Streetwise Professor

October 12, 2010

Po prostu powiedz nie do Gazpromu

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 3:53 pm

One of the first things I wrote on Russia was “Just Say No–to Gazprom,” published in Energy World Magazine in July, 2006.* Apparently the Poles didn’t have a subscription, as they seem bent on saying yes to Gazprom’s terms for a verrrrryyyy long term gas contract–with deliveries running out to 2037(!).  Vladimir Socor lays out some of the terms of the agreement:

1) Packaging the new agreement with the 1993 inter-governmental agreement on transit of Russian gas via Poland and deliveries to Poland, which runs to 2022; and setting the duration of deliveries by contract until 2037. All this would help Gazprom to continue monopolizing the Polish market for that duration, preventing diversification of Poland’s natural gas imports and discouraging investment in the LNG project.

2) Exclusive right for Gazprom to use the Yamal-Europe pipeline in Poland until 2045. This would consolidate Gazprom’s position in Poland and Germany for another generation.

3) Europolgas to retain ownership as well as commercial and other operating rights on this pipeline. Thus, Gazprom would be able to lock out any competitors, also precluding reverse-use of this line.

4) Poland’s national transmission operator, Gaz-System, to become technical operator of Yamal-Europe in Poland, limited to a service provider’s role. This would fall far short of the operator’s independence from the supplier.

5) Deeply discounted transit fees to remain in force on this pipeline. The discount is intended not only for Gazprom’s profit, but also to deprive Poland of plough-back funds for modernizing this pipeline independently of Gazprom.

6) A ban on Polish re-export of Russian gas to third countries, with a right for Gazprom in that case to reduce its gas supplies to Poland by a corresponding amount. This is in line with Gazprom’s traditional third-country clause, irreconcilable with the EU’s gas market legislation.

All of these terms serve to tie Poland’s hands, and perpetuate both its and Europe’s dependence on Gazprom–and its vulnerability to opportunistic behavior in the future.

This very long term arrangement would be very short-sighted, just from a narrow Polish perspective.  There is tremendous uncertainty about the gas market right now.  Shale has already revolutionized the market in the US, and the effects are so large that it is having spillover effects around the world.  There are very real prospects for shale to have similarly dramatic impacts in Asia and Europe.  LNG potential is also great, and the interaction between shale and LNG technologies could further transform gas markets.  Traditional relationships in the Caspian are changing, and quite volatile; gas that once moved only through Russia and by Russian sufferance, now could move in myriad directions to myriad markets.  Ditto the Middle East, with the Kurds in Iraq representing a real wild card, and in the longer term, the possibility for Iran to become a viable supplier.  The European gas market is liberalizing, and there is a real prospect for a spot market developing in the near- to medium-term.  All of these factors have the potential to enhance dramatically flexibility in obtaining supplies, and undermining the need for any consumer to rely on a particular producer and pipeline system.

The trends are against Gazprom, and even discounting the trends, the incredible amount of uncertainty about future supply prospects and transport technologies dramatically enhances the real option value of waiting before locking into legacy supply relationships for more than a quarter century.

This is exactly why Gazprom is so hot to do this deal now, and why it is attempting to impose all these restrictions that would sharply constrain Poland’s ability to respond to favorable supply shocks in the future.  That’s perfectly understandable: what’s more mysterious is Poland’s haste in doing a deal on terms that do not reflect Gazprom’s strategic weakness over the coming decades.

And it’s not as if Poland will benefit greatly if these developments do not pan out, and legacy production and supply systems remain dominant.  If that happens, Gazprom will act opportunistically and attempt to exploit its greater power (unconstrained by these new supply sources that proved chimerical) in the future.  In other words, this is pretty asymmetric from Poland’s perspective: they give up the opportunity to benefit from favorable supply developments, but will be at Gazprom’s mercy if those favorable developments don’t occur.

Thus, this doesn’t make sense from a purely Polish perspective.  But there’s also an externality involved: Poland dealing with Russia means that it will succumb to the typical disaggregation/divide-and-conquer strategy so beloved of Russia and Gazprom.  This will redound to the disadvantage of Europe.  Europe, therefore, is attempting to pressure the Poles not to sign this deal.  The European Commission claims that the deal contravenes EU law.

