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Disruptive change: Europe’s energy security and the US LNG

Accustomed the world has become over the past few weeks to implausible scenarios turning into reality: from Brexit to Trump presidential nomination; Turkey’s failed coup and the quickly organised sweeping purges in its aftermath; a sting of dreadful attacks in France and Germany; China’s robust defiance of international law in the South China Sea. And just when it seemed we have grown blasé to the unexpected, the US sent its first shipment of gas to the Middle East. In July, the US shale gas giant Cheniere Energy sent two LNG cargoes from its Louisiana plant to Kuwait and Dubai. Those were preceded by exports to Brazil, Chile, India and Portugal earlier this year, after the historic overturn of a 40-year ban on oil and gas exports in December, 2015. According to the Energy Information Administration (EIA), the US has exported more than 26Bcm of gas since the beginning of the year.  

The momentous shipment of US gas to the Middle East catapults America to the very pinnacle of global energy production and trade, and disrupts the established for about a century flow of hydrocarbons. The shifting patterns of energy trade and the fluidity of the LNG will have consequential effect on the nature of global gas markets and play havoc with prevailing energy alliances and reliances, put pressure on long-standing arrangements such as the oil-linked gas contracts, and narrow the price differentiation amongst regional gas markets. The end of the pipeline and all satellite implications this brings might stand to become the focal disruption in commodity markets over the next decade. The orthodox hydrocarbon producers (the Middle East and Russia) would be particularly affected by the changing status quo due to the intimacy amongst commodities production, domestic political stability and geopolitical remit in these countries. But would the disruption savour Europe’s ailing security of supply is less than certain. 


The gas market turnaround

The consequential hydraulic fracking and horizontal drilling technology has allowed the USA to unlock vast energy reserves. In 2015 alone, the country produced 760Bcm of gas, overtaking Saudi Arabia (106Bcm) and Russia (570Bcm) and becoming the largest producer of petroleum and gas hydrocarbons in the world. It is expected that America will achieve energy self-sufficiency by 2030. According to the EAI, the industry has added the equivalent of 2% to the country’s GDP and created 2 million jobs. In addition, the shale boom eased the staggering US trade deficit and prompted domestic industrial renaissance. 

The United States were quick to harness its newly found energy prowess and turn it into geopolitical premium. In its hinterland, the country put in place blueprints for an extensive pipeline network linking the Texan and Californian shale basins to Mexico’s power grid. To enter the global marketplace, the Department of Energy approved the build-up of six LNG export facilities (with 54 more projects capable to liquify 60% of domestic production awaiting sanctioning). Projections are that by the end of the year there would be 280Mt of LNG arbitraging on the global marketplace with the USA, Qatar, Australia, Nigeria, Angola and Mozambique competing for market share. Geological surveys point to even more staggering reserves in China (1,115Tcf of gas and 32 b barrels of oil); Mexico (545Tcf of gas; 13bbr of oil); and Russia (285Tcf of gas; 75bb of oil). The Eastern Mediterranean basin has significant resources, and shall regional politics allow it (read our report on the Politics and Prospects of the Eastern Mediterranean Gas for a detailed analysis), just Egypt’s Zohr field will supply up to 850Bcm. Others - Brazil, Chile, Argentina, but also many European countries (according to the EU Joint Research Centre, Europe has 16Tcm of technically recoverable shale gas and 78bbr of oil), sit on significant energy stocks. Despite the difficulty of replicating the US phenomenon elsewhere today, technological evolution can spring surprises on apparently solidly-based energy projections. The potential saturation of the market might crowd out some producers, notably in Angola, Nigeria and Mozambique and forge partial balancing of the global gas capacity (and macroeconomic instability in the compounding markets).

The added liquidity will force the emergence of a global buyer’s market with tolling type contractual structure, disappearance of previously clearly delineated regional gas markets and leveling down of price distinctions.

Glutted markets depreciate prices: just for one year, LNG lost 60% of its global value. A phenomenon likely to persist. The added liquidity will force the markets to become more responsive to hub-based pricing formulas, and move away from the traditional century-old oil-indexation. Due to the nimble transportation, large volumes of LNG will arbitrage across markets at the mercy of customers, with tanks quickly rerouted to the highest bidder. The result: emergence of a global buyer’s market with tolling type contractual structure, disappearance of previously clearly delineated regional gas markets and leveling down of price distinctions. Signs of this are already present. Today, US Henry Hub prices are $3MMBtu, while natural gas in Europe is at $4,40MMBtu and $5MMBtu in Asia; two years ago prices/MMbtu were $20(Asia), $10(Europe) and $5(US) respectively. The age of competition has caught up with the gas market.

