Russia’s aggression in Ukraine is part of a broader, and more dangerous, confrontation with the West THE ECONOMIST FEB. 15, 2015

THE pens were on the table in Minsk, Belarus’s capital, for the leaders of France, Germany, Russia and Ukraine to sign a deal to end a year-long war fuelled by Russia and fought by its proxies.

But on February 12th, after all-night talks, they were put away. “No good news,” said Petro Poroshenko, Ukraine’s president. Instead there will be a ceasefire from February 15th. A tentative agreement has been reached to withdraw heavy weaponry.

But Russia looks sure to be able to keep open its border with Ukraine and sustain the flow of arms and people. The siege of Debaltseve, a strategic transport hub held by Ukrainian forces, continues. Russia is holding military exercises on its side of the border. Crimea was not even mentioned.

Meanwhile the IMF has said it will lend Ukraine $17.5 billion to prop up its economy. But Mr Putin seems to be relying on a familiar Russian tactic of exhausting his negotiating counterparts and taking two steps forward, one step back. He is counting on time and endurance to bring the collapse and division of Ukraine and a revision of the post-cold war world order.

Nearly a quarter-century after the collapse of the Soviet Union, the West faces a greater threat from the East than at any point during the cold war. Even during the Cuban missile crisis of 1962, Soviet leaders were constrained by the Politburo and memories of the second world war.

Now, according to Russia’s chief propagandist, Dmitry Kiselev, even a decision about the use of nuclear arms “will be taken personally by Mr Putin, who has the undoubted support of the Russian people”. Bluff or not, this reflects the Russian elite’s perception of the West as a threat to the very existence of the Russian state.

In this view Russia did not start the war in Ukraine, but responded to Western aggression. The Maidan uprising and ousting of Viktor Yanukovych as Ukraine’s president were engineered by American special services to move NATO closer to Russia’s borders.

Once Mr Yanukovych had gone, American envoys offered Ukraine’s interim government $25 billion to place missile defences on the Russian border, in order to shift the balance of nuclear power towards America. Russia had no choice but to act.

Even without Ukraine, Mr Putin has said, America would have found some other excuse to contain Russia.

Ukraine, therefore, was not the cause of Russia’s conflict with the West, but its consequence. Mr Putin’s purpose is not to rebuild the Soviet empire–he knows this is impossible–but to protect Russia’s sovereignty.

By this he means its values, the most important of which is a monopoly on state power.

Behind Russia’s confrontation with the West lies a clash of ideas. On one side are human rights, an accountable bureaucracy and democratic elections; on the other an unconstrained state that can sacrifice its citizens’ interests to further its destiny or satisfy its rulers’ greed. Both under communism and before it, the Russian state acquired religious attributes. It is this sacred state which is under threat.

Mr Putin sits at its apex. “No Putin–no Russia,” a deputy chief of staff said recently. His former KGB colleagues–the Committee of State Security–are its guardians, servants and priests, and entitled to its riches. Theirs is not a job, but an elite and hereditary calling. Expropriating a private firm’s assets to benefit a state firm is therefore not an act of corruption.

When thousands of Ukrainians took to the streets demanding a Western-European way of life, the Kremlin saw this as a threat to its model of governance. Alexander Prokhanov, a nationalist writer who backs Russia’s war in Ukraine, compares European civilisation to a magnet attracting Ukraine and Russia. Destabilising Ukraine is not enough to counter that force: the magnet itself must be neutralised.

Russia feels threatened not by any individual European state, but by the European Union and NATO, which it regards as expansionist. It sees them as “occupied” by America, which seeks to exploit Western values to gain influence over the rest of the world.

America “wants to freeze the order established after the Soviet collapse and remain an absolute leader, thinking it can do whatever it likes, while others can do only what is in that leader’s interests,” Mr Putin said recently. “Maybe some want to live in a semi-occupied state, but we do not.”

Russia has taken to arguing that it is not fighting Ukraine, but America in Ukraine. The Ukrainian army is just a foreign legion of NATO, and American soldiers are killing Russian proxies in the Donbas. Anti-Americanism is not only the reason for war and the main pillar of state power, but also an ideology that Russia is trying to export to Europe, as it once exported communism.

Anti-Westernism has been dressed not in communist clothes, but in imperial and even clerical ones (see page 77). “We see how many Euro-Atlantic countries are in effect turning away from their roots, including their Christian values,” said Mr Putin in 2013.

Russia, by contrast, “has always been a state civilisation held together by the Russian people, the Russian language, Russian culture and the Russian Orthodox church.” The Donbas rebels are fighting not only the Ukrainian army, but against a corrupt Western way of life in order to defend Russia’s distinct world.

