The Organization of Petroleum Exporting Countries has influenced both the supply and the price of oil internationally for more than 30 years. Many commentators, consumers, and politicians in Organization for Economic Cooperation and Development (OECD) countries consider the rise of the cartel’s power to be a consequence of their countries’ becoming dependent on imported energy supplies to fuel growing economies.
OECD countries in East Asia and many in the European Union decades ago also had to come to terms with a dependence on imported natural gas.
In recent years the US and the UK have recognized a future that requires increasing gas imports to fill widening domestic supply gaps caused by increasing demand, primarily for power generation, along with the simultaneous decline of domestic reserves and production.
Many in the US and the EU are associating OPEC’s rise and subsequent many-fold oil price increases for consuming nations with a potential for the formation of a similar natural gas cartel of main gas reserve holders and producers-an OPEC-like Organization of Gas Exporting Countries (OGEC).
It is important to explore such an argument because the prospect is used, particularly by some in the US, to argue against building extensive additional LNG import capacity.
Furthering this apprehension, the world’s leading gas exporting nations met this April at the Gas Exporting Countries Forum (GECF) in Qatar and, with Russia as driver, agreed to establish a group to evaluate “gas pricing implications for gas exporters” and “cooperation to stabilize the market,” viewed by some as another step towards the creation of an OGEC.
Although the GECF includes the more-market-friendly nations of Qatar and Nigeria, it is the Russian, Iranian, Venezuelan, and Algerian contingent that is striving for a cohesive “gas OPEC” that can command an export price for gas that reflects its “real” value.
There are several relevant factors that influence how, when, and if a cartel of producing gas nations might form and the control it might leverage over supply and prices. Considered here are some of those factors and a comparison of the circumstances of the global oil and natural gas industries.
Who controls reserves?
Tables 1 and 2 summarize the latest BP Statistical Review statistics for June 2006 proved gas (Table 1) and oil (Table 2) reserves at yearend 2005, ranking the top 25 countries in descending order according to their reported holdings of gas and oil. In Table 2 the 12 OPEC countries are boldfaced.
Comparisons between the two tables are illuminating. The cumulative reserves column reveals how many countries together control what percentage of proved reserves worldwide. Although the broader distribution of reserves incorporating the lesser categories of reserves and potential resources provide the full long-term picture, proved reserves are those that are most likely to be converted into production in the medium term and will serve here to make the necessary points.
Tables 1 and 2 reveal striking similarities in the ranking of the largest reserves holders, particularly the top 10 nations.
Eight nations appear as the top 10 reserve holders of both oil and gas. Seven of these-Saudi Arabia, Iran, Iraq, Venezuela, Algeria, the UAE, and Nigeria-are OPEC members, and the other is Russia, which dwarfs the other countries in terms of its gas reserves much as Saudi Arabia dwarfs the other nations in terms of its oil reserves.
The US is 6th on the list for gas and 11th for oil, but it is rapidly dropping on both lists because of the way it has effectively exploited and consumed domestic oil and gas over past decades. Apart from the eight countries mentioned and the US, two others appear in the top 10 on one list and rank high on the other list: Qatar ranks 14th for oil and 3rd for gas, and Kazakhstan ranks 8th for oil and 11th for gas. Two others are much more oil-rich than gas-rich: Kuwait ranks 4th for oil and 21st for gas, and Libya is 9th for oil and 22nd for gas, although results of the current phase of exploration in Libya may yet change its position.
What these statistical rankings emphasize is that it is essentially the same group of countries that control the bulk of proved global oil and gas reserves. If reserves holdings were the only factor considered, they probably could have formed a gas cartel a decade or so ago.
However, it is the Russian Federation’s position that stands out in both tables: Together with Kazakhstan, it is the only non-OPEC member in the top 10 ranking for oil reserves, and it is at the top of the rankings for gas reserves, controlling more than 25% of the world’s resource. Despite its other mineral riches Russia remains a petroeconomy, historically booming when prices are high and suffering economic crisis when oil prices collapse, such as during the major recession in 1998.
Russia’s gas market role
Russia has remained outside of the OPEC cartel. If geopolitics in the days of the Soviet Union had been different, however, it could easily have become an OPEC member in the 1970s. Along with other non-OPEC oil producing nations, Russia certainly has been quick to exploit oil export supply shortages and price increases. It has been able to benefit more from being outside OPEC and responding to oil supply and demand circumstances on its own rather than as part of a group.