The impact on key producers

In the Middle East, the implications from the US shale boom are far-reaching: the OPEC producers have sustained high volumes of production to preserve market share and push out higher-cost US producers; the remarkable resilience of the latter alongside the slump in crude prices risks destabilising public finances across the region, and intensifying sectarian violence in Iran, Iraq and Libya. Further, the reduced US strategic interest in the region will give way to a reshuffling of the geopolitical map and the raise of new power relationships. Currently, China imports 2/3 of its oil from the Persian Gulf. A new strategic alliance, similar to the oil-for-security relationship between the USA and Saudi Arabia might soon emerge. In an indicative move, Beijing has published an Arab Policy Strategy earlier in the year. Previously, the country has played a key role in peacekeeping and anti-piracy operations in the region. How this new alliance will evolve would be consequential for Europe, given the proximity and geopolitical importance of the region to EU foreign and energy security aspirations, and the still ambiguous relationship with China, ranging from distrust to unmasked fear.

Russia will also be affected. And while the US LNG will not sway Gazprom’s market share in Europe (contrary to popular expectations), the global liquidity will force the gas behemoth to reconsider its contractual terms (read below). Further, bereft of allies in Europe, Russia is increasingly betting on synergies with Asian markets in a robust Asian Pivot strategy. Recently signed Sino-Russian agreements for a massive Western Siberia pipeline and Yamal LNG plant in the Arctic are indicative. Two years ago, the two countries signed another deal for a greenfield development in East Siberia, notably Kovykta and Chayanda fields to supply China with up to 38Bcm. Future development of shale oil and gas in the West Siberian Basin, but also considerable capacity in the Russian Arctic, the Caspian Sea, Vladivostok and Sakhalin might well be directed to Asia as well. The recent reconciliation with Turkey is also a case for concern in Europe. A deal between Turkey and Israel for the East Med gas might boost Turkey’s role as an energy transit super state and impose pressure on Europe if the Turkish question is not to be resolved soon, and if rapprochement with Russia pools Turkey away from the EU and exploits the (many) cleavages in EU-Turkey relationship.

Europe: greed, need and faulty assumption

In Europe, hopes that the US shale gas and the interconnectedness of previously tightly segregated global gas markets will strengthen the domestic energy security and defy the continent against suppliers’ pressure rise high. The European Union has been trying to consolidate its Energy policy for years. But while official communiques have projected a certain firmness in advancing the security of supply aspiration, prescribing common negotiation of contracts, integrated infrastructure and “mandatory solidarity” clauses, which sanction Member States to divert gas from their grids to help a neighbour in need, the tangible progress has not be as aspirational and the Russian share of gas has remained stagnant. The reason is that the EU energy security refrain presents a false dichotomy between public policy and private economics. Across the EU, the varied shadow Moscow casts over different member states (MSs), alongside institutional opacity, structural impediments and big utilities' corporate intimacies with Gazprom have fueled divergent interests concerning energy supply and investment, that, in turn, have marred EU’s capacity to marshal unified front in completing its internal energy market and diversify import routes and sources. Jettisoning collective policy blinders throughout the years has revealed the difficulty of achieving a supranational common goal over atavistic national energy diplomacy, dependencies and economics. Because, solidarity to a common ideal cannot fuel anyone’s national economy. And with all the projects, meetings and grand visions that portend collective responsibility, ambitious targets and opportunities for a [renewed] Caspian connection or Mediterranean gas, an alternative to Russian gas has been very hard to find. 

The EU energy security refrain presents a false dichotomy between public policy and private economics. Jettisoning collective policy blinders throughout the years has revealed the difficulty of achieving a supranational common goal over atavistic national energy diplomacy, dependencies and economics.

Until the US shale revolution prompted a quick spike of hope. Politicians and pundits across the policy spectrum shaped the perception of the US LNG as the long-awaited Holy Grail. Interchanging one dependency with another did not [does not] seem to bother. Poland and the Baltic states have been especially vocal and quick in building LNG terminals to accommodate US shipments. Lithuania recently launched processing facility with the symbolically charged name ‘Independence’. The EU energy chief, Maros Sefcovic went as far as saying that ”Like shale gas was a game changer in the U.S., American gas exports could be a game changer for Europe.” 

Political jousting in Europe for the US shale gas often ignores economic realities.

But optimistic scenarios warrant re-assessment. Political jousting in Europe for the US shale gas often ignores economic realities.  Currently, 4 out of the 6 LNG export terminals in Louisiana are earmarked for Japan, with only one plant (Corpus Christi) destined for Europe. China, India, Korea and Taiwan are increasing their leverage over US LNG through a collective buyer’s club, and the expansion of the Panama canal will only reduce costs of Asian exports. LNG demand is also robust in Latin America and, as the recent shipment indicates, is just starting to grow in the Middle East and Africa. Despite global price depreciation, Europe will likely remain at a price disadvantage compared to those markets. The benchmark production prices for export US LNG is about $7.50MBtu (including procurement, liquidation and transport costs). With LNG prices crumbling to around $4MBtu in Europe, the export premium of European shipments is unattractive to shale producers, and exposes Europe to a painful reality of further insecurity and dependence (and potential stranded assets) if investments and infrastructure are tailored to accommodate LNG shipments. 

