The Geopolitics of Natural Gas: Where Are We Going?

In remarks given at the North America Gas Summit in Washington, D.C., Charles Ebinger discusses the outlook for domestic and international production of natural gas, outlining various geopolitical implications of future flows in gas trade.

First of all, I would like to thank you the conference organizers for inviting me to this important event. It is also a privilege to be up here with such a distinguished panel. Following on Guy’s presentation, I am going to try and explain what the outlook for domestic and international production means in geopolitical terms. Obviously, given the uncertainties in the global economy as well as the various movements in natural gas production and consumption patterns, predictions at this stage are foolhardy. I will simply try to frame the discussion and explain the various geopolitical implications of future flows in natural gas trade.

Before going forward, it is important to analyze where we are starting from. The big news over the past several years has obviously been the shale gas revolution here in the United States and, to a lesser extent, in Canada. The fact that LNG import facilities are no longer needed in the capacity originally imagined—and that there is even the potential for U.S. exports!—has freed up LNG cargoes for export to Europe and Asia.

The existing market is still divided into three markets: the North American market, the European market, and the Asian market. The North American market trades mostly at spot rates. The European market is traditionally dependent on gas imports: it is a net importer of nearly 1 tcf a year. Most of its imports come from Russia, Norway, and North Africa, and most of these imports are sold through long-term contracts indexed to oil. Finally, in Asia, which is the largest importer of LNG, natural gas contracts tend to be the most expensive, generally $2-$3/mmBtu more than the contracts sold in Europe. The shale gas revolution has caused some changes to these markets: Norwegian suppliers have already renegotiated a number of the contracts to reflect spot prices and now, even Gazprom has started to show some increased flexibility about the nature of its long-term contracts. While Gazprom originally was obdurate in not renegotiating contracts, it has now shown concern as to its market share after 2016, when a number of the long-term contracts are set to expire. Part of this concern stems from the increase penetration of Qatari gas to European markets—which is based on spot prices instead. Already Qatar accounts for 25% of the UK’s LNG imports. Qatar is also selling gas to France, Belgium, and Spain. It is interesting to note that the current surplus of gas in the UK means that it could sell Qatari gas into the continental market via the interconnection with Belgium. Perhaps more concerning to Russia is that Eastern European markets will soon start receiving Qatari gas. Poland is expecting to receive Qatari gas by 2013, once its regasificaiton facility is completed. While all of this may concern Gazprom, it hasn’t yet impacted Algerian suppliers, who have shown little interest to revising its oil-indexed contracts with Europe.

In Asia, the market has shown a little more consistency: Japan and South Korea remain firm markets, particularly after the Fukushima accident has caused a review of Japan’s nuclear energy program. Russia, Qatar, and Australia have all increased LNG shipments to Japan.

More interesting for producers are the outlooks for consumer markets in China and India, which are seeing an annual gas demand growth rate of roughly 4%. The pipeline prospects for India look dim, despite the positive impacts they would have for all parties involved. Thus, the LNG outlook for India is positive for exporters: India is expanding its LNG import capacity to make sure that there is enough gas to meet India’s growing gas demand for power and fertilizer production. China is similarly bullish on LNG imports but is also more able to source gas via pipelines. Turkmen gas is being sourced via pipeline to the region, construction is underway for a pipeline between China and Myanmar. Looking into the future, China is also in discussions with the Russian government regarding a pipeline carrying gas from fields in Western Siberia, and has also showed interest in the TAPI or IPI pipelines, if India does not become a partner.

Given that brief overview, where are we going? I don’t think it takes an expert to realize that the future is highly uncertain. For starters, the fragile state of the global economy does not bode well for energy exporters. However, for the purpose of this event, let’s look at another world of uncertainty: what new unconventional resources around the world would mean for the future of the gas markets and, more specifically, what it would mean geopolitically. The prospect for gas security that seems to be enjoyed in the United States as a result of the sizeable shale gas resources has a number of other governments dreaming about their own gas independence. In many cases this means an alteration in traditional government-government relations.

Europe seems to be the fulcrum of these changes. As mentioned, Europe has already seen some flexibility at the negotiating table with their Russian counterparts. But more than just shifting its sources of imports—and rather than depending on the stalled and expensive Nabucco pipeline for new non-Russian pipeline imports—some European countries have been active in developing their own potential shale gas resources. Poland and Ukraine have seen most of the progress on this front, but shale gas exploration is also occurring in parts of Germany, the UK and Hungary. Even in France, where the government has put a ban on fracking, companies such as Total are holding onto their shale play assets, as they are hoping for a reversal in government policy. However, shale gas development in Europe is not a short-term solution and the obstacles to its development are well documented. The governments will likely be more reliant on partners in Doha to release their dependence on Moscow and even Algiers. UK Prime Minister David Cameron’s recent trip to Qatar was symbolic of a likelihood for close relations between Europe and Qatar in the coming years.

