Editor’s note: Natural gas futures are expected to increase their volatility as the beaten down sector could benefit from hot weather and increasing chances of hurricane related damage to Gulf infrastructure. On Monday, June 12, 2006, the International Energy Agency released a report on natural gas, calling it the fuel of the next decade.

According to a press release from the IEA, [“The natural gas industry is changing at a rapid pace. Global natural gas demand is rising but OECD production is plateauing”, said Claude Mandil, Executive Director of the International Energy Agency (IEA), today in Amsterdam, at the launch of a new publication: Natural Gas Market Review 2006: Towards a global gas market. “This evolution means that import dependence of the EU and North America will grow.”] The report is bringing liquefied natural gas to the forefront. ["In the next five years, global gas demand is projected to increase to 3.2 trillion cubic meters, or 2.4% per year. Even if high gas prices persist, a decrease in growth is only likely to be felt after 2010. The LNG industry currently constitutes only 6.5% of the gas market but is set to attract half of the sector’s investments - consequently; “the importance of LNG for OECD countries will double.”]

The IEA added the following: "LNG makes it possible to bring gas reserves to markets which are far away, without using pipelines, and is now an economic and competitive means of energy distribution. This is important as the OECD countries together hold only 9% of proven reserves, whereas the Middle East holds 41% and Russia alone 26%." Mandil also placed significant attention on Russia noting: "it is not clear where and when investments will be made to reduce the impact of declining production in its major existing fields. Both suppliers and consumers will greatly benefit from increased transparency in the Russian gas sector”.

In other words, despite the lack of a clear statement from the IEA, the oil industry, or major producers, there is a slow shift in the world from crude oil as the exclusive fuel source. And natural gas could well be the next area of major attention. In this article Dr. Duarte looks at the situation in Russia, the country with the largest reserves on natural gas in the world, and the difficulties in harvesting the resource. This analysis originally appeared at www.joe-duarte.com on June 14, 2006. Dr. Duarte is author of "Futures And Options For Dummies ."

Russia's Supply And Policy Conflict
The Kremlin Tightens Screws On Foreign Oil

With natural gas prices at twelve month lows, serious questions are being raised about Russia's natural gas supplies and Gazprom's ability to meet steadily increasing demand, while the latest round of Kremlin tightening moves on foreign energy companies is complicating an already complex picture.

Taking a page from the Venezuelan operations handbook, the Kremlin has made it clear that it will allow only "junior partner" status for foreign oil firms in Russia.

The development is the latest in a series of strong handed moves from Russia as the government continues to take control of its natural resources and is increasingly making use of them as political weapons.

According to the Wall Street Journal: "Senior Russian officials confirmed fears that the Kremlin will restrict foreign energy companies to the role of junior partners in all but the country's smallest oil and gas fields, keeping the richest reserves for newly assertive domestic companies. Speaking at a forum highlighting Russia's growing economic power and prospects, top government officials said the government isn't closing the door to foreign investors but wants to make sure control of key projects remains in local hands."

Yuri Trutnev, minister of natural resources "noted that Russia remains eager for foreign companies to invest together with Russian ones," adding that "the restrictions are included in a draft law on subsoil resources due to go to Parliament for approval soon. The rules would ban companies in which foreigners own more than 49% from winning development rights to deposits deemed strategic. That definition has broadened significantly since the idea of the restrictions was broached more than a year ago."

Questions Arise About Russian Natural Gas Supplies

The timing of the Kremlin's lates move may be as much a distraction as a policy move, given rising fears in Europe about Gazprom's ability to deliver on its contracts to the continent.

According to The Moscow Times, in an article penned by the well connected investigative reporter Catherine Belton: "Gazprom on Tuesday rebuffed fears over its growth strategy and said it was on track to bring major new gas fields on line, even as concerns mounted in Europe about its ability to meet growing demand."

Gazprom was responding to questions raised recently by the International Energy Agency about its ability to deliver enough natural gas to Europe.

According to Belton's report: Gazprom deputy CEO Alexander Ananenkov "told reporters that Gazprom's proven gas reserves of 29 trillion cubic meters, the largest in the world, meant that Gazprom could produce as much as 900 billion cubic meters per year, over 60 percent more than its output last year of 548 bcm. The only thing stopping it was market demand, he said."

Previously Claude Mandil the IEA Chief had noted in the IEA's first Natural Gas Report that Gazprom "might not be able to meet supply contracts in Europe by 2010 because of a lack of investment in boosting production."

Indeed, the IEA and Gazprom have widely divergent views of the situation.

