by Lauren Bardin
The United States’ potential as a major gas supplier has sent shock waves not only across state lines but also over oceans. As late as 2009 it was expected that the US would need to import LNG in major quantities in order to meet demand, yet almost overnight, import terminals became obsolete. Major producers like Qatar had been willing to meet US LNG needs, but since the shale gas revolution, this gas has not been necessary, leaving Qatar and other suppliers with excess gas. Even though the US has not yet begun to export its gas in the form of LNG, the effects of the revolution are already being felt around the world. Excess supply was one of the first effects the global energy market felt as a result of increased US gas production. Another has been the increase in European coal use. The US decreased coal consumption from 1,128 million tons in 2007 to 1,003.1 million tons in 2011, sending this superfluous coal to Europe. While the price of gas is fairly high for European customers, cheap coal has become much more appealing for power generation. This of course has decreased European demand for Russian gas, a consequence that Gazprom is having a difficult time confronting. Even though the gas market is not as vulnerable to price volatility as the oil market, the effects of one major actor can quickly lead to several impacts throughout the entire market.
Competing Pricing Formulas
The price of LNG is a major question in this growing market. Wood MacKenzie projected that LNG will increase by 49% or 5.7 tcf by 2020 and 22.2 tcf by 2025. LNG pricing is dominated by oil-indexation in Europe and Asia, meaning the price of imported LNG follows the global price of crude oil or petroleum products. This pricing mechanism, however, could see a radical change as incremental volumes of US natural gas reach Asian and European shores. The US pricing formula stems from gas-to-gas competition, implying that gas prices are based on supply-demand balances. As the barrel price of oil rises, the price difference between oil-indexed contracts in Europe and Asia and gas-to-gas contracts in the US increases. Consequently, a new contract with an American company linking price to supply and demand at the Henry Hub looks very appealing to foreign companies currently paying higher oil-indexed prices. From 2008 to 2009, the volume of LNG sold at a spot price increased in Algeria, Egypt, Trinidad and Tobago and, most notably, Qatar. In the Russian Federation’s recent publication of the Energy Forecast for the World and Russia to 2040, it was predicted that gas-to-gas competition will increase from 30% to 39%, while oil-indexation will decrease from 34% to 28%. This shift away from oil-indexation will be augmented when the US begins to export and gas-to-gas competition will become the dominant technique in the future of LNG pricing.
This pricing mechanism could see a radical change as incremental volumes of US natural gas reach Asian and European shores.
This shift is primarily an issue for continental Europe, whose gas market originated from oil-indexation and long-term contracts. Now, continental Europe counts on two main spot hubs, which strive to achieve market liquidity similar to the Henry Hub. The Zeebrugge in Belgium (connected to the UK hub) and the Title Transfer Facility in the Netherlands are the main hubs. The UK developed a spot market similar to Henry Hub, known as the National Balancing Point, and it is the only European marketplace considered mature by the gas market because of its high level of liquidity. It greatly influences northwestern continental European prices because of two important pipelines that connect the UK and the rest of Europe: the Interconnector Pipeline and the BBL Pipeline. Although continental Europe is currently dominated by oil-indexation, the growing LNG market could guarantee that these spot hubs play an even more influential role in the region’s gas market.
This change in the pricing formula will greatly affect exporters such as Russia, Indonesia, Algeria, and Malaysia that depend on gas revenues, thereby disrupting their state budgets and national security. A price change could affect energy security, dictate sustainability of future supply, and impact competitiveness. Lower selling price yields less revenue for the state budget and a weaker government, making the nation vulnerable to economic hardships, political disruptions, and social unrest. If profits were to become excruciatingly low, the exporter might not be able to sustain output. Its share in the market would shrink along with the overall competitiveness in the world market. Exporters so reliant on one source of national income could be confronted by a difficult situation if they do not recognize that a global shift in the pricing mechanism is approaching.
Role of the Asian-Pacific Market
Customers in the Asian-Pacific would like to switch from contracts based on oil-indexation to contracts based on the Henry Hub price. The region recognizes that its demand is growing rapidly and it must secure reliable and cheap sources of energy. It sees that Gazprom is adamant about keeping oil-indexation, take-or-pay provisions, and long term contracts in its deals with Europe and the Henry Hub appears to be a safer price foundation. Asian gas demand is led by the world’s fastest growing economy and largest energy consumer, China. The main competitor of gas in China is coal, with 190 Mt imported and 3,471 Mt produced, but it is expected that growth in coal consumption will subside in 2020. It is forecasted that Chinese consumption of gas will double its 2011 level to 260 bcm and its use in 2030 will equal what the European Union’s use was in 2010. Share of gas in its total energy consumption will double and the country will become one of the largest LNG importers in the world. The government aims to cut carbon emissions by 17% from 2011 to 2015 and use natural gas imported as LNG as the means to do so. The government’s Five Year Plan aims to have 87 million tons per year LNG receiving capacity by 2020, giving the nation the power to import almost seven times the amount it did in 2011. Due to its growing demand, desire for cleaner energy, and acceptance of spot-linked prices, China could be a willing and lucrative partner for US producers.
CPC is Taiwan’s sole importer of LNG with two import terminals of 7.4 Mmtpa and 3 Mmtpa; construction of a third is probable.
The nuclear disaster at Fukushima in 2011 created a new demand for gas in Japan, bringing it to its status as the world’s largest LNG importer, making up one third of world LNG imports. Moody’s Investors Service reports that Japan’s Tokyo Electric Power Company will be one of the biggest benefactors of US LNG export. South Korea, the second largest importer in the world, will also be a major benefactor.
