The April discovery of a new shale formation in Western Texas is another indication that the shale-gas revolution, which is rapidly changing the way that the world gas market operates, continues to press ahead. Russia is the world’s largest gas exporter, yet some experts believe that President Vladimir Putin and Russia’s energy establishment seem to be ignoring these changes—to their possible detriment. Alexey Miller, the head of Gazprom, has downplayed the shale gas revolution as nothing more than a PR campaign.
There are cracks in the façade that suggest that Mr. Putin and the Russian energy establishment do recognize the impact of shale gas on their strategy. In July, at the 2013 Gas Exporting Countries Forum, Mr. Putin acknowledged that developments, such as shale gas, are “a serious challenge for all [gas exporting countries].”
Mr. Putin has reason to be uncomfortable. The world energy market is shifting thanks to the shale gas revolution and the expansion of Liquefied Natural Gas (LNG) technology. These developments increase the uncertainty of Russia’s position.
The shale gas revolution has led to a steady and continued rise in U.S. natural gas production. Experts anticipate U.S. gas production to reach between 800 and 880 billion cubic meters by 2035. By comparison, US production was just 681 bcm in 2012. Prior to the revolution, the United States had been expected to import gas from Qatar and other producers. However, domestic gas production has diminished the United States’ dependence on foreign sources, freeing up those sources for import by other consumers, including Europe.
Increased U.S. production and the subsequent decrease in imports, combined with the possibility that the United States may export LNG at spot prices, could increase the quantity of gas on the market available to Europe. The saturation of available gas may put additional momentum behind efforts to shift prices away from long-term contracts with oil-linked gas prices, favored by Russia, towards cheaper spot pricing. In 2012, pressure from European consumers to change the gas-pricing formula forced Gazprom to return
The shale gas revolution is not exclusively a North American phenomenon. Experts believe that Poland, Ukraine, Bulgaria and Romania also have unconventional gas reserves. If Central and Eastern Europe develops these reserves, Russia’s more than 60 percent share of the Central and East European natural gas market may diminish.
Russia’s energy establishment is correct to argue that Russia’s conventional gas reserves are sufficient to maintain economical exports for many decades. In addition, Russia has extensive undeveloped conventional reserves in East Siberia and the Far East, which are well located to supply Asian demand. However, the majority of current hydrocarbon production in Russia comes from Soviet-era fields, whose production is declining. Experts believe that Russia may have to invest upwards of $92 billion to develop new gas fields in the east and build the necessary infrastructure.
If Russia develops Far East and East Siberian fields, it may have an opportunity to expand its role in the growing Asian market. Chinese demand for gas, while currently small, is expected to grow. Japan’s demand for natural gas has increased since the Fukushima nuclear disaster in March of 2011. Both provide opportunities for Russia to further diversify export markets.
President Putin and Russia’s energy executives acknowledge the importance of the Asian market but have not done as much as they could to secure new contracts there. Russia has an advantage if it chooses to play a larger role in the Chinese market. Unlike LNG from Australia, East Africa or the Middle East, pipeline gas from Russia would not go through the Straits of Malacca, avoiding a chokepoint vulnerable to pirates (or, in a conflict, to the U.S. Navy). In March, Russia and China’s state energy companies agreed to a memorandum of understanding regarding gas exports to China. However, China’s preferred price is 40 percent less than what Russia would like to charge and financing for the new Siberia-China pipeline has not been finalized. Russia has one complete LNG terminal at Sakhalin and are planning or constructing others. These terminals may provide Russian an excellent opportunity to meet demand in Japan or South Korea. Agreeing on an acceptable pricing formula may prove difficult; Japanese customers are negotiating with U.S.-based LNG producers for lower-priced gas, which may serve as leverage to negotiate for lower gas prices from Russia.
Contrary to some expert opinions, Russia’s energy establishment seems to accept that the world’s gas markets are changing. However, it does not seem to be adapting quickly enough. Despite mounting pressure from consumers to use spot-pricing, Mr. Putin continues to call the oil-linked pricing formula the “fairest and most market-oriented” way to price gas and is likely to try and maintain long-term contracts for as long as possible. Russia’s inflexibility on this issue could negatively affecting future contract renegotiations. Gazprom has also made it clear that it will not sell natural gas to China using Henry Hub spot pricing, once again casting doubt on the viability of a Sino-Russian gas deal and the success of Russia’s fifteen-year struggle to access China’s market. If Russia chooses to ignore the changes that it recognizes, it may see its access to existing and future markets sorely diminished.
Holly Decker is an ICP Associate for the American Petroleum Institute. These views are her own.
Image: Flickr/Jasper Morse. CC BY 2.0.