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05/02/2007 | Why a Natural Gas Cartel Would Not Work

Stratfor Staff

Iranian Supreme Leader Ayatollah Ali Khamenei proposed Jan. 29 that Russia and Iran join forces to form a natural gas cartel similar to the Organization of the Petroleum Exporting Countries (OPEC).

 

According to Khamenei's logic, the two states control half of the world's natural gas reserves, so organizing a new cartel would be a slam-dunk. Recent signs of cooperation between Russia and Algeria seemed to encourage thoughts that such a deal was in the works. But natural gas is an altogether different beast from oil -- and such a cartel simply is not in the cards.

The first and most significant reason natural gas cannot be cartelized is because it is illiquid -- both literally and figuratively. Natural gas is difficult to produce, store and transport. Unlike oil that can be put on a tanker and shipped anywhere in the world -- and then easily sold and resold -- natural gas is, well, a gas. It must be loaded into pipeline that goes from a specific buyer to a specific seller that lies along the pipeline route. Russian natural gas bound for Finland cannot suddenly be rerouted to Chile. Iranian crude oil can.

This all makes oil a more natural cartel commodity than natural gas. For example, should one country remove 10 percent of oil production from the world, bidding wars would start for control over the remaining 90 percent. However, should Canada reduce its natural gas output, its downstream consumers -- all in the United States -- would suffer a particularly acute panic attack, though the global market would barely notice.

There is, potentially, one exception to all this: liquefied natural gas (LNG). When natural gas is cooled to roughly minus 260 degrees, it becomes liquid -- literally and figuratively. Like oil, LNG can be pumped onto a tanker and sent wherever there is demand for it.

But two characteristics stop even LNG from being cartelized effectively. First, there is not a lot of LNG out there. Global LNG volumes total only about 6 percent to 7 percent of total natural gas use, so most LNG providers seek long-term contracts at fixed prices with specific consumers in order to ensure stability. Within the past five years this has loosened somewhat and there is now an LNG spot market, but it remains extremely small. The only countries that would be unduly impacted by an LNG cartel would be those whose natural gas comes almost exclusively in the form of LNG: Japan, South Korea and Taiwan. (China uses LNG as well, but natural gas only comprises about 4 percent of its energy needs, and only about 15 percent of that comes from LNG.)

Second, the LNG producers are not interested in forming a cartel. Safely cooling a potentially explosive gaseous material down to minus 260 degrees and shipping it across the planet is as difficult and expensive as it sounds. Liquefaction facilities cost several billion dollars each and are complex to operate. No energy company in the developing world has yet demonstrated the financial or technological ability to build one itself, and no developed world energy firm would seriously considering putting one in a country with a history of treating investors badly.

The world's LNG powers are not Russia, Venezuela, Iran or even Saudi Arabia, kingpin of OPEC. None of these countries has even a single LNG facility. (Russia does have one under construction, but only because originally it offered different terms -- which it recently changed -- to the developing foreign consortium.)

The real LNG powers are Trinidad and Tobago, Egypt, Australia, Qatar, Nigeria, Algeria and the United Arab Emirates -- all states the developed world considers relatively politically reliable when it comes to economic decision-making. These states are well aware of the consequences they would suffer should they impinge upon the LNG market's operations, and are not serious candidates for membership in any supposed natural gas "OPEC" that would threaten that investment.

To put Khamenei's suggestion into full context, Iran barely exports any natural gas at all -- about 5 billion cubic meters per year -- and that goes only to Turkey (in fact, in order to meet regional demand, Iran actually imports limited amounts from Turkmenistan and is considering doing the same from Azerbaijan). It should come as no surprise that Russian President Vladimir Putin's first public response to Khamenei's idea was to say he found it "interesting," though he said Russia would participate only if the new organization did not function as a cartel -- the implication being that such a structure would be bad for business.

Despite Russia's supposed cooperation with OPEC in years past, the only times Moscow has ever intentionally reduced its exports have been during disputes with its neighbors, most notably
Ukraine in 2006 and Belarus in 2007. And despite the Kremlin's protestations to the contrary, these disputes were far more political than economic -- just as any natural gas cartel would be.

If a cartel were to be formed, it would need to be in the one portion of the planet where there is a diverse infrastructure linking many customers, supplied by an oligarchy of piped natural gas suppliers. There is only one such spot in the world: Europe. It is theoretically possible for the suppliers of Europe's piped natural gas -- Russia, Norway, Algeria and Libya -- to pool their efforts and dictate prices to the Europeans.