Mistaken hopes

Many in the West equate the end of communism with the end of the cold war. In fact, by the time the Soviet Union fell apart, Marxism-Leninism was long dead. Stalin replaced the ideals of internationalism, equality and social justice that the Bolsheviks had proclaimed in 1917 with imperialism and state dominance over all spheres of life. Mikhail Gorbachev’s revolution consisted not in damping down Marxism but in proclaiming the supremacy of universal human values over the state, opening up Russia to the West.

Nationalists, Stalinists, communists and monarchists united against Mr Gorbachev. Anti-Americanism had brought Stalinists and nationalists within the Communist Party closer together. When communism collapsed they united against Boris Yeltsin and his attempts to make Russia “normal”, by which he meant a Western-style free-market democracy.

By 1993, when members of this coalition were ejected by pro-Yeltsin forces from the parliament building they had occupied in Moscow, they seemed defeated. Yet nationalism has resurfaced. Those who fought Yeltsin and his ideas were active in the annexation of Crimea and are involved in the war in south-east Ukraine.

Alexander Borodai, the first “prime minister” of the self-proclaimed Donetsk People’s Republic, who fought with anti-Yeltsin forces, hails Mr Putin as the leader of the nationalist movement in Russia today.

Yet for a few years after Mr Putin came to power he built close relations with NATO. In his first two presidential terms, rising living standards helped buy acceptance of his monopoly on state power and reliance on ex-KGB men; now that the economy is shrinking, the threat of war is needed to legitimise his rule.

He forged his alliance with Orthodox nationalists only during mass street protests by Westernised liberals in 2012, when he returned to the Kremlin. Instead of tear gas, he has used nationalist, imperialist ideas, culminating in the annexation of Crimea and the slow subjugation of south-east Ukraine.

Hard power and soft

Mr Putin’s preferred method is “hybrid warfare”: a blend of hard and soft power. A combination of instruments, some military and some non-military, choreographed to surprise, confuse and wear down an opponent, hybrid warfare is ambiguous in both source and intent, making it hard for multinational bodies such as NATO and the EU to craft a response.

But without the ability to apply hard power, Russia’s version of soft power would achieve little. Russia “has invested heavily in defence,” says NATO’s new secretary-general, a former Norwegian prime minister, Jens Stoltenberg. “It has shown it can deploy forces at very short notice…above all, it has shown a willingness to use force.”

Putin drew two lessons from his brief war in Georgia in 2008. The first was that Russia could deploy hard power in countries that had been in the Soviet Union and were outside NATO with little risk of the West responding with force.

The second, after a slapdash campaign, was that Russia’s armed forces needed to be reformed. Military modernisation became a personal mission to redress “humiliations” visited by an “overweening” West on Russia since the cold war ended.

According to IHS Jane’s, a defence consultancy, by next year Russia’s defence spending will have tripled in nominal terms since 2007, and it will be halfway through a ten-year, 20 trillion rouble ($300 billion) programme to modernise its weapons.

New types of missiles, bombers and submarines are being readied for deployment over the next few years. Spending on defence and security is expected to climb by 30% this year and swallow a more than a third of the federal budget.

As well as money for combat aircraft, helicopters, armoured vehicles and air-defence systems, about a third of the budget has been earmarked to overhaul Russia’s nuclear forces. A revised military doctrine signed by Mr Putin in December identified “reinforcement of NATO’s offensive capacities directly on Russia’s borders, and measures taken to deploy a global anti-missile defence system” in central Europe as the greatest threats Russia faces.

In itself, that may not be cause for alarm in the West. Russian nuclear doctrine has changed little since 2010, when the bar for first use was slightly raised to situations in which “the very existence of the state is under threat”. That may reflect growing confidence in Russia’s conventional forces.

But Mr Putin is fond of saying that nobody should try to shove Russia around when it has one of the world’s biggest nuclear arsenals. Mr Kiselev puts it even more bluntly: “During the years of romanticism [ie, detente], the Soviet Union undertook not to use nuclear weapons first. Modern Russian doctrine does not. The illusions are gone.”

Mr Putin still appears wedded to a strategy he conceived in 2000: threatening a limited nuclear strike to force an opponent (ie, America and its NATO allies) to withdraw from a conflict in which Russia has an important stake, such as in Georgia or Ukraine. Nearly all its large-scale military exercises in the past decade have featured simulations of limited nuclear strikes, including one on Warsaw.

Mr Putin has also been streamlining his armed forces, with the army recruiting 60,000 contract soldiers each year. Professionals now make up 30% of the force. Conscripts may bulk up the numbers, but for the kind of complex, limited wars Mr Putin wants to be able to win, they are pretty useless.

Ordinary contract soldiers are also still a long way behind special forces such as the GRU Spetsnaz (the “little green men” who went into Crimea without military insignia) and the elite airborne VDV troops, but they are catching up.