From the OECD perspective, Russia has a huge influence on global oil supply whether it is in or out of OPEC, and its inability to sustain year-on-year production growth of nearly 10% that it achieved during 2000-04 has partly influenced the high oil price environment of the last few years. It is not necessary for such a large reserve holder to be part of a cartel to make its mark on the oil industry, particularly when supply is tight.
Russia’s position for gas is even more dominant, and should a gas cartel form, Russia would have to be part of it for it to be effective on a global scale. Indeed gas reserves are even more tightly held than oil. Russia, Kazakhstan, Turkmenistan, and Uzbekistan together hold 30.7% of global proved gas reserves. Russia already controls gas supply from those countries to a great degree through infrastructure holdings and access to Western Europe.
By adding Iran and Qatar, a cartel of six nations could be formed, straddling parts of central Asia and the Middle East in one contiguous geographic block that controls some 60% of global proved gas reserves-the same percentage that Middle East OPEC nations control of the world’s oil.
By adding the North African producers-Algeria, Egypt, and Libya-along with Saudi Arabia and Nigeria, another 10% of global gas reserves could be controlled. It is certainly possible therefore, in volume and geographic terms, to conceive of a gas cartel, led by Russia, with as much resource might as OPEC holds in the oil sector.
So why has such a cartel not emerged? The different structures of the oil and gas industries, geopolitics, markets, and the consuming nations’ use and dependence on gas all play a role in answering this question.
Oil vs. gas dependence
Figs. 1a and 1b compare the contributions that different energy sources made to the world’s primary energy consumption mix in 1977 and 2005.
In the 1970s when OPEC began to exert an extraordinary influence on the oil industry, the world depended on oil for almost half of its energy requirements. Oil was used for power generation, transportation fuel, and as a petrochemical feedstock to create nonenergy products such as plastics, solvents, and paint. It was difficult to imagine how any modern economy could function or grow without access to a plentiful supply of oil.
OECD countries had grown accustomed to having ample supplies of cheap oil as a legacy from its colonial past.
In the 1970’s natural gas amounted to less than 20% of the primary energy mix, and few nations-OECD plus Russia-consumed it in substantial quantities. Gas was used almost exclusively for power generation and space heating.
Today, although oil’s use is reduced in percentage terms, it continues to dominate other forms of energy worldwide, particularly for transportation fuels, and it still vastly outweighs the world’s dependence on gas.
Table 3 shows that global consumption of gas, however, has more than doubled in absolute terms since the 1970’s, growing more rapidly than any other primary energy source in the past 15 years, whereas oil use has increased some 30% since the 1970s.
Although gas clearly is raising its profile and significance, it has a long way to go to rival that of oil. Moreover, with current infrastructure, it is easier to substitute alternative energy sources to replace gas for power generation, as required, than it is to replace oil for certain transportation fuels, such as aviation fuel, and for specialty petroleum products.
To achieve the impact and magnitude of control that OPEC has maintained over oil supply requires a lack of readily available substitutes and a dominant position in an environment of growing energy demand. Gas has yet to achieve such status in a global context, but could yet do so in the next 2 decades as oil supply becomes tighter and gas increases its share of the global energy mix.
Gas markets also are being diversified, with gas-to-liquids (GTL) projects producing Fischer Tropsch middle distillates, methanol, and dimethyl ether (DME) and gas being used as a source for hydrogen to fuel cells for transportation and embedded power generation projects.
However, such markets are likely to remain small for the next decade at least, and it is hard to see gas rival oil in any transportation market in the short term. The significance is that it diminishes the ability of a gas-producers cartel to influence the energy markets because any effort to constrain supply would result in consumers moving to alternative power generation fuels and emerging GTL industries being mothballed as uneconomic.
Gas markets regional
The world’s gas markets are not like the global crude oil market. Gas is less fungible than oil and is mostly traded regionally under long-term contracts. In addition, because of its physical properties, gas is much more difficult and expensive to transport and store. These high-cost and rigid supply chains do not lend themselves easily to manipulation by suppliers.
The highly seasonal nature of gas demand also distinguishes it from oil; most major consumers are in high-latitude, northern hemisphere regions.
