US Shale’s Seismic Shaking of Gazprom (and Putin)

By Peter C Glover

First Putin rubbished it. Then he tried to ignore it. Now the seismic tremors of the US shale gas boom are really being felt in Moscow. Not only are they rattling the Kremlin’s confidence in the future of its energy empire, but they could also prove fatal to Russia’s gas giant, Gazprom.

As the Wall Street Journal recently reported, with the formerly “unthinkable” scenario of U.S. energy independence becoming a serious proposition, “Russia could be the big loser”. Official EU energy policy has long been to wean the continent off its ‘addiction’ to imported Russian gas – and the political leverage this offers Moscow. But so far the EU’s myopic energy strategy has seen ‘green’ energy priorities and environmental concerns ignoring domestic shale gas reserves that are almost on a par with America’s. The impact of U.S. gas prices on global prices has, however, changed all that. In September, Gazprom bowed to inevitable market pressures. With US shale gas selling at $3 per million BTU (British thermal units), Gazprom was forced to make a significant cut to its $10 per million BTU price tag in Western Europe. As a result, European customers are set to further boost Russian gas imports in 2013; so much then for the EU’s energy diversity-away-from-Russian-dependency program.

The shale gas boom has seen the U.S. surge ahead of Russia as the world leader in gas production. That has allowed U.S. gas to sell at around one quarter the price Gazprom is currently charging in Eastern Europe. With the US well on the road to gas self-sufficiency, both the US and Canada are currently gearing up to produce more LNG prospectively for the Asian markets. But as the spot price for LNG has recently plummeted, it could just as easily be diverted to the European market, creating further prospective problems for Gazprom. Just for good measure, should he win the upcoming US election, Mitt Romney would pro-actively “pursue policies … to decrease the reliance of European nations on Russian sources of energy.” But these are not the only clouds gathering on Gazprom/the Kremlin’s horizon.

Even though the scale of any US and Canadian LNG imports to Europe is not vast, Chevron has already placed a major investment ‘bet’ on reaping the benefit as Europe’s antipathy crumbles, starting in the former Soviet satellite states. With the price so high, capitals in the east of Europe, especially in Warsaw, intent on breaking Moscow’s energy stranglehold see domestic shale gas development as the key. The Ukraine alone holds around 7 percent of Europe’s total shale gas reserves. Production of just 5 percent of that total could save the country between half and three quarters of a billion dollars per year.

But cracks in Russia’s energy hegemony are also appearing further west. The UK, with North Sea gas production falling at the rate of five percent per year, has just signed up to import more Norwegian gas. In addition, development of the UK’s own potentially world class shale gas reserves looks increasingly likely. Both developments will further impact current Russian gas imports.

On top of that there is the potential of the vast natural gas reserves about to be developed by Israel and Cyprus that, shipped to Europe, could offer Europe a very real alternative to Russian gas. It comes as no surprise that Russian officials are already showing an interest in buying into eastern Mediterranean gas production.

All told, Putin’s Kremlin and the state-owned battering ram which is Gazprom, are rightly rattled by the seismic impact of the US shale gas boom. In 2011, Gazprom made a staggering $44 billion in profits. Although that made Gazprom look to be the most profitable company in the world, it was something of an illusion. The company’s cash flow was already known to be poor. Most of the profit had disappeared into a Black Hole of inefficiency and corruption. During the first quarter of 2012, since the first US shale gas market tremors struck, Gazprom has been forced to axe the development of its enormous Shtokman field in the Arctic Circle stating that it could not justify the investment. Other significant pipeline projects, east to Asia, as well as the expensive South Stream pipeline project to Europe, are now in the spotlight. All could well, in terms of serious investment, prove “difficult to justify”.

Then there is the European Commission’s investigation of Gazprom for “dividing gas markets by hindering the free flow of gas across member states”, thus preventing the EU’s policy of diversification from succeeding, as well as keeping prices artificially high. If the case is proved, and it likely will be, Gazprom will be forced to give up its pricing policies, which could lead to even more enforced price cuts, further devastating Gazprom profits. The reality is that since 2008 Gazprom’s market value has slumped from $365 billion to just $120 billion today.

One way or another, the impending loss of its vital European market – albeit the EU’s own energy strategy is currently playing into Russian hands – looks increasingly likely. Some observers even predict the demise of Gazprom and a consequent waning of Russian political power.

Gazprom’s Sergei Komlev, however, remains bullish. Acknowledging the short-term impact of US shale developments, Komlev predicts that US LNG won’t make European shores in a sizeable scale nor does he “expect the abnormally low prices in the USA to last for long.” He could be right. The fact is that the global demand for natural gas is set to rise exponentially for decades to come. While we have yet to see Europe stop dithering and join the global rush for gas, Russia would be only too ready to develop its mammoth gas reserves. Maybe so, but Russia’s former global leviathan company, Gazprom, is facing a serious crisis. It’s an economy-busting scenario Putin’s Kremlin is desperately concerned to avoid.

In a recent report, Harvard University’s School of Government concluded, “the relative fortunes of the United States, Russia and China – and their ability to exert influence in the world – are tied in no small measure to global gas developments.” While Europe is still failing to get the message, Russia has. Not only has the U.S. shale gas tsunami transformed the domestic and global market, it is, even more significantly, re-empowering Western democracy and diminishing the ‘tyrannical’ political power bases of OPEC, the Middle East and Russia.

Now there’s an investment dividend that needs no “justifying”.

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