Poland, Belarus & Ukraine Report: August 15, 2006

AN EMERGING GAS CARTEL? Is Russia -- the world's leading producer of natural gas -- preparing to create a gas equivalent of the Organization of Petroleum Exporting Countries (OPEC)? The possibility of such a cartel has been discussed by Russian policymakers for years. But a memorandum of understanding signed between Russia and Algeria on August 4, which significantly calls for coordinated gas prices, could perhaps be a move in this direction.

The idea of a gas OPEC was first floated by Russian President Vladimir Putin in 2002. The idea was supported by Kazakh President Nursultan Nazarbaev, but was then shelved -- but not forgotten.

It was revived by Gazprom board member Aleksandr Medvedev in May when he threatened that Russia would create "an alliance of gas suppliers that will be more influential than OPEC" if Russia did not get its way in energy negotiations with Europe.

Today, with natural-gas prices high worldwide, a gas cartel is looking like a more realistic prospect. Algeria, with the world's eighth-largest gas reserves, might readily embrace the idea, as might Iran and Qatar -- which have the world's second- and third-largest gas reserves, respectively. Turkmenistan, Kazakhstan, and Uzbekistan could also join.

The implications of creating a gas cartel could be far-reaching. If a cartel were to coordinate gas prices it could, over time, limit Europe's ability to shop for cheaper gas and ensure its dependency on an organization controlled by Moscow. Europe presently buys gas from Norway, Russia, and Algeria.

Such an arrangement could be disastrous for the West if a major confrontation were to arise between supplier and consumer nations.

Quasi-Cartel

A little-known quasi-cartel already exists. The Gas Exporting Countries' Forum (GECF), which first met in Tehran in May 2001, consists of 15 gas-producing nations. It collectively controls 73 percent of the world's natural-gas reserves and 41 percent of production. Algeria was one of the founding members of GECF, along with Iran and Russia.

Thus far, the GECF is more talking shop than organization. It has no staff and no headquarters and it has not attempted to set prices. But with the signing of the Russian-Algerian agreement, it might be only a matter of time before this organization becomes more prominent.

Wrench In The Gas Works

Two factors that could delay the evolution of the GECF into a gas OPEC are the rapidly increasing Russian domestic demand for gas and Russian gas monopoly Gazprom's shortage of cash.

Gazprom's shortage of funds has meant it has failed to invest in greater geological explorations and develop new fields, raising fears that in a decade Russia will be forced to lower exports in order to meet rising domestic demand. Russian consumers are Gazprom's biggest customers, but they pay the lowest prices -- around $47 per 1,000 cubic meters.

The Russian government, fearing consumer backlash, has been reluctant to raise prices. And therein lies the dilemma. The Putin administration has been kind to Gazprom. It has given the company the exclusive right to sell gas to foreign customers and forced other Russian producers to sell Gazprom its gas for low prices, which Gazprom then resells in Europe at much higher rates. But, by keeping domestic consumer prices down, it is preventing Gazprom from being profitable in its largest market.

A cartel might demand that Russia sells gas to its own consumers at set prices, a move the Putin government would probably balk at. And a cartel could also demand greater transparency in the Russian gas business -- something that would likely irritate the Kremlin.

Depleting Gas Reserves

The situation is further complicated by the rapid depletion of gas reserves worldwide -- particularly in the United States, the world's largest consumer of natural gas. According to BP's 2005 reserves-to-production ratio, which predicts the number of years estimated reserves will last at current levels of production, U.S. gas reserves will be depleted in nearly 10 years.

In the not-so-distant future, the United States will need to rely on imported liquefied natural gas (LNG) from distant producers to satisfy its thirst for energy.

Assuming that a gas cartel will be formed by 2015 and that the United States maintains current levels of energy consumption, the country could well find itself at the mercy of two cartels, OPEC and the gas producers.

With other countries' gas reserves also depleting, worldwide demand for imported gas could skyrocket in the next five to 10 years, resulting in stiff competition on the gas market.

A gas cartel could conceivably benefit consumers by bringing stability into the market, but it could also hold consumers hostage by threatening boycotts and price gouging. (Roman Kupchinsky)

THE UNSETTLED GAS QUESTION. Viktor Yanukovych is going to Russia on August 15 for the first time since Ukraine's Verkhovna Rada approved him as prime minister earlier this month. He is scheduled on his two-day trip to the Black Sea resort of Sochi to talk with Russian President Vladimir Putin and Russian Prime Minister Mikhail Fradkov. The talks are expected to focus on the price of Russian gas supplies to Ukraine.

