Streetwise Professor

Old hat to SWP readers (I wrote about this repeatedly from last December through March), but apparently “news” to the NYT:

While OPEC members limped through a period of painful production cuts this year, Russian oil companies enjoyed an extraordinary run.

The year that has gone by since Russian officials floated — and then retracted — a proposal to coordinate production limits with the Organization of the Petroleum Exporting Countries illustrates why the Kremlin is unlikely ever to actually do so.

Already the world’s largest oil producing nation, Russia, pumping prodigiously through the downturn, this summer passed another milestone. As Saudi Arabia tightened its belt to live by OPEC cuts, Russia surpassed it to become the world’s largest exporter.

. . . .

Improbably, the once-neglected oil sector has emerged as one of Russia’s few growth industries, helped by the tax cuts, a devaluation of the ruble that aided exporters and a change of policies that may invite foreign companies back into the sector.

“OPEC made a concerted effort to stem its exports,” said Alex Fak, an oil analyst at Troika investment bank in Moscow. “The result of that action was higher oil prices. So Russia was encouraged to produce more and sell more. Which is what it did.”

Yet, for a time, officials had seemed ready to revise the long-held axiom that Russian national interests were not served by cooperating with OPEC. Sharp price declines had turned Russian oil companies, just a few months earlier seen as money printing presses for the government, into money losers. Far from propping up the Russia government, which relies on oil exports for about 40 percent of its budget, they needed help themselves.

Anyone who really believes that Russian officials were ready to cooperate with OPEC is incredibly credulous.  The Russians are notorious for playing double games, and for double crossing.  I just wonder if OPEC was as credulous as the New York Times.

That Sergei (“The Tarantula”*) Lavrov shot down in flames Hillary Clinton’s attempt to get Russia to agree to tough sanctions on Iran. Actually, I’m not.  I would have only been surprised if Lavrov and Putin had expressed a willingness to do something serious.  I would like to ask, though, that anyone who did fall for Medvedev’s showing a little ankle on this to email me at [email protected].  Have I got some deals for you!

And if anyone is confused on this, consider that Putin has also expressed his deep, deep concern for those oh-so-fragile Iranian psyches, and is recommending that nobody do anything that might scare the poor dears:

Russian Prime Minister Vladimir Putin Wednesday warned major powers against intimidating  Iran and said talk of sanctions against the Islamic Republic over its nuclear program was “premature.”

Putin, who many diplomats, analysts, and Russian citizens believe is still Russia’s paramount leader despite stepping down as president last year, was speaking after U.S. Secretary of State Hillary Clinton visited Moscow for two days of talks.

“There is no need to frighten the Iranians,” Putin told reporters in Beijing after a meeting of the Shanghai Cooperation Organization.

“We need to look for a compromise. If a compromise is not found, and the discussions end in a fiasco, then we will see.”

“And if now, before making any steps (toward holding talks) we start announcing some sanctions, then we won’t be creating favorable conditions for them (talks) to end positively. This is why it is premature to talk about this now.”

Premature, premature, premature.  Manana, manana, manana.  Get the picture, Hillary?  Russia ain’t going to do jack to pressure the Iranians.  Move on to plan B, or C, or whatever one we’re on now.

So just what did we get for the unilateral shafting of the Poles and Czechs?  Just asking.

For an interesting contrast, watch Putin and Russia deal with China. Putin traveled to China to announce big energy deals with great fanfare.  Everything is agreed!  Uhm, except the price.  Details, details.

China has shown no interest whatsoever in agreeing to the same oil-based pricing formula as Gazprom employs in its European sales contracts.  Given the bilateral monopoly condition that would characterize any Gazprom/Russia-China deal, the same sorts of issues that I addressed in my take-or-pay post will make any Russia-China agreement very hard to negotiate and enforce.  So, I wouldn’t hold my breath in expectation of such a deal any time soon.

It is very interesting to note, though, how much more difficult it is for Putin and Russia to deal with China than the Europeans.  The old standby divide-and-conquer gambits that routinely work with the Euros are not an option in dealing with China.  Putin doesn’t look quite so smart or powerful in dealing with a single, hardheaded negotiating partner as he does in rolling divided, squabbling, and politically vulnerable Europeans.  If the Euros were smart they would watch, learn, and imitate.  Note that this is a conditional statement, not a prediction.  I doubt that they will.