Boots on the ground

South-east Ukraine shows the new model army at work. Spetsnaz units first trained the Kremlin-backed separatist rebels in tactics and the handling of sophisticated Russian weapons. But when the Ukrainian government began to make headway in early summer, Russia had regular forces near the border to provide a calibrated (and still relatively covert) response.

It is hard to tell how many Russian troops have seen action in Ukraine, as their vehicles and uniforms carry no identifiers. But around 4,000 were sent to relieve Luhansk and Donetsk while threatening the coastal city of Mariupol–enough to convince Mr Poroshenko to draw his troops back.

Since November a new build-up of Russian forces has been under way. Ukrainian military intelligence reckons there may be 9,000 in their country (NATO has given no estimate). Another 50,000 are on the Russian side of the border.

Despite Mr Putin’s claim last year that he could “take Kiev in two weeks” if he wanted, a full-scale invasion and subsequent occupation is beyond Russia. But a Russian-controlled mini-state, Novorossiya, similar to Abkhazia and Transdniestria, could be more or less economically sustainable.

And it would end Ukraine’s hopes of ever regaining sovereignty over its territory other than on Russian terms, which would undoubtedly include staying out of the EU and NATO. Not a bad outcome for Mr Putin, and within reach with the hard power he controls.

The big fear for NATO is that Mr Putin turns his hybrid warfare against a member country. Particularly at risk are the Baltic states–Latvia, Estonia and Lithuania–two of which have large Russian-speaking minorities.

In January Anders Fogh Rasmussen, NATO’s previous secretary-general, said there was a “high probability” that Mr Putin would test NATO’s Article 5, which regards an attack on any member as an attack on all–though “he will be defeated” if he does so.

A pattern of provocation has been established that includes a big increase in the number of close encounters involving Russian aircraft and naval vessels, and snap exercises by Russian forces close to NATO’s northern and eastern borders. Last year NATO planes carried out more than 400 intercepts of Russian aircraft.

More than 150 were by the alliance’s beefed-up Baltic air-policing mission–four times as many as in 2013. In the first nine months of the year, 68 “hot” identifications and interdictions occurred along the Lithuanian border alone. Latvia recorded more than 150 incidents of Russian planes entering its airspace.

There have also been at least two near-misses between Russian military aircraft and Swedish airliners. This is dangerous stuff: Russian pilots do not file flight plans. They fly with transponders switched off, which makes them invisible to civil radar. On January 28th two Russian, possibly nuclear-armed, strategic bombers flew down the English Channel, causing havoc to commercial aviation. Such behaviour is intended to test Western air defences, and was last seen in the cold war. Mr Stoltenberg calls it “risky and unjustified”.

Since 2013, when Russia restarted large-scale snap military exercises, at least eight have been held. In December the Kremlin ordered one in Kaliningrad, an exclave that borders Lithuania and Poland, both NATO members. It mobilised 9,000 soldiers, more than 55 navy ships and every type of military aircraft. “This pattern of behaviour can be used to hide intent,” says General Philip Breedlove, NATO’s most senior commander. “What is it masking? What is it conditioning us for?”

A huge problem for NATO is that most of what Russia might attempt will be below the radar of traditional collective defence. According to Mr Stoltenberg, deciding whether an Article 5 attack has taken place means both recognising what is going on and knowing who is behind it.

“We need more intelligence and better situational awareness,” he says; but adds that NATO allies accept that if the arrival of little green men can be attributed “to an aggressor nation, it is an Article 5 action and then all the assets of NATO come to bear.”

For all the rhetoric of the cold war, the Soviet Union and America had been allies and winners in the second world war and felt a certain respect for each other. The Politburo suffered from no feelings of inferiority. In contrast, Mr Putin and his KGB men came out of the cold war as losers.

What troubles Mr Stoltenberg greatly about Mr Putin’s new, angry Russia is that it is harder to deal with than the old Soviet Union. As a Norwegian, used to sharing an Arctic border with Russia, he says that “even during the coldest period of the cold war we were able to have a pragmatic conversation with them on many security issues”. Russia had “an interest in stability” then, “but not now”.

Meddling and perverting

Destabilisation is also being achieved in less military ways. Wielding power or gaining influence abroad–through antiestablishment political parties, disgruntled minority groups, media outlets, environmental activists, supporters in business, propagandist “think-tanks”, and others–has become part of the Kremlin’s hybrid-war strategy. This perversion of “soft power” is seen by Moscow as a vital complement to military engagement.

Certainly Russia is not alone in abusing soft power. The American government’s aid agency, USAID, has planted tweets in Cuba and the Middle East to foster dissent. And Mr Putin has hinted that Russia needs to fight this way because America and others are already doing so, through “pseudo-NGOs”, CNN and human-rights groups.

