crimea: a crisis of gas, oil & uranium supply

Crimea: A Crisis Of Gas, Oil & Uranium Supply
BY RICHARD CAMPBELL - 17/03/2014

The Crimean crisis may prove more difficult than early reactions assumed. There is a profound a-symmetry, not only in the respective energy resources of the EU and Russia, but in the way the two blocks see the world.

It may be too early to define the immediate consequences for our markets, but it may be wise to lean towards pessimism as Ukraine flounders, talking of mobilisation but totally out- numbered militarily, with poor economic prospects and a weak and divided Europe for moral and economic support. It has no intention of engaging Russia in a land war.

Certainly Russian companies have rapidly repatriated bonds and cash as western investors in Russian assets try to do the same, but many are locked into existing supply and investment arrangements and even one of Russia’s great energy conglomerates, the state owned Rosatom has defied Putin’s immediate group by saying there is no question of stopping enriched uranium from reaching Ukraine’s 9 reactors. Even for a shut down fuel is required.

Who is more dependent on whom?

Behind the immediate issues of threats and physical occupation of Ukraine infrastructure the critical question: is Russia more dependent on the EU than the EU is on Russian energy. It is very messy as both sides take immediate pain, but the assumption by some of the western leaders and commentators that there is no contest seem alarmingly naïve. Given the scale of Russia’s energy resources, their strategic distribution, the EU’s energy deficit and the cost of finding alternatives quickly, seem to mean that democratic outrage should put on hold.

One claim put forward is that the oligarchs who now have prodigious wealth comprehension will bring Putin to heel. There has already been a sharp fall in the Moscow Exchange and calls on leveraged positions, but the key question is whether the “110 oligarchs” that apparently hold 30% of all Russian assets are a) united; b) have any political influence or that c) Putin and his inner circle care a fig. The more their assets fall, the cheaper it will be for state companies to buy them.

The case of Mikhail Khodorkovsky is instructive. For a brief period he was the richest individual in Russia after acquiring Yukos Oil for $300m and $2 billion in debt through a bank he controlled. The acquisition details were murky. There were gun shots and dead bodies. It was a wild time, but his timing was perfect. The distressed Yukos recovered with rising oil prices and Khodorkovsky’s wealth reach $17 billion. He thought this granted him immunity and made the mistake of regarding Putin a democratic politician, if a dangerous one. When Yukos was presented with a $24 billion tax bill he didn’t get the hint. He was charged with tax evasion and embezzlement, tried and found guilty and then spend the next decade in Arctic Circle prison camps. The most relevant point though is almost all his Yukos assets were transferred to Rosneft, Russia’s largest oil company.

Defender of the state

Putin turned the episode into a public triumph as a defender of the State and the people. He had cleaned the stables of oligarch swine just as he cleaned out the corruption and fraudulent dealings surrounding Gazprom and Sibneft. Assets sold off for a song to the first generation of oligarchs were reacquired and now, under the control of a long time friend and associate Dimitry Miller, Gazprom has with Sibneft back in the fold grown to be one of the largest energy groups in the world.

All that’s needed to appreciate some of the difficulties the EU and the US faces is to note that Rosneft’s oil and oil equivalent reserves are 30% larger than Exxon’s and growing faster. And to add a twist of the knife, its largest shareholder is the giant UK oil company BP. It holds 20%. Just a hint of tit for tat confiscation would send BP’s price tumbling.

It is certainly true that an EU decision to forego Russian gas would quickly destabilise Russian revenues, but there is little likelihood of a substantial shift in supply several years if not a decade. The EU’s combined energy grid is a patchwork of different energy sources, but over-all relies 30% on Russian gas and as there is much interdependence. Even energy independent France with its 55-59 operating reactors would be affected as neighbours lean on it for nuclear or hydro power while they made the transition. Germany might restart its idled eight reactors, but that would create political difficulties and appear to buckle to Putin at a time when Merkel is telling the world that Putin has lost contact with reality. There are also deeper, residual feelings. When Russian troops reached Germany in 1945 they behaved atrociously. Rape was indiscriminate. Generation X or Y may not know or remember, but the history is bleak.