Roman Kupchinsky at Jamestown notes that the Chinese are also quite concerned about the Russian ability to deliver on all the blank gas checks they’ve written–a point I’ve made repeatedly on SWP:

[T]he main concern analysts have is Russia’s ability to supply 68 bcm of gas per year to China while meeting long-term commitments to European customers as well as rapidly increasing Russian domestic demand for gas.

Earlier this year, Gazprom announced that gas from the Sakhalin-1 project will not be sold to China, but diverted instead to the gas hungry Russian Far East region of Vladivostok.  Gazprom is holding talks with Exxon about buying all of its gas output from Sakhalin and industry sources say the company is offering prices equal to Russia’s domestic gas prices – which are far below world prices. Exxon said it is studying all options to sell gas from Sakhalin-1.

In addition to making promises to supply China, Gazprom has also stated that it wants to capture  10 percent of the U.S. gas market within the next 5 years by selling some 66 bcm of gas in the form of LNG. The plan envisions that Sakhalin-2 will supply the bulk of this LNG.

The bottom line is whether Russia is capable of building such costly pipelines as Nord Stream, South Stream and a second string of Blue Stream; while at the same developing the Yamal peninsula into a major gas producing center and finishing the Shtokman project? These projects, and others too numerous to mention, are projected to cost hundreds of billions of dollars which Russia does not have and which Western companies might not want to spend given the shaky business reputation of Gazprom and its management.

Exactly.  The Chinese presumably extracted something from Putin in exchange for letting him put on this Potemkin/Putinkin-goes-gas display.  But China will almost certainly not rely in a serious way on Russian promises of future energy supplies, because it understands that Russia’s ability to perform on its commitments is so doubtful.  If it does enter into agreements with Russia, it will likely impose contractual terms that will shift the major risk of non-performance due to the inability to obtain the necessary supplies to the Europeans.  Yet more reason for the Euros to get their act together.

* I am counting the seconds until the eruption of howls of protest from Cutie Pie at this arachnomorphism.

Dmitri Medvedev stepped up what can only be considered his campaign against Putin and Putinism by emphasizing Russia’s dismal economic performance in 2009, and placing blame for the country’s economic malaise on its energy export dependence:

Russia’s economy may contract by a “very serious” 7.5 percent this year as dependence on energy exports left the country more vulnerable to the global financial crisis than expected, President  Dmitry Medvedev said.

“I must admit that we sunk below our lowest expectations,” Medvedev said in an interview to be broadcast today at 9 p.m. Moscow time on state television. “The real damage to our economy was far greater than anything predicted by ourselves, the World Bank, and other expert organizations.”

Initial forecasts indicated the economy may drop between 3 percent and 3.5 percent this year, Medvedev told Channel One. The government predicted last month that the economy will shrink 8.5 percent this year, the most in a decade. Russia will return to growth in 2010, the government forecast in a report published on its Web site.

. . . .

Russia needs to modernize the economy and reduce reliance on oil and gas exports, to protect it against financial crises, Medvedev said. This may take as long as 15 years, he said.

“That is a perfectly plausible time frame in which to create a new economy, an economy that will be competitive with other major world economies,” Medvedev said.

“Once a significant portion of our revenue is generated by something other than energy exports, let’s say at least 30 or 40 percent of it, then we would already be living in a different economy and in a different country.”

Russia should pursue energy efficiency, including creation of new fuels and energy saving, develop nuclear power, information infrastructure, and produce its own medicines, the president said.

“Everything was okay as long as prices for energy and raw materials were high,” Medvedev said. “Then those prices fell. Our economy was hit hard. Our citizens were hit hard.”

Several comments.

First, the tone and tenor of Medvedev’s remarks contrasts starkly with the happy talk that has been Putin’s staple for over a year.

Second, the repetition of the theme that it is imperative to wean Russia from its dependence on raw material exports is by now so frequent, and so contrasting to Putin’s position as the de facto Prime Minister of Gazprom (“Gazputin,” remember?–he’s now off to China to do more gas deals), that these statements must be considered as Medvedev’s framing of his challenge to Putin.  Blood brothers?  Really?  So were Cain and Abel, if memory serves.  It still remains to be seen, however, whether Medvedev has the personal steel and the political support to challenge Putin successfully.

