Currently, a major shift in global demand and supply patterns is underway. On the demand side, the center of gravity is moving east towards Asia and emerging economies. According to the International Energy Agency (IEA), energy demand growth in Asia will be led by China until about 2020. Driven by faster economic growth and strong auto sales, China has already overtaken the US to become the world’s largest energy consumer. After 2025, greater demand growth is likely to shift towards India. South East Asia will also contribute significantly to energy demand growth, with the IEA estimating that energy demand in the region could increase by over 80% by 2035. In addition, the Middle East is also emerging as a major energy consumer on the back of economic and demographic growth, with its gas demand expected to grow more than the entire gas demand of the countries belonging to the Organization for Economic Co-operation and Development (OECD) by 2035.
The shift in demand is consequently altering the global flow of energy. Global energy trade is likely to be significantly re-oriented from the Atlantic basin to the Asia-Pacific region. The IEA projects that between 2012 and 2018 oil exports from the Middle East to Asia will increase by 1.2 million barrels per day (mb/d), while exports to the US and OECD Europe will shrink by 1 mb/d and 0.3 mb/d respectively. China is expected to overtake the EU as the largest oil importer and India is expected to become the largest coal importer by the early 2020s.
Emerging and re-emerging energy superpowers
On the supply side, a number of emerging and re-emerging energy superpowers are set to make a significant impact in international energy markets.
Kazakhstan is already a major oil producer (1,7 million barrels/day) and is set to become a global player in the years ahead as its giant Kashagan offshore oil field in the Caspian Sea – the biggest oil find in the past 40 years - started production in 2013. The country is the world’s 11th largest oil reserve holder (30 billion barrels) and Kashagan alone has 13 billion barrels of proven oil reserves. Due to it being a landlocked country, Kazakhstan’s rise as a major producer and its ambitions to diversify its export routes will likely lend new importance and economic benefits to neighboring countries transporting Kazakh oil through their territories to world markets.
Iraq (reserves include Iraqi Kurdistan)
Iraq, once a major energy player prior to the war and the world’s 5th largest oil reserve holder (143 billion barrels), has started ramping up oil output. Oil production now stands at 3,6 million barrels/day – the highest level in 30 years. While the country’s official target of producing 9-10 million barrels/day by 2020 is overly optimistic due to a number of hampering factors such as a difficult security situation and technical issues, it is conceivable that the country can increase oil production by another 1 to 2 million barrels/day over the next six years.
Iraqi Kurdistan continues to contribute to the significant rise in Iraq’s oil production. The region averaged about 200,000 barrels of oil/day in 2013. The Kurdish Regional Government’s plans to increase production to 1 million barrels/day by 2015 are realistic given its estimated 45 billion barrels of oil. This makes the region the 10th largest oil reserve holder in the world. It also has gas reserves of up to 5,7 trillion cubic meters of (8th largest in the world), which could meaningfully contribute to Europe’s Southern Gas Corridor project.
A sleeping energy giant may also be on the verge of awakening. The recent progress in the P5+1 nuclear talks with Iran have brightened the prospects of its re-integration into the global economy. While there are still some outstanding issues regarding Iran’s nuclear program, there are indications that relations are thawing. Several industry delegations from France, Italy and Germany have already made the trip to Tehran. With the fourth largest oil (157 billion barrels) and second largest gas reserves (33 trillion cubic meters) in the world, and a strategic geographic position that gives it access to both Europe and Asia, Iran stands to play a key role in international energy markets should sanctions be lifted.
On the other side of the Atlantic, Brazil is set to emerge as a major new energy power. After many years in which production languished well behind domestic consumption, Brazil was catapulted into one of the world’s top oil resource-holders in 2006 with the discovery of the Lula field in the Santos basin, which was the largest discovery worldwide since the Kazakh Kashagan field in 2000. It is currently a top-15 oil producer (2,2 million barrels/day) and proven reserves stand at 15 billion barrels (15th in the world). These figures are likely to increase considerably in the coming years because the finds have confirmed the large-scale of oil-bearing formations with the potential for discoveries elsewhere.
