The New Cold War
America, China, and the Echoes of History
In less than a week, the United States will be able to send liquefied natural gas (LNG) from its shale reserves to any port around the world. The first U.S. LNG shipments could go anywhere from Chile’s Quintero to Guangzhou in Guangdong, China—or both. After all, the United States has the supplies to become the world’s third-largest LNG exporter after Australia and Qatar. That is, of course, if the U.S. LNG sector can find a way to sell its product.
U.S. companies have sold roughly 58 million tons of LNG under long-term contracts out of five facilities currently under construction in Louisiana, Maryland, and Texas. These facilities, experts suggest, will be able to sufficiently supply the combined LNG markets of Europe and South America. But flexible purchasing agreements, eroding prices, and weakened demand for LNG could make the United States shale market less attractive than it was mere months ago.
In other words, the United States is about to burst into a glutted market, defined by growing competition between exporters. At the same time, Asian demand is weak and European demand has not recovered from its pre-recession levels. Furthermore, in many countries, particularly in Europe, natural gas still competes for market share with cheaper coal and zero-emission renewables, which make future LNG demand—as well as future markets—uncertain.
As the United States started considering selling LNG abroad, Asia was considered the primary target market due to its premium prices and fast-growing demand. The idea was that the pricing differential between U.S. and Asian gas prices was big enough to cover the cost of buying the gas, transforming it to its liquid form, shipping it, regasifying it, and still leaving enough money in hand to turn a profit. But the economics of North American LNG exports have become less attractive as North Asian spot gas prices have hovered at $7.2 per million British Thermal Units (MMBTU) at the end of 2015, compared to roughly $14 per MMBTU last year. The dramatic narrowing of the spot price spread between the United States and Asia has created economic uncertainties for U.S. gas exporters, as their erstwhile market now looks domestically for cheaper product.
Asia’s largest gas markets are all showing signs of financial weaknesses as their national economies slow. Japan, the world’s largest LNG importer, has witnessed a 4.7 percent decline in LNG use due to its anemic economy, the proliferation of renewable energy, and the restart of its nuclear energy program. South Korea, the world’s second-largest LNG market, has experienced a 7.4 percent drop in LNG demand year over year as the nation’s use of natural gas declines and coal-based energy makes a comeback. China, considered the driver of future LNG demand, imported 3 percent less LNG in the first half of 2015 than it did in the year prior amidst the country’s economic slowdown.
The U.S. LNG market, meanwhile, hasn’t done itself any favors toward boosting the price of its goods. LNG facilities in the United States employ a revolutionary business wherein buyers are allowed to walk away from previously agreed-upon purchases, and have permission to send their LNG anywhere without a fixed destination attached—meaning that there is no predetermined dedicated market for U.S. exports. Under traditional long-term contract models, LNG shipments were required to go from one predetermined point to another, and buyers were fined for backing out of agreed-upon purchases. This newfound flexibility may make U.S. LNG appealing to purchasers, but it also creates unpredictability for suppliers, exporters, and market forecasters.
Because of slumping demand and the lack of competitiveness for U.S. imports in Asian markets, Europe, rather than Asia, may be the key to the United States’ rise as an LNG power. That’s because Europe has other reasons to import the gas—namely, to reduce its dependence on Russian gas, to replace its own declining domestic supplies, and to build a stronger case for the use of natural gas as a transition fuel toward greener European economies.
Indeed, Europe has become something of a last resort for global suppliers. As Asia’s market for LNG is all but satisfied for now, unwanted LNG shipments are being dumped into European markets. The 2016 U.S./EU price differential remains favorable for LNG suppliers, and the continent’s 25 operational LNG terminals make it infrastructurally appealing for exporters. Perhaps most importantly, Europe’s LNG import sector has room to grow: The continent’s import terminals only used 25 percent of their capacity in 2014. In fact, Europe imported 52.1 billion cubic meters (bcm) of LNG in 2014, and has the capacity to import as much as 200 bcm in the future. For context, U.S. exports could reach 70 bcm by 2020, and Russian exports to European markets reached 150 bcm in 2014. Europe’s dependence on natural gas imports is growing fast, and needs roughly 50 bcm of additional gas supplies after 2020 to replace its declining domestic production. European leaders could make a conscious choice now to favor LNG over Russian gas in the long term for its new energy supplies. And the United States, thanks to its flexible agreement structures for LNG, could be an ideal supplier.