A substantial amount of oil is traded on short-term and spot market contracts against the three major benchmark crudes Brent, West Texas Intermediate, and Dubai-Oman, underpinning futures trading on exchanges and interregional movements and arbitrage of physical marine tanker cargoes of crude oil.
However, for the most part, gas supply and trading is limited to strict regionally defined markets, e.g., Europe, North America, and Asia, each with its own distinct fundamentals, contract types, and pipeline or LNG supply chains. This makes it difficult to move gas parcels between regional markets.
We are a long way from being able to talk about a global gas market. LNG does theoretically offer the potential to move, trade, and divert cargoes of gas into more profitable markets, and some cargoes are traded in this way.
However, it is worth placing short-term gas trading in context. In 2005, about 721.45 billion cu m of gas was traded internationally, according to the BP Statistical Review, June 2006. Of these volumes, 532.65 billion cu m (74%) were shipped by pipeline, and 188.8 billion cu m (26%) were shipped as LNG. About 11% of the LNG exported was traded under short-term contracts-about 2.9% of the international gas trade.
Clearly there is a long way to go before gas can be considered a free-trading, global commodity. Even with further gas market liberalization and expanding trading opportunities, most industry analysts do not expect short-term LNG trading to account for more than 20% of LNG trade by 2020.
Gas is traded on long-term contracts primarily due to the high cost of the infrastructure, which can cost several billion dollars to establish an intercontinental supply system. To fund such facilities requires a substantial amount of capital and particularly debt capital in most instances. This means that financial institutions are supporting much of the international infrastructure being built to handle gas, whether it is by pipeline or as LNG or GTL.
The projects require guaranteed long-term revenue streams to support debt repayment schedules and therefore are underpinned by long-term offtake contracts, commonly 10-25 years, with onerous take-or-pay and send-or-pay clauses.
In such circumstances the borrowers, i.e., operators and owners, usually incorporating governments and state-controlled companies in joint ventures with international companies, have to post security and issue stringent guarantees to secure the financing. If the projects are shut down for any reason, including governments interrupting supplies to extort higher payments for the gas, financial institutions retain the option to call in their loans.
Repercussions in terms of lower credit ratings and restrictions of future international inward investment could be potentially punitive for governments triggering default on long-term gas supply contracts. Such contractual obligations act as major disincentives for governments to unilaterally attempt to manipulate supply or to breach contract volume quotas and prices. The foregoing all implies that a GCEF or an OGEC might not be able to influence regional gas markets and their gas prices very easily.
Supply diversification
Cost and debt funding are not the only drivers for long-term contracts in the gas industry. Security of supply for the gas-consuming nations is another key factor. Japan, for example, was badly impacted by the oil shortages that resulted from the oil crises that OPEC created in the 1970s.
To improve the security of its gas supply, Japan entered into a series of long-term contracts with a diverse range of international LNG suppliers in subsequent decades.
To further improve its security and control its supply, Japan’s state-controlled utility companies have taken equity positions upstream along the supply chain, all the way back to remote gas fields in some cases.
Subsequently, South Korea and more recently China have adopted similar models. Each consumer nation is taking steps to become involved in the upstream gas chains supplying gas from the Middle East, Far East (Brunei, Indonesia, and Malaysia) and Australia.
Australia is of particular interest to gas consumers of the Pacific Basin. Positioned at number 14 in the proved gas reserve ranking-with potential to rise up the ranking as more discoveries secure offtake agreements-it is unlikely to join an international gas supply cartel or to be influenced by radical religious fundamentalist governments that could renege on long-term gas contracts should they secure power at some stage in the future.
Long-term contracts with a large number of suppliers from different continents seems to be one means by which gas-consuming nations can protect themselves in part from the emergence of an international gas cartel in the future.
LNG offers a much better diversification lever for consumers than intercontinental pipelines. Not only can LNG provide gas from a number of sources, it also serves as competition to dominant pipeline suppliers such as Russia to Western Europe and can limit the supplier’s ability to use unilateral threats of supply interruptions to secure excessive price increases to captive customers.
Building and developing a vast network of LNG supply sources is likely to hinder or inhibit the influence that an international gas cartel could exert. New LNG supply chains such as those being built or considered by Angola and Equatorial Guinea in West Africa and by Norway and Peru all seem to be prudent steps along the diversification route.
