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Verleger: Natural Gas Cartel Could Emerge in Future, But Not Now

Interviewee: Philip K. Verleger Jr., President, PK Verleger, LLC
Interviewer: Bernard Gwertzman, Consulting Editor
April 10, 2007

Philip K. Verleger, Jr., a well known expert in energy policy, says meetings of natural gas exporting countries in Qatar are not likely to be very significant in short term, but in time “could be very significant.” He points out that OPEC was first formed in 1960, but says it did not function as a true cartel until 1999 when Saudi Arabia used its predominant position to push prices higher. Verleger says the United States has a healthy supply of natural gas and is not as dependent on imports as it is in oil.

What’s the significance of a two-day meeting in Qatar of natural gas exporting countries? Are they trying to form a natural gas cartel, analogous to OPEC [Organization of Petroleum Exporting Countries].

My impression is, short-term, not terribly important. Long term, it could be very significant. OPEC’s first meeting was in 1960, forty-seven years ago, and it really didn’t become a significant player in the market until 1973, and did not really act in a cartel-like fashion until 1999, when Saudi Arabia reduced production, causing prices to go from $10 to about $25 a barrel. Now, OPEC really doesn’t function like a cartel, it functions more like a dominant-firm monopoly where one firm tells everybody else what to do, with  Saudi Arabia being the one firm. Gas could develop the same way. Russia is the dominant exporter, dominant producer and has most of the reserves. And the Russian leaders and economists have looked at this pretty carefully. President Vladimir Putin apparently did a master’s thesis on the subject of maximizing value of resources, although it’s not available. The Russian approach to oil, metals and natural gas has been very consistent with a mercantile practice of extracting the maximum revenue for the country. One could say Russia is trying to win the second round of the Cold War. If energy prices keep rising, Russia will be very powerful.

Well, Russia’s already powerful because of the high oil prices, right?

That’s right, but we ain’t seen nothin’ yet. Russia could use its position in natural gas to accelerate the development of a natural gas cartel, were it to build outlets to China and more outlets to Europe so they could discriminate against countries that displease them.

We ain’t seen nothin’ yet. Russia could use its position in natural gas to accelerate the development of a natural gas cartel, were it to build outlets to China and more outlets to Europe so they could discriminate against countries that displease them.

The Europeans really have little choice but to deal with Russia. Russia could exert a very significant monopolistic power over Western Europe. And it would take Europe years to find alternative supplies of natural gas. It can’t build natural gas importing facilities quickly. So Russia has the capacity to exert a lot of economic pressure on Europe.

The price now in Europe for natural gas, is it high or is it low compared to oil?

My impression has been that the Europeans have been trying to work on a price that is close to the price of oil equivalent. BP’s statistical yearbook has natural gas prices, and the European Union price in 2005 was around six dollars per thousand BTUs [British Thermal Unit]. That was equivalent to the price for delivery to Japan, a little lower than in the United States.

Does that translate into oil?

Multiply it by six.

So it’s roughly two-thirds of the price of a barrel of oil. A commission has been set up at the Qatar meeting to look at prices. Is the intention to bring the prices of oil and natural gas closer together?

Years ago, it was argued that gas prices, because there are fewer greenhouse gases emitted when you burn natural gas, ought to be higher than oil. But the fact of the matter is, price is determined by how much is produced and how much is consumed.

In the United States, we produce about 80 percent of our own natural gas.

I think it’s a little more than 80 percent, yes.

And the majority of the imports come by pipeline from Canada.

Right.

And we take about 3 to 4 percent of LNG [liquefied natural gas] by ship. So at the moment, we’re rather immune to much price pressure on natural gas, right?

We’re immune from price pressures, pretty much. That would be correct.

Is U.S. natural gas depleting?

U.S. natural gas has been depleting, but the thing is, we’re also finding a great deal more. Oddly enough, where I live in Colorado, on the Western slopes of the Rockies, when you drive west to Las Vegas, one of the most beautiful drives in the world, you see there’s an incredible amount of drilling that started just in the last three or four years for natural gas.

It’s going to be very important for the Europeans to avoid being squeezed by a monopolist or a cartel, to develop alternative sources of imports. The big problem they face is that the logical place to bring those imports from is Iran.