At home Russian media, which are mostly state-controlled, churn out lies and conspiracy theories. Abroad, the main conduit for the Kremlin’s world view is RT, a TV channel set up in 2005 to promote a positive view of Russia that now focuses on making the West look bad.

It uses Western voices: far-left anti-globalists, far-right nationalists and disillusioned individuals. It broadcasts in English, Arabic and Spanish and is planning German- and French-language channels.

It claims to reach 700m people worldwide and 2.7m hotel rooms. Though it is not a complete farce, it has broadcast a string of false stories, such as one speculating that America was behind the Ebola epidemic in west Africa.

The Kremlin is also a sophisticated user of the internet and social media. It employs hundreds of “trolls” to garrison the comment sections and Twitter feeds of the West. The point is not so much to promote the Kremlin’s views, but to denigrate opposition figures, and foreign governments and institutions, and to sow fear and confusion.

Vast sums have been thrown at public-relations and lobbying firms to improve Russia’s image abroad–among them Ketchum, based in New York, which helped place an op-ed by Mr Putin in the New York Times. And it can rely on some of its corporate partners to lobby against policies that would hurt Russian business.

The West’s willingness to shelter Russian money, some of it gained corruptly, demoralises the Russian opposition while making the West more dependent on the Kremlin. Russian money has had a poisonous effect closer to home, too. Russia wields soft power in the Baltics partly through its “compatriots policy”, which entails financial support for Russian-speaking minorities abroad.

econ 2The Economist

Mr Putin’s most devious strategy, however, is to destabilise the EU through fringe political parties (see box).

Russia’s approach to ideology is fluid: it supports both far-left and far-right groups. As Peter Pomerantsev and Michael Weiss put it in “The menace of unreality”, a paper on Russian soft power: “The aim is to exacerbate divides [in the West] and create an echo-chamber of Kremlin support.”

Disruptive politics

Far-right groups are seduced by the idea of Moscow as a counterweight to the EU, and by its law-and-order policies. Its stance on homosexuality and promotion of “traditional” moral values appeal to religious conservatives. The far left likes the talk of fighting American hegemony.

Russia’s most surprising allies, however, are probably Europe’s Greens. They are opposed to shale-gas fracking and nuclear power–as is Moscow, because both promise to lessen Europe’s dependence on Russian fossil fuels. Mr Rasmussen has accused Russia of “sophisticated” manipulation of information to hobble fracking in Europe, though without producing concrete evidence.

There is circumstantial evidence in Bulgaria, which in 2012 cancelled a permit for Chevron to explore for shale gas after anti-fracking protests. Some saw Russia’s hand in these, possibly to punish the pro-European government of the time, which sought to reduce its reliance on Russian energy (Gazprom, Russia’s state-controlled gas giant, supplies 90% of Bulgaria’s gas).

Previously, Bulgaria had been expected to transport Russian oil through its planned South Stream pipeline, and its parliament had approved a bill that would have exempted the project from awkward EU rules. Much of it had been written by Gazprom, and the construction contract was to go to a firm owned by Gennady Timchenko, an oligarch now under Western sanctions.

Gazprom offered to finance the pipeline and to sponsor a Bulgarian football team. The energy minister at the time later claimed he had been offered bribes by a Russian envoy to smooth the project’s passage. Though European opposition means it has now been scrapped, the episode shows the methods Moscow uses to protect its economic interests.

In all this Mr Putin is evidently acting not only for Russia’s sake, but for his own. Mr Borodai, the rebel ideologue in Donetsk, says that if necessary the Russian volunteers who are fighting today in Donbas will tomorrow defend their president on the streets of Moscow.

Yet, although Mr Putin may believe he is using nationalists, the nationalists believe they are using him to consolidate their power. What they aspire to, with or without Mr Putin, is that Russians rally behind the nationalist state and their leader to take on Western liberalism. This is not a conflict that could have been resolved in Minsk.

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Investing in natural gas

29 August 2013

Investing in natural gas

By Bryan Borzykowski
Is it a good idea to invest in natural gas?(Thinkstock)

British Columbia is best known for its beautiful mountain views and world-class skiing, but by 2015 it could be famous for something else: natural gas transportation.

That may not sound as exciting as a night out in Whistler, but if the Canadian province can successfully build North America’s first major liquefied natural gas terminal, it could dramatically alter the energy industry. With many people’s money tied up in energy stocks, it could boost the average investor’s returns too.

While other LNG terminals in places like Malaysia, Qatar, Yemen, Australia and Norway already send gas to Europe and Asia, it is cheap, abundant North American gas, that many utilities and gas companies are waiting to get their hands on. Demand for the commodity is highest in Asia.

