The Huge Ramifications of Natural Gas Drilling Technology

Includes: OGZPY, UNG
by: Craig Pirrong

Developments here in Texas are having consequences around the world, in places that couldn’t be more different–like Russia. Specifically, Gazprom (OTCPK:OGZPY) has announced that the massive Shtokman gas project in Russia’s frozen north has been postponed. It may not be unpostponed any time soon. Part of the reason for postponement is the lingering effect of the financial crisis on the demand for gas in Europe. But another big part of the reason is that the economics of the project were predicated on exporting liquified natural gas (LNG) to the US. With the massive production of shale gas in Texas, Louisiana, and Arkansas, the US will not be needing LNG imports any time soon; as a result, the US has supplanted Russia as the world’s largest gas producer. Indeed, the US may become an LNG exporter. The technology for accessing shale gas may also open up previously unreachable supplies outside the United States, some of which should be able to reach consumption markets by pipelines, and some in the form of LNG.

Given the centrality of gas to Putin’s (“Gasputin’s”) geopolitical schemes, these developments are to be welcomed. They should be welcomed by Russians too (though not those feeding at the rent trough); anything that undermines the rents that support the natural state is a boon for those who suffer from its stultifying effects. These developments may save the Europeans from themselves and their inability to devise a coherent, unified strategy to combat the gas weapon, and reduce the intensity of the Great Game in the Caspian region and Central Asia. The development of new unconventional gas supplies should also be a serious crimp in any plans for a gas OPEC. All good.

In other words, drill horizontally baby, drill horizontally.

The development of a more active spot market for gas in Europe, driven by LNG, should also permit a change in contracting for Russian pipeline gas. Currently, contract prices for Russian gas are tied to oil prices. Although oil and gas are substitutes, and exhibit some correlation in values, the connection is quite loose. The development of a spot gas market would permit indexing contract prices for pipeline gas delivered to Europe to European spot prices. This would reduce, and arguably eliminate, the divergences between gas values and contract prices that create incentives for opportunistic behavior that necessitate rigid contractual terms such as take or pay provisions that are currently the source of friction between Gazprom and European consumers.

The huge ramifications of the technology of drilling for natural gas bring to mind the 1970s James Burke show “Connections.” What happens in the hot, humid Piney Woods country can shape destinies on the dusty plains of Central Asia or the frozen wastes of Russia. Truly amazing.

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