Indonesia, India, Japan and China in particular. But even in these increasingly desperate times, Russia is attempting to play hard ball with China, immovable on pricing. The Kremlin is now trying to get Beijing to fund 40% of the planned Altai gas pipeline stretching some 3,000 kilometers across Russia into China for $14 billion. This would be the trade-off for more reasonable gas prices, but so far, China doesn't look likely to play along.

Then we have reports of Gazprom-Kremlin corruption. Two years ago, opposition politicians in Russia published a very attention-grabbing little booklet on how cronies of Vladimir Putin have fleeced Gazprom through pipeline construction kickbacks and below market value sales of Gazprom financial and media assets. The publication was not lost on shareholders, nor was the drop in dividends. Since 2008, Gazprom shareholder dividends dropped from $365 billion to $120 billion.

The EU clearly thinks low gas prices will hold, otherwise it would not have been bold enough to launch formal proceedings against Gazprom for anti-competitive practices in a handful of Eastern European countries. To wit, the European Commission is investigating whether Gazprom is purposefully dividing gas markets by hinder the free flow of gas across EU states and imposing unfair prices. Significantly, though downplayed by Moscow, Gazprom on 29 September announced plans to restructure its European trading and logistics assets in a sign that EU pressure is having the desired effect. The EU could win this battle as long as it holds firm, which in turn will depend on gas prices. At the first sign of trouble, the EU will back down.

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Indeed, commenting on the EU's investigation on 9 September, Putin noted that Gazprom's prices were written in long-term contracts and that these principles had never been questioned before. It is an interesting point. The shale gas revolution and the resultant dip in gas prices have offered the EU the first opportunity to question Gazprom's pricing "principles" without fear. In other words, it is the first time that Europe thinks it might have enough muscle to take on Gazprom.

If one could substantiate widespread rumors that Gazprom is bankrolling anti-fracking protests with any concrete evidence, this would serve as one solid measure for determining exactly how concerned the Kremlin is. Gazprom's scramble to hit eastern markets is also another measure, as is its attempt to make up for investment shortcomings by trying to convince China to front the costs of a massive pipeline that will otherwise not be built. 

Gazprom's first mistake was its bullying of 2009, when it cut off supplies to Ukraine over a pricing quarrel. This was a power play whose message reverberated across Eastern and Western Europe. While it did much to demonstrate Gazprom's power, it also gave the EU its first real impetus to find a way out of the Russian stranglehold. Momentum to that end was slow and littered with a handful of unviable pipeline plans, but the shale gas revolution, which Gazprom hadn't counted on, changed that.

Politically, all eyes are on Gazprom's dwindling power base, from Brussels to Washington. Gazprom has been an extremely useful political tool for the Kremlin and diminishing that usefulness would be a geopolitical game-changer. Gazprom, however, remains insistent that the shale gas revolution is no cause for concern. In fact, Gazprom seems to think that we will soon see a halt of shale gas capital in the US and a subsequent rise in gas prices. This is where exports come in.

If Washington wishes to take advantage of Gazprom's losses, exports will be key. A US commitment to natural gas exports will further irk Gazprom, but on this sensitive (campaign) issue we are not likely to see movement until after the elections. The Obama administration is stalling on the issue under pressure from the Sierra Club and others, who claim exports would lead to a price increase. Exports are likely to go ahead though because they will politically too tempting to resist and because natural gas producers are itching to see this happen. If the US starts exporting natural gas, this will give Europe that much more bargaining power against Russia.

By. Charles Kennedy of Oilprice.com