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Analysis & Opinion
22.05.12 Blue-Flame Apocalypse
By Tai Adelaja

Economists from Russia's largest lender are the latest to warn the Kremlin of the disastrous consequences of Gazprom's rigid oil-linked pricing formula incorporated into its long-term contracts. Russia's gas export monopoly stands to lose a significant share of the European market by 2016, with dire consequences for the country’s budget and its main source of income, the economists at Sberbank said in a presentation on Friday. They predict inevitable erosion of Gazprom’s dominance as the United States ramps up shale gas production, cuts back on natural gas imports and re-exports excess capacity to its European allies, which have hitherto been relying on Russia for their energy needs.

As the European spot market for natural gas expands, Gazprom, which ties its gas prices to oil and refined products, will face fresh demands from consumers to lower gas prices, the Sberbank economists led by Ksenia Yudaeva said in their report. Europe currently depends on Gazprom for about a quarter of its gas needs, but spot prices for natural gas had been lower than Gazprom’s rates for most of the past two years, said Yudaeva, the chief economist at country's biggest lender. Gazprom could face an existential threat as early as 2016, the economist said, adding that the main risk will emanate from the current boom in North American shale gas production as well as a spike in the number of liquefied natural gas (LNG) terminals that have been granted export licenses in recent years.

Doomsday predictions about Gazprom's future are nothing new. Last week qualified experts attending the Reuters Global Energy and Environment Summit made a similar forecast, albeit without naming anyone. The boom in North American shale gas production in the past five years, they said, has not only resulted in sharp falls in domestic power and gas prices there, but could also turn North America from a gas importer into a large exporter. “[The United States] will have the cheapest power, gas and oil, and that could lead to an industrial revival as the U.S. industry becomes globally competitive again because of cheap energy,” Daniel Jaeggi, the cofounder and head of global trading of the Geneva-based commodities trading house Mercuria, said during the summit, Reuters reported. “Unconventional resources will be flattening the role of energy superpowers with major geopolitical implications,” said Fatih Birol, the chief economist of the International Energy Association (IEA), according to the agency.

Yet, the biggest risk for Russia is not the U.S. shale gas but the potential for development of similar reserves in neighboring Bulgaria, Romania, Poland and Ukraine, analysts say. Eastern European countries are racing to tap shale deposits using the same technology – hydraulic fracturing, known as fracking, and horizontal drilling – used in the U.S. gas industry, according to Financial Times Commodities Editor Javier Blas. "Gazprom supplies Europe with about 20 percent of its gas needs, so the development of shale deposits in its backyard is a serious long-term threat," Blas wrote. "Until now, European companies have found it difficult to renegotiate their expensive contracts with Gazprom because of the lack of alternative suppliers. Over the next decade, the development of the European shale industry could give the continent’s natural gas consumers a bit more leverage."

Russian Western neighbors like Poland and Ukraine have indeed taken steps to explore local shale gas reserves in efforts to weaken the influence Russia attempts to wield over their economies and politics. Ukrainian Prime Minister Mykola Azarov last week hailed the recent agreements with Royal Dutch Shell and Chevron Corp to explore two large shale natural gas fields as critical steps to increase the country's energy independence, Reuters reported. He said shale gas could hold the key to eventually "covering all of Ukraine's needs." Ukrainian officials say they expect to start producing from five to 15 billion cubic meters of shale gas per year by 2020, depending on the results of exploration. The optimism underscores U.S. Energy Information Administration’s estimates that Ukraine has the third-largest shale gas reserves in Europe at 1.2 trillion cubic meters.

In the past Gazprom has dismissed such talks, arguing that the high cost of shale gas production will doom its commercial prospects. However, market dynamics have been changing and not in favor of the state-run gas monopoly. In addition to the immense shale gas exploration opportunities, European gas consumers are also pinning their hopes on recently discovered gas reserves in the eastern Mediterranean Sea, which some analysts say could exceed 100 trillion cubic feet, enough to supply Britain – the euro zone’s biggest gas consumer – for almost 30 years.

Meanwhile, shale natural gas amounted to 27 percent of the overall U.S. natural gas production in 2010, and is expected to increase to 43 percent in 2015 and 60 percent in 2035 when it could support up to 1.6 million jobs, according to America's Natural Gas Alliance (ANGA). Growth in domestic shale gas production is fuelling the production of petrochemical derivatives and plastics and helping to reduce U.S. natural gas prices, which dipped to $70 per 1,000 cubic meters in April, the lowest level in ten years.

But the moment of truth for Gazprom may well come in 2016, when both the United States and Canada are expected to start exporting gas to the global market, Sberbank economists said. Russian President Vladimir Putin acknowledged the threat last month. In a speech to the State Duma in April, Putin told legislators that the boom in shale gas can “seriously” reshape the global energy market. “National energy companies, obviously, must respond to these challenges,” he said, in a clear reference to Gazprom.
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