Recently, Taiwanese Premier Jiang Yihuah has expressed the nation’s desire to become a contractual partner with US gas companies to aid in Japan’s attempt to decrease its use of nuclear power. Today, natural gas makes up 11.6% of Taiwan’s energy mix. Nuclear makes up 8.7%, but the government plans to decommission all nuclear power plants by 2055. CPC is Taiwan’s sole importer of LNG with two import terminals of 7.4 Mmtpa and 3 Mmtpa; construction of a third is probable. Taiwan’s total LNG imports in 2012 rose 7% to 12.8 Mmt and if it were to enter agreements with the US, CPC would be ready to link prices to Henry Hub and leave behind volatile oil-indexation.
On the opposite end of the spectrum is Australia, the world’s third largest LNG exporter in 2012, according to EIA. About half of the natural gas it produces is converted to LNG for export and in 2010 it exported 872 bcf of LNG, up from 714 bcf in 2009. In 2010, 70% of LNG exports from Australia went to Japan, its largest partner, followed by China, South Korea, and Taiwan. Australia’s private gas sector recognizes the growing market and welcomes foreign investment; several new export facilities are planned or now under construction. US export will compete in the same market but Australia’s existing resources and advanced experience in LNG will ensure that it stays competitive. Moody’s Investor Service projects that although Australian companies like Woodside Petroleum and BHP Billiton Limited will experience competition in Asia, Australia is ready to overtake Qatar as the world’s largest LNG exporter.
The global impacts of US export are as geopolitical as they are economic. The increased coal consumption has added to tensions in the green-leaning European Union. It has made agreement between member states on environmental issues even more difficult; some nations find low coal prices more important than low carbon emissions. Now, the market is not only being controlled by environmental politics but is also balancing price changes made by the US shale gas revolution.
While American coal is being pushed into Europe, American LNG could counter coal’s environmentally threatening consequences and pacify some EU members’ climate change concerns. Helping the EU diversify its supply and lower carbon emissions could only improve the US-EU partnership. On the other hand, this diversification will increase tensions between Russia and European customers and Russia and American competitors.
OPEC does not feel immediately threatened by the US shale gas revolution because it believes that there will always be demand for oil, and oil will always be cheaper than natural gas.
Although not directly involved in gas production, OPEC is another important actor to consider. Oil will remain cheaper than natural gas, but many parts of the world are still trying to decrease dependency on oil because of political instability in exporting countries, price volatility, and damage to the environment. OPEC does not feel immediately threatened by the US shale gas revolution because it believes that there will always be demand for oil and oil will always be cheaper than natural gas. Fhalid al-Falih, head of Saudi Aramco, said that OPEC welcomes the US shale oil boom (America is also experiencing an increase in oil drilling and production thanks to technology and resources) because it eases countries’ worries about over-reliance on Middle Eastern oil. He said that it cements what OPEC already knew: “Oil is going to be the fuel of choice, in terms of its overall performance, for an extended period of time, and we need to manage it, we need to invest in it.” OPEC’s role in the oil market will not be directly affected because demand for oil is likely to continue.
The geopolitical effects in Asia caused by US export are widespread. Ian Bremmer, president of Eurasia Group, has discussed what a Cold War with China could look like if US-China relations were to worsen. Another, more hopeful scenario, is that LNG trade partnership could turn into an historical relationship between the two superpowers. The United States, though powerful, is threatened by the potential of Chinese economy and growth. China is America’s largest holder of foreign debt, linking the two nations monetarily, politically, and militarily. US naval ships currently guide oil tankers from the Middle East through the Strait of Hormuz and the Malacca Straits to Chinese shores in order to ensure delivery and compensate for some of that foreign debt. Chinese businesses have also increased investment in American oil and gas, adding up to $17 billion since 2010. But, improved energy relations between the US and China could go a long way in calming fears that the two powers will enter a cold war driven by economic rivalry. Those wary of American dominance could be pacified by the fact that the US could be a much more reliable and stable energy provider than other sources.
Although Chinese demand is rapidly growing and the country is greatly in need of more energy, China possesses the ability to greatly impact major gas providers. The previous discussion of US-China potential illustrates the importance of Chinese demand for the US, but perhaps the larger influence is held over Russia. Gazprom and China have been discussing gas contracts for several years; in 2004 Gazprom and Chinese National Petroleum Company signed the Agreement of Strategic Cooperation, but several factors have blocked them from making a concrete decision on volumes, schedule, routes, and price. Gazprom’s Eastern Gas Program hopes to develop East Siberian fields, production centers, an East-West unifying pipeline, offshore fields, and LNG export from Vladivostok and Sakhalin, all to help meet China’s massive demand. The Russian government has chosen Gazprom to head this program and it has invested heavily in its commencement and progress. The Asian market, particularly China, is a crucial market for Gazprom and Russia.
The international gas market is experiencing some electrifying remodeling with anticipated American LNG export at its center. When the US does begin to export, some shockwaves will hopefully have subsided and nations and companies will be able to more appropriately react to the changes. But, to reach a conclusion on the future of a global pricing formula, the market will need mature spot hubs all over the world in order to facilitate liquidity. Europe will continue to discuss how to diversify its supply and explore a transition away from oil-linked contracts, while Asian nations will deal with their own burgeoning demand and hope for the lower Henry Hub prices.
Lauren Bardin is an MA candidate at European University at St. Petersburg. She recently completed her thesis entitled, “Shale Boom in America, Gas Leak in Russia: US LNG Export and Gazprom’s Battle to Remain Relevant.”
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