We must get off Russian gas – and it’s not because of Putin or Ukraine

News on another potential Russian gas crisis is galore. Not a week without page-filling analysis if Russia will cut the gas or Ukrainians will simply resort to stealing or, or, or. All this commenting on the troubles between Russia and Ukraine masks another, much more serious issue, which threatens European gas supply security much more seriously than any land grab could ever do.

In 2005, I joined EconGas, a small Central European gas distribution and trading company in Vienna. It was also my debut in the gas world and one of the first lessons I learned was that we get most of our gas from Russia. This supply agreement was something like the holy grail of the company. Just looking at it strangely got you in trouble. Further, I learned about how the Russian gas supply infrastructure developed from Siberian fields in the Sixties and that those fields are still the main source of all the gas coming our way. Those working on this supply contract proudly gave me great lessons in gas history.

It did not take me a degree in geology or in oil engineering to figure that if those fields have been producing gas for Russia and Europe for close to half a century, there must be much less of the stuff in them reserves right now than when this all began. If you keep withdrawing from a reservoir for a while, it will reach the point of maximum production and then a plateau, which means essentially that it will keep producing oil and gas (or whatever else at a stable rate for a whole while).

Almost spent …

At some point in time, though, the pressure in the reservoir will begin decreasing and in spite of all stimulation that is being performed shoring up production for another while, it will eventually drop and one day it will become so small that further operation of the field becomes uneconomical. A field has peaked when production starts this irreversible decline.

All the fields that a usually producing gas for consumption in Russia and Europe have peaked years ago. If one keeps pulling from the bottle, the bottle is eventually going to be empty. That means that there is less gas available for sale every year. In order to keep gas exports at current levels, Gazprom would have to develop new sources of gas. However, this is not so easy.

If we assumed that the currently producing fields in West Siberia were undeveloped today (let us just imagine that for a moment) and someone would appraise them for their economic viability today, they would most probably be declared stranded gas. What is stranded gas?

Not every oil or gas field is comparable to the other. Basically, every time it’s a calculation of “What’s my cost of finding, lifting, conditioning and transporting the gas to a paying customer” on one side and the “Price I may realistically expect to extract from the customer” on the other side. Not very different from a candy store that must always ask itself if a certain product can be bought wholesale, stored, given shelf space and sales force attention for less than it can be sold. A simple profitability calculation like very sound entrepreneur makes them on a napkin every day.

In oil and gas, it’s a bit more complex as both the expected cost and the – price that can be expected from a market – must be guessed over decades. We all know what future projections are worth. They are bull for the next year – let alone for the next 20 – 30 years. However, big energy has developed ways to deal with this and I must admit that if sound methods are being used, this can be done with a great deal of comfort for investors.

In Russia’s case and its Siberian fields, this calculation would almost certainly fail to produce profits. We can see this sorry tale unfolding right now in Eastern Siberia where gas fields are being developed for the China contract that has been signed with Pomp and Gloria. Battle-hardened upstream analysts have a tough time to see how all this gas could be sold at a profit to China. It much more looks like a political deal where Russia would never make a dime of the project. Moreover, even if Russians understand natural gas, they are no magicians able to suspend the laws of gravity in oil and gas economics.

That’s how it goes …

So, how did the Russians then sell all this gas to Europe and make huge profits on it in the past? Easy, the currently existing pipeline and upstream infrastructure have been developed and built in the Sixties and the Seventies and modern Project Economics had not to be factored in. Conscript labor at the scale necessary for such a colossal undertaking and an utter disregard for the life’s of those prisoners are also hardly available, even in today’s Russia. Therefore, profitability is an issue.

This same thing has already all but killed another once promising prospect for European gas in Russia, the Shtokman field development that has been hailed as the Holy Grail by European executives until just a few recent years.

Gazprom and Russia are living on investments made half a century ago and those fields are running empty rapidly. The once mighty gas-exporting nation is rapidly seeing its reserves dwindling away and its gas transport infrastructure falls to pieces.

This means that in time it simply won’t be able to deliver the gas to Europe anymore, no matter what happens in Ukraine or not. We must get off Russian gas not because Russia has invaded Ukraine or because we must uphold human rights (those sure are debate-worthy issues) but much more and simply because Russia won’t be able to deliver all the gas we have contracted for any more in less than a decade.

If we don’t wake up to this hard fact very soon, we will have an energy crisis with no equal.