Daniel Yergin has labeled the unconventional revolution as “the single biggest innovation in energy so far this century”. However, what has made it so remarkable is not necessarily the utilization of the hydraulic fracturing technique (indeed, the technology was employed as early as the 1930s in the U.S.), but that this development has taken place on an industrial scale in one of the biggest and most influential energy-consuming countries in the world.
The incredible surge in unconventional oil and gas production in the U.S. has set the country on a fast-track path to energy independence. Gas production – 40% of which comes from shale gas – has increased by over 30% since 2005 (from 511 bcm/year to 681 bcm/year). The U.S. overtook Russia for the first time in 2009 to become the world’s leading producer of natural gas and is likely to move into the export business as early as 2016.
Its oil production is also up significantly, from about 7 million barrels/day in 2005 to nearly 9 million barrels/day. The U.S. oil production increase, in absolute terms, is larger than the total output of each of 8 of the 12 OPEC countries.
Broader implications of globally changing energy flows
Historically, due to generally similar energy interests, geopolitical dividing lines could be summed up as ‘the West vs. the Rest’. However, with the advent of the unconventional revolution in the U.S., the rise of new energy superpowers and rapidly growing emerging economies, these lines are increasingly becoming blurred or are being redrawn.
Most Western advanced economies during the 20th century were characterized by rapidly expanding, yet largely energy dependent economies. Conversely, developing economies were either energy suppliers or were not overly concerned with securing vast amounts of energy supplies. However, a number of emerging economies today are increasingly concerned with securing energy to fuel their growing economies while advanced economies are becoming more fractured on energy questions. As the U.S. becomes increasingly energy independent due to higher domestic energy production, the EU will begin to share more dependence concerns with Asian states like China than its traditional partner, the U.S. In the past, the U.S. and EU approach to securing energy supplies was very similar – both relied on free enterprise and market principles to procure energy. However, emerging import dependent states like China increasingly rely on state-controlled mechanisms like national oil companies to secure foreign energy resources. The EU will increasingly have to adjust to these new market realities in order to manage competition and a rising risk of energy imperialism. The same applies to other major importers like India, Japan and South Korea. What is more, concerns over energy prices and industrial competitiveness have been pushed further up the priority list in Europe and Asia in light of the fragile global economy and the unconventional revolution in the U.S., which has brought about its own set of challenges.
Economic implications of the U.S. unconventional revolution
Domestic (U.S.) impact of unconventional revolution
Rising unconventional oil and gas production in the U.S. has had a number of energy and economic impacts. Five years ago, it was expected that the US would be importing large volumes of liquefied natural gas to make up for an anticipated shortfall in domestic production. However, surging unconventional production has allowed the U.S. to decrease its oil imports from 61% in the year 2000 to 53% at the end of 2012. Gas imports have decreased from 18% to only 6% over the same period. The reduction in gas imports amounts to about $100 billion in savings on the U.S’ annual import bill. What is more, the U.S. will also become a natural gas exporter as early as 2015/16. The Department of Energy has already issued non-FTA export permits to seven LNG export projects, with an LNG plant to be built in the state of Oregon being the latest to gain export approval.
The increased gas supply has drastically reduced US gas prices from a high of $13/MMBtu in 2005 to around $5/MMBtu. The relatively inexpensive natural gas has fuelled a US manufacturing “Renaissance”, as companies hire new workers, build new plants and expand existing facilities. The unconventional revolution currently supports around 2 million jobs in the U.S. and chemical industry investment projects linked to lower gas prices are valued at $100 billion (53% of these investments are from companies based outside the U.S.).
Unsurprisingly, the positive economic benefits of cheap domestic energy has given rise to strong opposition to U.S. gas exports. The petrochemical sector, led by Dow Chemical, has spearheaded efforts to prevent exports in order to maintain a competitive edge. Moreover, groups like the Tea Party argue that it is in the national interest to remain energy independent for as long as possible. Nevertheless, considerably higher gas prices in Asia, coupled with the potential of U.S. LNG to positively impact trade imbalances (the U.S. currently has record trade deficits while states like China have huge trade surpluses), will very likely lead to the start of exports by 2015/16.