But, as the Kremlin is well aware, one does not need a cartel to dictate prices. European natural gas demand is so inelastic that the Russians have tripled the European price for their natural gas in less than five years through little more than a series of press releases.

Who needs a cartel?

U.K.: Some 200,000 civil servants went on strike in the United Kingdom on Jan. 31 to protest job cuts. The strike, the largest walkout by government workers since 1981, caused delays at ports and shut down more than 700 government offices, including the tax authorities, passport offices and national museums. The strike was organized by the Public and Commercial Services Union, which also has organized a two-week ban on overtime beginning just after the strike. The union has said further strikes are possible. The government is planning to cut one-fifth of civil service jobs by 2008 in a move meant to increase the privatization of many public services. The cuts -- 54,963 of which have already been made and 84,000 more of which are scheduled by March 2008 -- are expected to save the government $43 billion a year, said Chancellor of the Exchequer Gordon Brown. Responsibility for the job cuts and strikes is being placed on Brown, who is expected to take over Prime Minister Tony Blair's post in June.

CANADA: Swiss-based mining group Xstrata reached a tentative contract agreement with workers at its Sudbury unit in Canada late Jan. 31, just minutes before midnight, when a strike was set to begin. Details of the three-year agreement will not be released until it is presented to the unionized workers. The price of nickel on the London Metal Exchange dropped slightly at the news, hitting $36,800 per ton at 2:11 p.m. London time Feb. 1, compared to $37,000 per ton at the close of business Jan. 31. Strikes at Xstrata's Sudbury-area mines, which account for 4 percent (63,000 tons) of annual world nickel supplies, would have exacerbated the global shortage of the metal and increased already high prices.

IRAN: National Iranian Oil Co. (NIOC) Managing Director Gholam-Hossein Nozari said Jan. 29 the company has reached a preliminary $10 billion deal with Spanish company Repsol and Royal Dutch/Shell to produce liquefied natural gas (LNG) from the South Pars field in Iran, though he said a final decision will not be made until the end of the year. According to Nozari, each foreign company would take a 25 percent share in phases 13 and 14 of South Pars. A Shell spokesman said nothing has been decided, and that the decision is a year or two away. Oil executives say Iran typically offers lower rates of return on oil investments -- restricting earnings to a little above costs -- before the foreign companies are required to turn over control of the fields to NIOC. Considering the warnings by U.S. President George W. Bush's administration against oil and natural gas companies investing in Iran, coupled with Iran's lower investment returns, the deal with Shell and Repsol will be a long time coming, if it materializes at all.

CHINA: The Agricultural Bank of China is seeking a government bailout to clear $95 billion worth of nonperforming loans, 40 percent of which are from state-directed lending, Han Zhongqi, the bank's vice president, said Feb. 1. The final bailout amount will be set at the end of February following an audit, and the capital is expected by the end of 2007. According to Standard & Poor's Rating Service, the Agricultural Bank could need as much as $140 billion to cut its bad loans from 23.55 percent of loans to less than 5 percent and meet the 8 percent adequacy requirements specified by the central bank. The Agricultural Bank, the last of China's four largest state banks to go public, will spend more to clean up bad debt than any of the others. According to figures released by the bank, the institution's savings rose by 17.3 percent, or $90 billion, in 2006 -- making it China's largest deposit-taking financial institution. Considering the amount of savings held at the bank, once its bad debts are cleaned up the Agricultural Bank will be a promising investment opportunity for foreign companies interested in generating retail banking profits.

INDIA: India's Tata Steel announced Jan. 31 it has acquired Anglo-Dutch steelmaker Corus Group for $12 billion, ending a bidding war with Brazilian Companhia Siderurgica Nacional and making the company the world's fifth-largest steelmaker. A Tata-Corus company could produce 25 million tons of steel annually. The deal, India's largest foreign takeover, is likely to add momentum to the new wave of consolidation in the industry sparked by Mittal Steel's $32 billion acquisition of rival Arcelor in 2006.

CHINA: China's Commerce Ministry announced Jan. 29 -- a day ahead of President Hu Jintao's eight-nation tour of Africa -- that the country will lend $3 billion to African nations over three years and double aid and interest-free loans during the same period. On his 12-day tour, Hu will visit Cameroon, Sudan, Namibia, South Africa, Seychelles, Liberia, Zambia and Mozambique. Although Hu will focus on strengthening diplomatic ties, he will seek primarily to secure relations in line with China's economic interests, with a particular interest in access to commodities, including timber.

Stratfor (Estados Unidos)

 


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Center for the Study of the Presidency
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