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Analysis
Shell’s landmark Ukraine move

Shell’s landmark Ukraine move

Consequences for Gazprom and Putin
Shale gas investment now part of standard energy portfolio

by Nick Butler, Advisory Board

Wed 30 Jan 2013

Shell’s decision to invest $10bn in shale gas development in Ukraine is a significant move that will shape opportunities for investors in energy and infrastructure across Europe. It also raises new questions over the value of Gazprom and associated Russian assets.

The move confirms Shell’s commitment to shale and the company’s determination to override environmental objections to the technology of fracking. Shell believes shale can be developed safely and cleanly enough to avoid damaging either the environment or the company’s reputation. This move helps confirm shale’s arrival in the mainstream of the energy market. For investors, shale gas can now be considered as part of a standard energy portfolio.

Shell clearly believes that the European gas market is going to change radically. Countries such as France and Germany may not want to develop their own shale gas but will be prepared to import either direct supplies of gas, or supplies of electricity generated by burning the gas in Ukraine and other producing countries.

For historical reasons the electricity market in Europe tends to be nationally based. This deal suggests that the whole market is now likely to change. Ukrainian shale reserves are likely to produce more gas than the country itself needs, and the investment makes sense only if an export market is available.

There are major medium term opportunities here for investors in infrastructure and big questions for those who have tied themselves into the sectors which could suffer – in particular expensive renewables.

Perhaps most important, the deal highlights Shell’s apparent indifference to Russian opinion. Seen from Moscow, Ukraine is still very much in the Russian sphere of influence.

Ukraine itself is divided on the matter. The eastern part of the country tends to look to Moscow, while western Ukraine looks hopefully towards Brussels and the EU. The deal is a boost for this westward perspective, even if the EU is currently too preoccupied to welcome new member states.

The exploitation of shale gas in Ukraine will further undermine the market position of Gazprom. Ukraine is currently Gazprom’s largest single international market. Once development gets underway – realistically five years from now – much of this trade will dry up. And once the surplus gas starts to be exported to western Europe more of Gazprom’s trading business will be put in jeopardy. One can argue that this is just normal business with one technology overtaking another. On this view competition is healthy.

I am not sure if Russia in general, and its president Vladmir Putin in particular, will take such a relaxed view. Relationships between Russia and the ‘near abroad’ – the name applied to the states that managed to slip away from Moscow’s formal control after the collapse of the Soviet Union – have never been good.

The relationship is about more than economics, but a simple economic issue such as the changing gas market could trigger a sharp deterioration in relations.

Gazprom is a key part of the Russian state. Shell’s move shifts power from Moscow to Kiev in a way that demonstrates the weakness of Russia, which while seeking to remain a superpower has not managed to escape being an economy desperately dependent on the development of natural resources.

Russia is more dependent now on oil and gas revenues than it was when Putin first came to power. It is a uncomfortably vulnerable to any fall in energy prices and to any loss of market share.

Russia has already sent Ukraine a bill for $7bn for gas the country had promised to buy but did not need. It is not clear whether Ukraine, already deeply in debt and seeking an $15bn IMF bail-out, can afford to pay the bill, and even more unclear what action, if any, Russia can take to get its money.

Cutting off supplies in the period before any local production comes on stream would be an act of aggression and would hardly help Gazprom.

What is happening in eastern Europe is just part of the worldwide story. In just five years shale gas in the US has come from providing minimal supplies to being the source of almost a third of daily gas needs.

Worldwide resources are extensive. Their development will alter not just the energy market but also the values of many of the assets and companies involved.

Nick Butler is Visiting Professor and Chair of King's Policy Institute.

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