Poland, as so often in the past, is caught between Western Europe and Russia.  But the choice should be an easy one.  EU and Polish interests are aligned: Polish and Russian interests are not.  If this lot of Polish pols does the deal now, Poles and pretty much everybody to the west will be paying the price for a long time to come.

* That’s a gated link.  I’ll try to get a PDF put online.

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  1. Either Poland is failing to act in its national interest – or the Poles are significantly more pessimistic on the future prospects of shale gas than SWP, and want to lock in supplies now before they’re snapped up by someone else.

    Comment by Sublime Oblivion — October 12, 2010 @ 5:35 pm

  2. 1. That’s exactly why I framed it in terms of uncertainty and the (real option) value of waiting, S/O. Again, read and understand before reacting. I quote: “even discounting the trends there is an incredible amount of uncertainty etc.” In conditions of uncertainty, the value of the option to wait is great.
    2. Uhm, just who else is going to “snap up” gas in Yamal? Relatedly, that’s the Russian’s problem. The gas is in an isolated location, costly to explore and produce from, costly to transport from, and with pretty much one outlet. It ain’t going to China. The only market for it is Europe. Period. Another reason for the Poles to sit it out. That Yamal gas ain’t going anywhere.
    3. Finally, the asymmetry in performance risk is great. Gazprom/Russia have a track record of turning the screws when fundamentals turn in its favor, contracts be damned. Moreover, losing gas in the winter in a contract dispute is a helluva lot more costly than not selling the gas then, but selling it at a future date. And the Poles have little other leverage with the Russians. So if gas prices turn out to be low during the life of the contract because of favorable supply developments (e.g., shale), the Poles won’t be able to avail themselves of that being locked into a long term deal, whereas the Russians would surely make them pay if the reverse is true.

    The ProfessorComment by The Professor — October 12, 2010 @ 7:28 pm

  3. Either the Poles are stupid, or they’re corrupt (significantly moreso than the Russians), or you’re missing something.

    Comment by Andrew #2 — October 12, 2010 @ 8:50 pm

  4. Governments make mistakes all the time. All the time. In matters large and small. Governments are particularly bad at dealing with uncertainty and change in a rational way. Many politicians are fixated with the past; greatly discount the future; and are extremely risk averse. The Polish rush to embrace Gazprom reflects all of those defects.

    The ProfessorComment by The Professor — October 12, 2010 @ 10:15 pm

  5. The question begs itself: what the late Polish president would have said if he were still alive, and whether this is why he is not.

    Comment by Ivan — October 13, 2010 @ 12:55 am

  6. “The question begs itself: what the late Polish president would have said if he were still alive, and whether this is why he is not.”

    Ah, yes. Eeeevul warlock Putin cackled gleefully as he looked into his crystal ball and saw….

    So now you’re ascribing the gift of prophecy or something to him? Pish. All he needed o know is that the Baltic Sea is unlikely to ever elect loony Russophobe twins as President and Prime Minister.

    Comment by rkka — October 13, 2010 @ 8:57 am

  7. I’m guessing the Poles are paying a crude oil-indexed price for their looooooong term gas as well? Brilliant.

    This has to be an inside job.

    Comment by MEBarham — October 13, 2010 @ 9:34 am

  8. What is uncertain to individuals may – in some cases – be clearer to government technocrats with far more information and analytical resources at their disposal.

    They may have crunched the numbers, found that shale gas has no long-term prospects in Europe, that gas supplies from the North Sea / North Africa will not be significantly increased, and that gas demand in Europe is going to continuing going up. Furthermore, why can’t China compete for Yamal? Even if pipelines are unrealistic, since the Arctic ice is melting and the Northern Sea Route may be open half the year by 2020, why not build an LNG terminal there?

    Comment by Sublime Oblivion — October 13, 2010 @ 10:38 am

  9. Very true; it’s why I usually ignore people who say “This huge organization needs to do this to succeed”. They probably know better.

    As for it being a mistake, I’m sure an entire government has the resources to make a similar analysis to yours above. Unless you’re wrong in your accessment, and there are benefits for Poland other than “So Russia likes us”.