The gas deal hatched in January, after Russian gas giant Gazprom briefly cut supplies to Ukraine and Europe, has never been particularly popular in Ukraine. Kyiv agreed to an increase in the price of Russian gas imports from $50 to $95 per 1,000 cubic meters.

Critics of this deal, including former Prime Minister Yuliya Tymoshenko, have repeatedly called for its renegotiation.

Unpopular Points

There are two provisions in the January deal that are subject to particular criticism in Ukraine.

First, the deal established the price of gas imported by Ukraine only for the first half of 2006. At the same time, it set an invariable tariff for Russian gas transit to Europe via Ukraine for five years in advance.

Some Gazprom managers have already suggested that Ukraine should be ready for another gas price hike in 2007, which could mean Ukraine paying as much as $230 per 1,000 cubic meters instead of the current $95.

Second, the deal introduced a murky intermediary, the Swiss-based company RosUkrEnergo, as a monopolist responsible for gas supplies to Ukraine. Under a scheme laid down in the deal, RosUkrEnergo mixes Russian gas priced at $230 per 1,000 cubic meters with much cheaper Turkmen gas and sells the mix to Ukraine at $95 per 1,000 cubic meters.

Although it was revealed in April that RosUkrEnergo is owned half by Gazprom and half by two Ukrainian businessmen, both Moscow and Kyiv have so far failed to explain satisfactorily why they needed to include this company in the gas deal.

Yanukovych told journalists on August 14 in Kyiv that he is not expecting any substantial change in the Russian-Ukrainian gas-supply scheme this year. "If it is possible to change the price, I mean, make it lower, we will go for it. We will see what we can achieve. As for 2007, we will create a transparent system and inform both the international community and the Ukrainian public about the way the system of relationships will work on the Ukrainian gas market," Yanukovych said.

Further Hikes Possible

Can the Ukrainian government hope for the preservation of the current gas price in 2007? Probably not.

Some Gazprom managers have already suggested that Ukraine should be ready for another gas price hike in 2007, which could mean Ukraine paying as much as $230 per 1,000 cubic meters instead of the current $95.

The question of how much Kyiv will pay for gas in the future will also depend on the amount -- as well as the price -- of Turkmen gas in the Russian-Turkmen mix sold by RosUkrEnergo. Turkmenistan has already signaled that it wants to increase the price of gas sold to Gazprom from the current $65 per 1,000 cubic meters to $100.

On the other hand, analysts warn that $120 per 1,000 cubic meters is the highest gas price the Ukrainian economy can accept without losing its competitiveness.

Ukraine's Options

But what about Ukraine's bargaining chips?

For many years Moscow sought to persuade Kyiv to set up an international consortium, with Russia as a major partner, in order to manage the Ukrainian pipeline pumping Russian gas to Europe.

It's possible that the issue of control over the Ukrainian gas pipeline will resurface at the Sochi talks. In the past, the issue has been successfully delayed and torpedoed by Kyiv.

But Yanukovych unambiguously told journalists on August 14 that he will not agree to turning over Ukraine's gas-transport system to Russia. "This [gas-transport] system will be owned by Ukraine. We will never do this, because it does not serve the national interests of Ukraine. The matter of reconstructing this system is a separate question. We will invite partners regardless of what part of the world they are from," Yanukovych said.

That leaves Moscow with a headache: how should it react to Yanukovych's political comeback. Russian media see Yanukovych's return as a major victory for the pro-Russian forces in Ukraine over the Orange Revolution camp personified by President Viktor Yushchenko and former prime ministers Yuliya Tymoshenko and Yuriy Yekhanurov.

Now Moscow must confirm in deeds what it asserted in words in the past 18 months -- namely, that it is easier for Russia to come to an understanding with "pro-Russian" Yanukovych than "pro-Western" Tymoshenko or Yekhanurov. In other words, Yanukovych will have to return from Sochi to Kyiv with a small political victory if Moscow is to remain true to its word.

While it is highly unlikely that the price of Russian gas for Ukraine will remain unchanged in 2007, a staged price increase cushioning the Ukrainian economy against any shock hike could well soften the blow. (Jan Maksymiuk)