Third, with respect to the economics, even if Medvedev did not face a political battle over the future of the country, comparative advantage is what it is, and will inevitably affect the structure of the Russian economy.  That said, the wealth consequences of Russia’s natural resource factor intensity, and the susceptibility of the country to terms of trade shocks could be mitigated to the extent that these risks could be shared through the financial markets, e.g., by exchanging claims on Russian natural resource endowments for claims on capital assets in other countries.  The inability of Russia to precommit credibly not to expropriate foreign natural resource investments limits, however, the potential for this potentially beneficial exchange.  This will continue to shackle Russia to the vicissitudes of commodity prices, and perpetuate its status as a very high beta (that is, high risk) economy.

Fourth, and relatedly, this inability to precommit in large part reflects the political obstacle that Medvedev is unlikely to overcome.  Skimming resource rents is very lucrative to the siloviki elements, and they are almost certainly unwilling to constrain themselves institutionally and legally even though such constraints would increase Russian wealth–because it would reduce the siloviki wealth.  They are perfectly happy to have a big piece of a smaller pie than a small (or non-existent) piece of a bigger one.

There’s one last thing in the article that deserves comment:

The jobless rate fell to 7.8 percent in August, lower than previously estimated, from 8.3 percent in July on rising seasonal demand for agriculture and construction. The number of unemployed was 6 million, the Federal Statistics Service said.

It is very hard to square the relatively low (compared to the US, for instance) and falling unemployment rate with an economy that sank “below [the] lowest expectations.”  This translates into plunging productivity, and means that true unemployment is almost certainly masked, probably by companies under state pressure and receiving state support continuing to pay unutilized or heavily underutilized workers.  Big Russian companies are almost certainly serving as de facto providers of a social safety net, which does not speak well for Russian state capacity.  Moreover, it means that either (a) these companies will be badly positioned financially to recover, or to exploit a world rebound, or (b) the government will likely provide additional support to these companies going forward, thereby impairing the state’s fiscal condition. Either alternative, or a combination of both, will serve as a drag on Russian economic performance in 2010 and beyond.

that Russia has made a deal to restore gas flows from Turkmenistan exactly when the weather is starting to turn cold?

Accident, my foot.

The gas trade in Eurasia is conducted primarily under “take-or-pay” contracts, which obligate the buyer to pay for the contracted amount, regardless of whether they take the gas or not.  The Russians buy from Turkmenistan under take-or-pays, and sell to Ukraine and Eastern and Western Europe under such contracts.

Problem is, nobody is taking or paying.  Ukraine renegotiated its take-or-pays under the threat of neither taking nor paying.  Russia infamously balked on its take-or-pay obligations to Turkmenistan, and in so doing, caused an explosion in Turkmenistan’s pipeline system.  Both countries are still at loggerheads.  Now Europe is balking at paying the Russians:

Europe’s three largest purchasers of Russian gas – German E.ON, Italian ENI and Turkish Botas – have all challenged Gazprom over paying for deliveries of gas that they contracted for but did not take due to reduced demand in 2009.

These three, along with other European companies, all have long term “take or pay” contracts with Gazprom. According to  Kommersant Daily the total amount due to the Russian concern is approximately $2.8 billion.

The European’s point out that Russia made a deal with Ukraine that released the later from paying the full sum of contracted gas earlier this year and they insist on the same treatment. The companies also point out that Russia did not pay Turkmenistan any compensation whatsoever after it ceased taking delivery of Turkmen gas in April.

Once upon a time take-or-pays were common in the US too.  An excellent paper by Scott Masten and Keith Crocker in the AER in 1985 argued on classical transactions cost economics grounds that these contracts were to protect site specific investments in gas wells.  In those days, gas was purchased by pipelines that both transported the gas, and served as merchants: they bought the gas at the wellhead and sold it to industrial users and municipal utilities.  Given the natural monopoly aspects of gas transportation, this “bundling” of merchant and transport functions created a potential for holdup.  Once a well was in the ground, the (usually one) pipeline capable of shipping the gas could opportunistically demand a lower price, particularly when demand was low.  Masten and Crocker showed that take-or-pay was like a pre-packaged expectations damages clause that gave the parties an incentive to perform when the buyer would otherwise have an incentive to breach.

Seismic shifts in the gas business resulting from the perverse effect of price controls; the energy price shock of the 1970s; and the subsequent deregulation of gas prices by Reagan in the 1980s; combined to wreak havoc with these contracts in the 1980s.  Many pipelines had entered into huge take-or-pays in the 1970s when there were widespread fears of gas shortages and energy prices skyrocketed.  When prices plummeted, these contracts were extremely burdensome to the buyers, who sought any way to escape their obligations.  Moreover, the disparity between contract prices and market prices provided incentives for end users to try to buy gas directly from producers, and somehow secure the ability to transport the gas.

