The Global Zeitenwende
How to Avoid a New Cold War in a Multipolar Era
A GLOBAL GAS MARKET
A new global energy business -- natural gas -- is emerging. It will have a far-reaching impact on the world economy, bringing new opportunities and risks, new interdependencies and geopolitical alignments. As natural gas becomes a traded global commodity, it will be critical to meeting a host of urgent needs. The United States needs it to keep the lights on and stave off a coming energy shortage, Europe to rejuvenate its industry, developing countries to boost growth, and all of them to meet their aspirations to have a cleaner environment.
The change will be accomplished both with long-distance pipelines and with natural gas that ironically is no longer in gaseous form, having been liquefied through cooling. This "liquefied natural gas" (LNG) will be carried in tankers that can change direction on the high seas to respond to sudden shifts in demand or prices. Thanks to this emerging global commodity market, lights, air conditioning, and factories in the United States will run on electricity that is sometimes generated with natural gas from Indonesia, the Algerian desert, the seas of Trinidad or Nigeria, the island of Sakhalin in the easternmost part of Russia, the frigid northern waters of Norway, or the foothills of the Andes.
Yet, one of the more haunting aspects of this new global gas business is its reminder of the transformational years of the late 1960s and early 1970s, when the United States became integrated with the world oil market. In a few short years, the United States went from being a minor petroleum importer to a major one. The surge in demand from the world markets, pulled by the engine of the American economy, helped set the scene for the oil crises of the 1970s and created dependencies with which the world still wrestles.
For more than half a century, the United States has been broadly self-sufficient in natural gas, save for imports from Canada. In the next five years, it is likely to become a large gas importer; within ten years, it will overtake Japan as the world's largest. As it inevitably becomes part of this new global gas market, will the United States inadvertently trigger new security issues -- or will new interdependencies help reduce future risks?
Many businesses have become truly global in their operations and perspectives over the last decade. Natural gas has been an exception until now. Although it is huge -- a business worth over half a trillion dollars a year -- it has been a local, national, or continental business, limited by the reach of pipelines and the absence of a global marketplace. But this picture is changing because LNG will allow the world's plentiful but long underdeveloped and "stranded" gas reserves to be efficiently carried to consumers.
The need for a global LNG market is growing urgent. In the United States, gas prices have doubled since the second half of the 1990s, placing a new burden on the economy and portending a shortage. Federal Reserve Chairman Alan Greenspan warned recently that dwindling domestic supplies were "a very serious problem" and a major threat to the U.S. economy and spoke out forcefully on the need to develop LNG supplies.
Much is now expected of LNG. But developing its full potential could cost as much as $200 billion worldwide, and energy companies will have to choose between investments in LNG and other investments. Will the complex network of technology and investment be established in time, given uncertainties about markets, regulation, and government policies? Will geopolitical risks constrain -- or disrupt -- development? Can natural gas live up to the need, and the high expectations, that the world now has for it?
Natural gas, like oil, is a hydrocarbon, and it is found either with oil or by itself. There is a joke from the early days of the oil business: a geologist reporting back on drilling a wildcat exploratory well says, "The bad news is that we didn't find oil. The good news is that we didn't find gas." The punch line reflects the traditionally much more limited market for natural gas, its lower value compared to oil, and the general nuisance value of something that could not be pumped into the tank of a car. Over the last few decades, however, gas' advantages have become increasingly clear.
Gas is the cleanest burning of the fossil fuels; it produces little pollution and emits less carbon dioxide -- the key greenhouse gas -- than either oil or coal. It also is abundant. Proven reserves total what, in oil terms, would amount to over one trillion barrels. Russia -- with 30 percent of known reserves -- is the "Saudi Arabia of natural gas." Another 25 percent lies under Iran and Qatar, jointly pooled in the giant North Field/South Pars field, which straddles the waters between the two countries. Next, in terms of reserves, come Saudi Arabia and the United Arab Emirates. The United States falls sixth -- but with only 3.3 percent of global reserves. Other countries with even smaller reserves, such as Indonesia and Malaysia, still rank among the largest LNG exporters. Large reserves that can serve as the foundation for LNG developments are also found in many other countries. Indeed, because of growing interest in natural gas, much larger gas reserves are expected to be discovered around the world. Nigeria, for instance, is normally thought of as a major oil country; but to those who know its prospects, its real promise is as a potentially huge natural gas province that also happens to have oil.