One reason why people are excited about North American gas is that many gas-using companies want to buy from a locale that doesn’t face political risks, said Maartin Bloemen, a Toronto-based portfolio manager with Templeton Global Equity Group. European companies import a lot of gas from Russia, while Japanese and Chinese businesses buy from the Middle East.

Currently, natural gas sells for about $3.50 per 1,000 cubic feet in North America; it goes for $9 in Europe, and about $16 in the growing Asian market. Many investment experts think that once China, Japan and other markets get a hold of North America’s abundant supply of gas, the price gap between North American and Asian gas could close, said Ted Davis, portfolio manager at Denver-based Fidelity Investments.

A more global gas market could give people’s investment portfolios a boost. — Andrea Williams

A more global market could give people’s investment portfolios a boost, said Andrea Williams, a London-based portfolio manager with Royal London Asset Management. Since 2008, investors around the world have suffered from falling North American natural gas prices. The price of gas plummeted by about 85% over the last five years and that has impacted the earnings and stock prices of the many energy operations exposed to the region.

If North American gas prices rise, so too should the fortunes of the continent’s companies, said Davis. Conversely, if gas prices fall overseas — it’s likely they’ll drop somewhat after North American supply hits Asian shores, said Williams — the Russian, Middle Eastern and Australian companies that supply Europe and Asia now could be in trouble, she said.

Getting excited

While the first North American gas plants are still a couple of years away from being built, investors are already getting excited about North American investment opportunities, said Davis.

According to the US Energy Information Administration, North America produces the most natural gas out of any region in the world. With such rich resources, many companies will be able to grow production for decades, said Davis. Right now, all that production is a problem — there’s not enough domestic demand to reduce supply — but investors are anticipating that once gas goes offshore, that imbalance will be fixed.

Historically, European and emerging market producers traded at a premium to North American companies, but that’s starting to change. For example, Russian energy companies have traded at an average 24% premium over the past decade, but now trade at a 70% discount, said Davis. Major European energy companies have traded at a 26% premium over the last 10 years, but now trade at a 27% discount.

Despite the rising valuations, Davis still thinks that North America companies are the better bets in this changing energy environment.

Best bets?

The best bets are the mega-cap energy players, such as Chevron, Royal Dutch Shell and ExxonMobil, said both Williams and Bloemen. Many already have a stake in LNG terminals being built in North America. They are also buying stakes in terminals in Australia, which will help get gas off that continent, too.  In addition, these heavyweight companies have a leg up on signing long-term contracts with utility companies.

“You want someone who already has projects on the go,” Bloemen said. “Newer projects are way behind the eight ball and you want to own a company that can scale up easily.”

Williams is partial to integrated producers — companies that sell gas, but also produce and refine oil as well. These operations are more diversified and should therefore be better able to withstand short-term volatility in the sector than a pure gas producer, she said.

While Davis is keen on the bigger players too, he also suggests looking at small North American exploration and production companies, such as EOG Resources and Apache Corp, which have been much more successful at finding resources than their European and Asian peers.

These operations aren’t necessarily involved in transporting gas overseas, but they are assisting other nations, such as China, Latin America and the U.K., tap into their own gas fields.

“These are the companies that took the risk and unlocked these resources over time,” said Davis. “Their technology will be applied elsewhere in the world.”

Energy experts say there’s no question that global demand for natural gas is increasing and that the industry will forever change once natural gas gets shipped from North America to Asia. While it’s likely big global companies that will benefit first, nearly all investors with exposure to the energy sector should see some bump in their portfolio starting in 2015, said Williams.

“We’re happy to invest in this sector,” she said. “As emerging markets become more westernised, the need for gas will just go up.”

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In bustling Houston, it’s a case of ‘Build, baby, build!’

In bustling Houston, it’s a case of ‘Build, baby, build!’

9:11am EDT

By Anna Driver and Ilaina Jonas

HOUSTON/NEW YORK (Reuters) – With Texas one of the few bright spots in the U.S. economy, the skyline of swaggering Houston is where the action is as builders and global oil companies, from Phillips 66 to Exxon Mobil Corp, look past previous busts and spend billions on gleaming new buildings.

The U.S. shale oil and gas revolution – which has already changed industries from railroads to pipelines and refineries – is helping drive the voracious appetite for office space needed for the expanding workforce in the world’s energy capital.

Demand is so hot that Houston is one of the few places where banks – including Wells Fargo & Co, which is seen as one of the more conservative big banks – will loan money for a new building without demanding developers first have a tenant.

“Houston is booming and bar none the strongest market in the United States of America,” said Joseph Sitt, chief executive of Thor Equities, which has two projects underway in Houston.

There are some 56 office buildings totaling at least 11 million square feet under construction in and around Houston, according to real estate services firm CBRE Group Inc. That is equivalent to 190 football fields.

In the forested suburbs, Exxon has what it calls “one of the largest commercial construction projects underway in North America.” The nearly 400-acre campus with 20 buildings will have enough room for 10,000 employees.