They’re finding a lot of it. In fact they found so much of it that natural gas in Colorado is very inexpensive because there’s no way to get it east. There are not enough pipeline facilities to do that. President Richard Nixon also had proposed developing shale oil here, and they’re talking about it again. If they can make the shale work, there’s more shale between Colorado and Utah than there is oil in Saudi Arabia. The problem is you need water to produce, and the thing we don’t have is water.

So the Americans are immune really from this whole discussion in Qatar?

Yes.

But its allies are not. The Europeans are not immune, and the Japanese and the other Asian countries are not immune. Now does China have much natural gas?

China has some and they’re drilling. They may have more.

But then, as you were saying at the beginning, the chances of this group forming a cartel, the equivalent of OPEC, is still some time off?

Yes. This group being able to generally manipulate prices is still some time off. And Russia will be looking at something else. Russia’s going to be trying to move much more quickly to exert more power on natural gas and capture increased revenue from Western Europe. It’s going to be very important for the Europeans to avoid being squeezed by a monopolist or a cartel, to develop alternative sources of imports. The big problem they face is that the logical place to bring those imports from is Iran, which has all the problems we know about. There’s discouragement on investing in Iran, even though it’d help Western Europe. And the direct way to get the gas to Western Europe would be to bring it through Turkey by pipeline. Or, you know, you can bring LNG into Greece, but pipelines through Turkey make a lot of sense. And that opens up the second can of worms, which is whether Turkey is going to become a member of the EU or does Turkey charge above normal transit rates and essentially squeeze Europe that way? It’s a very complicated chess game.

And things like windmill-generated power and that sort of thing, that’s really minor right?

Well, they’re all great ideas, but as I said it’s too late. Wind’s a great thing, and in thirty years, maybe we’ll have a lot of windmills. But not now. The only choice we have right now, both for natural gas and oil, for the United States and Europe and China, is to pay a hell of lot more.

And nuclear power?

Well, it’s a great solution, but we stopped educating nuclear engineers thirty years ago. I have the data. I’ve just been looking at the idea. We produced a quarter of the nuclear engineers in the last five years that we produced in the sixties. And they have to replace the guys who are retiring. You know, even the French, who build a lot of nuclear plants, let a lot of people go and they just keep a skeleton business going. It’s going take years to ramp that back up. Maybe 2020, we’ll begin to see some increased nuclear output, maybe 2025, but this is a long time down the road.

Peripheral to our discussion, but you at one point were talking about a hundred dollars a barrel for oil. Is that still possible?

Well, one of the interesting things is that crude prices right now, if you look at the New York Mercantile Exchange, are around $60 a barrel. They’re at sixty because there’s no way to get the oil you deliver, the West Texas Intermediate to refineries. It’s bottled up, due to some refinery problems. The correct price of oil right now, if there were no bottleneck, would be about $72, and that’s where the international market’s trading. Gasoline is trading as if it’s $90. It’s a stealth oil price increase. But it’s big.

Explain to this layman, if the price in the New York Mercantile Exchange is around $60 a barrel, why is it $70 elsewhere?

Because commodity markets—this is something about one person in a thousand understands—commodity markets deal with a deliverable. WTI (West Texas Intermediate), which is what New York Merc. trades, is delivered in Cushing, Oklahoma. Cushing, Oklahoma, is out in the middle of nowhere. It used to be that Cushing flowed from Cushing up to Chicago. Well now there’s a lot of Canadian oil coming into Chicago, so that the oil can’t go from Cushing to Chicago. As a matter of fact, Canadian oil is coming down toward Cushing. It can’t go anyplace. It’s just going into tanks. And a major refinery that took a lot of that oil out of Cushing blew up in February. And tanks have been filling. The ultimate solution is going to be to take the Canadian oil on south down to Houston, and I think that will be implemented in a couple of months. When that happens, this bottle neck will go away. There are two crudes that everybody always watches. One is Brent, which is produced in the North Sea, and one is WTI. Brent used to trade normally about two dollars below WTI. And it’s trading now at sixty-six dollars where WTI is at sixty-one. So you say that WTI should be about sixty-eight dollars a barrels. It’s very complicated, but that’s fair.

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