VINACHEM

History shows that thatgovernments usually lose arguments with energy suppliers. UKpremier Harold Macmillan summed up the position when talking about coalminers in the 1950s, warning:

“There are three bodies nosensible man directly challenges: the Roman Catholic Church, the Brigade ofGuards and the National Union of Mineworkers”

Unfortunately, Europe nowpotentially faces an argument with its leading gas supplier as the Ukrainestand-off continues. Russia supplies around 30% of Europe’s gasdemand each year (155 bcm), and more than half of this transits through theUkraine into Europe (82 bcm).

There is no immediate threat. But last month, Russia threatened to cut off gas supplies to the Ukraine itselfin a row over unpaid bills. It has now suggested thesebills total $22bn, instead of the initial figure of $2bn.

The map above from theFinancial Times highlights the potential difficulty this couldcause:

• Those countries marked in red depend on Russia for >75% of their gas needs
• Turkey and Greece depend on her for 50%-75%
• Germany, Italy and the other orange-coloured countries depend on her for 25%-50%
• Even France and the Netherlands have some dependence

Of course, no threats have yet beenmade about these supplies. That would make little sense during the summerperiod, when gas purchases are seasonally low. But if the Ukraine issuesremain unsolved, who knows what might happen as we move into autumn.

For the moment, Europe isbusy increasing its storage of gas, with 38bcm already in tank, 48% of thepossible total. And it is looking to increase LNG imports, with Lithuaniaand Poland both investing in new receiving terminals.

But Russia’s gas volumes are simplytoo large to be easily or quickly replaced. Whilst replacement will alsonot be cheap – current world market prices are high due to Japan’s decision toshutdown its nuclear facilities after the Fukushima tragedy. At themoment, Europe pays around $11/MMBTU, whilst Asian prices are $15/MMBTU.

Of course, shale gas mightenable Europe to become self-sufficient in gas over time. But several countries have already allowed environmental politics toban this option, whilst early exploration work in Poland has disappointed.

And, of course, there is also thequestion of Russia’s oil supplies. Central Europe is particularlydependent on these due to the pipeline legacy from communist days. ButWestern Europe couldn’t manage without Russian cargoes.

As Hyman Minsky warned long ago, too much stabilitycreates complacency. And it is 40 years since the last major disruptionon oil markets – when the Arab oil embargo led to motorists queuing forhours for gasoline in some major countries, including the USA:

• Its very easy to worry about possible risks from fracking when your home is warm, and the transport system is working normally
• But its too late to worry about finding alternate sources in the winter, if your major source of supply has just been cut off

As the blog has noted before, oilmarkets have drawn out probably the largest ever triangle shape over the past 5 years. The bulls and the bears have fought themselves to a standstill, and areexhausted. So the next price move is likely to be violent, either up ordown.

China’s slowdown is most likely tobe the catalyst for a price fall. But prices would almost certainly goup, and by a large amount, if markets start to worry that Europe couldbe held hostage over energy supplies later this year.