Abstract

Although not really understood by many observers, the energy situation in Russia has drastically changed over the past few years. As with the OPEC countries they are in the driver’s seat, thanks largely to the expansive and growing energy requirements of China and India. The pressures that these (and other) countries will place on the global oil and gas markets cannot be easily accommodated in the short run, and it would not be surprising if the price of natural gas goes even higher than the $8 per million Btu that many observers expect.

Key words: International Energy Agency (IEA), effective demand, Gazprom.

The story of Russian gas is to a certain extent beautiful. Somewhat like the soap-opera about the perennially rejected suitor who ends up as the object of everyone’s affection. And that wasn’t the only rejection I had in mind while preparing this note. Professor Jonathan Stern took issue with my book on natural gas because I insisted that the more Soviet gas purchased, the better for everyone on the buy side of the market. He liked however my claim that the only conceivable attack by Soviet citizens on Western properties during the later stages of the Cold War, would be an attack on the duty free gin and whiskey so prominently displayed at various diplomatic and commercial receptions.

In any event, the kingpins of the European Union (EU) recently held a meeting at which the availability of Russian natural gas and oil was discussed at length, and none other than the Financial Times (March 23, 2006) suggested that the sale of Russian gas to China and Japan might have a negative effect on the energy prospects of Western Europe. By extension, in the long run, this also means North America, because the global gas scene has begun to take on some of the features of a mainstream textbook market. Of course, it could never take on all the attributes because – as pointed out in the later chapters of your favourite volume on price theory – a ‘natural’ oligopoly or monopoly in natural gas has too many special features to end up with a perfectly competitive configuration.

Exactly what took place in the energy discussions of the aforementioned Brussels conclave is unknown to this humble teacher of economics and finance, but undoubtedly the gas price and reliability of delivery were somewhere in the picture. As far as I can tell though, the year 2015 kept entering the deliberations like a pop-up version of the Ghost of Christmas Past – to be specific, the one associated with the first and second oil price shocks. Both the International Energy Agency (IEA) and the United States Department of Energy (USDOE) have assured us that we can forget about our oil anxieties until 2030, which implies that we do not need to worry about gas until an even later date, however this is the kind of assurance that in theory no intelligent person would entertain for a fraction of a second, although for assorted reasons (mostly connected with money), many do, and also attempt to impose on others.

Even if those technological miracles appear that energy corporations have started to promise us in the millions of dollars worth of advertisements they have plastered over full pages in almost every Sunday supplement in the civilised world, it is impossible to avoid suspecting that some very ugly energy news could appear at any time as an integral part of CNN or Fox News infotainment. The problem here is simple and reduces to numbers rather than economics. The IEA estimates that gas currently supplies about 21 percent of the global energy supply, and is on its way to 24% of a much larger amount. The latter observation is conveniently played down by that organization because it places a very large question mark next to their earlier (informal) predictions about future energy prices. Note, energy and not just gas prices!

According to Claude Mandil, executive director of the IEA, gas import dependence for the 25 EU members will grow from just under 50 percent to 80 percent (which says something about the expected decline of output in the North Sea), while in North America, the present small level of imports will reach 14 percent (FT, 23 March). Mandil also confirms that the import reliance of Japan and Korea will remain very high, while China and India will emerge as “big gas importers”. How big? This he doesn’t reveal, although I feel sure that his experts have provided him with some guidelines. In case they provided him with the wrong ones, let me suggest that the effective demand of these two giants is potentially large enough to cut the ground out from under the international macroeconomy (By “effective” I mean that they can pay for any purchases they make with hard currency). Anyone doubting this should schedule a heart-to-heart with the former boss of the Federal Reserve System Alan Greenspan before he loses interest in these matters

In the line of fire

When in danger, when in doubt
Run in circles, scream and shout!

