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Global Gas Giants Form Cartel, But Experts Say It Won't Work
The Washington Diplomat / March 2009

By Larry Luxner

The world's largest country, one of its smallest and two medium-sized Middle East nations have officially inaugurated the Gas Exporting Countries Forum — a sort of "gas OPEC" patterned after the Vienna-based Organization of Petroleum Exporting Countries.

In late December, the energy ministers of Russia, Algeria, Iran and the tiny Persian Gulf emirate of Qatar met in Moscow to forge closer ties. The highly publicized event went ahead, even as tensions simmered over Russia's threat to cut gas supplies to Ukraine during a freezing European winter in a bitter dispute over unpaid bills.

The GECF meeting basically transformed the grouping from a loose, consultative body into a formal organization with a permanent secretariat. According to Alexander Medvedev, export chief at Russian gas monopoly Gazprom, four cities are vying to host that secretariat: Algiers, Tehran, St. Petersburg and Doha.

For now, the GECF maintains a liaison office at the Qatar Petroleum tower in Doha, according to the organization's website.

Yet experts consulted by The Washington Diplomat say that since most of the world's gas still moves via pipeline, the new OPEC-inspired gas cartel has little hope of controlling world commodity prices.

"Because the gas markets aren't as interconnected, it isn't going to behave quite as well as the oil market does," said Arnold Baker, chief economist at Sandia National Laboratories in Albuquerque, N.M. "So being able to maintain and enforce a natural-gas cartel might be a bit more difficult."

Jorge Piρσn, an energy expert at the University of Miami's Center for Hemispheric Studies, was more blunt.

"It's a totally ridiculous idea," he said. "I don't care what the gas cartel does in Europe, it won't have one single iota of impact on the gas business in the United States, Brazil or Bolivia. Because of the availability and logistics of gas, a gas cartel is only effective in those countries served by pipelines. The only place it'll have an impact will be in gas coming from the Soviet Union into Europe."

According to the Oil & Gas Journal, total world natural gas reserves as of 2008 amount to 6,185.7 trillion cubic feet. Russia has about 27 percent of that total, followed by Iran, with 15 percent, and Qatar, with 14 percent. Algeria has only 3 percent of world gas reserves — well behind Saudi Arabia, United Arab Emirates, United States, Nigeria and Venezuela — though for some reason it has chosen to join the three much larger gas exporters in forming the world's newest cartel.

"The countries involved are unsure how they want the organization to work," said Jeff Mankoff, an adjunct fellow for Russian studies at the Council on Foreign Relations.

"Obviously, the model they're using is OPEC, but the gas market doesn't work the same way as the oil market, primarily because most gas is sold through pipelines on the basis of long-term contracts. And even if it did, OPEC has not proven to be that successful in regulating oil prices."

And that's because of fungibility — defined as the property of a commodity whose individual units are capable of mutual substitution. Examples of highly fungible commodities are crude oil, wheat and currency.

Baker, a senior associate with Washington-based Center for Strategic and International Studies, says natural-gas markets "are not yet quite as fungible" as crude-oil markets, even though the market for liquefied natural gas (LNG) — gas chilled to a liquid for transport by tanker — is growing rapidly.

"If you're a producer, you don't have much to lose by trying," he said. "When demand exceeds supply, it's easier for cartels to have some sort of quota, because revenues are rising and they don't need to cheat. But when supply exceeds demand and prices are falling, it becomes much more difficult, because cartel members who can expand production have an incentive to do so in order to increase their revenues."

Jason Feer, a top energy analyst with Argus Media Ltd. in Singapore, explained that gas is different than oil because of how it trades.

"Typically, LNG contracts are long-term deals, often with fixed prices, while crude is typically priced against spot prices and can be quite volatile. Even LNG contracts that are tied to spot markets often contain adjustment factors that reduce volatility," said Feer, who is senior vice-president and general manager of Argus Media's Asia-Pacific region.

"Another key difference is that natural gas is delivered in different forms and each form has dramatically different costs. Nearly all Russian gas is delivered by pipeline, which is much cheaper than LNG, which requires expensive liquifaction facilities," Feer told the Diplomat.