Europe also has an historic opportunity to use natural gas as a transition fuel as it moves to greener technologies. U.S. LNG could reinvigorate investments in Europe’s natural gas economy, which in turn would promote the use of less environmentally damaging fossil fuels. Europe’s natural gas sector has looked grim over the past five years, mostly due to its association with Russia and its expense compared to coal. As LNG becomes more affordable, accessible, and secure, however, the calculations are shifting. Helping matters along, the 2015 Paris Climate Conference led several European nations to consider phasing out coal, which could prove to be a boon for natural gas. This, in turn, could accelerate the use of U.S. LNG imports in Europe.
The problem for U.S. LNG in Europe is that it is still more expensive than Russian gas. At the moment, Russian gas, at $6 per MMBTU is comparable in price to regasified LNG from the United States, at $7.5 per MMBTU, with the price of Henry Hub—a major market for U.S. natural gas—at $2 per MMBTU. A market share war could force prices to drop below $5 starting this year. It is uncertain how long Russia or the United States could sustain such a price war. For Russia, it would mean diminished state revenues during a recession; for the United States, it would mean risking the underutilization of its LNG export facilities. Russia may be willing to endure low prices in the short- to medium-term in order to gain long-term benefits, such as long-term contracts, strengthened ties with its European customers, and the opportunity to maintain or even increase its market share. Russia is already negotiating new pipeline routes (such the expansion of its Nord Stream pipeline), which could position Moscow favorably when it comes to signing new gas contracts. Meanwhile, the jury is still out on whether U.S. LNG exports will reach their full potential. If the United States boosts its LNG output, European utilities would become a vital market. This would mean that Europe would have to eschew Russian pipeline gas, and not every country in the European Union is willing to do so.
To be sure, in a price war, European consumers would come out on top. But perhaps not for long. After all, there is no guarantee that the United States would continue to prioritize the European market if the Asian market rebounds. In that way, the LNG market is more volatile than gas pipelines, which bring countries together for the long haul. That issue is exacerbated by the United States’ flexible LNG contract terms, which do not include the traditional notion of security of supply.
But there are measures that could ensure that Europe remains a key destination for U.S. LNG reserves. U.S. gas exports create foreign policy opportunities for Washington, but it will also create many beneficial positive externalities for the world. The United States is working to create a global gas market with more competition, market rules, liquidity, and efficiency. This in turn will improve global energy security. So long as Europe is willing to invest in its infrastructure and sends the right price signals to its providers, it will continue to draw interested parties to its ports. And because the global gas market will remain well supplied beyond 2020, there should be more than enough energy shipments to go around for Asia, Europe, and the rest of the world. After all, Europe has never been the market of first choice for energy supplies—it is too staid for that—but it has and will always be its market of comfort.
Washington, meanwhile, could make itself a more reliable LNG supplier through the Trans–Atlantic Trade and Investment Partnership’s (TTIP) provisions for free LNG trade. Although the TTIP’s impact on LNG supplies would be more symbolic than anything else, as the U.S. Department of Energy has already issued timely project approvals, it could provide relief for leaders that would otherwise be concerned about restrictions on U.S. imports. It would also alleviate psychological anxiety against the risk that Washington could revoke LNG export permits to non-Free Trade Agreement countries if the Department of Energy believes that the exports are no longer in the public interest. Those European utilities that are concerned about potentially replacing their Russian gas dependence for dependence on the United States could rest easy with assurances that Washington would not use exports as a policy weapon.
European leaders have an opportunity to choose the cleanest, cheapest, and most geopolitically stable fuels to power their continent. Although U.S. LNG is entering the global energy market at a time that might be less than advantageous, it also has a unique opportunity to give Europe another option for inexpensive, politically safe energy when it needs it the most.