The New Geopolitics of Energy
In January 1959, the Methane Pioneer, a converted World War II cargo ship, set sail from Louisiana for the United Kingdom. It was a historic occasion: the Methane Pioneer was the first tanker to transport liquefied natural gas (LNG). The voyage marked the start of a new era in global energy trade. In the half century since, global LNG trade has boomed, led by countries such as Algeria, Australia, Indonesia, and Qatar. But aside from a small terminal in Alaska, the United States has sat on the sidelines—until now.
In late-February, the first ever large-scale shipment of LNG from the lower 48 states set sail. The milestone marked a stunning turnaround. A decade ago, U.S. developers were planning dozens of projects to import LNG to meet rising demand and dwindling supplies. Most analysts thought that Iran, Qatar, and Russia would dominate the supply of gas for years to come. Those countries held by far the world’s largest gas reserves and they used their position as monopoly suppliers to many countries as geopolitical leverage. In 2008, the Iranian oil minister even announced that these countries might form a gas equivalent of the Organization of the Petroleum Exporting Countries, the cartel that has controlled oil supply and influenced oil prices since the 1960s.
But then came the shale gas revolution. The shale boom of the last decade has brought U.S. consumers rock-bottom natural gas prices and helped displace coal and lower carbon emissions, even as it has raised concerns about local environmental impacts. What’s more, the United States will soon be a net exporter of natural gas. By 2020, the volume of global LNG trade will rise by up to 50 percent, almost entirely thanks to the United States and Australia. Iran, Qatar, and Russia are struggling to maintain market share. Although much remains uncertain, U.S. LNG exports may well transform energy geopolitics in the years to come.
A SINGLE MARKET
Unlike crude oil, which is easy to ship and store, transporting natural gas globally is a difficult business. The gas must first be converted to liquid form by cooling it to about minus 260 degrees Fahrenheit. Then it must be loaded into specially designed tankers for shipment, before it is turned back into gas at import terminals. As a result of these challenges, the development of a global market for liquefied natural gas has lagged far behind the one for oil.
Instead, natural gas typically has been transported through pipelines between fixed points. The price of natural gas was often linked to the price of oil because the two fuels were close substitutes in power generation in the early days of the natural gas trade.
By 2020, the volume of global LNG trade will rise by up to 50 percent, almost entirely thanks to the United States and Australia.
The pipeline system has given suppliers of natural gas who are willing to exercise their leverage more influence over importing countries than suppliers of oil have. Most importers can’t simply buy gas from another country in the event of a dispute. And if exporters threaten to turn off supply, importers have few options if they want to keep the lights on.
But the shale gas revolution has the potential to change all of this. Already, the shale boom has displaced the need for LNG imports to the United States, freeing up supply from places such as Qatar to flow elsewhere and creating more competition. The export of U.S. LNG will accelerate this process. U.S. gas can be sold anywhere in the world at market-based spot prices, encouraging the emergence of an integrated global market. Now, the price of gas will reflect the supply and demand for the commodity more accurately, and the global gas market will gradually come to look more like that for oil. And as supply increases, consuming countries will enjoy more power.
WINNERS AND LOSERS
European customers know all too well the geopolitical leverage that dominant gas suppliers such as Russia have been able to exert. Russia stopped exports to Ukraine in 2006 and 2009 after disputes over back payments. As a recent European Commission antitrust investigation recently revealed, Gazprom, Russia’s largest natural gas company, has also used its dominant market power in Central and Eastern Europe to block the integration of the region’s gas markets, attempting to maintain control over a key transit pipeline in Poland and strong-arm Bulgaria into backing a gas pipeline project as a condition of continued gas supply.
As LNG floods the global market, however, much more U.S. LNG will head to Europe—and that will pose serious challenges for Russia. Over the last several years, Russia has placed its bets on vast strategic gas pipeline projects, such as the highly controversial Nord Stream 2 that connects Russia to Germany by bypassing Ukraine; the Turkish Stream project, intended to connect Russia with Turkey and Southeastern Europe; and the Power of Siberia pipeline system that connects Eastern Siberia with China. In the age of cheap, flexible, and abundant LNG, however, Russia can hardly justify the steep prices of such megaprojects, particularly if they will bring Moscow little geopolitical benefit.
At the same time, Russia has been slow to enter the LNG game. Gazprom focused on building strategic pipeline projects and Novatek, Russia’s largest independent gas producer, was only granted an LNG export license in 2013. As a result, Russia will likely only complete one additional LNG project through the end of the decade. The handful of other proposed terminals will likely be postponed since the current wave of U.S. and Australian projects, and the low price of oil-indexed gas contracts, has rendered them uncompetitive.
