Streetwise Professor

March 14, 2012

Gazprom: Disconnected From Commercial Reality

Filed under: Commodities,Derivatives,Economics,Energy,Politics,Regulation — The Professor @ 9:06 am

Gazprom is having difficulty making inroads into Asia generally, and into the LNG market particularly.  Its problem?  Apparently so used to dealing with Europeans who have few outside options (yet), the company is incapable of operating in a competitive environment.  It is fixated on maintaining its traditional oil-linked pricing formula, despite the facts that (a) in the US natural gas prices on an energy equivalent basis have fallen to an all time record low vis-a-vis oil, and (b) US firms, notably the Cheniere Energy* mentioned in the Bloomberg piece, are gearing up to export LNG, particularly to Asia, making the US the likely supplier of the marginal mmbtu of gas, and hence making it the world price setter:

OAO Gazprom (GAZP), the world’s largest natural-gas exporter, is struggling to get a foothold in the Asian markets leading global economic growth.

The Russian company’s plan to supply liquefied natural gas to India from 2016, the year the U.S. is set to start gas exports, is faltering after buyers said they’re looking for cheaper fuel from North America. Last year, decade-long talks to supply pipeline gas to China foundered over price disagreements.

“Gazprom has a major problem of having a fixed view on what the price of gas should be, irrespective of market conditions,”Jonathan Stern, chairman and senior research fellow at the Oxford Institute for Energy Studies, said by e- mail. “If this continues, it will create increasing problems for Russian gas exports.”

“Irrespective of market conditions.”  Yup.  That’s the Gazprom way, and that way doesn’t work when it’s not the market.   In contrast, Cheniere is linking LNG prices to US natty gas prices:

GAIL India Ltd. (GAIL), the country’s largest gas supplier, became the first Asian buyer of U.S. natural gas in December when it signed a 20-year deal with Cheniere Energy Partners LP (CQP), which is planning the first U.S. export terminal. The contract, targeting 3.5 million tons a year starting in 2017, is linked to the day- to-day U.S. benchmark gas prices, which fell to a 10-year low of $2.21 a million British thermal units in January. It will also include a fixed component.

Note that this also permits companies like GAIL to lock in a fixed price fairly easily, given its ability to use derivatives to swap floating prices into fixed ones.  (The fixed component in the formula mentioned above covers liquification and transportation costs.)

Gazprom is a hidebound organization, grotesquely inefficient, notoriously corrupt, and unused to and arguably incapable of operating in truly competitive conditions.  It has a guaranteed monopsony at the upstream end (being the only company permitted to export Russian gas) and has traditionally sold in markets downstream where there is little, and often no, competition from other sellers.

Its disconnect from commercial reality grows with every widening of the difference between gas and oil prices.  It can insist on its self-serving formula, but as the US becomes a major exporter of gas-as fundamentals imply that it should be-its insistence will make it an also ran in the LNG market.

Right now, Gazprom’s biggest hope is that political resistance to gas exports in the US lead to bans or limitations on those exports, or the approvals and permitting for export terminals getting bogged down in the American bureaucracy.  Usual Suspect Ed Markey (D-MA) has introduced a bill to ban gas exports.  This will not go anywhere, but it does give edgy Asian buyers pause.  In the aftermath of Keystone XL, moreover, it is clear that failure to secure regulatory approvals can delay or derail altogether extremely beneficial energy initiatives.

Ironic, isn’t it, that Gazprom’s biggest hopes may be in DC: The White House, Capitol Hill, and FERC (which is responsible for permitting LNG export facilities)?

* Full disclosure: #1 daughter works for Cheniere. Any reader of this blog knows, however, that my criticism (ridicule, really) of Gazprom and my commitment to free trade long pre-date her employment there.

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  1. They are trying to put an LNG export facility in the Port of Coos Bay. Envo’s are opposed.

    Comment by Jim Verger — March 14, 2012 @ 9:11 am

  2. Don’t they always, Jim. And they consider themselves “progressive” to boot. I guess they think its progressive to advance the interests of one of the most loathsome companies in the world, that is the main support to a loathsome regime and its rent seeking parasites to boot. I guess they also think it is progressive to make it more expensive for poor people in poor countries to get energy. I guess they also consider it progressive to make a less-polluting fuel more expensive, thereby encouraging the use of far dirtier coal. What accomplishments! They should be so proud.

    The ProfessorComment by The Professor — March 14, 2012 @ 9:17 am

  3. Maybe exporting coal out of the same port. Envo’s in Eugene really upset as the rail line passes west of there. Dust is the concern. An announce on this project may come as soon as the end of the month. You can imagine how much outside money has shown up to resist both projects. Fun to watch!

