Streetwise Professor

October 22, 2011

How Do You Know Gazprom’s Medvedev is BSing? His Lips Are Moving.

Filed under: Commodities,Derivatives,Economics,Energy,Politics,Russia — The Professor @ 1:50 pm

By the sounds of this speech by deputy chairman Alexander Medvedev, Gazprom is indeed feeling that its beloved oil-linked pricing mechanism is under siege.  Medvedev’s tone is very defensive, and his arguments risible.  How risible?  Let’s deconstruct.

Fail #1:

“Oil-indexed , long-term contracts that ensure the basic supply volumes from Russia, Qatar, Norway and Algeria… are exactly the mechanism that protects all the parties, since the gas market is not like, for example, the fish market, where you can catch, sell, and make a profit in one day,” Medvedev said.

Well.  Oil isn’t like fish: don’t catch, sell, and profit in a day on oil.  But there are vibrant spot and term markets for oil: oil prices aren’t linked to anything else, but fluctuate minute-to-minute with market forces.  And gas isn’t like fish either, but there is a vibrant spot and term gas market in North America.  So it’s obviously nothing inherent in gas as a commodity that precludes the development of a vigorous spot market, or necessitates oil-linked pricing.

Jeez, apparently Medvedev has been consulting with Gensler about inane market analogies.  Gensler: apples.  Medvedev: fish.  Both: lame.

Fail #2:

“Two-and-half years of abominably low spot prices in Europe have created the illusion that gas has lost its link to oil once and for all. This is not true.

So gas has decoupled from gas in the short run.  Even if they recouple in the future, gas is always coupled with gas.  A gas-based pricing mechanism can never become decoupled from gas, but gas and oil can become decoupled.  So the movement away from oil-linkages towards reliance on robust gas pricing mechanisms reduces the risk of decoupling and more efficient pricing.

Fail #3:

Spot-price trading is incapable of giving correct price signals to the market due to the small volumes and low liquidity.

Trading volume is endogenous.  Liquidity feeds liquidity.  As the US experience shows, liquid and deep cash and derivatives markets can develop very quickly given the right structural conditions: movement away from oil-linked mechanisms would accelerate this process dramatically.  What’s more, the Dutch gas hub is already pretty liquid, as is the UK’s National Balancing Point.  They certainly give better pricing signals than oil.  They will only give more accurate signals as market liquidity develops–which it will quite rapidly if oil-linked pricing and contracts fade away. Moreover, prices that don’t reflect fundamentals spur transactions that tend to eliminate inaccuracies.

Fail #4:

“US prices are so low they do not cover operating costs and in our opinion this situation will not last long. The situation there will return to normal and will make the US market attractive again.”

A lot of smart people are betting otherwise.

And here’s some whine to go with all that fail:

Medvedev also hit out at Europe’s efforts to reduce Gazprom’s dominance. “Natural gas has become a hostage of geopolitics in which there is an artificial demonisation of Gazprom,” he said. “Sometimes it seems that if even the export of bananas or coal were the largest source of budget revenues for Russia, it is in this area that political games would be played. We do not believe that there is an energy security problem in the EU.”

All at once now: awwwwwwwwww.  Boo-frickin’-hoo.  Poor, poor, persecuted Russia.  Poor, poor, misunderstood Gazprom.

Amazing.  Gazprom is a grotesquely inefficient state protected monopoly with a reputation for thuggishness, corruption, and opacity.  Gazprom isn’t demonized: it is justifiably reviled.  100 percent natural ingredients: nothing artificial about it.

Again, it warms the cockles of my heart to hear Gazprom attempt to defend an archaic pricing mechanism.  The defensiveness means they are feeling the heat: the silliness of their arguments makes it plain that the economics are inexorably consigning oil-linked contracts to oblivion.  The fundamentals of the gas market are changing as dramatically as the contracting practice: indeed, these fundamental changes will drive the move to new pricing mechanisms.

Medvedev knows that Gazprom is a Soviet relic that will face daunting difficulties in a more competitive environment in which gas fundamentals, not oil fundamentals, drive prices.  Gazprom is attempting to fight market forces, but in the end, market forces will win–with bleak consequences for Gazprom, and the parasitical class that feeds off it.

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  1. And that will make me very happy!

    Comment by voroBey — October 22, 2011 @ 2:37 pm

  2. This is most excellent news! And once the Russian economy collapses due to the effect of collapsing natural gas prices, We will step in to take Our rightful position of ownership of Russia’s energy sector. Then we will utilize Our new power to free Our junior colleague Mikhail and give his present place of residence to Our rebellious servant Vladimir. We will restore Russia’s tax legislation to what it was under Our dear departed assiduous servant Boris. Once more, the proper share of Russia’s national income will accrue to Capital (all of it), and Our first principle “All for Ourselves and nothing for other people.” will once again prevail in Russia, as it did during the halcyon days of Our dear departed assiduous servant Boris.

    Who knows, perhaps we can once again get the parasitic Russian population declining by a million a year! A good decimation would teach them not to aspire to more than their proper place in the natural order of things, right Finnpundit?

    Of course, any effort on GAZPROM’s part to resist market forces will prolong and deepen the present recession, just as FDR’s attacks against “malefactors of great wealth” contributed to the regime uncertainty that retarded recovery in the Great Depression.

    The duration of the Great Depression had nothing to do with the fact that the US GNP had declined from $103.6 billion to $56.4 billion between 1929 and 1933. Nothing at all.

    Comment by a — October 23, 2011 @ 3:08 am

  3. Gosh, a, you really do seem to say the nicest things all the time!

    I really like that part of “the proper share of Russia’s national income will accrue to Capital”. That’s where it belongs, after all: with capitalists. I only wish that it were true, in Russia as well as elsewhere.

    I always trust rich people to know more than government officials in deciding how to best put money to work. No government bureaucrat could possibly be in a better position, when it comes to allocating resources, than the private marketplace.

    Comment by Finnpundit — October 24, 2011 @ 4:28 pm

  4. …and as for President Medvedev his lisps are moving.

    Comment by pahoben — October 25, 2011 @ 6:31 am

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