Some nations have even had the foresight to legislate for a diverse gas supply base. Spain, for example, has required that its utilities limit supplies from individual nations to specified percentages and ensure that supplies from pipeline and LNG sources are well balanced.
It would be easy for Spain to take all of its gas by pipeline and LNG from nearby Algeria, but it would be prudent to avoid relying completely on a single source, which would undoubtedly be a disadvantage should a gas cartel emerge.
Germany, on the other hand, is heavily reliant on Russian gas via pipelines crossing Eastern Europe. It does take some supply from Norway, the Netherlands, and Algeria, but it is most dependent on Russian supply.
The Russian-Ukrainian incidents of January 2006 that led to supply interruption to Western Europe during its peak winter demand period should be a warning to Germany and other Western European consumers of Russian gas to further diversify their supply.
The UK is establishing new gas supply chains by building new pipeline and LNG infrastructure. Pipeline gas supplies will come from Norway and continental Europe, including some gas originally derived from Russia.
LNG will come from Algeria, Qatar, Nigeria, Trinidad and Tobago, and other suppliers. It is tempting for the UK to sign up to large-scale supply deals with Russia once the trans-Baltic Nord Stream pipeline-now under construction-is completed. However, a competitive price for such gas only makes sense in terms of supply security if it is backed up with a large percentage of gas from other suppliers. The new LNG supply chains being developed should provide this leverage.
Diversification also means using a variety of primary energy mixes. If the major energy-consuming nations have learned anything from the evolution of the oil industry over the past 50 years, it is that it would be folly for the world to become as highly dependent on gas for power generation as we are on oil for transportation fuel. Hence it makes sense for nations to have a diversified, long-term energy supply strategy incorporating nuclear, coal, hydro, and renewables as well as gas.
This is in the interest of the consumer and the gas industry, as it will help to preempt attempts by gas-producing nations to hold consuming nations ransom over access to future supplies, and it is more likely to lead to more-stable and moderate gas prices.
Geopolitics
Regional geopolitics in Central Asia and the Middle East regions, where most gas reserves are located, have been dynamic and turbulent over the past few decades. Extreme optimism is required to believe that this situation will change over the next few decades. Hence, commercial, ideological, and ethnic conflicts and suspicion among Russia and its neighbors in the Caspian region, for example, or Iran and its neighboring Persian Gulf Emirates, including Qatar, may well undermine any potential power over consuming nations that organizing themselves into an international gas cartel could bring.
Russia has long exerted its power and influence in the Caspian states of the former Soviet Union, including control over their gas infrastructure and exports. Often this has worked to the detriment of those nations. For example, Russia prevented Turkmenistan from continuing gas exports to Europe following the breakup of the Soviet Union, and it continues to restrict Turkmenistan’s ability to transit gas.
Those nations may show reluctance in further constraints on their export capabilities that a gas cartel led by Russia might impose. However, there are signs that Russia does see potential in developing closer ties with these nations and with Iran to coordinate their strategies in exporting gas by pipeline both east to China and beyond and west into Europe. If Russia and Iran were to forge such an alliance, an international cartel for gas would have a better chance of emerging.
Iran has yet to decide what it wants to do with its vast excess gas resources. It exports small quantities by pipeline to Turkey and imports some gas into northeast Iran from Turkmenistan, not a great export record for a county with more than 14% of the world’s gas reserves.
Iran itself consumes substantial volumes of gas, both for reinjection and pressure support in its oil fields and to supply its own domestic energy needs. Indeed, there are powerful factions within Iran that argue against exporting gas at all, but urge retaining it for domestic consumption once the oil reserves are depleted.
The country has negotiated for many years with consortiums of international European and Asian companies-US companies are not allowed-for building both LNG and GTL plants. Despite Iran’s entering many preliminary agreements and heads of agreement over the past decade to further develop its gas production leading to exports to India and China, final investment decisions by international companies to sanction the building of gas liquefaction and GTL plants in Iran continue to be delayed.
Because of geopolitical constraints, Pakistan, India, China, and perhaps Japan are the most likely customers of gas from Iran, either as LNG or by pipeline. The potential of long-distance pipeline exports to Europe through Turkey and Greece and to China through central Asia are themselves fraught with major geopolitical hurdles.