The modern U.S. gas industry was born during some of the darkest days of World War II, when energy shortages threatened the Allied war effort. "I wish you would get some of your people to look into the possibility of using natural gas," President Franklin Roosevelt wrote to Interior Secretary Harold Ickes in 1942. "I am told that there are a number of fields in the West and the Southwest where practically no oil has been discovered but where an enormous amount of natural gas is lying idle in the ground because it is too far to pipe to large communities."
After World War II, the gas did get hooked up and piped by newly constituted gas companies from the Southwest of the United States to the Northeast. Today, gas provides almost a quarter of the total energy for the U.S. economy. Although Europe's gas market only started up on a large scale in 1959, with a major discovery in the Netherlands, gas currently provides over 20 percent of the region's energy, and that share continues to rise.
Europe's leading source for this gas has been the Soviet Union (and now Russia). In the 1980s, the proposed expansion of Soviet gas deliveries to Europe caused a geopolitical imbroglio -- the most divisive dispute between the United States and Europe of the decade. Proponents of new pipelines from the Soviet Union thought that the gas they would bring would reduce Europe's dependence on the Organization of the Petroleum Exporting Countries (OPEC) and enhance its economy. Opponents, primarily in the United States, argued that they would increase Europe's dependence on the Soviet Union and give the Kremlin both political leverage and additional hard currency to feed its military-industrial complex. Although moderated by intense diplomacy in the mid-1980s, the conflict ended only with the collapse of the Soviet Union. But the development of what is now a 6,000-mile-long pipeline network from Siberia to the shores of the Atlantic was also one of the major harbingers of the internationalization of the gas business. Another was the emergence of LNG.
Natural gas -- in its gaseous form -- can be carried efficiently only in pipelines. But when oceans get in the way, pipelines do not work. Fortunately, when natural gas is refrigerated down to temperatures of minus 260 degrees Fahrenheit, it contracts into a liquid, which can be put in a tanker and transported thousands of miles across the sea. On delivery, this liquefied gas is restored to its original state in a regasification terminal. Traditionally, the whole process has been relatively costly. But it is very effective -- methane is 600 times less voluminous as a liquid than as a gas -- and it allows large amounts of energy to be packed into a single cargo: one shipment holds the equivalent of five percent of the gas consumed in the United States on an average day.
The first commercial LNG business got started in the mid-1960s and ran between Algeria and both the United Kingdom and France. But that budding trade was soon supplanted by cheaper pipeline supplies from the Netherlands and the British North Sea -- and then from Russia and Norway. It was not until the late 1990s that new projects in Nigeria and Trinidad, and later Qatar, brought more LNG to Europe.
LNG's real growth, however, came from Asia. Japan wanted to reduce air pollution by shifting from coal and oil to natural gas to generate electricity, but pipelines were not an option. So, in 1969, Japan began to import LNG from Alaska (which it still does today). Then, after the 1973 oil crisis, the Japanese government promoted LNG for energy security reasons: to reduce dependence on oil from the Middle East. Since then Japan has diversified its sources, importing LNG from various states, such as Abu Dhabi, Australia, Brunei, Indonesia, Malaysia, and Qatar. South Korea became the second major importer in Asia at the end of the 1980s, and Taiwan joined the Asian importers' club in the 1990s. Faced with an ever-rising demand for electricity, the huge economies of China and India are set to join the ranks of LNG importers in the next few years.
In the 1970s, it looked as though the United States was going to climb onto the bandwagon when it started importing LNG from Algeria. But then the growing availability of North American gas cut the boomlet short and created the extended surplus of domestic supply that became known as "the gas bubble." LNG moved out of the ships and into the courts, as disputed contracts gave way to financial distress and litigation. Regasification terminals were closed down, and for several years no LNG at all was imported into the United States.
