The Buck Stops Here

By Chris Cook -Trend:

You have to admire the chutzpah of the US. Not satisfied with the comprehensive sanctions on Iran, they've now applied financial sanctions on key players in the only other country with oil and gas reserves which exceed Iran's - Russia.

According to the Voice of Russia this is not something that President Putin will take lying down.

This article claims Russia is redoubling its own efforts to by-pass the stranglehold of the dollar on world trade, saying that "Lately, China has led the BRICS efforts to dislodge the dollar from its position as the main global currency, but the "sanctions war" between Washington and Moscow gave an impetus to the long-awaited scheme to launch the petroruble and switch all Russian energy exports away from the US currency."

There is specific reference to the proposed barter transaction between Russia and Iran which was recently covered by Reuters.

According to the report, "two separate Iranian officials said the deal was valued at $20 billion. One of the Iranian officials said it would involve exports of around 500,000 barrels a day for two to three years."Iran can swap around 300,000 barrels per day via the Caspian Sea and the rest from the (Middle East) Gulf, possibly Bandar Abbas port," one of the Iranian officials said, referring to one of Iran's top oil terminals."

A Reality Check

The role of the dollar in world trade is often misunderstood. The key element of the seminal deal between the House of Saud and the US after the 1973 Oil Shock was not that oil was priced and paid for in dollars: it was that the Saudis were prepared to retain their dollar proceeds and invest them in dollar assets - or US Treasury liabilities.

Just because a transaction is priced in dollars - ie the $ is the 'numeraire' or 'unit of account' by reference to which deals are priced - does not mean that the necessary dollars cannot be acquired in a microsecond on the foreign exchange markets. However, if a country is frozen out of the dollar clearing system, like Iran - and as is threatened for Russia - then settlement must necessarily be made using some other conventional bank-created currency; in some other credit instrument; or in barter.

The Russia-Iran oil swap referred to above envisages a barter deal, and there is nothing new about oil swaps by Iran, or energy swaps by Iran either, come to that, such as their gas for electricity swap with Armenia.

Under the sophisticated oil ministry of Bijan Namdar Zanganeh during the Ex-President Mohammad Khatami (1997-2005) administration, Caspian oil swaps enabled crude oil to be imported into Iran from the North for use at (say) the Tehran refinery. In exchange, the supplier to Iran received prepaid crude oil deliverable in the Persian Gulf , thereby creating a geographic 'oil swap'. Under the Ex-president Mahmoud Ahmadinejad (2005-2013) administration such swaps became increasingly opaque, fell into disrepute and were discontinued. The return of minister Zanganeh now sees the swap option under review.

A well informed Iranian source points out that the swap transaction reported by Reuters appears to be over-optimistic in suggesting that 300,000 barrels per day could be exported by Iran to Russia via the Caspian Sea. Even when properly dredged, Iran's Caspian crude oil port of Neka is only capable of taking vessels lifting a maximum of 5,000 tonnes (or about 36,000 barrels) of crude oil.

Moreover, the expert pointed out that the only viable Russian import terminal in the Caspian feeds a pipeline to the Black Sea which would merely make worse an existing glut at that location. So the only viable swap would be for Russia to receive an entitlement to 500,000 barrels per day out of the Persian Gulf, which is problematic for a number of reasons I will not rehearse here.

Where there's a Will there's a Way

As Pepe Escobar astutely observes in an article published on Asia Times, "Only the blind won't see that Moscow and Tehran are evolving towards a closer strategic partnership as much as Moscow and Beijing. There's a real strategic geopolitical axis in the house - Moscow-Beijing-Tehran - and the whole developing world has already noticed that's where the real action is. "

How might this axis manifest itself? Firstly, there's the institutional framework envisaged by President Rouhani at Davos for international energy co-operation by producer and consumers.

Secondly, there is the funding instrument known as Prepay - prepayment for commodities, goods and services at a discount - which is now re-emerging in use. Prepay pre-dates modern banking by hundreds, if not thousands, of years.

For the last ten years or more prepay crude oil contracts have been used opaquely to manipulate and support crude oil prices. But in 2013 Russian Rosneft began to enter transparently into prepay crude oil transactions in order to repay bridging bank financing of their acquisition of BP-TNK and thereby fund the purchase in the long term. Rosneft firstly entered into medium size transactions with traders such as Trafigura and Vitol and then in October 2013 we saw the announcement of a >$85bn crude oil prepay transaction between Rosneft and the Chinese state-owned Sinopec.

A Gas Clearing Union

The global physical and financial crude oil markets are complex and centralised around the North Sea Brent/BFOE (Brent, Forties, Oseberg, Ekofisk) benchmark price and complex of contracts. There are many vested interests, and these markets are essentially run and manipulated by middlemen such as traders, banks and exchanges in their own interests.

There is no such global benchmark or contractual nexus for natural gas, and this is where the opportunity lies to create one, and build upon it a new global financial energy market infrastructure.

Four nations possess two thirds of global gas reserves: Russia has 26% ; Iran has 18%; Qatar (which shares a gigantic field with Iran) has 13% while Turkmenistan - with pipeline connections to Russia, Iran and China - has 9%. Russia, Turkmenistan and Iran all border the Caspian Sea, which itself contains vast reserves of gas, much of it being exported West.

Russia and Iran could agree with China a benchmark gas price at a virtual 'balancing point' in the Caspian Sea. This would be initially set at a suitably high level - say $10/ Mmbtu - and all supply contracts would then be set by reference to this price, bearing in mind the cost of shipping gas via pipeline or otherwise.

Russian and Iranian gas producers would then be in a position to issue prepay gas credits to Chinese buyers and to investors and they would agree - within a mutual guarantee agreement - to accept each others' credits in payment for gas and to account to each other for the balance. The outcome would be an embryonic Gas Clearing Union, to which other producers, such as Turkmenistan and Qatar, and consumers, such as the EU would be invited to join. The pivotal country, as the gateway from the Caspian to the West is Azerbaijan, who are well placed to drive such an initiative through their leading role in the Economic Co-operation Organisation (ECO).

Transition through Gas

The cheapest and least controversial energy of all is energy saved. Take Ukraine as an example: of the gas delivered by Russia into Eastern Ukraine only 50% makes it through to the EU to the West. The rest of it is used staggeringly inefficiently by consumers who are accustomed to free Soviet gas and suffers massive losses from the reliable but extremely inefficient Soviet era fleet of pipeline compressors.

Iran is no better: for every Mmbtu of electric heat delivered to a Tehran family perhaps 10 Mmbtu of gas was dispatched from the well-head, with the balance wasted by inefficient transmission, and gas-fired power generation operating at a derisory 13% efficiency.
Prepay gas credits will enable simple but effective interest-free investment in new gas infrastructure and efficiency measures of all types, through gas loans repaid directly from gas savings.

Through the international networked adoption of an energy clearing union, it is possible to envisage a global transition from the debt-based 'least $ cost' principle underpinning dollar economics to an energy economics and policies based upon the 'least carbon fuel cost' principle pioneered by Denmark.

In this way, a Transition through Gas may lead to a low carbon economy.
Chris Cook's exclusive article for Trend. Cook is a former director of the International Petroleum Exchange. He is now a strategic market consultant, entrepreneur and commentator.

Chris Cook's exclusive article for Trend. Cook is a former director of the International Petroleum Exchange. He is now a strategic market consultant, entrepreneur and commentator.