In the end, the entire structure of natural gas regulation collapsed.  Starting in 1986, the Federal Energy Regulatory Commission passed a series of orders that “unbundled” the merchant and transportation functions of pipelines.  Essentially, pipelines became regulated common carriers obligated to provide open access transportation to anyone who was willing to pay the tariff rate.

Soon thereafter, a vibrant gas market developed.  In place of negotiated contracts between big buyers and big sellers, there developed a whole array of markets, including daily markets, monthly markets, longer-term markets, futures markets, and swap markets.  Long term, take-or-pay contracts went the way of the dodo because every seller could contract directly with many buyers (who could get access to transportation), reducing the potential for holdup and opportunistic breach.

In brief, take-or-pay was largely an artifact of the integration of the pipeline transportation and marketing of gas.  Once pipelines became open access common carriers, these contracts became unnecessary, and buyers and sellers relied on more market-like arrangements.

Nothing like that is in prospect in contracting for pipeline-transported gas in Eurasia.   This is primarily true because the mother of all bundled gas companies–Gazprom–sits at the center of everything.  Indeed, Gazprom wants to extend its integrated activities into downstream marketing.

With an integrated Gazprom in the middle, European buyers cannot contract with Turkmenistan directly, meaning that the Turkmen need some contractual protection against expropriation.  Similarly, with all its specific investments in pipelines and producing fields, Gazprom is potentially vulnerable to holdup and opportunistic, inefficient breach, by buyers.  There is unlikely to be any prospect for the development of a vibrant gas market resembling that of the US anytime soon given the integrated, monopolistic market structure, particularly in Russia.

This also means that pricing mechanisms in contracts will have to rely on relatively inefficient proxies, like lagged oil prices.

But, as current events demonstrate, and as events in the US in the early-80s showed, take or pay contracts are also subject to breach when contract prices diverge from market values.

Things are not likely to change for the foreseeable future because Putin has announced his intention to retain the integrated, export monopoly structure of Gazprom:

Russia will maintain gas giant Gazprom’s (GAZP.MM) export monopoly in the medium term but will seek to liberalise the domestic gas market, Prime Minister Vladimir Putin said on Tuesday.

“In the near future we will try to liberalise the domestic market…, will try to liberalise access to pipelines. But the monopoly for sales on external market will be maintained…in the medium term for sure,” Putin said.

If in the long run we’re all dead, I guess in the medium run we’re all old.

It is an interesting question as to why Russia relies on an export monopoly to extract rents, rather than other mechanisms.  For instance, as in the oil market, Russia could permit open access to its pipelines and permit direct contracting between buyers and sellers, but charge a hefty export tax.  It does something analogous to this in oil.  Alternatively, it could permit direct contracting and open access common carriage, but instead of setting tariffs at levels sufficient to provide a competitive rate of return, it could set them at monopolistic levels and extract rents that way.

Both mechanisms would like be more efficient than the current system, with an integrated export monopolist.  These mechanisms would involve deadweight losses from monopoly/monopsony pricing, but would mitigate the transactions costs associated with the current structure.  Under these schemes, markets for gas could develop that would price efficiently, and which would be more flexible and less susceptible to the kinds of misalignments so evident today.  That is, transactional hazards would be mitigated under such alternatives.

So why not do it?  I have some cynical explanations.  Most importantly, the current opaque and convoluted system maximizes the potential to siphon off rents to private/siloviki pockets–or should I say the private accounts of public officials?  The tax alternative would result in monies going to the government; not that government monies are immune from theft, but it is likely easier to divert the money directly from Gazprom.  Moreover, it would give more folks a license to look into the company’s operations.  It would also expose those in Gazprom who do shady things to try to circumvent the taxes to the risk of ending up in a jail cell next to Khordovsky.

Similarly, the creation of efficient markets and fixed tariffs would make Gazprom’s finances much more transparent.  People would have a better idea of Gazprom’s real revenues, and the efficiency of its operations.  The company’s finances would be a lot simpler, and given this simplicity it would be easier to detect the diversion or tunneling of funds.   Put differently, an unbundled pipeline company with a regulated tariff provides fewer–though not zero–opportunities for theft than an immense corporate octopus engaged in all sorts of opaque deals.  The merchant function in particular permits all sorts of deals with shady intermediaries that can be–and almost certainly are–used to divert monies into silovik pockets.