LNG projects in Asia and Europe developed according to a very particular set of unwritten rules -- what might be called "the LNG paradigm." The paradigm aims to ensure that a logistic, financial, and commercial chain links suppliers to consumers through contracts that govern every step of the process, from extraction and liquefaction to shipping, delivery, and regasification. Specific reserves are earmarked and developed for specific liquefaction facilities, the output of which is delivered by specified tankers to specific markets. All the elements of the projects -- which last for 20 or more years -- are laboriously worked out and settled before any serious dollars are spent. Gas prices are set according to formulas that link LNG prices to oil prices, keeping them competitive and insulating them from subsequent decisions by buyers and sellers.
The LNG paradigm developed for two reasons: the huge capital costs of LNG projects and the inevitable interdependence of gas buyers and gas sellers. Simply put, there is no point in developing reserves if the market is not there -- and vice versa. Supply and demand, according to the paradigm, need to be developed in tandem. The costs of LNG projects -- which run from three billion to as much as ten billion dollars for a single project -- mean that investors want to lock in future sales and revenue streams, protecting themselves from unanticipated or unpredictable shifts in the market.
This paradigm is very much at odds with the way the gas business has been organized in the United States since its deregulation in the 1980s. The U.S. market is anything but long term: it runs on spot and futures markets and short-term contracts. The mismatch between the LNG paradigm and the way the business works in the United States had led many observers to conclude that the United States is unlikely ever to import significant quantities of LNG. At least that was the view until very recently.
If there is a single thing responsible for the emergence of natural gas as a global commodity, it is the rising demand for electricity. Today, natural gas is the "fuel of choice" for meeting escalating electricity needs, whether in the developed or the developing world. In the United States, demand grows at a rate that is about two-thirds of the growth rate of the overall economy. In the developing world, growth rates are much higher. China's electricity consumption today is more than three times what it was in 1990; lately, it has been growing at an extraordinary 17 percent a year.
The "combined cycle gas turbine" (CCGT), a new technology for generating electricity that was borrowed from jet engines, has given gas a major advantage against its competitors -- coal, nuclear power, hydropower, and oil. CCGT plants are easier to finance, quicker to build, and more efficient in their consumption of energy than existing coal plants. Environmental considerations also have reinforced the position of gas as the new fuel of choice. Of all the fossil fuels, it is the best suited to the post-Kyoto world: electricity generated from it emits only 40 percent of the carbon dioxide produced by electricity generated from coal. And because these gas-fired power plants are smaller and much cleaner, they can be located within or near cities, which obviates the need for long-distance power lines.
Policymakers around the world have been deregulating the power business to move from "natural monopolies" to a marketplace of multiple parties that trade and compete with one another. New, independent power-generating companies have been encouraged to enter the business. The gas-fired turbines -- small, cheap, quick, and clean -- have proved well suited for the era of deregulating energy markets.
Technology has also affected the supply side of the market. The costs of LNG terminals and tankers once appeared to be irreducibly high, but they have in fact been reduced. Recent improvements in engineering and construction brought those costs down by as much as 30 percent. And reductions continue.
But there was one missing ingredient to the formation of a global marketplace -- the United States.
THE AMERICAN ENGINE
In the last two years, the United States has emerged as a key -- indeed the key -- future growth market for LNG. It alone accounts for a fourth of the natural gas consumed in the world each day. As American imports from Canada increased over the 1990s, what had been national self-sufficiency slowly evolved into continental self-sufficiency -- and interdependence. And now, in addition, Mexico imports gas from the United States.
The United States enthusiastically embraced the new gas-fired technology to generate power. Altogether its use of natural gas in electric power production has increased almost 40 percent since 1990 -- with much more growth to come. Over 200,000 megawatts of new power-plant capacity has been recently constructed or will soon start production. This is a huge amount of power capacity, equivalent to more than a quarter of the country's entire installed capacity in the year 2000 -- and larger than the entire electric power industries of the United Kingdom and France combined. Well over 90 percent of the new capacity is fueled with natural gas.