With crude now above $100 a barrel, money is flowing freely. And while the shale oil and gas transformation means North America may be energy independent by the end of this decade, economists are wary when people say this boom will be different. They counsel caution.

“The Texas oil and gas industry is not known for long periods of stability,” Karr Ingham, economist for the Texas Alliance of Energy Producers. “Nobody wants what happened (in past busts) to happen again.”

To be sure, the amount of space being built is still only a fraction of the 88.9 million square feet developers constructed in Houston from 1980 through 1986, a flurry that more than doubled the city’s office market, according to real estate research firm Reis Inc.

The Texas economy grew 4.8 percent last year, the fastest pace among the big U.S. states. New workers are pouring into Houston, which needs new offices for the 100,000 jobs it added last year. Houston is on track to add another 80,000 this year.

But over-exuberance about real estate and oil have afflicted Houston before. In the early 1980s developers built a 71-story green glass tower with a footprint shaped like a dollar sign.

It took nearly two decades to recover from Houston’s big crash in the 1980s, which was brought on by a collapse in oil prices. Vacancy rates soared to near 30 percent in 1983 from 9.8 percent two years prior, according to Reis.

The current building cycle is in large part propelled by burgeoning domestic production of oil and natural gas unlocked from shale formations through hydraulic fracturing and horizontal drilling.

“If you are investing in Houston, you’re a believer in the energy sector long term, which we are,” said Russell Cooper, managing director of capital transactions at Shorenstein Properties LLC in San Francisco.

The firm in January bought a building of more than one million square feet in downtown Houston from Exxon for $48 million. It plans to put a new glass skin on the building and may connect it to the air-conditioned tunnel system downtown, where office workers eat and shop to escape torrential rains and steamy heat.

Exxon has put two other buildings in Houston and one in Virginia up for sale, ahead of the move to its new campus.

ENERGY CORRIDOR

Tower cranes dot the landscape of Houston’s so-called energy corridor, about 15 miles from downtown. The area, located on the western edge of the city, is experiencing rapid growth as companies build and expand. There, refining company Phillips 66 is constructing a 14-acre campus with over a million square feet for its 1,800 employees.

Firms are loading their blueprints with plans for everything from basketball courts to childcare centers and fancy coffee shops to attract hard-to-find energy experts.

Near the Exxon campus, an entire master-planned community called Springwoods Village with room for up to 5,000 houses and apartments is going up to accommodate new workers.

While others construct facilities for employees, some companies are building space to push the frontiers of oil technology.

BP Plc is spending more than $100 million over the next five years to build a new three-story building that will house the huge supercomputing complex used to speed up BP’s search for oil and gas around the world.

“It made more sense to create a new home,” said Keith Gray, manager of BP’s High Performance Computing unit. “It became clear that a freestanding building was needed to address growth needs.”

Other oil and gas companies with buildings under construction or in preliminary stages in Houston include BHP Billiton Petroleum, Anadarko Petroleum Corp, Royal Dutch Shell and Chevron Corp, which plans a 50-story tower downtown.

One building which started on spec – meaning banks loan money for construction even if a tenant isn’t lined up – is the 550,000-square-foot Energy Center Three in west Houston.

Principal Real Estate Investors, part of Principal Financial Group, and developer Trammell Crow Co started the building with a loan of roughly $100 million from a Wells Fargo-led syndicate.

Within four months, oil company ConocoPhillips signed a lease for the entire building and half of Energy Center Four, which is not yet under construction, said Aaron Thielhorn, managing director of Trammell Crow’s Houston business unit.

Brian Stoffers, president of CBRE Capital Markets, said spec building in Houston in many ways makes it an outlier.

“The dynamics of the Houston market are so robust right now that it’s the exception to the economic rule around the rest of the country,” he said.

Of the buildings under construction, 29 will be rentals that will not be owner-occupied. Of those, 13 broke ground without signed leases but six of those have since found tenants.

Vacancy rates in the most expensive, modern office buildings in Houston are tumbling. Second-quarter vacancy slid to 6.9 percent from 12 percent in the same period two years ago, according to CBRE. The broader office vacancy rate is 14.2 percent versus a national average of 17 percent.

DANGER AHEAD?

While access to shale deposits has diminished worries about supplies, much of the new demand for crude oil in recent years has been led by developing nations such as China and India.

Big slowdowns in those developing economies could hit the price of crude and cool enthusiasm for building in Houston.

“If China and India have hit a plateau, then I think we have to ask where are the drivers for oil demand in the future,” said the University of Houston’s Robert Gilmer.

Chinese growth slowed to 7.5 percent in the second quarter – below the 8.9 percent average of the last six years.