Further, due to the volumes needed, it is simply unserious to assume that the US LNG will emancipate Europe from the Russian energy grip. In 2015, the EU imported 158.6 Bcm of gas from Russia (30 percent of total demand, and approximately 15% of total energy consumption). For the first 5 months of 2016, the US has exported just 1.5Bcm of gas via LNG. Total production for the same period stands at 450Bcm with overall exports at 26Bcm. In optimistic export scenarios by 2020, the US will be able to export anything between 80 and 120Bcma (3 times the current export levels) with Wood Mackenzie Ltd. projecting about 65Mt of LNG capacity (or the equivalent of 4Bcm). Even if we assume that technology and cost depreciation will make it economical for the US to liquefy up to 50Bcm (or 10 times the current projections) and the entirety of this liquified gas is earmarked for Europe, this would represent just about 1% of actual consumption. Adjusting to factor-in the dwindling domestic production (Europe is set to lose about 50Bcm of domestic production by 2020) means that the US LNG, even in such exaggerated hypothetical example will hardly even offset the domestic generation gap and thus, impact marginally Russia’s market share (set to become even more firmly embedded in the European system with the Nord Stream - OPAL - Gazelle and the Yamal Europe pipelines). This being said, the future level of gas demand is likely to considerably decrease, which nevertheless belies the additional risk of investing in fossil fuel infrastructure expansion that might remain underutilised.

rather than arbitraging amongst different supplies, and gleeing at the prospects of receiving US LNG, the EU needs to forge the development of a pan-European integrated, reverse-flow, transmission grid

In terms of price, despite the European tainted love relationship with Russian gas, it will likely remain the cheapest option to power our energy system. Gazprom has already renegotiated some long-term contracts and granted 10% discount and retrospective reimbursement to most of the big European utilities. A percentage of the gas is already linked to spot prices as well. Further discretionary price depreciation and loosening of the oil-linked structures of gas contracts will make importing US shale gas simply uneconomical on current commercial terms. In the context of strained public finances and competitiveness discussions, public subsidies to boost shale imports will also prove difficult (let us not forget that 3 years ago a government in Bulgaria was forced to resign over high energy prices).

Most importantly, Europe lacks the infrastructure to accommodate LNG imports, even if, forgoing commercial and economic logic, such become available to our market. Today, the EU disposes of 22 LNG import terminals with a combined capacity of 190Bcma or almost half of overall gas demand. Nevertheless, the majority of those stay idle at present and have not accommodated the abundant Qatari LNG for instance (European Commission data shows that only about 45Bcm were used in 2014). Spain and Portugal do not have interconnectors with the rest of Europe, thus LNG imports reaching the Iberian peninsula with its  8 terminals cannot easily flow into dependent continental Europe; same is valid for the recently constructed Polish (4.8Bcm) and Lithuanian (3Bcm) LNG plants. The problem clearly is not the lack of available gas but the inability to distribute available capacity to where it's needed.

Thus, rather than arbitraging amongst different supplies, and gleeing at the prospects of receiving US LNG, the EU needs to forge the development of a pan-European integrated, reverse-flow, transmission grid. The use of the Future European Fund for Strategic Investments for new infrastructure and the creation of dedicated funding under the Connecting Europe Facility and the Projects of Common Interest stream has already proven propitious with interconnectors between Romania and Bulgaria, Bulgaria and Greece, Romania and Hungary, Hungary and Slovakia, Hungary and Croatia planned or already commissioned. The approved in July almost €190M of EU money for building a gas pipeline between Finland and Estonia (the Balticonnector) as a continuation of the Poland-Lithuania link will help develop the regional gas market and reduce the region’s isolation.  And while this might not reduce the amount of Russian gas in the system it will drastically reduce the leverage of Russia over individual MSs. But the infrastructure effort should be matched with similar dedicated funding for renewable energy, energy efficiency and demand-management initiatives, currently not earmarked in any Energy Union financial commitments. Better utilisation of existing LNG regasification facilities should also be fostered before further investments are directed to new terminals. Establishing common capacity reserve, given the meagre storage capabilities of MSs in the South-East, and a regulatory harmonisation to streamline the uncoordinated national gas market liberalisation dynamics are natural next steps in the security of supply refrain. This will forge the development of solidarity in energy policy strategising and diplomacy, and facilitate the patching of the fragmented European market. In time, the exercise might well spillover to other archetypical areas of considerable divergence, notably foreign and geopolitical policy. 

The only game changer for the EU energy security and competitiveness is the completion of an integrated internal energy market and a deep low-carbon transformation. Voluntary dependencies, faulty assumptions and empty statements have proven time again to be a blunder solution to hapless public. A strong European energy union relying on outsourcing security of supply sounds nonsensical. The US LNG cannot be the solution. Making a tangible strides in our efforts to complete the internal energy market will represent a far more brazen and audacious attempt to ensure Europe’s energy security than succumbing to another dependency or hopes for a Holy game changer.


The above article has been written by Yana Popkostova as part of the ECEGA Energy and Geopolitical Weekly magazine and was first published on the 20th of July, 2016. For comments and feedback please write to yana.popkostova[@]

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