But rising demand for gas has collided with what is now emerging as a natural gas shortage in the United States. Traditional sources of supply can no longer keep up with electricity-driven rising consumption. Very disappointing results from the drilling boom of 2000-2001 were the first indicator of this disparity. Since 2001, supply has declined by four percent. New wells will be drilled in the years ahead, and new supplies added. (Owing to the depletion of existing wells, in ten years more than half of domestic supply will have to come from wells that have not yet been drilled.) There may be a modest rebound in supply over the next couple of years, which, together with a weak economy and mild weather, may temporarily mask the reality of the shortage. But, as the U.S. National Petroleum Council observes in its new study, the reality remains that the geological base in the United States is mature -- that is, it has been thoroughly explored. Supply shortages, and the resulting jump in the cost of producing electricity from natural gas, were one of the reasons for the California power crisis of 2000-2001.
In response to the tightening of supply and demand in the United States, domestic gas prices have doubled, weighing the economy down. And today's supply gap is small in comparison to what it could be a few years from now, when the real North American gas production decline begins. Higher prices will hurt homeowners and such industries as fertilizer, chemical, and plastics that depend on gas. Companies in those sectors are already cutting back on production and closing plants. But the full effect of higher gas prices has not yet been felt. When it is, factories will be exported, and jobs -- measured in hundreds of thousands or even millions -- will be lost. In a very painful way, that will lower consumption in the industrial sector. Some of this is already happening.
Conserving energy will play an important role in mitigating the tight supply problem, but there will be limits as to what it can do, especially with the demand for electric power inexorably increasing -- thus increasing demand for natural gas -- and outpacing improvements in energy efficiency. Major new discoveries or breakthroughs in drilling technology could increase domestic supplies. And there are major prospective areas in the United States -- the eastern Gulf of Mexico, the Rockies, and off the eastern and western coasts of the United States. But they are currently off-limits for environmental reasons, and any efforts to improve access to them would inevitably lead to a political storm. A new gas pipeline will eventually bring large amounts of new supply from Alaska's North Slope (not to be confused with Alaska's controversial Arctic National Wildlife Refuge), but that project will probably take a decade or more to realize and, even then, would only make up part of the shortfall.
Thus, LNG is needed to fill a big part of the supply shortfall. In 2002, LNG accounted for just one percent of the United States' natural gas supply. By 2020, it could exceed 20 percent. But if LNG is to meet its potential, the United States needs to invest reasonably swiftly in regasification terminals -- the portals that link the global gas network to our domestic markets. Environmental controversies over licensing and siting issues, which could disrupt investment, need to be managed sensibly, and regulations coherently applied. As Greenspan commented to Congress, "We cannot, on the one hand, encourage the use of environmentally desirable natural gas in this country while being conflicted on larger imports of LNG."
The market appears to be responding: more than 30 regasification projects have already been proposed. Some plants will be on land. Others may be offshore floating terminals. And to satisfy the states that most desperately need them but are among the most environmentally conscious, terminals may be built in neighboring countries -- in Mexico to feed California, in the Bahamas to supply Florida, and in Canada to meet New England's needs. At least a third of the proposed projects need to be built over the next decade to counter the United States' shortfall. All of them will need to wind their way through a complicated maze of permit and approval processes.
An even more critical question is whether gas fields and liquefaction plants will be developed to supply the regasification terminals. Much still needs to be done to turn the vision of having LNG from around the world supply the United States into the reality of steel and concrete. The single largest hurdle is the sheer scale of the capital required: developing reserves to serve a single terminal in the United States costs billions of dollars. And for companies providing the capital, LNG projects are only one of several possible investment opportunities. It is not enough for LNG projects to be attractive; they must be more attractive than other prospects. Realistic and timely negotiations between companies and countries is one essential step toward overcoming the financing hurdles.
LOOKING INTO THE FUTURE
What could capsize LNG's development? At a time when oil and gas prices are high, optimism about the prospects for a new LNG market is only to be expected. But the industry will not develop along a straightforward course; it will have to weather disruptions and make midcourse adjustments. Low gas prices, even if they are only temporary, could discourage investors and stifle growth. It takes more than growing demand, plentiful reserves, and competitive costs to make a global market. Private companies need to commit the necessary capital and human resources. State-controlled companies have to resolve the conflicts between the commercial attractiveness of LNG and other political and social imperatives. Banks and other lenders need to be confident about the projects' financial soundness. All participants need the ability to weather the ups and downs of a commodities market.