Apart from shale, crude oil prices generally need to stay above $65 per barrel to produce from the deepwater Gulf of Mexico or the oilsands in Canada for companies to make money.

Another risk is overbuilding. Houston, a sprawling 8,778-square-mile metropolis, has no zoning restrictions, a fact that has some investors including New York-based GreenOak Real Estate Advisors, looking elsewhere to buy.

Owners in areas where building is constrained can reap big rewards when demand for space rises, fueling rent spikes of sometimes 20 percent. That rarely happens in Houston, where developers can easily build.

“When you’re dealing with a market like Houston, there’s nothing to hold developers back,” Ryan Severino, Reis senior economist said. “You can literally can go next door and put up a building.”

(Additional reporting by Kristen Hays in Houston; Editing by Terry Wade and Claudia Parsons)

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LESSONS FROM BIG OIL EARNINGS

This week’s round of Big Oil earnings showed that some of the world’s dominant energy companies are struggling to make money from massive bets on the shale boom in North America. The Wall Street Journal explains that this is because the deposits of oil and gas found there are proving abundant, but not always profitable.

Exxon Mobil’s earnings, reported here by the Journal’s Tom Fowler, show the company is still feeling the effects of its plunge into natural gas in 2010, which left it exposed to low prices.

Royal Dutch Shell, meanwhile, took a write-down of more than $2 billion on the value of its North American acreage, the Journal’s Selina Williams reports. Although the U.K.-based company didn’t identify which shale formation was responsible for the write-down, the Journal’s James Herron says it likely just failed to get lucky. That’s a big hit for bad luck.

Big Oil is running to stand still, says the Journal’s Liam Denning. Big Oil’s big dilemma, he says, is that every barrel pumped out of the ground has to be replaced with new reserves, unless companies want to shrink to nothing. If they want to increase production, they need to discover more than one barrel for every one pumped.

It’s a treadmill, and investors aren’t buying into scale these days. Growth rates at a company like Apache, which this week reported a significant profit increase, are increasingly attractive.

Sometimes less really is more, the Journal’s Spencer Jakab says. Welcome to Medium Oil.

U.S. BEGINS OFFSHORE WIND REVOLUTION

Some 200 wind turbines will be installed in the Rhode Island Sound, on the U.S. East Coast, as the country’s first ever offshore wind-energy auction concluded this week.

A milestone moment, said U.S. Interior Secretary Sally Jewell. An enormous step forward, said the winning bidder, Deepwater Wind.

It could invest $6 billion building turbines and transmission lines, having snapped up some 165,000 acres of federal waters for just $3.8 million, plus $500,000 a year rent until a wind farm is operational.

Next under the hammer are 113,000 acres offshore Virginia, to be followed by blocks off the coasts of Maryland, Massachusetts and New Jersey.

It has taken a long time to get to this point, and there can be no doubt that a number of factors are behind the U.S. lagging, say, Europe in this sector.

But a revolution could be beginning.

MOVING CANADA’S OIL

TransCanada, the company behind the controversy-plagued, long-delayed Keystone XL pipeline, is planning another route out of Alberta for all that heavy oil.

It plans to spend $12 billion building a pipeline all the way from Alberta and Saskatchewan to Canaport in Saint John, New Brunswick, the Journal reports. From there, Canadian crude will be able to access the world once a deepwater port is built (and have the knock-on effect of displacing imports from Africa, the Middle East and Venezuela).

What does this mean for Keystone? President Barack Obama has twice been openly critical of the proposed pipeline, Bloomberg reports. New Energy Secretary Ernest Moniz won’t even have a say in whether Keystone will be built.

Opposition to the Alberta-Gulf Coast pipeline is mostly on environmental grounds. This New Scientist report on out-of-control oil leaks in Alberta will add fuel to the debate.

MARKETS

Crude oil futures were slightly lower Friday as traders took profits after a slew of positive economic news from the U.S., Europe and China pushed the contracts to recent highs. Read the Journal’s latest market report here.

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US Oil and Gas Boom is Bigger Than Majors Can Handle Alone

EARNINGSAugust 1, 2013, 8:14 p.m. ET

Shale-Boom Profits Bypass Big Oil

Shell, Exxon Came Late to the Party, Then Made Massive Investments

By DANIEL GILBERT, JUSTIN SCHECK and TOM FOWLER CONNECT

Billion dollar write downs and falling profits from two of the biggest oil companies could mean a limit to how big oil companies can get. Heard on the Street’s Liam Denning joins MoneyBeat. Photo: AP.

Some of the world’s biggest energy companies are struggling to make money from massive bets on the shale boom in North America, where deposits of oil and gas are proving abundant but not always profitable.