Given these realities, it is likely that the Eurasian pipeline gas market will continue to be burdened by high transactions costs and inefficient contracting practices.  Contractual breaches and supply cutoffs will be chronic, especially when gas values move a lot one way or another.  In contrast, the open access US market has shown its ability to deal efficiently and rapidly with extreme shocks to supply and demand conditions.  But Gazprom ain’t going open access in the medium term, and in my view, in the long term either barring some miraculous change in the political economy of Russia.

Congressional proposals regarding derivatives on carbon dioxide subject these products to the most onerous regulatory regime: they require trading on exchange, just like derivatives on agricultural products.  This probably reflects the fact that those legislators who are most concerned about carbon vapor are the same ones who get the vapors from derivatives.

The International Emissions Trading Association has warned against such a cramped regulatory regime:

The rules for buying and selling pollution credits under a proposed U.S. “cap-and- trade” program shouldn’t be tougher than those being debated in Congress for other markets, the  International Emissions Trading Association said today.

Geneva-based IETA, whose members include  Chevron Corp.,American Electric Power Co. and  Goldman Sachs Group Inc., said in a  report that “future financial services reform legislation should supersede the carbon market oversight provisions” of any cap-and-trade legislation that passes Congress

. . . .

Some lawmakers have expressed concern that a new U.S. carbon market may be more vulnerable than others to manipulation and fraud. They are considering special rules for the cap-and- trade program that would restrict OTC dealing in futures and other derivatives contracts, block the involvement of banks and impose price controls.

‘Out of Step’

These proposals are “out of step” with the new regulations being considered for other markets, IETA said. The group said concerns over manipulation and fraud can be dealt with through “stringent disclosure requirements of all OTC transactions” to the Commodity Futures Trading Commission.

The group said while lax oversight can enable fraud, “overly cumbersome oversight rules can discourage market participation, stifle investment, raise compliance costs, and threaten the program’s environmental performance.

The IETA concerns are quite sensible: the very onerous regulations in the Waxman-Markey (ACES) bill are not.

I’ve written in detail about the problems with the ACES regulatory scheme in a piece for the Brookings Institution that will be coming out in a volume later this fall.  It is available online now (follow the link).

Here are some of the arguments I make there, in brief:

Manipulation of carbon derivatives would not be impossible: even though the costs of delivery are theoretically zero (involving only book entries), just as in Treasury markets there will be frictions that can be exploited by a manipulator.  However, it is better to deter such manipulations ex post than attempt to prevent them by imposing tight trading regulations.

Moreover, an exchange trading requirement will prevent many market participants from realizing the risk management benefits of derivatives.  Most firms that face carbon price risk (in the event of the adoption of a cap and trade scheme) will face long-lived exposures that interact in a complex way with other risk exposures.  For instance, in a cap and trade world a power plant faces risks from power prices, fuel prices, and the quantity of power generated, as well as carbon prices.  Moreover, these exposures are likely to be non-linear in nature (due to the options inherent in plant operations, like the ability to turn it on and off, and perhaps fuel switching options).  In addition, they are likely to be very long-lived, because the plant is long-lived.

In contrast, most liquid exchange traded derivatives are simple, vanilla, linear products (forwards) with short maturities, or simple vanilla options with shorter maturities.  These are not well-suited to managing the complex risks that many carbon-intensive companies are likely to face.

Furthermore, the costs of rigid mark-to-market collateralization are high, and many market users could avoid these costs by trading customized OTC products.

This all means that requiring only exchange trading of carbon derivatives is likely to greatly increase the costs, and reduce the effectiveness, of carbon price risk management.  This will force firms exposed to carbon risk to bear risks that cost more for them to incur than it would cost the potential counterparties of customized derivatives.  By impeding efficient risk transfer, onerous regulations will increase the costs of a cap and trade system.

This is bad public policy.  Congress should be looking for ways to mitigate the costs of a CO2 trading system, not increasing them.  Impeding carbon risk management would do just that.

The joys of dealing with Putin’s Russia.

