Does a Future Gas Glut Shape Russian Decision Making in Russia-Ukraine Conflict?

Russia may appear to some observers to have all the cards in its continued negotiations with Ukraine over their high stakes natural gas pricing dispute, in which European gas supply remains a hostage. But long term trends in global natural gas might not be on Moscow’s side. Russia’s willingness to talk about compromise with Ukraine about continuing natural gas shipments is not necessary a sign of any shift away from revisionism but more likely a reflection of the commercial realities that the global natural gas market is likely moving towards oversupply in the coming years.

Spot liquefied natural gas (LNG) prices in Northeast Asia have hit a 20 month low during the normal seasonal downturn in demand, dipping below $13 per MMbtu, well below peak levels the $20 plus per MMbtu levels seen post-Fukushima. European spot prices are also falling due to high inventories and redirected spot supplies from Asia where new supplies from ExxonMobil’s Papua New Guinea LNG export facility, lackluster Chinese demand, and predictions of a mild summer (based on the El Nino weather phenomenon) are contributing to a sense of surplus. The larger than expected seasonal drop in spot liquefied natural gas prices, both in Europe and in Asia, comes even as geopolitical threats to supply loom large.

There is no question that certain European countries, including Ukraine, would have difficulty replacing Russian natural gas supplies in the immediate term and more so this winter, were relations with Moscow to deteriorate to the point of a cutoff. But the recent easing of European and Asian spot natural gas prices in recent weeks are a longer term sign that Russia should think twice about how many times it can overplay its “cut-off threat” hand. Markets have their own ways of correcting over time for problems like Russian revisionism, and the global natural gas market could easily move to a supply glut in the coming years.

One factor not in Russia’s favor is the geopolitical posture of Qatar which has skillfully positioned itself to play a swing supplier role in times of market dislocations. Qatar was able to respond rapidly with spot cargoes to Japan’s supply distress in the aftermath of Japan’s Fukushima disaster. And, it has responded equally swiftly to demands in Europe in the wake of Russian supply concerns by increasing seasonal shipments in April 2014 to the UK by over 1 million tons of LNG (1.38 bcm). These sales represent a threefold increase over Doha’s typical seasonal boost to Europe when Asian demand wanes seasonally in the spring. Europe’s lack of pipeline connectedness and sticky monopolies remains a barrier to free-flowing trade in natural gas but Moscow inadvertently could solve the EU’s reform problem quickly by creating a crisis that would surely motivate political will.

While short term inelasticities can dominate for a winter or two, markets tend to respond to supply risks by allocating solutions – ranging from stockpiling that can eventually pressure prices; to fuel substitution that can eventually curb long term demand; to greater efforts at fuel efficiency. In Europe right now, all three of these things are being studied carefully and in the long run, buyers will also look for new suppliers. UC Davis-Baker Institute-Harvard studies on global LNG show that Russia could lose substantial market share over time, if liberalization in Europe gains pace. The European Union is pushing a liberalization message and it is even impacting negotiations with Bulgaria regarding Russia’s South Stream gas pipeline project. In an example of how US LNG may help with diversification strategies over time, Spanish utility Iberdrola just signed a multi-billion dollar deal to buy 35 billion cubic feet of US LNG from a subsidiary of Cheniere starting in 2019.  

Relatively high prices in Europe and Asia have been encouraging active investment of new supplies aimed at serving those markets. The idea that shale development will stay limited to North America is not a sound one. Already, ExxonMobil and Chevron Corporation have announced substantial progress in new shale production in Argentina. The longer term picture shows lots of investors with natural gas to hawk. The cue of LNG developers is a long one and Russia’s willingness perhaps to cede its markets accidentally could bail out producers from cost overrun crippled Australia to West Africa to open sales opportunities that might not otherwise have been available.

 Russia’s strategy of a pivot to China may also be hard to implement despite its prestigious announcement in April. That’s because if sanctions hit, Moscow might have trouble sourcing the gas to ship to China. Most, if not all, of the natural gas produced in the Russian east involves fields developed, or to be developed, with Western partners ( in other words putting the finance and operational equipment to the fields within the reach of the US and European governments). Of course, it is possible for Moscow to replace companies like ExxonMobil and Shell with Chinese firms albeit at a sizable inconvenience and greater indebtedness to Beijing. But President Putin might want to take a lesson on the problems of that idea from Venezuela’s beleaguered leader Nicolas Maduro. The Maduro regime is teetering on the brink of economic disaster as Venezuelans protest in the streets while vast quantities of Venezuelan oil is shipped to China to pay back $60 billion in Chinese loans. It is unclear how the Maduro regime will keep the lights on and still pay back Beijing in promised oil. Putin, who is already shipping some oil to pay back $20 billion in Chinese financing to Russia’s oil industry, will have to ask himself how much of a financial vassal state to China is his federation willing to be in order to appear like a threat to Europe.     

Moreover, Russia’s entire pitch to Western companies for assistance in Arctic LNG projects could also end abruptly, should a changing posture by Moscow on Ukraine invite deeper economic sanctions. That is because LNG development requires equipment and technologies that could easily be deemed as dual-use by the Obama administration. A delay in signing on Arctic deals could prove a death nell for Russian Arctic development even years later if sanctions are removed. That because once American and European firms have moved on to other LNG projects in their cue, they would be unlikely to return to Arctic projects, especially as more and more shale prospects beckon in less difficult terrains.

Time is not on Putin’s side when it comes to long term natural gas markets. Russia may feel it can grab a political victory to transform Europe back to its liking through natural gas, but the costs of that glory might prove extremely high and its spoils extremely short-lived.