Royal Dutch Shell PLC, which has had a tough time coaxing crude oil from dense rock formations, said Thursday its shale holdings in the U.S. are worth $2.2 billion less than it had previously determined. The write-down helped push the Anglo-Dutch oil giant’s second-quarter earnings down 60% from a year earlier. The company said it would explore selling some of its U.S. shale properties.

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Heard: Big Oil’s Rodent Problem

Exxon Mobil Corp., the world’s largest publicly traded energy producer, is still feeling the effects of its plunge into U.S. shale gas in 2010, which left it with a big exposure to persistently low natural-gas prices.

Rising expenses and falling oil-and-gas production contributed to a 57% drop in quarterly earnings for the Irving, Texas, company. Its profit per barrel of oil and gas fell 23% from a year earlier.

Shares in both companies declined Thursday, with Shell’s class A shares dropping more than 5% to $64.47 in trading on the New York Stock Exchange. Exxon’s stock dropped a little more than 1% to close at $92.73.

U.S. oil production has soared to levels not seen in decades, and profits at some smaller energy companies have surged. But big international oil companies, which were late to exploit shale rocks, haven’t capitalized on the boom in the same way.

Exxon and Shell have spent billions to acquire companies and drilling rights to shale discovered by others at a lower cost. Their sheer size—Exxon produces nearly as many barrels of crude a day as the entire state of Texas—also makes it harder for them to replace the reserves they deplete and increase their output.

As for shale, “they bought in late in the game, and it’s hit or miss,” said Ken Medlock, senior director of the Center for Energy Studies at Rice University in Houston. “Whether or not it pays off is going to be highly dependent on what happens to commodity prices.”

Along with Chevron Corp., Exxon and Shell are investing at record levels to find and produce energy, aiming to spend a combined total of about $111 billion this year, 8% more than in 2012. They are adjusting to a world in which countries with some of the richest oil deposits—from Iraq to Mexico—have limited their access, adding to the difficulty of expanding production.

Exxon and Chevron are sticking to aggressive goals to increase their slumping production over the next four years, by about 14% and 26%, respectively, from 2012 levels.

But Shell said it would stop setting targets for how much oil and gas it hopes to pump and just focus on profits. “If we are solely focused on a volume-related target, we may make less profitable long-term investments,” Simon Henry, Shell’s chief financial officer, said in an interview.

In Big Oil’s hunt to add to its reserves, North America emerged as a bright spot in recent years. Smaller companies like EOG Resources Inc. and Chesapeake Energy Corp. capitalized on drilling sideways through shale, breaking it up with a high-pressure stream of water, sand and chemicals, allowing oil and gas to flow.

The Energy Information Administration said Thursday that exploration and production companies operating in the U.S. raised their oil reserves by nearly 3.8 billion barrels in 2011, the largest single-year increase since the government starting publishing the data in 1977. The EIA now estimates the U.S. has about 29 billion barrels of oil that companies can recover at a profit, the most since 1985.

Natural-gas reserves also expanded to 348.8 trillion cubic feet, the EIA said, a 9.8% annual jump that ranks as the second-largest increase on record.

The boost in domestic oil production is providing a “major economic benefit” by reducing the amount of crude the U.S. has to import, according to U.S. Energy Secretary Ernest Moniz.

That hasn’t necessarily translated into corporate profits, however.

Shell has tried for months to boost the profitability of its U.S. shale assets. Since U.S. gas prices remain low, Shell said early this year that it would try to shift its North American production toward more profitable oil.

The strategy hasn’t panned out. Finding shale oil turned out to be tougher than finding gas, the company said. Its overall exploration and production operations in the Americas sustained a loss in the second quarter, partly because of higher costs. And, with current oil and gas prices, the business will likely continue losing money at least through the end of this year, Shell said.

Exxon, which spent $25 billion in 2010 to buy shale-gas specialist XTO Energy Inc., said an increase in natural-gas prices in the U.S. last quarter helped increase its domestic profits by 62% to just over $1 billion. But its XTO investment diluted its profits and isn’t making up for the company’s problems increasing oil-and-gas production around the globe; its overall production fell 1.9%, the eighth quarter in a row of year-on-year declines. Profits from producing energy dropped 25% in the quarter to $6.3 billion.

But the steep drop in Exxon’s overall profit for the second quarter was due in part to a tough comparison; asset sales and tax breaks helped drive earnings to a record in 2012.

Chevron, which reports earnings Friday, has taken a more moderate approach to investing in shale resources in the U.S. and Canada. But late Thursday, Chevron said that a subsidiary had acquired drilling rights to 67,900 acres in a shale formation in Western Canada, adding to its holdings there. The company didn’t disclose a purchase price.

—Ryan Tracy contributed to this article.

Write to Daniel Gilbert at daniel.gilbert@wsj.com, Justin Scheck at justin.scheck@wsj.com and Tom Fowler at tom.fowler@wsj.com