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msn.money (UK): Russia, gas prices and you

By Nick Louth
January 10 2008

The start of a new round of price increases for domestic fuel has brought attention back to natural gas, the fuel we rely on for domestic heating and cooking and which powers more than a third of Britain’s electricity generation capacity.

Natural gas is relatively clean, adaptable, efficient and was until recently abundant in the North Sea. For years, Britain was entirely self-sufficient in gas.

All that is changing now.

First, gas output from the North Sea is in decline. Second, new supplies right across the globe are coming onstream slower than hoped. Finally, the global distribution of gas reserves has given an enormous power to an old adversary: Russia.

Local supplies run low
As North Sea output declines, Britain may be importing 40% of its gas by 2010 and 80% by 2020. Some of that gas will come from new pipelines from Norway, and some will come from liquefied natural gas (LNG) shipped in from the Middle East, Algeria and the Caribbean.

Most of the rest will come down trans-continental pipelines through Holland and Belgium. Where do those pipes start from? Russia, mostly.

Indeed, by 2015 Europe as a whole will be importing three quarters of its gas, compared with 57% now. Most of that will be Russian. “So what?”, you might say. Europe has been importing some Russian gas for decades. The difference now is that we will be dependent on it.

This comes at a time when Britain is facing a growing energy gap as old nuclear power stations are closed and not yet replaced and at a time when the relationship between the Kremlin and the west is distinctly frosty. The Litvinenko affair, in which a KGB defector was poisoned with radioactive polonium-210 in 2006, has marked a particular spat with Britain which accuses a Russian agent of being responsible.

World’s largest gas reserves
You can’t mess with Russia now. It has the world’s largest gas reserves, with around a quarter of the total, almost as much as the next biggest suppliers, Saudi Arabia and Iran, combined. However, it is geography rather than geology which really marks out Russia’s energy power.

With its vast land mass, Russia sits astride almost all the most important transcontinental pipelines taking gas from central Asia to Europe. Unlike oil, gas is hard to ship at ambient temperatures, so pipelines are the method of choice.

Lock on the pipelines
So as well as its own production, Russia is the conduit for most of the gas coming from the former Soviet states of Azerbaijan, Kazakhstan, Turkmenistan and Uzbekistan. That adds another few percentage points to its share of reserves, but more importantly gives it a strategic grip on the newer supplies from these emerging nations.

In 2005, Russia showed what it could do when it cut off gas supplies to Ukraine in a dispute over unpaid bills. The landlocked nation, fresh from its “Orange Revolution” which Moscow saw as a threat, was forced to pay up by early 2006.

Forced contract changes
British firms, which signed contracts to exploit giant gas fields in the Russian far east, have found contracts being re-written to the advantage of the Russian the state-owned gas giant Gazprom. BP was in 2007 forced to yield control of the huge Kovytka gas field in eastern Siberia, while Shell had its interest in the Sakhalin II field diluted in 2006.

Now, Gazprom is taking on the world’s largest energy company, Exxon, over its plans to export gas from Sakhalin I to China, which is relatively nearby. This is the only remaining gas venture in Russia which Gazprom does not yet have majority control. If precedent is any guide, Gazprom will soon have the control it craves.

Overseas reach
However, Moscow’s reach is not confined to its own borders. Gazprom is negotiating with Nigeria to gain control of vast untapped gas resources in the troubled west-African state, reserves which western oil companies had thought to be theirs to develop.

At the very least, the courtship of Vladimir Putin will allow Umaru Yar’Adua, the Nigerian president, to get higher prices and more of the kind of investment he wants from the west, whose companies have long had a lock on the countries oil and gas development.

You don’t have to be a Cold War conspiracy theorist to be a little alarmed by some of these recent events.

Inefficiency or muscle-flexing?
However, Soviet-era inefficiency may be as great a foe as the country’s resurgent assertiveness. A key pipeline, being built under the Baltic (so that Russian gas can bypass politically troublesome Ukraine, the Baltic republics and Belarus) is years behind schedule.

Nordstream was due to be open in 2010, it will not be even tested properly until a year after that and the cost has ballooned from €5 billion to €8 billion.

The International Energy Agency is very worried by the slow development of many of the world’s gas fields and the pipelines to connect them. Surging demand from newly industrialising countries like China and India, plus the traditional cheapness of natural gas has not until recently spurred the investment that is required.

“Investment in the gas sector is a serious cause for concern,” the IEA said in a 2006 report. “Gas investments everywhere are suffering higher costs and construction delays… (yet) in Europe, almost two-thirds of new electricity plant under construction is gas-fired.”

The wrong kind of gas?
In Britain, we are not yet ready to face the challenge. The facilities to handle liquid gas shipments (LNG) are running behind schedule and the new pipelines to move the gas around the country and the storage sites to hold reserves are far from ready.

Ageing Magnox power stations are likely to be replaced by a new generation of reactors to keep producing the 20% of UK’s electricity that comes from gas, yet there will be a gap of several years between the de-commissioning of one and the arrival of the other.

At the same time several of the gas-cooled nuclear reactors will have to be closed by 2015 as will a number of coal-fired power stations which can’t meet EU emission standards. The green energy push, mostly in wind turbines, will fill only a tiny part of that gap.

Ironically, for a country which basked for years in the abundance of North Sea gas, Britain is particularly vulnerable. As we discovered in 2005 when too little gas was being piped over the Interconnector line from Belgium, you need a hefty price premium to make sure that you get the gas you need.

We are at the farthest end of a very long series of pipelines. Like being last in the queue at the buffet, the danger is that there will be little left at the table when you finally get there.

http://money.uk.msn.com/mortgages/billsandenergy/article.aspx?cp-documentid=7196138

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