- Gazprom, the Russian energy crown jewel, has seen its valuation drop considerably.
- Sanctions against Russian-linked investments must be carefully watched as they have significant valuation outcomes. Shorting Russia, so to speak, shorts many others.
- The North American energy trifecta of the U.S., Canada and Mexico need steadfast, well-conceived policies, keeping recent events in mind.
- Monitor energy plays that seek to diversify Europe's reliance on Russian oil and gas like the Eastern Mediterranean alternatives and infrastructure that links alternative routes and supply sources.
In 1989, as one of the first European Studies graduates at the London School of Economics to study the integration of Europe, I witnessed, as did the world, the falling of the "wall or iron curtain" that began the crumbling of the Soviet Union. Fast forward 25 years, and the effects of that disintegration of authoritarian hold over the satellite countries surrounding Russia has had another major reversal with the annexation of Crimea by Russia from Ukrainian control. A plethora of industries may be impacted in the future by the Russian move, depending on the countermoves by NATO countries and major European Union countries such as Germany, France and the U.K. The canary in the coal mine however is energy resources.
A question may arise in the minds of Westerners not closer to the geopolitical realities of Russia. Why would Russia, after hosting a well-received global cooperative event, the Sochi Winter Olympics, "annex" parts of its neighbor Ukraine? Ukraine is much more than a thoroughfare for natural gas to Europe.
Perhaps Putin and Co. have their own narrative spinning: The Crimean peninsula is practically Russian (and was in fact until given to Ukraine by Khrushchev in 1954). The logistics and infrastructure assets of Crimea are virtually Russian. Europe is increasingly integrating former Soviet satellites. And gas exports to China are starting to look increasingly desirable and probable via Gazprom OAO (ADR OTCPK:OGZPY), the jewel of the Russian crown.
First, in oil markets, the U.S. cannot dramatically influence the global benchmark price of Brent crude except through consumption. We do not directly export crude oil, and so we cannot influence price in a significant manner. Only demand shocks would send the price down enough to hurt Russia through oil, and that would hurt our recovery. The U.S. gasoline exports (refined crude) have risen considerably since we began producing more supply domestically, becoming a "refiner to the world." While this is a form of potential supply for Europe (to reduce Russian oil imports via gasoline, diesels, jet fuel, etc.), it is a small contribution.
Largely because of shale oil, the U.S. is slated to provide the biggest increases of non-OPEC oil supply in global markets, but this mostly helps U.S. trade balances. The U.S. consumes most of what it produces. In the near term, Russia does not come close to U.S. oil production increases.
Russia however did not want to see the Ukraine side closer to Europe and tamper with its influence in the warm-water ports of Crimea and its oil and gas reserves. Gazprom, wasting no time, has proposed to develop the deposits held in the area, one of the largest oil and gas deposits in the Black Sea region. The stock is taking a hit, as shown later. And this is the way the West can influence the Russian play, right? The assets of Russian firms are the pocketbook of the country, and oil and gas firms support the valuation of the Russian economy the most.
Looking at the chart below, one sees why Gazprom is the Russian jewel of the crown. Interestingly, Gazprom was "founded" in 1989, right after The Wall crumbled, by the then longest-serving Russian Prime Minister.
Gazprom sees markets in the Middle East, Asia, other Europe and Eurasia as their growth markets to 2030. Advanced European consumption shrinks (see pages 4-7 IR presentation of March 3, 2014.) With a 26% Europe market share, growing to 28% in 2030, Europe still matters to Gazprom. It has two LNG terminals expected to come online in 2018 (Vladivostock) and 2019 (Baltic); Europe's Mediterranean ports and countries are a key customer for Baltic LNG plans, currently in the pre-feasibility stage. Vladivostok LNG goes mainly to Japan, India, Taiwan, China, Korea and Singapore.
Meanwhile Russia's second largest oil producer, Lukoil (OTCPK: OTCPK:LUKOY), is looking to frac in Saudi Arabia for desert gas. This could be seen as an effort to learn about fracing efficiently rather than needing to frac for resources, necessarily in near term. Many other national oil companies - the Chinese, Indians and Japanese - are learning about practices and technologies from joint ventures with U.S. independent firms. Rosneft (OTC:RNFTF), the other large Russian oil firm, is 20% owned by BP (NYSE:BP). So one sees why energy-oriented sanctions can hurt the West.
Alternative Supply for Europe
A potentially bright spot, Eastern Mediterranean gas could be a new source for Europe. Noble Energy (NYSE:NBL) is a leading U.S. firm with ties to East Med gas. (A recent detailed article about this very development is here.) The recovery of the resource is in the early stages and infrastructure to transport the gas still needs to be built, however. Noble cites its "total combined discovered resources for all of the company's Eastern Mediterranean fields (to be) approximately 40 trillion cubic feet of natural gas." That amount of gas is similar to the economically recoverable shale gas resources of the Barnett shale gas mega-field's recent appraisal.
The countries impacted by Russian gas are many. Russia, according to The Economist:
"...provides about a quarter of the gas burned in the European Union, and almost all of it in several countries, including the Baltic trio, Finland and Bulgaria. Eastern Europeans are urging Germany to wean itself off Russian gas, and America to increase exports of shale gas. Europe had a taste of gas wars in 2006 and again in 2009, when Russia shut the pipelines to Ukraine, leaving many downstream countries, mostly in south-eastern Europe, to shiver in the winter cold. ("Adrift over energy," Mar 22)
Gas could also be transited through Spain's LNG terminals to France once interconnections are built to deliver gas European-wide. There are diversification strategies available to Europe but it will take time, capital and decisions. Europe can decide to develop its own shale gas resources in earnest now that backs are against the virtual wall.
And then there is U.S. shale gas. Once prices become more favorable to producers, U.S. shale gas reserves, which continue to grow, can be part of Europe's (potentially) medium-term diversification strategy. The North American energy trifecta of the U.S., Canada and Mexico can be a supplier for oil, but especially gas resources that could further be relied upon. Policymakers will need to be clear, decisive and unwavering in their ability to be "open for business," a tall order, while keeping the Russian geopolitical chess moves in their rear view mirrors.
Obviously, Gazprom's stock has taken a hit, but it has been lower in the past. Moving forward, investment capital may be stalled until Russia puts a floor under their future movements. Lukoil pinged back up slightly, possibly as the market digests a lesser impact for Russian oil than gas. Gazprom has declined nearly 30% and Lukoil 20% since late 2013.
Unfortunately, Russia stood in a better light immediately after the Winter Olympics, receiving a reputational benefit in the eyes of the world and borderline investors. There were options for Russia other than annexing Crimea to redress the ousting of Russia-leaning ex-President Viktor Yanukovych. Perhaps the Russian psyche's attraction, through the eyes of Putin, to the Soviet Union's mythical allure held sway over the economic and geopolitical direction of much of the globe.
Investors are once again reminded of the geopolitical risks inherent in investing, and must tread carefully with investments linked to Russia. Fiona Hill at Brookings* recently noted that BP, Exxon (NYSE:XOM), Chevron (NYSE:CVX) and Shell (NYSE:RDS.B) (NYSE:RDS.A) would be hurt by deepening sanctions against Russia. As for a growth opportunity, monitor energy plays that seek to diversify Europe's reliance on Russian oil and gas.
*Source: The Economist, "The West's sanctions," March 22, 2014.