Since the Ukraine crisis erupted in 2014, Europe has redoubled its efforts to reduce its vulnerability to changes in Russian gas supply, which makes up more than 40 percent of European gas imports. In February 2016, the European Commission released its latest energy security strategy for the European Energy Union, an attempt to create a common market for energy across Europe. It repeated previous calls to add more pipeline interconnectors and reverse-flow capability, which will allow gas to travel from country to country more efficiently. And it called for more LNG receiving terminals, so that European countries can import gas shipped from the United States and elsewhere. Such terminals can serve as leverage in negotiations with suppliers: Lithuania recently built a new LNG import terminal and used it to negotiate a 25 percent discount from Gazprom.
If U.S. LNG capacity and European gas production both fall short of expectations, Russia may be able to maintain its export volumes into Europe without making any major concessions. The more likely scenario, however, is that Russia will try to retain its market share by lowering prices and using its more than 150 billion cubic meters per year of low-cost spare production capacity to crowd out U.S. imports from the European market.
Russia has been slow to enter the LNG game.
If this happens, U.S. LNG exports may have the perverse effect of increasing Europe’s reliance on Russia for natural gas. However, European consumers would see their already low spot gas prices fall even further, if Russia decided to wage a “price war” on U.S. LNG. As long as there is a glut of LNG supply and the United States remains the marginal supplier, the very existence of U.S. LNG export capacity could effectively cap European spot gas prices at the variable cost of delivering U.S. LNG to Europe, even if little U.S. gas physically reaches Europe.
Just as importantly, the option to import U.S. LNG would help Europe reduce Russia’s geopolitical leverage. If Russia were to threaten to turn off the taps, a more interconnected and integrated European gas market could bring in alternative sources of gas more easily.
Russia is not the only country that U.S. LNG will weaken. Qatar has enjoyed a degree of pricing power in some of its export markets, and has been able to exploit the difference in prices between the European and Asian LNG markets to choose where it will send exports. U.S. LNG, however, will also be able to “swing” between the Atlantic and Pacific, and will soon eclipse Qatar as the biggest source of flexible LNG supply, thereby undermining Doha's ability to exercise pricing power. Last year, for instance, India’s Petronet challenged one of its unfavorable long-term gas contracts with the Qatari company Rasgas and won substantial concessions. Such moves will only be more likely amid increased competition from U.S. LNG and other suppliers.
The United States, which just a decade ago was forecast to become one of the world’s largest gas importers, is now set to emerge as a global gas superpower.
As a result of the global increase in supply, Qatar’s share of the LNG market will shrink and low natural gas prices will reduce its export revenues. Countries that buy gas from Qatar will increasingly push for more flexible contracts and reject traditional oil-indexed prices, although the majority of Qatar’s long-term contracts do not come up for renewal until 2020. And Qatar’s massive current account and fiscal surpluses will likely turn into deficits in the near term.
The real geopolitical impact depends on how the gas market evolves over the coming years. Given recent history, few would predict the outlook for U.S. LNG and the demand for global gas with much confidence.
In 2011, a special report by the International Energy Agency heralded the arrival of a “Golden Age of Gas.” “The future for natural gas is bright,” the IEA confidently proclaimed. They assumed that demand would stay strong, supported by ample supply from shale and growing trade in LNG. Five years later, European gas demand is in decline and Asian demand is slowing, challenged by cheap coal, cheaper renewables and even, in some cases, climate policy that has supported renewables but failed to deter coal use.
Moreover, the collapse in oil prices (and thus oil-linked gas prices) and the coming surge in LNG supply have left some analysts skeptical that there will even be enough global demand for U.S. LNG exports. As the gap between U.S. and Asian gas prices narrows, building new LNG export terminals may make less economic sense.
At the moment, however, the five projects currently underway in the United States are still likely to be profitable and move forward, supplying the world with close to nine billion cubic feet per day of natural gas, almost as much as Qatar, the world’s biggest LNG exporter, puts on the market every day. If demand for LNG rises in the future, as current projections suggest, the United States is well-positioned to supply it: It has a stable political environment and its terminals are relatively cheap to build.
The United States, which just a decade ago was forecast to become one of the world’s largest gas importers, is now set to emerge as a global gas superpower. This historic shift will improve the energy security of its allies and undermine the geopolitical leverage of its adversaries. And, perhaps most important, as a more efficient gas market emerges, people the world over will have better access to energy.