It is unlikely that the international financial community would debt-secure such pipelines from Iran, either west or east. Moreover, it would be an intrepid nation in Europe that would sign deals to offtake gas from such pipelines for a significant portion of their long-term gas supply.
Without the investment in such infrastructure and the commercial trust and rapport with many of the gas-consuming nations of the world, much Iranian gas seems destined to stay in the ground for the foreseeable future. This situation would dramatically reduce Iran’s current influence in an international gas cartel should one materialize.
However, once major pipelines are in place to Europe and China from the Middle East and Central Asia, including East Siberia, and Russia has secured the substantial gas liquefaction capacity it currently is seeking on Sakhalin Island, in Shtokman field in the Barents Sea, and at St. Petersburg, with the aid of investment from OECD consumers, the impact of a gas cartel would be more influential on consuming markets.
Geopolitics, massive investment requirements, technical hurdles, consumer mistrust, and time to construct such epic gas supply systems all indicate that a gas cartel is not going to happen in the medium-term.
However, by investing in such projects OECD countries and companies should realize that they are sowing the seeds for a potentially formidable international gas cartel to emerge.
Geopolitical influence and threats to stability of worldwide gas markets do not just come from Central Asia and the Middle East.
The gas-producing nations of North Africa-Algeria, Libya, and Egypt-could certainly coordinate supply to the southern Mediterranean countries of Europe and perhaps cooperate with Russia in squeezing supply to Europe.
However, there is substantial competition among these North African suppliers to secure supply contracts and market share with European and North American consumers, and in the medium-term it is unlikely they would take actions that would risk loss of market share or alienation from their main gas markets. Algeria’s more established infrastructure and supply contracts place it in a stronger position, with more market power than its neighbors. Algeria’s recent moves to increase its fiscal take and control over exploration and production contracts testify to such power.
Venezuela, ninth in the proved gas reserves ranking, like Iran has been extremely slow to develop and exploit its reserves. The radical, anti-US, and expansionist policies of the Hugo Chavez government sought in 2006 to coordinate gas movement across South America by promoting an ambitious Venezuela-Argentina gas pipeline through Brazil and Bolivia.
Such coordination could consolidate Venezuelan control of most gas reserves in South America. Such a cartel would undoubtedly be willing to cooperate with Russia, Caspian, and Middle East gas producers to squeeze the international gas trade.
However, in order to do so, massive investment in the form of tens of billions of dollars to build long-distance pipelines and gas liquefaction facilities would be required to provide this potential South American cartel with the ability to export gas at all.
The OECD financial sector and international companies from those countries would be ill-advised to sanction investments in such infrastructure projects that risk ultimately being used to leverage control of international gas supply in a direction that would be disadvantageous to OECD gas-consuming nations.
Implications for the US
The US already imports large volumes of gas by pipeline from Canada and exports some pipeline gas to Canada and Mexico and LNG to Japan (Table 4). However in recent years it has become clear that its gas supply gap is widening rapidly as domestic production declines and gas demand rises. The position of gas imports and exports in the US in 2005 is illustrated in Fig. 2 together with the location of existing LNG receiving terminals and those under construction in 2006.
Most in the energy industry and in government recognize and accept that importing larger volumes in the form of LNG is essential for the US. Opposition, however, has come from two elements: local communities concerned about potential environmental and safety impacts of specific sites and from independent US gas producers that see imported LNG as threatening to flood the US market with “cheap” gas and erode their currently healthy profit margins.
The battle with the former has been largely overcome with new legislation in 2005 and government and state commitments in 2006. However, there has been substantial delay in commitment to many proposed LNG receiving facilities, particularly in California and the northeast seaboard. So much so that in 2006 the Energy Information Administration and others forecast that new US terminals are unlikely to contribute to much more than a third of LNG imports by 2020 (Fig. 3).
Most imports will come from expanding existing US terminals and from new terminals being built more rapidly in Canada and Mexico.
The position taken by the US independent gas producers is traditional protectionist rhetoric; they are emphasizing the risks of “getting hooked on gas imports” and the specter of “an OPEC for gas.” Their aim is to raise the fear of a future US gas crisis caused by a cartel of international gas producers to which the US would remain impotent to respond. Such independent producers, however, would be among the first to benefit from the high prices that would accompany interruptions to international supplies.
