Friday, January 06, 2006

More Russian Risk

In recent conversations with family and friends I've been lamenting the conversion of the news media to an entertainment business model, robbing us of a more complete picture of what's going on in the world. Again this week, their "flash mob" approach to the tragedy in West Virginia overshadowed larger events across the globe. From an energy perspective, the story we should have been paying closer attention to was the natural gas dispute--now resolved--between Russia and Ukraine, because it has important implications for our future energy supplies.

Last week I discussed why Russia's willingness to threaten to cut off supplies over a disagreement on pricing should concern the EU, which relies on Russia for much of its gas imports. But the issue goes deeper and could have an influence on long-term global oil supplies, as well. Russia offers one of the best prospects outside of OPEC for bringing new oil supplies to market over the next decade or two. But ever since President Putin began to roll back the privatization of energy resources, foreign investors have seen the trends on "above-ground risk"--having to do with legal systems, politic stability and corruption--go the wrong way. The dismantling of Yukos was a giant red flag for anyone contemplating investment in Russia. The Russia/Ukraine gas standoff compounds these concerns.

One of the basic principles of the energy business is that getting oil or gas out of the ground is pointless if you can't sell it to someone. In Russia, that means being able to export to a buyer in Europe or Asia, because the internal Russian market is saturated with cheap government oil and gas. President Putin's threat to cut off gas exports to Ukraine raises the specter that he might actually follow through in a future dispute with some other country. If the oil or gas in question were coming from a multi-billion dollar private project, such as one of those on Sakhalin Island, the consequences for the project's economics would be dire.

To the extent this sort of power-play deters investment in the Russian oil and gas sector, the whole industrial world is worse off, because it makes us even more reliant on the Middle East. Apparently the global role Mr. Putin is looking to fill is not that of "reliable energy supplier." Companies will have to figure out just what his aspiration is, before putting more money into the Russian energy sector.

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