Gazprom: The Russian Invasion

By Julian Murdoch

In a deal we expected to get a bit more press, Gazprom (OTC: OGZPY) and Shell (NYSE: RDS) announced a deal on Thursday that will allow Gazprom to export liquefied natural gas [LNG] to Shell's terminal in Baja California. The gas will then be transported via pipeline to Southern California. From Russia with love.

In this time of depressed U.S. natural gas prices - down 74% to around $3.50 per MMBtu from last July's high of $13.31 per MMBtu - why in the world would Gazprom be making a deal to bring in more supply?

It's all about plans for world domination, eventually.

Today's Market

By all accounts, the natural gas market is oversupplied right now. There are currently 1.674 trillion cubic feet of natural gas in inventory. In fact, the recent U.S. EIA Natural Gas Storage Report showed that natural gas supplies rose 20 billion cubic feet while the market had only expected an increase of 14 billion. Needless to say, prices dipped a bit on the news.

Natural Gas (NG, NYMEX) Daily

This even-greater expansion of the gas stocks comes on top of huge highs: The five-year historical average for stocks is only 1.364 TcF (trillion cubic feet), and we're currently sitting on 35% more natural gas than we were just this time last year.

Demand is so low that the number of natural gas rigs currently operating has dropped from 970 the last time we checked in (just last month!) to 790 in the latest report. To put that in perspective, in September 2008, the number of rigs operating topped out at 1,606. Natural gas prices just aren't high enough to make production cost-effective, even at some low-cost sites such as Barnett Shale in North Texas. As Richard Mason, the publisher of The Land Rig Newsletter, put it in the Star Telegram:

"Gas needs to be at least $3.50, or even $4 [per 1,000 cubic feet] for it to be economical to drill in the Barnett Shale," Mason said. But some producers have received less than $3 for their gas at major trading hubs, he said.

For higher cost producers, it will be a while before drilling activity resumes. "A sustained gas price of about $8 per 1,000 cubic feet is needed to boost drilling activity," Thomas Gardner of Simmons & Co. International stated in the same article. The market hasn't seen sustained prices of that level in quite a while.

Natural Gas (NG, NYMEX) Monthly Price Chart

Low natural gas prices are even causing problems for Big Oil - Chevron just warned of a sharp drop in profit due to low oil and gas prices. Chevron's first-quarter earnings will be reported May 1. It would be easy to look at the natural gas industry and conclude it's basically in shutdown mode.

Gazprom's Love Letter?

So why would Gazprom be so anxious to move into a market that is currently so well supplied? Russia, and by extension state-owned Gazprom, holds 20% of the global natural gas reserves. The top five countries it exports to are Germany, Italy, Turkey, Great Britain and France - all of which it supplies via pipelines. The U.S., for its part, consumes more than 20% of the world's natural gas, though it does produce a large majority of that domestically. But here's the key: By gaining entrance to the U.S. market - no matter how small and temporarily unprofitable the on-ramp - Gazprom diversifies its buyers.

And diversifying its buyers is very attractive to Gazprom, as buyer-issues with their pipeline partners are almost a constant problem. A Forbes article at the beginning of April mentioned that Gazprom is considering liquefying gas to transport it, rather than sending it through pipelines to Europe.

"In circumstances when LNG markets are becoming more global and because of a substantial increase in transit risks, when documents ignoring the interests of Russia are signed, we need to have a new look at our LNG strategy and study the need to start new projects," Gazprom's chief executive said in a statement.

This was apparently in response to an agreement between the EU and Ukraine concerning investment in Ukraine's gas network. I guess the "substantial increase in transit risks" comes from the fact that Gazprom supplies 25% of Europe's natural gas, with most of it carried on Ukraine's pipelines, pipelines they don't own and can't really control. If the EU and Ukraine play nice with one another, Russia ends up in a worse position to play hardball. They don't get to be the originator of the "transit risks," as they have in the past, turning off the spigot when pipeline partners fight like petulant children. It's worth noting that a recent explosion on the pipeline in Turkmenistan is actually being blamed explicitly on Gazprom's hardball tactics.

Which makes it interesting to think of Gazprom as a future supplier of LNG to the U.S. Right now it doesn't affect the market one way or another - the amounts involved are trivial: 250 million cubic feet. Chris Theal, managing director at Tristone Capital Inc., was quoted in the Financial Post as saying, "In terms of overall U.S. demand, that's less than 0.5%." But if the natural gas proponents succeed in decreasing coal use in favor of natural gas, or the Pickens Plan comes to pass and we're fueling our cars and trucks with natural gas, the U.S. could be in a position to consume more Russian gas.

Comments

[Ferdinand E...:]

Let's see now, Russia decides to ship gas to the U.S. rather than to sell it to Japan and China, who are (almost) next door, and where the price of gas is much higher than in the US. That sounds as if the Gazprom people have lost their minds.

One of the arguments in my energy economics book is that somebody in Russia may have lost their mind. but that somebody is not selling gas or oil..

Apr 14 09:28 AM

[Dustinian:]

I believe that the Russians ARE selling gas to the Chinese. And those sales will increase over the coming years.

Geopolitically, this can be seen one of two ways. Either ourselves and the Russians are not compatible for cooperation in the long term, which makes this move foolish from an American perspective (as we are opening up a new, lucrative market for one of the most potent instruments of foreign policy the Russians have). However, if one is to believe that an understanding with Russia is in our long term interest, to offset Chinese power, this can be seen as a step in the right direction toward improved ties.

Either way, I like OGZPY long.

Apr 16 01:27 PM

[adamnb:]

Of course, as you infer, it's a political move in this era of the new perestroika. What is far more interesting is the Gazprom bid to become a partner in the proposed Alaska gas pipeline. Wonder what Palin will make of that one.


On Apr 14 09:28 AM Ferdinand E. Banks wrote:

> Let's see now, Russia decides to ship gas to the U.S. rather than
> to sell it to Japan and China, who are (almost) next door, and where
> the price of gas is much higher than in the US. That sounds as if
> the Gazprom people have lost their minds.
>
> One of the arguments in my energy economics book is that somebody
> in Russia may have lost their mind. but that somebody is not selling
> gas or oil..

Apr 16 05:08 PM