The reality is that regardless of how much money is invested in US gas exploration, it will not generate enough gas, from either conventional or unconventional resources, to meet ongoing demand. Imports will continue to be necessary.
There are risks associated with becoming dependent on gas imports, but countries such as Japan, South Korea, and many European countries have been dependent on them for decades. These risks can be managed if consuming nations and companies follow some clear strategies-diversification of gas supplies, long-term contracts, integrated joint ventures, and diversification of energy mix-and collaborate with producing nations along the entire supply chain so that all parties benefit from the massive investments required.
At this stage the questions that should be asked in the US should be associated with “how best to” structure intercontinental gas-LNG imports, not whether gas should be imported at all.
The way forward
The logical way forward for the US would be supply diversification and the location of strategic infrastructure investments in countries that do not rank in the top 10 reserve holders-countries such as Equatorial Guinea, Angola, and Peru-and that pose the least threat of future alignment with any incipient international gas supply cartel that may emerge.
Embracing the international diversification of the LNG industry in collaboration with other major consuming nations in Europe and Asia seems to be the most positive step the US could make towards ensuring its future security of gas supply and helping to minimize the emergence of a cartel of international gas suppliers seeking to exert control and extract higher prices from the international gas trade.
Fig. 4 shows that the US must work harder to diversify its LNG supply. Trinidad and Tobago has dominated LNG imports to the US since 2002, benefiting from its closer location and lower marine transportation costs than other existing suppliers on the far side of the Atlantic and further afield in the Middle East and Asia.
The emergence of Egypt as an LNG exporter in 2005 plus the imminent new supplies from Equatorial Guinea, Norway, Nigeria, and Qatar, all expected on stream by 2008, should improve diversification and therefore security of supply. Based upon these discussions, a prudent national gas import strategy would avoid becoming reliant on a single nation supplier (Trinidad and Tobago or Qatar?) for more than about 20% of the nation’s import demand.
The deregulated North American gas market has become accustomed to trading gas on a short-term basis. This doesn’t make sense for the bulk of long-term base-load LNG imports. Long-term contracts with send-or-pay clauses and some supplier guarantees to both offtakers and financiers improve security of supply and minimize risk of supply interruptions and the possibility of suppliers’ market manipulation.
Encouraging some supplier nations to take equity positions in LNG receiving terminals in the US also improves the chances of long-term relationships with a range of suppliers that can survive difficult market conditions without degenerating into contractual defaults.
Of course, the US is not in a position to dictate to its deregulated industry that gas imports should be limited from certain suppliers or expanded from others. Each LNG supply chain project is a stand-alone investment decision for the equity holders and their financiers.
However, it is the role of government to develop a long-term energy strategy and promote sustainable energy supplies. Therefore government has a role in promoting and providing incentives for prudent diversification, contractual security of supply, and coordinating among the supply chains to provide some strategic volume of LNG reserves to withstand supply interruption from whatever cause.
OECD gas-consuming nations should have little to fear from the market power and control that an international gas supply cartel could exert or from manipulated supply shortages if they execute the following long-term gas import policies:
- Diversification of gas supply.
- Diversification of primary energy mix.
- Long-term supply contracts with volume guarantees.
- Limited investment in gas infrastructure projects that enhance the market power of potential international gas cartel coordinators such as Russia, Algeria, Iran, and Venezuela.
- Disregard for domestic lobby groups with vested interests to keep gas imports in tight supply, enabling them to exploit captured consumers with high prices.
Also, should a gas cartel materialize in the future, it is unlikely to ever influence worldwide trade in gas to an extent comparable with the power that OPEC continues to enjoy.
Nevertheless, prudence in contracting and sanctioning of international supply chain investments, coupled with vigilance and suspicion of the strategies and motives of those nations seeking to establish and exert coordinated global control over worldwide gas markets, is required to avoid the emergence of an OPEC for gas at some stage in the future.
The author
David Wood ([email protected]) is an international energy consultant specializing in the integration of technical, economic, risk, and strategic information to aid portfolio evaluation and management decisions. He holds a PhD from Imperial College, London. Key parts of his work are research and training concerning a wide range of energy related topics, including project contracts, economics, gas-LNG-GTL, and portfolio and risk analysis. Wood is based in Lincoln, UK, (www.dwasolutions.com) but operates worldwide.