Bloomberg: Energy markets made a retaliatory move against Russia

The attempt of the Russian Federation to organize an “energy dominance” has failed.

Russia and Ukraine conflict for decades in the style of a bad marriage on the issue of natural gas, recently agreed to extend an abusive relationship for some time, writes for Bloomberg (translation inosmi.ru) Liam Denning. Such an agreement, under which Moscow had natural gas, and Ukraine tube, worked fine when both parties were under the banner with the hammer and sickle, however, the situation became worse after their formal divorce. At the same time Ukraine wants to move away from previous agreements, and Russia eventually tries to return to the previous situation.

Geopolitical intrigue makes even the most uninterested players to pay attention to energy markets. Yes, shows like a new story connected to the Russian and European gas industry, fate is often determined by quite prosaic things. Description so many dramatic events present in the book “the Bridge” (The Bridge) Thane Gustafson (Thane Gustafson), an expert on Russian energy by IHS, Markit, from secret meetings in an Austrian castle during the cold war to the history of the former Prime Minister of Ukraine, the revolutionary and once considered a “gas Princess” Yulia Tymoshenko.

More significant story is not so visible revolutions in technology and Economics. However, these factors give a new form not only the gas markets in Russia and Europe, and energy markets worldwide.

Beginning of Russian-European gas the “bridge” was initiated in 1960-ies, and then the situation, of course, was complicated by the presence of the iron curtain, but commercially everything went without any problems. Russia needs money and technology (primarily steel pipes and compressors) for the development of its vast Siberian fields, while the market capable of supplying these things and in need of natural gas, was Western Europe. The first deals with Austria and especially the two Germanys is much like barter exchanges. And they, in fact, was — in the absence of liquid markets energy (liquid energy markets), markets with high activity of buyers and sellers, no one really could figure out what was “real” price of natural gas.

Natural gas differs from oil, since it is much more difficult to transport and store. In General, you need to have a direct communication and usually we are talking about the pipeline. Its construction cost a lot of money, and bankers are becoming more cooperative if you present them a signed long term contract. As a rule, it is made in such a way that the price of gas is determined as a function of the price of oil — a liquid market — and as a result, the seller is subject to the risk that if oil prices decline. On the other hand, buyers had to purchase a certain amount of gas or, at least, to pay for it, and this meant that they were at risk in the event of lower demand. Everyone was happy, more or less.

But then many failed to satisfy this provision. On one side of the Berlin wall, the neoliberal tendencies of Ronald Reagan and Margaret Thatcher began to function as a hammer in relation to the old gas bridge. In the early 1990-ies, just at the time when the income from the sale of natural gas was, according to Gustafson, “the main support of the failed state”, ideas regarding the departure from vertical integration and vague contracts and movements in the direction of choice and transparency began to spread to the East from the United Kingdom, and Brussels, as you know, is near the English channel. Gustafson is the chronicle of a long battle initiated by the European Commission, especially the commissioners in the field competition Nikki Cruz (Neelie Kroes) and Margaret Vestager (Margrethe Vestager) and aimed at the destruction of the private club, which was a continental natural gas market, and, ultimately, long-term contracts of Gazprom.

However, the philosophy ends here. The combination of the time factor and technology has allowed the European Commission to approve its programme. Since 1960-ies of the isolated European municipal gas networks have become, as the ivy to spread across the map, and as a result was created a continental network. The existence of networks, especially with the inclusion of a terminal for liquefied natural gas — means a lack of attachment to one vendor and its steel cord. If we add to this the ability to trade gas in real-time using increasingly more powerful computers, then there are building blocks to create a liquid, competitive market with transparent pricing.

Gazprom, for obvious reasons, was against such cooperation, and preferred the certainty of an established relationship and of course, the ability to use the old bridge as leverage. More difficult to intimidate an anonymous hedge Fund in London than official in some Eastern European gas Ministry. However, Gazprom is well adapted in some areas, including in the conduct of international trade transactions. However, the institutional resistance against the change caught the company off guard, particularly on the issue of liquefied natural gas. Russian President Putin, which Gustafson calls a “fanatic energy”, realized quite early that liquefied natural gas has a great future, and he ultimately surpassed Gazprom and provided tacit support to the ascent of the independent operator, NOVATEK.

Perhaps Putin is a fanatic, but to call it a secret head would be an exaggeration. His strong-arm tactics implemented using the valve overlap in 2006 and in 2009, resulted in further distancing Ukraine; it harms the reputation of Gazprom and first of all shows that the energy weapons worked better in the past, when consumers were isolated, was dependent a party is a strong need of gas and not organized on a network basis by colleagues with a set of options. Even Ukraine was able to loosen the grip of Russia, including due to a significant reduction in energy consumption.

Putin, however, quickly learns. His support of liquefied natural gas, as well as recent tactical deal with Ukraine and new pipeline to Germany, Turkey and China indicate the understanding that the only way to deal with the diversification of Europe, the largest customer of Russia, is to diversify its options. But here it should be noted that efforts aimed at the establishment of such alternative export routes as “Blue stream” to Turkey was made even before Putin came to power.

In my opinion, the most important place in the book by Gustafson and is where he notices that, despite the decline in domestic natural gas production in Western Europe, its expanded network provides greater security. “Today it is more important not who delivers the gas, and the fact that market forces are creating a system of checks and balances,” emphasizes Gustafson. This is a defining aspect of departure from existing in the XX century predominantly oligopolistic energy models. The rapid growth of demand and geographical differences, characteristic of mineral resources, put in a more advantageous position of suppliers. The advent of modern networks, the competition between different fuels and also simple energy-saving change this situation.

In the book “the Bridge” there is a lesson for Washington, which spent decades on a successful struggle with the lords of energy by using support liquid markets and efficiency, is now trying to strengthen its direct effect via the “molecules of American liberty”. It is an anachronism in the networked century, although it reflects, apparently, the frustration of America in these networks.

As for Russia, it adapts to the new commercial realities (and their influence on the old geopolitical rules). However, revenues from the sale of hydrocarbons account for almost half the Federal budget and the energy sector produces the lion’s share of export revenues, and therefore Russia is chronically suffering from a lack of diversification on important level.

At the same time, the world continues to move forward, and — crucially — it does this taking into account climate change. In the recently published criticism of the energy strategy to 2035 — with the characteristic subtitle “a Desperate struggle for continuing relevance” (Struggling to Remain Relevant) — the authors note that “the climate agenda is the last on the list and in the list of priorities.” However, this question represents an existential challenge for the energy of Russia’s income, regardless of those or other gas, and at the same time is an extremely important variable. Fortunately, the question of how Russia is rebuilding itself and preparing for the energy transition, is the subject of the next book project Gustafson.