- Informal US Navy SOP (Great Lakes, Illinois, 1952)

One of the items in my gas book that apparently kept it from a prominent position on the favourite bookshelf of Mr Stern was my contention that while the U.S. and most of the states of Western Europe were political allies, they were also economic rivals: they have always been, and they always will be – and this is even more the case now than ever. One person who had some difficulty with this concept was former U.S. president Ronald Reagan, whose experts informed him that instead of buying gas from the Soviet Union, his European comrades-in-arms should make some effort to obtain the supplies they required from e.g. Africa and Argentina. The reason the chief executive was told this was because he was constitutionally unable to accept the logical option, which was to contract for the largest possible quantities that could be obtained from the Soviet Union.

I also took the liberty of claiming that the energy rivalry between Europe and the U.S. would be increasingly intense because Japan and other rapidly developing Asian countries would become major players in the great gas game. Now it appears that the chickens have come home to roost. Mr Stern couldn’t possibly have gotten this correct however, because as he enjoyed proclaiming at the energy conferences where he was an honoured guest, he had no background in economics or engineering, and thus could not possibly understand the complex cost-benefit issues that form the basis of a scientific inquiry into this subject.

When I wrote my gas book the ideological commitment of the Soviet Politburo was ostensibly to Marx and Lenin, although I was assured by some very serious persons that it was equally to dollars and deutschmarks, which made executives in the Soviet gas industry prone to discharge their business obligations. If we can assume that there is no change in this posture, then it might be useful to examine the proposals of Claude Mandil to prevent what he views as a potential supply gap whose closing will take “money and time”.

Given that he estimates that it will require only 11 billion dollars per year if sufficient investment takes place so that Russian production and export goals can be met, the key issue appears to be time, because it should be possible to obtain the cash involved by just passing the hat at an ad-hoc photo-op arranged for the most presentable billionaires in a recent Forbes listing (March 27, 2006).

My assumption is that this 11 billion would actually go to the production and transportation of gas, rather than things like junkets to wonderful Courchevel or gorgeous ‘Kitz’ at the height of the skiing season, as Mr Mandil indirectly implied. Personally, I believe that the Russian firm Gazprom was correct in dismissing this aspersion. They would also be correct in ignoring Mr Mandil’s suggestion that the Russians should provide “real third-party access” to gas pipelines, since by third-party he probably means foreigners interfering with matters whose interior logic they are incapable of understanding.
It has been suggested by some of the Norwegian colleagues that for Russia to live up to expectations about supply, high gas prices will be necessary if investments are to be financed. How high? My teaching of game theory leads me to believe that the same low-level, half-baked analysis is being resorted to on this topic that was utilised in the electric and gas deregulation farces. The key issue is clearly production capacity, and so the optimal strategy is probably for the EU – and perhaps others – to lend Russia the money they need to expand capacity, with the provision that repayment would be in gas. The repayment schedule would be designed not to interfere with privately arranged transactions, and if possible the gas would e.g. be sold to private consumers and firms.

More and more the question is being raised as to how we are going to make sure that we will never be painted into an energy corner. As I see things, there is an excessive reliance on natural gas, and not enough reliance on nuclear. I would therefore like to see a number of things carefully investigated and discussed. For instance, exactly why did Finland choose nuclear instead of gas and/or renewables when they decided to increase their electric capacity by 1500 MW.

Concluding remarks

In the conference of EU movers-and-shakers referred to above, it was proposed that the EU countries should formulate a joint strategy for dealing with their energy vulnerabilities.

I can sympathise with this to a certain extent, although I fail to see how this suggestion ties in with the deregulation nonsense that was launched by the EU Energy Directorate. I can also note that while Hannibal was the commander of a multinational army that defeated many foes, these outcomes might have been different if the same army had been commanded by his wine steward.

Let me put this another way. The commander of the EU Energy Army is a man who believes that ‘peak oil’ is only a theory, and even worse, has announced that electric and gas deregulation makes good sense. Accordingly, I think that we would all be better off if we pretend that this high-flown and dispensable conference with its bogus deliberations never took place, and future calls for a joint energy strategy are either pointedly ignored or ridiculed.

References

Banks, Ferdinand E. (2007). The Political Economy of World Energy: An Introductory Textbook. London, New York and Singapore. World Scientific.