Multiple choices

In contrast Putin has many choices. One is to do nothing. He had forgiven Ukraine unpaid energy debt in the past. He could show a statesman like forbearance as the EU seeks other sources of oil and gas at substantial cost, not only in price, but in new capital outlays for LNG receiving depots. The US gas industry is salivating at the opportunity, but the first US LNG tanker will not leave until 2015 if all goes well. This will not be a great help. There is also large new supply coming from East Africa and Mozambique, but not before 2020. Iran may speed up development of the giant South Pars field, but the first priority will be gas starved Iran and few companies have any interest in helping Iran’s deeply corrupt and incompetent leaders.

Putin can also be selective. Russian supplies pass through 12 different pipelines to Europe and already Italy had made it clear that it apprehensive. It has almost no coal to fall back on; some internal gas and not entirely reliable gas supplies from Algeria and Libya.

Russia can also claim the moral high ground by arguing that it has been generous to Ukraine all along been providing gas at a significant discount despite late payments. Whether this involved a gigantic skim involving corrupt Ukraine politicians and Putin’s immediate circle we can only guess. There are certainly grounds for the claim that Putin is an extremely rich man for a public servant from such a humble background, but this is irrelevant as on the surface Ukraine was given concessions for allowing Russian gas to cross its territory and because in a broad historical sense Ukraine is “the mother country”. Once Moscow was a far northern trading post of Kiev.

Ukraine the progenitor of Russia

It can also argue that Ukraine with its shifting boundaries has been part of Russia for 170 years. This undercuts Hilary Clinton’s claim that Putin’s actions are like Hitler’s invasion of German speaking Czechoslovakia. Technically she is right, but the “illegal” vote by Crimean Russians simply restores the historic reality after Russia devolved quasi-independence to Ukraine in the fifties. It depends where you draw the line. Peter the Great’s generals took western Ukraine (Ruthenia) back from the all conquering Swedes and a century later Catherine’s generals secured the Crimea for the Russian fleet.

The larger and defining issue is Europe’s energy deficit. Its black, high calorie coal which drove the first industrial revolution is largely gone. Once the UK had several thousand coal mines; now just three deep pit mines are operating. France mined out its Alsace coal by the late fifties. Germany’s last hard coal mine will close in 2016. Poland, Hungary, the Czech Republic and Slovakia are in varying degrees in the same position as black coal in deep seams is nearing an end. Germany, Poland and Hungary have large lignite resources, but this is energy going backwards. Lignite has 60-70% water content and mining tears into farmland and remnant forest. It releases 20-30% more CO2 than brown coal. As a fall-back position, it will have to do.

Germany has periods of a few hours on some summer days when it can claim 30% of its energy is derived from renewables, but this doesn’t apply in winter or on still days. Like Denmark it periodically relies on neighbouring countries for additional power. If it did not have Russian gas as a back stop to manage support daily peaks, it might have to restart its eight idled nuclear reactors creating deep angst across Germany and what may become irrational actions.

The Baltic countries are even more dependent on Russian gas. Hungary is vulnerable now that it has become an industrial annex of German car production. If the Russian gas tap was turned off the economy would bottle in weeks, less because energy prices would soar, but because uncertainty would prevail. For all its bravado, Germany would be in a similar position. Its 45 days of gas reserves provide over a month of negotiation space, but Putin could bide his time, issue veiled threats and keep Europe on a short leash while still accepting gas revenues with a poker face.

Certainly the Russian economy is imbalanced with oil and gas representing half its exports. Gazprom alone accounts for 7% of GDP, but cautious Europeans will remember that Putin does not aspire to be a liberal democratic leader running poll-driven democratic state. He has made it amply clear that Russia is different. It is not interested in US politics with its endless stalemates and uncertainties. Russia on the other hand can take the best of the west and provide the people with excellent health and education. To do this strong, clear leadership is required. It seems significant that when asked what paintings he required for the Presidential office, Putin didn’t call for any recent Soviet heroes – his grandfather had been a chef for Lenin – instead he called for a large portrait of Peter the Great – the autocratic moderniser of Russia.