"So it will be difficult for the gas producers to form a cartel that is as effective as OPEC in managing prices. The long-term nature of gas contracts and the technologies involved makes it difficult to turn the taps on an off — and the more stable pricing mechanisms reduces the incentives to do so."

Baker agrees that GECF's formation will have little impact on the United States, which gets most of its natural gas via pipeline from Canada.

"In the current market circumstances, I wouldn't expect it to have a major effect on the U.S.," he said. "But over time, if a larger share of U.S. natural gas comes through LNG markets, then this cartel could become more effective."

In 2007, according to Department of Energy figures, the United States imported 4.6 billion cubic feet of natural gas. Of that, 83 percent moved via pipeline — nearly all of it from Canada, with a tiny fraction from Mexico — and 17 percent was in the form of LNG. The largest LNG suppliers to the United States were Trinidad & Tobago (447.8 million cubic feet); Egypt (114.6 mcf), Nigeria (95.0 mcf) and Algeria (77.3 mcf).

Western Europe, on the other hand, is highly dependent on Russian gas piped through Ukraine. In 1965, only 9 percent of European energy came from natural gas; today it's 35 percent. And in some countries, it's much higher than that. Lithuania, for example, depends on Russia for 85 percent of its gas supply, Bulgaria 90 percent, and Slovakia 100 percent.

"Europe is looking at diversifying where it gets its gas from," Mankoff told the Diplomat. "Long-term projections indicate demand will increase, and at the moment, they're particularly worried about their depenence on the Russia-Ukraine corridor, so they're looking for alternatives. Some of that gas will presumably come from countries like Egypt, Iraq and Qatar."

In early January, at least 13 European countries reported a drop in their natural gas supply after Gazprom turned off the spigot in the midst of a long-running price dispute between the Russian and Ukrainian governments. On Jan. 19, however, Russian Prime Minister Vladimir Putin and his Ukrainian counterpart, Yulia Tymoshenko — with EU mediation — signed a deal to resume gas flows, though Ukrainian President Viktor Yushchenko is said to be unhappy with the deal.

"A new attempt to review these agreements at the presidential level is the best confirmation" that the political instability in Ukraine is a threat to Europe's energy security, Putin said in a televised interview Jan. 27.

Mankoff, who besides his position with CFR is also associate director of international security studies at Yale, said the long-running dispute goes back to the collapse of the USSR.

"The pipeline was built in Soviet days when the border between Russia and Ukraine didn't matter," said Mankoff. "But once they became separate countries — Russia as a producing country and Ukraine as a transit country — they found themselves in different positions."

The pricing dispute is complex, but as Mankoff explained, it focuses on two aspects: the price that Ukraine pays for gas, and the debt that Ukraine owes Russia for gas shipments in the past that it hasn't paid for. Gazprom accuses Ukraine of withholding about $2 billion in payment for 2008 gas supplies.

According to Mankoff's analysis, "there's also a political subtext because Ukraine, since 2005, has had a government that is interested in pursuing integration with Euro-Atlantic institutions including NATO." As a result, the foreign policy landscape for Russia and shipments of natural gas from Russia have changed from before, when Ukraine had received natural gas from Russia at a much lower, subsidized, price than what European consumers further downstream have paid.

In the meantime, Gazprom is reportedly expanding beyond its European client base. The company, which is pursuing energy projects from Libya to Bolivia, plans to load its first LNG cargo sometime in February, in a move that would open up new markets for Russian gas in Japan, South Korea and North America.

The irony is that the Russia-Ukraine dispute over gas prices comes as the world's other major fuel — petroleum — is in free fall. At press time, a barrel of crude was selling for just under $35, despite OPEC production cuts of 4.2 million barrels a day. OPEC says it expects world demand for crude will fall 180,000 barrels a day in 2009.

"They didn't have control of oil prices when it was on the way up," energy analyst Stephen Schork told AP. "They don't have control of it when it's on the way down."

That gives the new GECF cartel little reason to hope it'll be able to control world gas prices — hence Russia's attempts to squeeze the Ukrainians on the pipeline issue.

"Internationally, energy prices are down relative to what they've been over the last couple of years, and the Russian economy is hurting," said Mankoff. "The Russian government is very wary of giving up any opportunity to generate money. They're looking for every source of revenue thaey can get right now."

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