Russia and the Ukraine – The Worrisome Connection to World Oil and Gas Problems

What is behind the Russia/Ukraine problem? It seems to me that what we are seeing is Russia’s attempt to fix a two-part problem:

  1. Some oil and gas exporters, including Russia, are not receiving enough oil and gas revenue to meet their needs. They are not able to collect enough taxes to provide the services they have promised to their citizens, plus allow the amount of reinvestment that is needed to maintain production. Russia is starting to experience economic contraction because of the low revenue situation. This situation very closely related similar problems I have written about  previously. In one post I talked about major independent oil companies not producing enough profit to provide the revenue needed for reinvestment, and because of this, cutting back on new investment. In another, I talked about the problem of too low US natural gas sales prices, relative to the cost of extraction.
  2. Some oil and gas importers, including Ukraine, are not using their imported oil and gas in productive enough ways that they are able to afford to pay the market price for oil and gas. Russia gave Ukraine a lower natural gas price because some of Russia’s pipelines cross Ukraine, and Ukraine must maintain the pipeline. But even with this lower natural gas price, Ukraine is behind on its payments to Russia.

If a person thinks about the situation, it looks a lot like a situation where the world is reaching limits on oil and gas production. The marginal producers (including Russia) are being pushed out, at the same time that the marginal consumers (including Ukraine) are being pushed out.

Russia is trying to fix this situation, as best it can. One part of its approach is to make certain that Ukraine will in fact pay at least the European market price for natural gas. To do this, Russia will make Ukraine prepay for its natural gas; otherwise it will cut off its gas supply. Russia is also looking for new customers who can afford to pay higher prices  for natural gas. In particular, Russia is working on a contract to sell LNG to China, quite possibly reducing the amount of natural gas it has available to sell to Europe. Russia is also signing a $10 billion contract with Iran in which it promises to construct new hydroelectric and thermal energy plants in Iran, in return for oil exports from Iran. This contract will increase the amount of oil Russia has to sell, and will increase the oil available on the world market. Russia’s plan will do an end run around US and European sanctions.

Gradually, or perhaps not so gradually, Russia’s exports are being redirected to those who can afford to pay higher prices. European Union purchases of natural gas imports have declined since 2008, presumably because they are having difficulty affording the current price of gas, so they are being relied on less for future sales.

The Russian approach seems to include building a new axis of power, including Russia, China, Iran and perhaps other countries. This new axis of power may threaten the US dollar’s reserve currency status. With the dollar as reserve currency, the US has been able to buy far more goods from other countries than it sells to others. Putting an end to the US dollar as reserve currency would leave more and oil and gas for other countries. If purchases by the US are cut back, it will leave more oil and gas for other countries. The danger is that prices will drop too low because of the drop in US demand, leading to lower production. It this should happen, everyone might lose out.

I am doubtful that Russia’s approach to fixing its problems will work. But if Russia is “between a rock and a hard place,” I can understand its willingness to try something very different. It now has more power than it has had in the past because of its oil and gas exports, and is willing to use that power.

The US/European approach to this problem is to loan Ukraine $17 billion to pay for past natural gas bills. The hope is that with this loan, Ukraine will be able to make changes that will allow it to afford future natural gas bills. There is also the hope that the United States can step in with large natural gas exports to Europe and Ukraine. In addition, the US and Europe are trying to impose sanctions on Russia.

I find it very difficult to believe that the US/European approach will work. The idea that the United States can start exporting huge amounts of natural gas to Europe in the near future borders on the bizarre. There are many hurdles that would need to be overcome for this to happen. Installing LNG export facilities is among the least of these hurdles.

In fact, the West badly needs both the oil and gas that Russia is producing, so it really is in a very precarious position. If Russia cuts off exports, or if Russia is forced to cut off exports because of financial difficulties, both the US and Europe will suffer. It is clear that Europe will suffer because of its dependence on pipeline exports of oil and gas from Russia. But the US will suffer as well, because the US is tied closely to Europe by financial ties, and by import and export arrangements with Europe.