EU industry, along with Asian states, will face a much more challenging and competitive industrial environment than anticipated just a few years ago. There is already a strong divergence in gas prices observable between the U.S., the EU and Asia, where gas prices are two to four times higher than in the U.S., respectively. The dichotomy within the OECD is also notable, with U.S. gas prices being about 75% cheaper than most of the other OECD countries. Particularly the petrochemical industry in the U.S. has a major advantage over its European and Asian competitors. The costs of ethylene production in the U.S. is second lowest in the world among the major regions (after the Middle East), whilst the costs in Western Europe are the second highest in the world after Northeast Asian states. The same trend can be observed when comparing naphta and ethane prices. International companies are already undertaking measures to take advantage of the lower prices in the U.S. German chemical company BASF is converting a naphtha cracker in Port Arthur, U.S. to run on ethane (produced from shale gas). Meanwhile, Linde, the German industrial gases company, is to invest $200 million in La Porte, Texas to create the world’s largest natural gas based gasification complex for synthesis gas chemicals. These developments are worrying industrial leaders in Europe, who are becoming increasingly concerned about the loss of competitiveness to factories that use low-cost natural gas and a consequent de-industrialization as manufacturing shifts from Europe and other parts of the world to the U.S.
Geopolitical implications of the U.S. unconventional revolution
As wide-ranging as the economic impact of the U.S. unconventional revolution is, the global geopolitical impacts may be even more significant. Four key implications are worth noting.
Firstly, added U.S. gas supplies will strongly affect the current balance in the relationship between energy importers and exporters. The seven non-Free Trade Agreements (FTA) approved by the U.S. Department of Energy have an export capacity of almost 95 bcm a year (14% of entire U.S. production). This is more than Germany’s entire gas consumption of about 93 bcm a year. Just to illustrate: Qatar, the world’s largest LNG exporter, currently exports 288 million cubic meters a day – or 105 bcm a year. This huge flow of new LNG from the U.S. to world markets will likely increase the bargaining power of major gas-importing states vis-à-vis their suppliers by placing downward pressure on international gas prices. Traditional gas exporting states, on the other hand, could suffer a decline in revenues due to price decreases and supply displacement. Even if gas supply in a region is not directly displaced by U.S. LNG exports, its producers might suffer a decline in profits due to lower prices affecting the region. Furthermore, gas exporting countries could face increased pressure to adopt or adjust to market-based gas prices instead of oil-indexed prices, as was the case when Russia’s Gazprom had to re-negotiate the terms of its contracts with German utility giants RWE and E.ON a couple of years ago.
Secondly, this development could accelerate the transition away from oil price indexation of gas supply contracts. While decoupling from oil-indexed prices is already occurring in some European markets, it might also happen in Asian markets, especially if meaningful supplies of Australian LNG come on-stream towards the end of this decade. If Asian markets start decoupling from oil-indexed prices as well, their prices could decline sharply over the next several years. Since supplies for U.S. LNG exports are expected to be pegged to U.S. gas prices (e.g. Henry Hub), rather than oil prices, the additional volumes could result in global gas markets transitioning more rapidly to prices set by “gas-on-gas” market competition1.
Thirdly, importers and exporters will have to assume greater responsibility for securing supply and demand security, respectively. The rapid increase in shale oil production is prompting many analysts to suggest that the U.S. could become wholly energy independent by 2020. While this may not fully be the case, as the US will still be tied to global oil markets, it is certainly taking big steps to diversify its supply portfolio by reducing its dependence on foreign supplies. This adds an element of uncertainty regarding the degree and willingness of the U.S. to continue to secure vital oil routes. It seems increasingly likely that major energy importers and exporters will have to take on more responsibility in securing their own supplies and vital shipping and transport lanes.
Fourthly, the added supply of U.S. shale oil will most likely also exert downward pressure on global oil prices. While this may be a welcome development for consumers, it could prove to be very problematic for a number of Middle Eastern producers whose budgets primarily rely on oil revenues. Major producers like Saudi Arabia, Iraq and Libya, for instance, need an oil price of at least USD 85 to balance their budgets. In addition, following the Arab Spring, political stability in some Middle Eastern countries such as Kuwait, Saudi Arabia, and the UAE was achieved by making new public expenditure commitments, which is expected to foster long-term dependency on higher oil export prices. Lower oil prices mean lower revenues left over for public expenditures and subsidies; this could ultimately become a politically de-stabilizing factor in oil-revenue dependent states.