Putin’s mind set

The real worry may be Putin’s take on Russian history. Napoleon had not lost a set battle by the time he reached the outskirts of Moscow. The Russians fought bravely at Borodino, but retreated burning Moscow to the ground rather than ceding control to the invader. The Russian strategy ultimately worked. Napoleon looted Moscow but his troops were decimated as they retreated through the marshes and mud of Belarus. It was much the same treatment for Hitler’s Field Marshalls. Paulus surrendered after his starving troops were cut off and hunted down, building by shattered building. In besieged Leningrad Russians ate rats, bark and dead bodies rather than give in to the Germans. (Putin’s elder brother died of diphtheria during the siege). If this is only vaguely remembered by Russia’s young, it can all be quickly resurrected.

European energy potential

Europe’s shale gas potential is now raised as a rallying cry, but the talk tends to be second hand and half baked many unaware that the US Geological Survey’s claims about European shale potential were highly speculative. Poland’s 5.3 trillion cubic metres would set it up for 300 years of energy independence, but in the three years since the claim was made Exxon, Chevron, Talisman and Shell have pulled out. Poland’s own Geological Survey cut the potential resource back by 90%. Not all shale has the required organic content and that can only be judged by deep drilling at very high cost.

In the UK there is large potential as the Bowland shale beds of Lancashire are of the same era and type as the Marcellus below Pennsylvania, but as ASX listed AJ Lucas has discovered, the fear and loathing of “fracking” is delaying development. So too in Europe. Both France and Germany have banned fracking due to the concern about the solvents added to the gritty water pumped into dense, fractured shade beds.

It can be taken as read that Putin and his energy advisers are well aware of all this down to the last detail. Putin’s doctoral thesis for the Mining Institute was focussed on the marketing of Russia’s oil and gas. He many have had the assistance of others, but it was an obvious topic for someone with high political ambitions in post Soviet Russia. He is also close to the Chairman of Gazprom, Alexey Miller who worked under Putin in St Petersburg with lawyer, close friend, ex President and now Prime Minister, Dimitry Medvedev. This is the troika which re-assembled Gazprom. Now it is an immensely large state corporation on the scale of Exxon or Shell with 18% of the world’s gas reserves.

The power of gas, oil and uranium supply

This gives Putin an almost dictatorial depth of economic and political power save for the exception of Rosatom’s declared independence. Ukraine made the mistake of denying Rosatom’s transfer of enriched uranium to Bulgaria, which earned a retaliation from Russia’s deputy PM - the gesture Rosatom disapproved of in relation to Ukraine’s supply - but if Rosatom’s Sergei Kiryenko is over-ruled, we have real reason to worry. Ukraine’s reactors have relatively small reserves of fuel and can’t be shut down quickly. It will mean Putin is not just a populist dictator like a Peron or a Mussolini in his early years but a man of real menace.

Ultimately some complex compromises will have to emerge. Ukraine may be dismembered and the EU may have to lump it. Europe can’t afford to cut off its nose to spite its face and the idea of wrecked Russian economy doesn’t help either. Russians may simply close ranks.

The Australian connection

One glimmer of hope does have an Australian connection. As all this unfolds GE and Hitachi are in discussions with the US Department of Energy about transference of control of its Paducah Kentucky uranium enrichment plant to GE and its associates. For years the US Enrichment Corporation has been unable to copy the Russian and French centrifuge enrichment technology and relied on antiquated technology for reactor supply. It was cheaper to import down-blended war heads from Rosatom, but now Rosatom will be well aware that GE and Hitachi have secured the Silex (SLX) enrichment method that is “2-18” times cheaper than its own centrifuge. GE has also gone a step further and is preparing to deploy the same process to extract the active isotope from the depleted tailings on site at Paducah. Silex and GE say there is $3 billion in value in these tailings. One treated, the tailings will create low storage risks.

This is a serious commercial issue for Rosatom as GE’s consortium could outflank it globally at both ends of the market: enriching raw yellow cake and tailings. There are tailings all over Europe.

At this stage this is just a small foot note to the tensions over European gas supply, but ultimately throws a spanner in the works. Europe cannot go on using fossil fuels in perpetuity and is unlikely to be able to run 28 increasingly sophisticated economies on renewables alone. The two kilometre deep ice packs of Greenland are steadily melting and the Russian tundra is thawing. In half a century Europe’s ports will need re-engineering. There are many large issues buried in the Crimean conflict.