High energy prices could also disrupt the business, by renewing the traditional battle over economic rent between governments and foreign companies. Encouraged by market demand, financial pressures, and nationalist sentiments, governments could be tempted to try to renegotiate deals to extract more value for their resources. Ultimately, large gas projects will only move ahead when the deals' terms are equitable, fair, and stable for all parties. New fiscal regimes are likely to evolve to reflect the perceived risk and anticipated profitability of gas developments and to bridge the gap between the volatile U.S. gas market and the traditionally stable long-term LNG paradigm.
Governments in consuming countries will also need to resist a series of temptations. If the market is allowed to work, the textbooks say, rising gas prices should create more supply, bringing the market and prices back into balance. In reality, however, such prices could also prompt governments to adopt policies that, although politically popular, may be economically counterproductive. There is already talk in the United States of imposing price controls and restricting gas consumption with "fuel use acts." Serious consideration of such measures will increase the risk and uncertainty for new projects and thus delay much-needed investment. Implementation of such restrictions might stop development altogether.
The globalization of the gas market also raises geopolitical questions. Some analysts anticipate that the new interests and interdependencies brought by the LNG trade will bolster relations between producing and consuming countries. Others, however, worry that it will only lead to dependence on imports for yet another key commodity, which will create vulnerability to deliberate machinations, political upheavals, or economic problems.
These concerns cannot be dismissed. In 2001, an Islamic secessionist insurgency on the island of Sumatra temporarily shut down LNG facilities that supply Japan, although LNG from elsewhere in Indonesia made up for the shortfall. In the last year, oil production was disrupted in Venezuela by a virtual civil war between President Hugo Chávez and his opponents and in Nigeria by ethnic tensions and regional conflicts -- with much impact on the world oil market. One can well envision scenarios in which the future large LNG exports could be subject to some kind of interruption, even if only short-lived. But the best response to such security concerns is to develop the global LNG business and ensure that ample supplies come from many countries. Encouraging LNG projects in various countries is a safeguard against undue dependence on too few nations.
What about an "OGEC" -- a gas version of OPEC? Might a few countries come to dominate the supply of LNG and adopt policies harking back to the confrontational OPEC of the 1970s? An association of some kind among LNG exporters is likely. Many of them are also oil exporters, and the desire to compare fiscal terms will be irresistible. But there will be limits to how far they can go. For one thing, there will likely be too many too diverse countries to form a single bloc. Australia, Yemen, and Angola will each see the world very differently. Moreover, exporting countries will compete not only among themselves but also with local production in consuming countries and with pipeline supplies, which will reduce their leverage. Ultimately, exporting countries themselves also need to maintain good relations with their customers, to protect their market share and promote additional investment. Therefore, they will likely be cautious about taking actions that could disrupt the critical flow of revenues back into their national treasuries.
These geopolitical issues should serve as a reminder that the gas trade will also have political implications, although not necessarily any that would spark confrontations. Gas is not just another commodity. Because it is traded internationally, it is also an opportunity for states to establish lasting relationships, as nations in Asia and Europe have done over the past three decades. Energy-short Japan has long seen the need to forge strong political bonds with its gas suppliers. The Sakhalin LNG project, a $10 billion investment to supply Russian gas to Japan, for example, is the single largest private foreign investment in Russia -- a monumental undertaking that has depended critically on government-to-government commitment to bolster private-sector investment.
The natural gas business is on the brink of profound change. It is set to become global and to adopt a more flexible market model. Gas may indeed become the fuel that helps keep the world's lights on. But this development is not predetermined; the United States needs to embrace the LNG market to complete the transformation. That engagement is also necessary to meet U.S. energy and economic needs. Company strategies and government policies need to move forward together to make this happen. A variety of risks will come from increased interdependence, but, in a growing, diversified global market, they can be managed. And they are dwarfed by the much greater risk that the United States and Europe could face a persistent shortfall in natural gas. There is a growing urgency to make investments in LNG in the near term in order to avoid more serious disruptions in gas markets and economies later in the decade.