The Crimea Crisis – A New Geopolitical Challenge for Europe
In addition to the challenges posed by the U.S. unconventional revolution, the EU is confronted with a new geopolitical challenge. The crisis in Ukraine has sparked new concerns over a possible cut in Russian natural gas to Europe and has catapulted the topic of energy security back on top of the EU agenda. Europe currently imports roughly 30 percent of its gas supplies from Russia, and about half of the delivered gas travels through Ukraine. In response, leaders in the EU and the U.S. are increasingly calling for Europe to reduce its dependence on Russian gas. U.S. House Speaker John Boehner, for instance, wants to expand natural gas production and accelerate the construction of export facilities in order to supplant Russia as Europe's natural gas supplier. But, can U.S. LNG realistically displace Russian gas over the short-term?
If American LNG were to make its way to Europe, the combined production and transportation costs would amount to around USD 11/MMBtu (given a current production cost of USD 5/MMBtu and additional transport costs of USD 6/MMBtu). Based on current prices, U.S. LNG would be roughly as expensive as the Russian gas under European purchase contracts. For U.S. gas to make economic sense in Europe, it has to stay cheap. Right now, Russia can undercut U.S. LNG supplies if it needs to and sell its gas as low as USD 6/MMBtu.
While Europe currently has enough LNG import terminals to handle a substantial surge in supplies, gas prices are higher in Asia and more attractive for US producers. This is why a large number of the LNG export facilities approved so far have long-term contracts with customers in Japan (which pays about USD 19/MMBtu). Hence, the gas will initially flow East instead of West. The bottom line is that US LNG is not a realistic substitute for Russian gas over the short-term.
What is more, Europe has few other gas diversification options, at least until 2020. Alternatives such as gas from Azerbaijan, the Eastern Mediterranean, Iraqi Kurdistan and Iran will not become a reality for the EU until at least the start of the next decade. Therefore, it is clear that the EU’s dependence on Russian gas will almost certainly increase in light of declining indigenous gas production. Even beyond 2020, Russia will remain one of the largest foreign suppliers of natural gas to the EU.
So what measures can be undertaken to address this daunting geopolitical challenge? Well, continued diversification efforts and the creation of a single European energy market (e.g. interconnectors, reverse flow, etc.) are certainly steps in the right direction, even if only to spur competition and increase market liquidity. But, what is perhaps even more important, is to maintain dialogue with Russia and align interests in Ukraine.
Ever since the collapse of the Soviet Union, Russia has gradually ceded ground vis-à-vis the West when it came to foreign policy and setting the international agenda. However, over the past year, starting with the Syria conflict, it became apparent that Russia is no longer willing to make the compromises it used to make. The Ukraine crisis was the tipping point – Russia’s so-called “red line”, where it has demonstrated its power to resist. This re-emerging geopolitical challenge has resulted in a conflict of interests that requires aligning. It is becoming clear that the U.S. cannot determine the global agenda unilaterally any longer. Both China, and increasingly Russia, will have to assume greater responsibility and act as potential protagonists. While the U.S.’ drive towards energy independence is understandable, it is ultimately interdependence that will significantly contribute to global peace in the years ahead. Nations should attempt to understand each other and see from each other’s perspectives – this is a core theme of foreign policy.
Moreover, Germany has recently been accused of “appeasement” and disloyalty to its allies because it has kept channels of communication with Moscow open – unjustly so, in my opinion. An alliance of free nations means aligning the different histories, geographies, experiences, mentalities, and conditions - which form the different interests of nations - under a common banner. The genuine legitimacy of a strong alliance ultimately stems from a fundamental consensus on differing interests.
Prof. Dr. Friedbert Pflüger, retired Secretary of State, is director of the European Centre for Energy and Resource Security (EUCERS) at King’s College London. His contribution for ENERGLOBE is an edited version of a lecture he recently gave to a leaders’ summit in Paris.