Furthermore, the US/European approach involves a great deal of new debt, in an attempt to fix an inherent inability of the Ukrainian economy to afford high energy prices. Without a huge transformation, Ukraine will be in even more financial difficulty when it comes time to pay back the new debt–it will need make debt payments at the same time that it needs to pay for more expensive future natural gas. More debt doesn’t necessarily fix the situation; it may make it worse.

The US powers that be do not understand what Russia (and the world) is up against, so the policies they propose are likely to make the situation worse, rather than better.

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Natural Gas: The Squeeze at the Bottom of the Resource Triangle

Theoretically, we have a very large amount of resources of many kinds available–oil, natural gas, coal, uranium, gold, fresh water. There is a relatively small amount of high quality, inexpensive-to-extract resources, and we tend to extract those first. From there, we move to lower quality resources that are more expensive to extract. The question comes: How do we reach limits for the extraction of any of the resources?

For oil, I have shown this chart:

Figure 1. My version of the oil resource triangle.

I recently explained what I think is happening with oil, as we are extracting lower and lower quality resources, in my article Oil Limits, Recession, and Bumping Against the Growth Ceiling. High oil prices are squeezing the economy, leading to recession. I think this squeeze may ultimately lead to serious financial problems and reduced oil production.

In this post, I want to discuss natural gas, instead of oil. Here we are also moving down the resource triangle, getting to lower quality, more difficult to extract resources as well.

Figure 2. Stephen Holditch’s resource triangle for natural gas 

Shale gas is very low on the resource triangle for natural gas, at least according to Stephen Holditch, in a paper authored under the Distinguished Author Series of the Society of Petroleum Engineers. It has even lower permeability measured in millidarcies or md) than tight gas or coal bed methane.

It seems to me that in the United States we are, or will soon be, reaching a different kind of squeeze at the bottom of the triangle for natural gas–the squeeze of too low prices for shale gas producers to be profitable. If, somehow, natural gas prices do manage to rise sufficiently for the majority of shale gas producers to be profitable, the higher prices are likely to add to the oil’s high price squeeze on the economy that I noted in my earlier post.

In this post, I will explain what I see as happening with US natural gas supply and prices, and how this fits in with the natural gas supply controversy we have been reading about in the press recently.

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Don’t count on natural gas to solve US energy problems

We often hear statements suggesting that by ramping up shale gas production, the US can raise total natural gas production and solve many of its energy problems, including adding quite a number of natural gas vehicles, and replacing a large share of coal fired electricity generation. While there is the possibility that shale gas will allow US natural gas supplies to increase for a few years (or even 10 or 15 years), natural gas is only about one-fourth of US fossil fuel use, so it would be very difficult to ramp it up enough to meet all of these needs.

One issue is whether a rise in shale gas will mostly offset other reductions in natural gas supply. In Annual Energy Outlook 2011, EIA forecasts that shale gas production will increase from 23% of US natural gas production in 2010 to 46% of US natural gas production by 2035, but that these increases will mostly offset decreases elsewhere. Even with this huge increase in shale gas production, the EIA only sees US natural gas production increasing by an average of 0.8% per year between 2011 and 2035, and US natural gas consumption increasing by an average of 0.6% per year per year to 2035–not enough to make a very big dent in our overall energy needs.

Figure 1. EIA Figure from the Early Release Overview of Annual Energy Release 2011. (Upper caption is EIA's.)

I don’t know that the EIA forecast is correct, but below the fold are some related issues I see. While we may see some increase in natural gas supplies, there is significant downside risk if shale gas cannot continue to ramp up considerably, because of cost, or fracking issues, or CO2 issues, or any number of other problems. Even if shale gas does continue to ramp up as planned, the EIA forecast suggests that the overall increase in total US natural gas production is likely to be modest at best. It seems to me that steps we make to use this new supply should be made cautiously, being aware that the increased supply may not be all that much, or last all that long.  Continue reading