According to Belton: "IEA gas supply expert Daniel Simmons said Tuesday that Gazprom had still failed to make it clear how it would meet growing demand over the next four years, even if it would be able to start production at major new fields after 2010."

Yet, Ananenkov maintains that "Gazprom was on track to bring the next generation of major new fields on the Arctic Yamal peninsula on stream by 2011."

Three points are crucial in Belton's article:

1. "Europe has been dogged by concerns about being overly dependent on Gazprom since January, when Russia cut off supplies to Ukraine, which handles 80 percent of exports from Russia to Europe. Fears over the cutoff were exacerbated by an extreme cold snap in Russia and Europe weeks later, which forced Gazprom to lower supplies to Europe for the first time in four decades."

2. "As Europe woke up to the fact that gas supplies from Russia might not be endless, EU officials have been calling on Gazprom to break up its monopoly on exports and allow greater access to its pipelines for independent producers."

3. "Gazprom has steadfastly resisted such calls and President Vladimir Putin on Tuesday once again reiterated that the government would maintain its monopoly over natural gas exports through Gazprom."

Conflicts Likely

Russia's record on consistency regardig its foreign investment policy in energy, and its dealings with its clients is spotty at best. The rules change on a regular basis, and interpretation of any written rules or laws is highly unpredictable.

In February 2004, Moscow threatened to end a deal with Exxon Mobil with regard to exploration of the Sakhalin 3 field. At the time, Exxon had been operating under a 1993 deal and had paid $60 million to Russia for the rights, but the Kremlin decided that it wanted a billion dollars instead of the already negotiated fee.

More recently, according to Catherine Belton's recent report: "the government has recently repeatedly delayed major new projects, such as the creation of a consortium to develop the vast Shtokman field in the Barents Sea. Gazprom has been spending more on acquiring assets outside of the gas sector -- such as its $13 billion acquisition of oil major Sibneft last year and recent forays into the electricity sector -- than it has on investments into gas production."

But there are rising questions about Gazprom's ability to keep up with demand: "Gazprom began production at a major new block, the Zapolyarnoye fields, in 2001 to combat an alarming decline in production at its existing fields. But analysts say that Zapolyarnoye has so far only managed to make up for the shortfall at existing fields. Gazprom's output grew 1 percent last year."

In other words, this latest move is part of a pattern, with the goal of strengthening Russia's state owned energy firms Gazprom and Rosneft.

According to the Journal: "The new rules likely will reinforce the dominance of Russia's state-owned energy giants OAO Gazprom, the natural-gas monopoly, and oil company OAO Rosneft, which have emerged as powerful instruments of Kremlin policy in the energy sector."

Yet, there seems to be a disconnect in the policy, as in Venezuela, as "Russia has the world's biggest reserves of natural gas and the seventh-largest reserves of crude oil, but needs tens of billions of dollars for investment to bring new projects to market."

In fact, Russia has done a great deal of talking along the way, especially on and off talks with the United States about using the Siberian port of Murmansk as a launching pad for tanker traffic to Alaska, as well as about the development of liquified natural gas operations involving Gazprom, with little to show for it.

For now reaction is muted with executives from Exxon, Conoco Phillips, and BP, all of which have joint ventures with Russian energy firms being cautious.

Still, having been burned before, many companies, and Russia's main client, the European Union are likely to be quietly apprehensive.

Conclusion

There are two major issues at hand.

First is whether Russia has enough natural gas available to meet both internal demand and the demand of its customers.

Second, if there is enough supply, can Russia's helter skelter policy making apparatus, driven mostly by remnants of Cold War ideology and mistrust work in an increasingly contentious and capitalist world?

Russia continues to maximize its strengths and attempt to manage its weaknesses. The former of course is energy, with the latter being clumsy development and implementation of policy.

Over the last several years, though, the Putin government has taken care of its major opposition, the oligarchs, and is now in the driver's seat, at least of how it does business and with whom.

What makes life difficult for anyone doing business with Russia, though, is the fact that actions and reactions from the Kremlin, are highly unpredictable, and that once a deal is struck, there is no guarantee that it will actually bear any fruit, or that it won't be changed on a whim from a bureaucrat or even Mr. Putin.

The struggles within the Kremlin remain a key factor, and continue to color the Chaotic nature of policy emanating from the Putin government.

Yet, the real key is whether Russia's reserve data can be trusted. The IEA seems to have its doubts.

© 2006 Joe Duarte, M.D.
Dr. Duarte's Bio and Archive