    Comment by Andrew #2 — October 13, 2010 @ 1:02 pm

  10. S/O. Re “government technocrats with far more information and analytical resources at their disposal.” That’s one of your most clueless comments e-vah.

    And you compound the cluelessness–if LNG from Yamal is economical for shipment to China, it would be far more economical to ship to Europe. So why should Poland lock itself into pipelines? Instead, build an LNG terminal, which would allow it to take cargoes from Yamal and other places too (e.g., US where there is a strong move to build LNG reliquification plants, including converting import terminals to export terminals).

    Andrew #2. See above.

    To both of you. Yes. Our government masters know soooooo much more than anybody else. They prove it every day. Uh huh. You are hopeless.

    The ProfessorComment by The Professor — October 13, 2010 @ 2:42 pm


    …on the same day that a massive new Liquefied Natural Gas (LNG) tanker left Sakhalin in the Russian Arctic Circle, bound for the Baja coast of Mexico, several top executives from Oklahoma City-based Chesapeake Energy met at those Gazprom offices I mentioned in Houston.

    The Game Begins

    That meeting was quickly followed by another one, and both were top secret. Dominion’s LNG terminal at Cove Point, Maryland, you see, imports natural gas – and it can export it. And that is of great interest to both Gazprom and Chesapeake.

    So from Russia’s Arctic to Mexico, up to California, across the U.S. on the brand new Rocky Express pipeline to Cove Point and from there to Spain – it’s all one seamless liquid network, running both ways.

    Gazprom – like CNOOC, coming to a shale gas play and LNG export terminal near you, Professor? I wouldn’t count on the Republicans if they get back into the House to roll back the ‘reset’, the fix is in. And not just in Houston, but OKC too.

    Comment by Mr. X — October 13, 2010 @ 5:15 pm

  12. And is Vlad Socor really a reliable source anyway? The guy works for a think tank of ‘former’ or wannabe spooks in D.C. and supports a Moldovan anschluss with his native Romania.

    Comment by Mr. X — October 13, 2010 @ 5:18 pm

  13. China is in a rush making deals to secure food and energy supplies like the one with Potash bid. maybe other countries (e.g. Poland) feel it already.

    Comment by a.russian — October 14, 2010 @ 2:04 am

  14. “China is in a rush making deals to secure food and energy supplies like the one with Potash bid. maybe other countries (e.g. Poland) feel it already.”

    Indeed. China is getting access to the new oil and gas fields of Siberia and Central Asia. Europe is being supplied from depleting fields.

    Europe will rue the day they gave Russophobes a say in their energy relations with Russia.

    Comment by rkka — October 14, 2010 @ 5:23 am

  15. Like I said, the Jamestown spooktastic bunch of Russophobes are playing checkers, or to quote ‘Spengler’, monopoly – a base here, a base there, a client state in Georgia, a pipeline from Kurdistan. And the Chinese and Russians are playing chess.

    Comment by Mr. X — October 14, 2010 @ 5:27 am

  16. On the same day that a massive new Liquefied Natural Gas (LNG) tanker left Sakhalin in the Russian Arctic Circle, bound for the Baja coast of Mexico…

    Sakhalin is not in the Arctic Circle and I am reasonably certain no tanker that left there went to Mexico. IIRC, almost all Sakhalin Energy’s shipments were going to either Korea or Japan with the remainder being sold by Shell independently.

    Comment by Tim Newman — October 15, 2010 @ 10:36 am

  17. Oh, and it does make me laugh whenever I see Gazprom proudly talking about the Sakhalin II project. Their sole contribution was to make the project about twice as expensive as it should have been.

    Comment by Tim Newman — October 15, 2010 @ 2:08 pm

  18. @Tim. Re #17 and “twice as expensive”–that was a feature, not a bug, from Gazprom’s perspective, no doubt. Because we know where a good deal of that added expense wound up.

    The ProfessorComment by The Professor — October 15, 2010 @ 7:33 pm

  19. Good point, Prof!

    Comment by Tim Newman — October 16, 2010 @ 3:51 am

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