First, from Stratfor:

The Israelis also understand the Russia factor. Russia is engaged in an ongoing struggle to win Washington’s recognition of its influence in the former Soviet region. So far, the United States hasn’t given Russia what it wants. Consequently, Russia continues to flaunt the leverage it has with the United States over its ties to Iran. Not only can Russia completely destroy the effectiveness of a U.S.- led sanctions regime, but it can provide Iran with critical weapons systems that could seriously complicate an attack against Iran down the road. The Israelis simply are not seeing the value in delaying much longer.

Israel therefore is leaning heavily on the United States to reach some sort of compromise with Moscow and bring the Russians in line on the Iran issue.

Russian President Dmitri Medvedev made a statement on Wednesday that might indicate that such a compromise has a chance — however slight — of happening. “I told the president of the United States that we think it necessary to help Iran make the right decision,” Medvedev said, with just the right touch of ambiguity. “As for various types of sanctions, Russia’s position is very simple, and I spoke about it recently. Sanctions rarely lead to productive results, but in some cases, the use of sanctions is inevitable. Ultimately, this is a matter of choice, and we are prepared to continue cooperating with the U.S. administration on issues relating to Iran’s peaceful nuclear program, as well as other matters.”

This is a notable shift in tone coming out of Moscow, but does not yet signify that a deal has been made between the Americans and the Russians that would alleviate the crisis over Iran. Our Russian sources are hinting that something bigger may be under way, but they also have made it clear that this is just the beginning of negotiations. One source in particular has indicated that thus far, Washington is at least considering a Russian demand to postpone the U.S. deployment of a Patriot air defense battery in Poland. In return, Moscow would stick to its pledge to delay delivery of the S-300 strategic air defense system to Iran. In essence, this would be a mutual commitment to postpone commitment to their strategic allies.

A few comments.

First, many US commentors and Obama cheerleaders have seized on Medvedev’s words–which Stratfor rightly characterizes as ambiguous–like drowning men grasping at straws.  Note: (a) Medvedev doesn’t matter, Putin does, (b) there is so much wiggle room in this statement it means nothing, and (c) there are more examples of Russian now-you-see-it-now-you-don’t, Lucy-and-the-football dekes than it is possible to count.  There’s a sucker born every minute, and anyone who relies on Medvedev’s words is a sucker indeed.

Second, note Medvedev’s use of the phrase “Iran’s peaceful nuclear program.”  That is, he does not even concede acknowledge that Iran’s program is explicitly intended to develop a nuclear weapon.  Given Russia’s enabling of Iran’s nuclear ambitions, this isn’t surprising.  But note that this formulation gives Russia a perfect escape valve from supporting any sanctions: why would you impose sanctions on a “peaceful” program.  Until Russia officially and unambiguously acknowledges that Iran’s nuclear program is military in nature, there is no reason whatsoever to place any reliance on Russian support against Iran.

Third, note the disgusting, revolting immoral equivalence here.  Iran=Poland.  On the one hand: A totalitarian dictatorship that supports terrorism; a virulently anti-American and anti-Western regime; a Holocaust celebrator (not denier); an aggressive, irredentist nation; a crazed, millenarian theocracy.  On the other: a democracy that has supported the battle against terror and tyranny; pro-Western and pro-American; a nation that has grappled with its anti-Semitic past; a nation that is merely looking to defend itself from the predations of outsiders rather than dominate others; a religious, but politically secular country.

Contra Obama, and pace Mark Steyn: Nations should be–must be–defined by their differences.  The differences between Iran and Poland are so stark that the foregoing list barely even scratches the surface.  To treat Poland as a bargaining chip with the Russians in dealing with Iran is beyond disgusting.

And note: the Russians will just take any concession and ask for more.   Note very well: when it comes to Eastern Europe, the former Soviet space, and Poland in particular, Russia wants the United States to make very public concessions so as to undermine American credibility among these nations, all the better to induce them to reach an accommodation with Russia: an accommodation that will effectively concede Russian suzerainty.

Iran is important.  But to make concessions to Russia in the vain hope of making progress on containing the Iranians would be a strategic mistake of historic dimensions, not to mention a deep stain on American honor.  (How’s that for Jacksonian, Steve?)

Russian grabbiness is not limited to the diplomatic sphere.  It also extends to energy.  (You’re shocked to read this, I’m sure.)  Yes, Putin the Spider (too bad his first name isn’t Boris) is more than willing to lure Western energy firms into his Arctic web, but on his terms:

This looks like a proposal to form a cartel-type arrangement of gas (mainly LNG) exporters through price-formation and market share allocation. Russia would provide the gas resources while international companies would provide the technology and, presumably, share in a commercial bonanza through this arrangement. Moscow probably hopes that some international companies would vie with each other to be picked for the project on this basis.