    Comment by Jim Verger — March 14, 2012 @ 9:21 am

  4. But even the coal is likely to be relatively clean Powder River Basin coal, which would displace much dirtier stuff (mined in appallingly unsafe conditions to boot) from China. I thought these people cared about the global environment, and people everywhere. Apparently not.

    This is one of the most maddening things (and the list is long) about enviro campaigns. They are utterly clueless about trade-offs. Utterly. As a result they routinely push policies that are actually contrary in effect to their purported beliefs and goals. It is usually moral preening, often subsidized by those with a very clear economic interest (e.g., Warren Buffett opposing Keystone XL because his BNSFRR is coining it hand over fist by shipping oil by rail from ND and Canada to the Gulf).

    The ProfessorComment by The Professor — March 14, 2012 @ 9:31 am

  5. I have just this moment (really, just this moment) come from a session with one of the top executives of one of the world’s largest oil and gas companies in which he was asked “What was your biggest challenge of 2011?” Without hesitation his response was “Our decision to increase our investment in Russia.” He went on to say in no uncertain terms that Russia is one of the riskiest places to do business (this for a company which has investments in Nigeria, Angola, Democratic Republic of Congo, Iraq, and Syria) and investors are requiring ever more persuasion that investing in Russia to develop their oil and gas reserves is a good idea. The way things are going, most Russian gas will remain in the ground due to lack of anyone willing or able to extract it. Finding customers may becomea secondary issue. Talk about playing a strong hand badly.

    Comment by Tim Newman — March 14, 2012 @ 12:18 pm

  6. […] Craig Pirrong, aka the Streetwise Professor&#44&#32&#104as an even harsher judgement: […]

    Pingback by Here’s Why Gazprom Is Getting Whupped In Asia – Finding Out About — March 14, 2012 @ 12:25 pm

  7. @Tim-thanks as always for that inside-baseball (or would it be inside-cricket?) tidbit I am glad that the supermajor exec is worried about his decision to increase investment in Russia, as his rationale makes perfect sense. My only question is: what information could he have obtained since making the investment to make him understand that it is one of the riskiest places in the world to do business? Seems gobsmackingingly obvious, IMO, at least on any investment post-Sakhalin II.

    I write frequently about Gazprom’s obsessions with oil-linked gas pricing because I think it demonstrates in microcosm what a completely effed up company it is. The reason for the preference is clear. But hell, every seller would like a formula that resulted in massive overpricing. Most come to realize that you have to accommodate market realities, which Gazprom does only grudgingly. I also find the arguments they usually offer in defense to be unusually stupid and again revealing no understanding of the way markets really work .

    But you are right. If the stuff never gets out of the ground b/c of the political risk, not having customers or not having a realistic pricing formula is irrelevant.

    Thanks again. Always appreciate the insight/info.

    The ProfessorComment by The Professor — March 14, 2012 @ 1:36 pm

  8. You loathe enviros while linking to freakin’ Twitter lunatics obsessed with regime change who spread lies (i.e. ‘Ron Paul is a Nazi/Stalinist whatever’) like Josef Goebbels. Hypocrite, fake libertarian, always cluck clucking about the company they keep while keeping company on Twitter with some of the weirdest, most obsessive hacks Coinintelpro has ever vomited up.

    And why are you so obsessed with the fact that much of the Stratfor were done under FBI kontrol anyway? Alex Jones said these hackers were being used by the feds months ago, but he’s a conspiracy theorist nut job for saying that, clearly.

    Comment by Mr. X — March 14, 2012 @ 5:55 pm

  9. My only question is: what information could he have obtained since making the investment to make him understand that it is one of the riskiest places in the world to do business?

    Oh, they understood the risks way before, which was why making the investment was the hardest decision of the year. He partly answered your question in his follow-up: Russia simply has too much oil and gas to ignore, and despite the risks, companies must try to find ways of developing its reserves. Making very difficult things happen is one of the main reasons supermajors exist.

    Comment by Tim Newman — March 15, 2012 @ 12:26 am

  10. Actually, perhaps I should have asked why we have also invested heavily in US shale gas. I guess between Russian LNG and US shale, one will gain at the expense of the other, depending on who fucks up their strategy the most. I’m wondering if our execs. have spotted this and are ready for either scenario.

    Comment by Tim Newman — March 15, 2012 @ 6:14 am

  11. @Tim-Was this exec a ringer for the monster in Young Frankenstein but with a somewhat larger vocabulary? Does he look fit enough to outrace the pitchfork bearing crowd through Red Square? And finally did he pass the hat for Obama at the end of the meeting? The IChicago money connection runs strong with that one.

    Comment by pahoben — March 15, 2012 @ 6:37 am

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