Moving east, the major trend will be the improvement of relations between the Middle East and growing consumers in China and India. However, the question is whether this will be an oil relationship, or both an oil and a gas relationship. For starters, power demand growth in Middle East is increasing at dizzying rates. More and more gas (and oil) is being diverted to domestic power generation, at great cost to national coffers—electricity is almost free in many of these hydrocarbon-exporting nations.

The other side of this relationship is the demand in China and India. Growing gas demand has meant an increased reliance on imports. In India, production at the prolific gas field in the Krishna-Godavari basin has great promise, but there have been recent questions as to the actual size of the reserves and whether they will impact India’s gas security as much as expected. India’s shale gas resources have been estimated as high as 63 tcf, with the government seeing potential for more than 100 tcf. Having just gotten back from India, I saw how keen the government and industry officials are in tapping this resource. However, the number of obstacles that shale gas production has in India are many: pricing reform, land reform, and regulatory reform are all desperately lacking, and investment in the sector is paltry. I don’t see India becoming gas independent in the next decade. More disappointing has been India’s inability to approve gas pipeline projects from Turkmenistan and Iran. While there has been progress on the TAPI pipeline in recent years, they are still several years away from making a deal, much of this due to India’s internal politicking. Therefore, I think this means the Indian government will find itself increasingly reliant on producers in both the Middle East and Australia.

But there will be significant competition for these resources. For starters, China’s natural gas consumption is minimal when compared to their total energy mix, but it is projected to skyrocket in the coming years. This means that it will be open to gas coming from all markets. It has shown interest in developing its large shale gas reserves—estimated at about 1,200 tcf—to help offset the rising cost of imports. It recently held its first auction for shale gas leases and plans on having a second and maybe even a third by the end of this year. Now, while the prospects are promising and the government has shown an interest in getting the technology and expertise for production, (Shell and Hess have already signed agreements with Chinese partners to explore for shale gas) a number of obstacles remain. First, energy companies sometimes find the Chinese business landscape difficult to operate in. Second, and perhaps more importantly, is the water scarcity. Many of China’s shale gas resources are also in the most water starved regions of the country—the northwest and the central north. Thus, at least in the near and mid-term, China will be competing with India, Japan, and South Korea for imports from Qatar and Australia. More interesting will be how the China-Russia relationship develops. While it would appear, especially given recent effusive statements from both countries’ leaders, that an energy relationship would be mutually beneficial, China and Russia are quite unnatural partners. I don’t think that the relationship will develop as projected. Instead, I think that Japan and Russia will continue to firm their energy relationship, in spite of some territorial disputes. This will also occur because Japanese consumers care less about price and more about diversity and security of supply.

Finally, I will touch on a region that I have not mentioned today: South America. The projected resources in Argentina, Brazil, and Chile are astronomical. ARI’s report suggests potential reserves of nearly 800 tcf in Argentina, 230 tcf in Brazil, and 60 tcf in Chile. I see this as a potential economic boon, particularly for Argentina whose economy has shown signs of life in the past year.

I know my remarks have not clarified the future for geopolitical relationships. For each possible outcome, there is a legitimate case for the opposite to happen. For instance, I think Russia will be more flexible at the negotiating table with European customers because of Qatari gas and the prospects for domestic shale gas. However it is possible that the market will tighten if both Russia and Qatar are enticed by higher prices available in Japan, South Korea, and China. Similarly, I see a significant development in relations between China and India and the producers in the Middle East, likely to be at the expense of the United States and Europe’s influence in the region. However, it is possible that the extent of this relationship will be minimized to one solely based on oil—if both India and China’s shale gas resources are developed quickly and at the scale that is possible. Finally, the China-Russia relationship, I think, will remain frosty. Any progress, I think, will be slow and steeped in mistrust with the other party. However, China’s thirst for energy, and Russia’s interest in diversifying export markets may break down some of the apparent geopolitical barriers.

Ultimately, I think one thing will be true. As MIT’s recent study has shown, I think that the world is moving towards a more global gas market. The prospects for shale gas has increased the leverage of many traditional importers and will, in most cases, put downward pressure on oil-indexed contracts. I think this means that gas trade will end up being based on arbitrage and identifying marginal cost benefits. For instance, the United States could emerge as both an LNG exporter and importer, depending on prevailing costs. Please keep in mind that our program at Brookings is looking at the feasibility and implications of U.S. gas exports, and has not yet come to any conclusions. But as I see it right now, the world is heading to a more global natural gas market.