Streetwise Professor

August 10, 2015

Gazprom Has Unprotected Sales, And Pays the Price

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 5:40 pm

I have long mocked Gazprom’s obstreperous, and economically unhinged, defense of an oil price peg of its gas sales. So today is another schadenfreude day, as the FT reports that Gazprom’s vaunted gas deal with China is finding that The East is Red (as in ink) because the price was linked to oil and “offers no protection against low [oil] prices.” (And despite the evident risks of going without protection, Russia is contemplating a ban on foreign condoms! Maybe Gazprom needs to be more “strict and discriminating” in its contracting practices.)

Apparently the company took strategic advice from Obama, who when asked by Fareed Zakaria what would happen if the Iran deal failed, said that “I have a general policy in big issues like this not to anticipate failure“:

Asked whether the contract built in protections to ensure that Gazprom would not make a loss in the event of a prolonged period of low oil prices, Pavel Oderov, a director at the company, said: “We have registered high risk appetite for this contract and we do not envisage such an event.”

By “high risk appetite,” I think he meant: “we were freaking desperate and we put it all on black (as in oil) to gamble for resurrection.”

And of course, Putin can’t let Gazprom eat a loss:

Separately, the Russian government is preparing to support the flagship project. According to a document published by the Kremlin on Monday, president Vladimir Putin ordered the Russian government to draw up by the start of September a “comprehensive action plan to ensure government support for the construction of gas transport infrastructure, including the Power of Siberia pipeline”.

Like the Russian government has money to throw around, especially since Gazprom (and Rosneft) are supposed to be the cash cows that feed the rest of its corrupt cronies, and the budget.

Insisting on the oil peg was always nuts. Note that one reason why many buyers of LNG want to move away from the oil-link is to diversify their price risk: that’s exactly why Russia, already a huge oil long, should have jumped at the chance to move away from a 100 percent reliance on oil price linkages. Yes, oil and gas prices are correlated, but imperfectly so, and moving away from oil-based pricing for gas would have reduced the country’s exposure to oil prices. But apparently Gazprom management and Putin believed that oil would always outperform gas, and insisted on the link. Be careful what you ask for, Vlad!

This is just the latest in a litany of Gazprom failures. Along with today’s bad news about the China contract-the cornerstone of Putin’s vaunted pivot to Asia-the company disclosed that production was down and sales to Europe were down in the first quarter. The company’s ruble profits rose only because the ruble cratered: talk about the cloud engulfing the silver lining. Further, the Turkish Stream project appears dead in the water, foundering upon-you guessed it-the inability to negotiate a price. That, and the cracked economic rationale for the project.

The world is finally awakening to the fact that the alleged energy behemoth is in fact an economically incoherent mess. In the US, it would have been taken over, and ruthlessly rationalized. Or put into rehab. Or broken up. But Putin continues to let it blunder on, like a vodka-sotted giant.

Not so long ago, Putin was considered some sort of virtuoso. He apparently thought so too. But now everything that used to work for him is self-destructing. And he seems quite bewildered at his turn of fortune.

In truth, Putin was not a virtuoso: he confused luck–high oil prices–for some sort of strategic genius. He was a huge spec long on oil, and looked brilliant when the price was high. When it is low, not so much. And idiotically, one of his champions insisted on increasing that exposure instead of diversifying away from it.

Well played. Well played.

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  1. sophomoronic question
    But why, if the costs of drilling and transportation are the roughly the same, should Gazpeom nor link to oil. The end user is only interested in the energy return. So should be indifferent in a global market.

    Comment by James Harries — August 11, 2015 @ 3:39 pm

  2. @James-in the long run, the supply side factors you suggest should lead to a convergence between the prices of oil and gas. But in the short or medium run, oil and gas are not close substitutes in most uses: not all BTUs are interchangeable. For instance, natural gas is a poor substitute for oil in most transportation uses. Indeed, over recent years, substitutability has declined: whereas oil was often used in power generation, it is now almost never used for this purpose. As a result, gas and oil BTU values can diverge substantially for extended periods of time.

    The ProfessorComment by The Professor — August 11, 2015 @ 5:32 pm

  3. Much more difficult to transport the relatively diffuse BTUs of gas compared to relatively dense BTUs of oil. BTUs per unit volume much different.

    Funny that the oil shale (not shale oil) in the western US that contains Kerogen and is sometimes touted as providing the US the oil reserves of Saudi Arabia has a similar BTU content per unit volume as baked potatoes. Shell had a brilliant development plan that included a nuclear reactor constructed new to provided the power needed to recover usable hydrocarbons.

    Comment by pahoben — August 12, 2015 @ 2:56 pm

  4. Putin’s Pivot (VVPP) to the east took another spin in the wrong direction today….

    Comment by Wilhelmus Janus — August 12, 2015 @ 3:03 pm

  5. The Shell plan was absurd enough that the DOE must have been writing checks.

    Comment by pahoben — August 12, 2015 @ 3:24 pm

  6. @pahoben-Was that Shell plan concocted in the Carter era? I have a vague recollection of seeing a video at the Naval Academy in 1977 or 1978 touting the potential of oil shale. It plugged the same “as much oil as Saudi Arabia” propaganda. I don’t recall the nuclear generator angle, but it was pre-Three Mile Island, when new nuclear was still potentially viable. By 1979, no way.

    The ProfessorComment by The Professor — August 12, 2015 @ 4:05 pm

  7. @Professor
    Yes-I think your timeline is spot on.

    Now the power would have to be provided by square miles of solar panels to receive DOE funding. 🙂

    Comment by pahoben — August 13, 2015 @ 4:00 am

  8. @Professor
    Just ballparking it maybe 15 square miles of solar panels and maybe 2,000,000 10kwh Musk Powerwalls to equal the Three Mile Island pre incident output and adequate for the Shell Project power requirements. Kinda pricey but hey a good grant proposal. Crap ideas like this worked for Musk so a fortune to be made.

    Comment by pahoben — August 13, 2015 @ 5:03 am

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