The conditions for participation would, however, force the international companies to turn over to Gazprom their own competitive assets and lose some of their revenue sources. As spelled out by Shmatko and Economic Development Minister Elvira Nabiullina, international strategic partners in this project would be asked to: transfer Western technologies for the manufacturing of advanced drilling equipment, onshore and offshore, to Russia; allow Gazprom direct access to gas markets in consumer countries, using the distribution networks of partner companies; recognize a right for Russian companies to acquire energy infrastructure on territories of consumer countries; and assist Gazprom with marketing methods and personnel training (Interfax, RBK, September 24).

So, Russia gives access to Yamal in exchange for: money, technology, expertise, access to Western domestic markets (which Putin knows will be protected by Western legal norms), marketing, and training.  And, rest assured, that access to Yamal and the goodies of the cartel arrangement can be taken away at a whim–and likely will be taken away once the gas actually flows.

In other words: asynchronous performance.  The Western companies do everything today: the Russians “promise” to do something later.  Another sucker’s game.

Will there be any suckers to play?  Sad to say, the answer is likely “yes.”  I would hope that anti-trust authorities in nations intending to import Yamal gas, and in nations whose companies would participate in the project, will subject any such agreement to intense scrutiny.

The energy majors–and the Europeans–would be much better advised to do things like ramp up exploration of shale gas in Europe than invest huge sums in Yamal.

One has to have some grudging admiration for Russia’s aggressive negotiating, given its fundamental economic, demographic, political, and social weaknesses.  By the same token, one has to have nothing but disdain for those who seem more than willing to be duped and pushed around by a has-been giant with feet of clay.

Russians have a reputation for being a dour, humorless people.  I know this is wrong.  There are some great Russian comedians; and no, I’m not talking about Yakov Smirnov.  Take Vladimir Putin–please.

Consider this comic classic: “Putin seeks stable and long term partners for Arctic investments“:

Russia wants foreign energy majors for “stable and long-term” partnerships to develop gas deposits on the Arctic peninsula of Yamal, a region with enough gas in the ground to satisfy world demand for five years.

Prime Minister Vladimir Putin, hosting executives from several international energy companies on Thursday, said Russia would consider tax breaks to encourage development of gas fields in the region. State giant Gazprom (GAZP.MM) backed the move.

“We would like you to consider yourselves participants in our undertaking,” Putin told a meeting in Salekhard, the capital of the Yamalo-Nenets region. “The main condition from our side is that partnerships should be stable and long-term.”

“The main condition from our side is that partnerships should be stable and long-term.”  From “our” (i.e, the Russian) side.  Stop it!  You’re killing me!  You’re one of the great dead-pan comics of all time!

Uhm, Vladimir.  Any “short-termism,” any “instability” that has plagued past western energy investments (and other investments, cf. Telenor), has one source, and one source only: your side.  Russian opportunism and expropriation.  And not just directed against foreigners, but against the unfavored in Russia too (most notably Khodorkovsky).

The Telegraph opines that this reflects Putin’s desperation, given Gazprom’s financial difficulties and limited technological expertise:

No doubt his guests salivated at the idea of getting a piece of the action. By 2020, Yamal is estimated to be capable of yielding up to 300bn cubic meters of gas annually. This compares with a total annual Russian production that currently stands at around 550bcm. State-owned Gazprom spends around 25pc of its capex on the Yamal fields.

But Gazprom is running late, and it’s running short – of both technology and money. It needs foreigners. The aim is to use the Yamal resources to become a major player of liquefied natural gas – which can be exported anywhere without the need for pipelines. Hence Putin’s friendly hand.

. . . .

But Western companies should pause and think. They’ve been burnt before – as when Shell was bullied out of the Sakhalin-2 gas project three years ago. Since then, the legal framework under which Western companies operate hasn’t improved a bit.

What has changed is Putin’s need for foreign capital and expertise. This would be a good thing if it were accompanied by more than words to reassure investors that their money is safe and that they can plan on staying in Russia for the long term, without the hassle of corrupt bureaucrats and judges. Westerners must seize the chance to extract serious concessions from Russia before they rush head-first into the great gas hope, in what otherwise risks being a triumph of greed over experience.

