Gas OPEC Not Likely

Implications: - Gas is an increasingly important commodity in world energy markets and a price-fixing cartel would raise alarm bells around the globe

- Russia, Iran and Qatar are the three largest gas reserve owners.  President Putin recently visited Qatar to expand energy cooperation.  Russia is close to Iran since it is their supplier for commercial nuclear technology and weapons.  Energy cooperation is high on the Russia-Iran agenda. 

- Despite these contacts, it is unlikely that a gas cartel will emerge due to the significant differences between oil and gas trade.

Analysis: Natural gas is an important world energy commodity comprising about 21% of world fossil fuel demand, behind oil and coal.  In some regions such as Europe and the US, however, gas is the second most important fossil fuel.  In Europe gas comprises 24% of supply and will grow to 29% by 2030.  Its use worldwide will continue to grow through 2030 (See, International Energy Agency, World Energy Outlook 2006 at www.iea.org) 

The oil market has been the subject of manipulation by companies and governments for years.  The Organization of Petroleum Exporting Countries (OPEC) was created in 1960 by most of the significant oil producers as a mechanism to influence production and prices.  It has had successes and failures.  Recently, it has been more successful due to tight markets and limited spare capacity.  Its actions have more impact in tight markets than in surplus markets.  As a result, the announcements by OPEC officials and more importantly by Saudi Arabia, OPEC's largest and most influential member, can drive oil prices.

In recent years, there has been discussion of developing a gas cartel that could influence gas prices as OPEC influences oil prices.  Russia, Iran and Qatar, the three largest reserve holders, control about 56% natural gas reserves.  The largest producers include Russia, US, and Canada.  

Why is the formation of a gas OPEC unlikely?  The reasons are several with the following the most significant.

1.  Unlike the oil market, there is a large mismatch between reserve ownership and production.  Russia is the largest reserve owner and producer.  Iran and Qatar, the second and third largest reserve owners are important producers, but not nearly as large as the US or Canada.  More gas is produced outside any potential gas cartel than is the case with oil.

2.  More important is the way oil and gas are traded.  Oil trades in a world market, with prices set in large openly traded exchanges.  While contracts are important for determining buy-sell relationships, they are short-term, often rolled over on a 30 day basis, and can be adjusted rapidly.  Contract prices are determined through reference to the open exchanges.  Quantities sold are determined on a short-term basis and can be adjusted rapidly to fit changes in supply and demand, including OPEC quotas.  Gas is traded through long-term contracts with complex pricing structures (usually referring to various types of oil or coal) and often have restrictive clauses that make adjustments in volumes sold difficult, if not impossible.  For example, many gas contracts have take-or-pay clauses which mean the buyer either must take the contracted volumes or pay for them even if not taken.  The contracts usually have penalty clauses if the seller does not meet contracted for volumes.  With these types of contracts in place, it would be extremely difficult for producers to alter volumes in order to affect price without suffering penalties.  Newer contracts have tried to eliminate take-or-pay clauses and other restrictive clauses, but many still exist.  

3.  Gas normally moves through pipelines that are extremely capital intensive; that is, they have high up front capital costs.  The underlying contracts used to purchase the gas usually are used to finance the pipelines--project financing.  The banks and other financial institutions would have a lot to say if they thought that the gas purchase contracts were being manipulated to affect prices.

4.  Gas often is considered as trading in regional markets due to the pipeline interconnections.  A gas cartel that wants to have an impact in world market would have substantial difficulties in trying to affect world prices.

5.  Increasingly, gas is being traded as liquefied natural gas (LNG).  This product also trades using long-term contracts that are used as the basis for project finance of the costly LNG facilities.  While some spot cargoes are traded on a spot basis, this is still small portion of the overall market.  Even as a world market is evolving, it is not there yet; regional markets still predominate.

Thus, the differences between oil and gas markets make it unlikely that a gas OPEC will evolve any time soon.  Those watching the gas market should take some comfort in the fact that even though Russia may be discussing the formation of a gas cartel with Iran or Qatar, the emergence of this gas cartel is extremely unlikely in the foreseeable future.