Profit From the Russian Gas Crisis No One's Covering

Nov.29.10 | About: PJSC Gazprom (OGZPY)

Greetings from Mother Russia, where some unusually warm temperatures have given way to a frigid spell. Not unusual this time of year, but the weather outside seems to be just beginning to offset the rising temperatures within.

There is a disagreement brewing inside the Russian establishment. And playing its results will make investors some good money back in the States.

I am in Moscow to address an annual ministerial planning conference. My appearances at these meetings have taken place since 2004. The occasion always marks one of my several trips each year back to Russia. The sessions allow me to renew old acquaintances, visit places I used to frequent when I was living here, and they provide an opportunity to investigate the latest developments in what remains one of the most interesting places on Earth.

My presentation comes tomorrow (November 30th). Its scheduling will also allow me to travel out to western Siberia (a delightful place to be in December!), and I will bring you there for the next Oil & Energy Investor installment coming Friday (December 3rd).

You see, there are significant developments coming from the best Russian oil majors few people in the West ever consider. I will be out there to talk to company folks and review some field data. If my suspicions are correct, something is about to hit that will be of great interest to individual investors.

But first things first…

The Future Price of Oil

My address to the planning sessions in Moscow considers what the pricing market for crude oil will look like as we move into a supply-constricted global market.

What happens when pricing in the oil market begins to reflect a concern over whether there is sufficient supply to meet rising demand?

Russia is all about producing and exporting oil and natural gas. The country’s central budget depends upon the largesse gained from tax receipts on both, while the exporting of hydrocarbons to places like Western Europe and, more recently, Asia comprises a rising component of Russian foreign policy.

And that is where the disagreement has settled in during these meetings. The essential issue is whether the largest natural gas company on the face of the Earth will revise how it sets up export contracts to Europe.

There are two overriding considerations here. The first concerns the tax proceeds to Moscow.

The second points toward an improving opportunity for investors to make some money off of the changing situation.

Gazprom (OTCPK:OGZPY) is the world’s largest natural gas provider, Russia’s largest company, and the largest source of export tax proceeds to the government. It has monopolistic control over export pipelines, owns more of the world’s known conventional natural gas resources than any other company, and provides the bulk of extractions inside Russia.

Should be a readymade revenue machine.

And it has been, at least until recently. The European Union (EU) certainly has had concerns for some time over Gazprom being its primary source for imported gas.

That concern has been heightened by an ongoing two-year-old gas crisis between Russia and Ukraine, leading to cuts in Russian exports to Europe. Most of that gas crosses Ukraine on its way west, and when the disagreement hit, either Ukraine or Russia stopped the flow (depending on which side you talk to). Russia is now busy pushing two pipeline projects to circumvent Ukraine.

But the EU remains concerned about relying too much on one source for gas, regardless of how it gets to Europe.

Two new departures have emerged. One, the EU has begun a separate pipeline project (the Nabucco Pipeline) to source gas from central Asia and Iraq, bypassing Russia. That project still has insufficient commitments of volume, and its 2014 introduction is considered unlikely because of that.

It is the second development, however, that is already a game changer. It is also the 800-pound gorilla (or Russian brown bear) in the room that nobody wants to discuss (at least not in public) during the current sessions. On the other hand, it makes for some interesting sidebar conversations.

The rapid import of liquefied natural gas (LNG) into Western Europe is changing the face of negotiations with Gazprom and putting both the company and government revenues in jeopardy.

Usually, natural gas exports are dependent upon where pipelines go. However, LNG cools the gas to a liquid, allowing it to move by tanker – anywhere. This is already the most important development in global energy trade in decades. Major producers, such as Qatar, are moving all of their production from conventional pipelines to LNG.

And Europe is benefiting with rapidly increasing LNG imports from North Africa and the Persian Gulf. The new Rotterdam Gate LNG terminal, one of the largest in the world, is open. Several on the Spanish and Italian coasts are already in operation, three are open in the UK, and another is almost completed on the Polish Baltic.

All of these are fundamentally changing the gas market in Europe, lowering import costs, but straining Gazprom’s strategy. The Russian exporter insists on signing only long-term contracts for its piped gas that contain “take or pay” provisions. That means a customer must take a minimum amount of a contracted volume (usually 70%) or pay for it anyway.

When Gazprom was the only game in town, Europe had no choice. With the rapid introduction of LNG, however, things have changed. Already, the LNG coming into Rotterdam has begun to set up a real local spot market (where deliveries take place within 72 hours instead of requiring long-term commitments).

And that spot market price is now about $20 per 1,000 cubic meters (the standard contract volume in most of the world other than North America – where we use 1,000 cubic feet) below the price of Gazprom’s conventionally delivered gas.

Gazprom has been quietly scurrying to re-negotiate contracts, but Europe has a new bargaining chip, and it is changing the dynamics of Russian export potential. The EU will still need to import Russian gas, even with the rising LNG imports, because demand remains higher than current LNG receiving terminal capability. But the terms will be changing.

There will be a further expansion of European LNG import capacity. And here is where the opportunity comes in for investors.

Go Long US and Canadian Shale Gas Producers

I have already discussed the likelihood that the accelerating production volume in US shale gas will end up allowing the export of LNG, especially from the Cove Point, Maryland, terminal (the largest LNG facility on the East Coast), and especially to Europe (see “A Solution for North America’s Natural Gas Surplus” from November 2nd).

Given the virtual certainty the shale gas (and, to a lesser extent, unconventional production from coal bed methane) will result in a continuing surplus on the American market, an LNG outlet to Europe and elsewhere allows for increasing production profits on one side of the Atlantic from LNG sales on the other.

This is going to allow investors to “play” the rising differential between LNG and piped gas in the European market by investing in US and Canadian shale gas producers. (Here are several ideas from a recent Oil & Energy Investor.)

Meanwhile, back in Moscow, the Gazprom export strategy is coming under fire, resulting in divisions among policy makers creating quite a bit of heat beyond the public eye. It is apparent from who is not at this annual meeting. Despite being the major exporter of energy and provider of revenue to the government, Gazprom is not even here.

All of this is introducing a new mix in Russian production and a mad dash to develop pipelines to Asia, offsetting the rising uncertainty in future European sales.

Unlike Gazprom and Europe, the Asian opportunity is a major topic of discussion at the meetings in Moscow. How likely this is, however, is another matter, as are the returns to the government. This will center on whether companies other than Gazprom can pull off a significant switch in Russian production priorities.

And that is why I need to go out to Siberia and talk to some folks. More on that Friday…

Disclosure: No position

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