In one of my earliest SWP posts, I noted that fools and their money are soon parted, and that companies would be foolish to invest in specific assets in Russia–particularly in the energy sector, or any other sector deemed strategic.  With the experiences of Yukos, Telenor, Shell, TNK-BP, and arguably now Exxon behind them, western investors have to know that the likelihood that they will be parted from their money is very high if they fall for Putin’s come hither look, and get entangled with Gazprom in Yamal or anywhere else.

Put differently, Putin is the spider, and any investor would be the fly.  Putin may be desperate now, but once there is pipe in the ground and the gas is flowing, his (or his successors) desperation will disappear, and the temptation to expropriate will be irresistable.   Once caught in the Russian web, any foreign energy investor is likely to be the spider’s meal, sooner or later.

Like the Telegraph says, absent credible, enforceable legal safeguards, western investors should avoid Putin’s blandishments like the plague.  The existence of a resource is a necessary, but by no means a sufficient, condition for a profitable investment.  To profit, you must be able to protect the asset against the predations of the state.  These protections are completely absent in Russia.  STAY AWAY.

It is sometimes argued that, echoing Willie Sutton, energy majors have to invest in Russia because that’s where the oil and gas are.  But, Russia is the Willie Sutton of nations: it will rob energy investors because, as Willie said, that’s where the money is.  But only if they are foolish enough to put it in Putin’s reach.  If they do, it will be no laughing matter.

Russia has invited OPEC to an oil summit in Moscow, and Charlie . . . I mean OPEC has accepted:

Abdalla El-Badri, secretary general of the Organization of Petroleum Exporting Countries, accepted the invitation in a phone conversation this week, Russian Energy Minister  Sergei Shmatko told reporters in the Siberian city of Abakan today.

“We agreed that Russia and OPEC are still interested in developing partnerships in the near future,” Shmatko said.

Deputy Prime Minister  Igor Sechin told OPEC in December that the government was ready to limit output to support prices. Russia has since ramped up exports of crude oil and refined products, overtaking Saudi Arabia and causing Qatari Energy Minister  Abdullah bin Hamad al-Attiyah to say he was “fed up” with non-member producers. OPEC didn’t invite Russia to attend its last meeting in Vienna on Sept. 9, breaking with tradition.

“We will continue to cooperate with OPEC, while keeping our own national interests” in mind, Shmatko said today.

That last sentence is priceless.  Let’s see how Shmatko defines “cooperate”:

Russia, fresh from a record month of oil production, will be able to invest in new fields at current crude prices and makes no apologies to OPEC for refusing to rein in output, Energy Minister Sergei Shmatko said.

“We never had any obligations (to OPEC). When we were communicating, we never promised anything,” Shmatko said late on Thursday. “To say that we do not abide by the rules is not correct.”

Russian oil output hit a record monthly high in August, nearing 10 million barrels per day, as the world’s second-largest crude exporter launched a major new field in the Arctic and grabbed more market share from OPEC.

OPEC Secretary-General Abdullah al-Badri, speaking after an OPEC meeting in Vienna on Thursday, said the lack of any tangible cooperation from non-member Russia in the group’s output cuts “not encouraging.”

Russia took a hit when oil prices plunged last year, stripping the country of a vital source of budget revenues. A bounce in the oil price since has brought early signs of economic recovery.

“One always wants something better. One can always say that, at a higher price, some projects will be more profitable, but today the price of oil does not set any limits for the oil industry’s development,” Shmatko said.

Shmatko also said Russian oil producers would be able to avail themselves of a zero duty on exports from 13 oilfields in East Siberia by the end of September. No time limit has been set for the tax breaks.

This is not at all surprising.  And, as I’ve said before, I’m all for Russia ramping up its output and undercutting OPEC.  I bring this up mainly to make the point that only fools expect any kind of reciprocity from Russia; only buffoons think that Russia will do anything but ruthlessly exploit any opportunity they are given.

The White House would have done well to heed the lesson that Russia gave OPEC before announcing its decision to shut down the Poland-Czech missile defense initiative in the hope that this wold induce cooperative reciprocity from Russia.  Instead, it has ignored it, raising the distinct possibility that fools and buffoons are in charge of American foreign policy.

I’ll be speaking on a panel on Systemic Risk and Speculation at the CME this afternoon at 2PM Central.  The event will be webcast.  Here’s the link.  Click on the grey box on the right-hand-side of the page to get to the webinar: registration is required.  The panel should be quite interesting.