RSVP Angst: Who Will Take US Gas? Europe?
An alternative version of this piece appeared in Foreign Affairs on January 8 2015.
In the next two months, the first shipments of US liquefied natural gas (LNG) will mark a new milestone in the history of international gas trade. However, muted demand in Asia, along with the erosion of the region’s gas prices suggest that Asia won’t be the preferred destination for US gas in 2016. In contrast, with its infrastructure, political agenda and geographical proximity, Europe could become a natural anchor market for US gas.
US LNG constitutes a historical opportunity for Europe to reduce its dependence on Russian gas, replace declining indigenous supply and build a stronger case for the use of natural gas as a transition fuel to a greener European economy. All the stars seem aligned: there is a supply looking for buyers and a market with a need. But US LNG long-term role in Europe is not to be taken for granted. Here is the missing piece of the US-EU gas puzzle.
Western European gas business’s ambivalence towards Russia and energy security
At the policy level, LNG is the fuel of choice to meet Europe’s future imported gas needs for geopolitical and security of supply reasons. Tense Russia-Ukraine gas relations have worked against the idea of increasing the share of Russian gas in the EU mix which is already at 26-30%. However, European utilities are the ones who will ultimately decide whether EU’s need for additional gas will be met by new Russian pipe or LNG. They are the ones signing company-to-company deals to secure future supplies.
The debate over the expansion of the Nord Stream pipeline, which brings gas directly from Russia to Germany through the Baltic Sea, highlights the stark disagreement between the European Commission (EC)’s political strategy and the corporate thinking of European utilities. The EC is taking a strong stance against Nord Stream’s expansion because it contradicts the EU’s energy diversification strategy.
The line – which would double the current 55bn m³/yr capacity – does not constitute a new route or a new source, and does not even bring new gas (yet). In addition, it would expand Russian gas dominance in Germany and further reduce the role of Ukraine as a transit country. Nonetheless, a consortium of five European groups, along with Gazprom, is committed to expanding Nord Stream, which would position Russian supply to retain or win market share post-2020.
In a nutshell, the EC considers Ukraine a reliable transit country with an important role to play in the future of EU energy, but western European utilities deem Russia a reliable supplier and show more concern for the economics of gas supplies than for the future of Ukraine. Increasingly those two positions have become incompatible.
The Nord Stream debate also highlights first the divergent interests of western and eastern European countries, with the latter seeing more urgency in reducing Russia’s gas share in the European mix; and second, the ongoing market share war between LNG and Russian gas, for which Europe is the battlefield.
For now, the EC will challenge the construction of the line at the political level by making the advancement of the Energy Union a high priority, starting with the announcement of its LNG strategy in February, while Russia will continue to push for it by dividing European member states and their utilities. Russia is playing a long-term game and will show patience because a lot is at stake, especially in the context of a post-honeymoon hangover with China.
US LNG, if competitive and reliable, can play a long-term role in Europe
That US LNG will play a long-term role in Europe is not to be taken for granted, because this gas made-in-USA has to first win the hearts of European utilities and consumers by offering competitive pricing, secure deliveries and reliable exports.
First, US LNG could be competitive with Russian gas and drive gas prices lower for consumers. Fighting for market share will mean cutting prices further at a time when European hub prices are already below $5/mn Btu.
Interestingly, the short-run marginal cost of landed Russian gas is similar to the price of regasified US LNG into Europe at around $4/mmbtu, which means that in the context of a looming market share war, prices will go as low as $4/mn Btu. However, it is uncertain how long these players could sustain such price war scenarios, as they won’t make money (or little). For Russia, going for a volume-over-pricing strategy means lower state revenues at a time of economic challenges due to sanctions and low oil prices. Meanwhile, US LNG offtakers will not lift cargoes if the netback is less than 115% of Henry Hub and LNG export facilities could be at risk of underutilization. Bottom line, European consumers will be the main winners of this price war and gas has a chance to regain its share in Europe’s energy mix.
Second, US LNG provides a different notion of gas security which will eventually be trusted. Unlike other LNG exporters, the US is a geopolitically stable supplier, but the security concern is of another nature. European utilities are still unsure whether the LNG market can address its longer term energy gas security, as there is no guarantee that that US LNG cargoes would still flow into Europe once oil prices Henry-Hub linked US LNG recovers its competitiveness in Asia.
The perception is that LNG is more volatile than a long-term pipeline marriage. In addition, the flexibility of US LNG cannot give the kind of security of supply that rigid long-term contracts used to provide. However, a functioning gas market with the needed infrastructure and price signals, can become attractive enough to draw cargoes into Europe. And because the global gas market will remain well-supplied beyond 2020, there will be enough cargoes for Europe, Asia and the rest of the world. Europe has never been the market of first choice, but it will always be the market of comfort.
On the policy side, the US and Europe could make US LNG even more reliable by signing the Trans-Atlantic Trade and Investment Partnership (TTIP) to allow “free LNG trade.” Similar to the Trans-Pacific Partnership (TPP), TTIP on LNG will be more symbolic than commercially tangible, but it would provide some relief of getting unconstrained US LNG exports. It would also alleviate psychological anxiety against the risk that Washington could revoke LNG export permits. In addition, European utilities are concerned about the risk of replacing a Russian gas dependence by a US dependence and would welcome as many guarantees as possible that Washington will not use exports as a policy weapon. True, the US will use gas as a tool to serve its national interests and create geopolitical dividends, but it will also create many beneficial positive externalities for the world. The US is working on creating a global gas market with more competition, market rules, liquidity and efficiency, which in turn will improve global gas security. It is also worth noting that US LNG offtakers, unlike Gazprom, are not a monolithic group, but are composed of various kinds of players (traders, integrated international companies and state-own entities) which makes it harder to define a uniform strategy. Far from weaponizing natural gas, the US boom may lead in part to the disarmament of the energy wars.
There is a moral responsibility, along with an historical opportunity for European stakeholders to choose the cleanest, cheapest and most geopolitical stable fuels to produce electricity, heat houses and power cleaner ships. US LNG could ensure a competitive, stable, and reliable source, and above all a greater social acceptance of gas in Europe in the longer-term.
Leslie Palti-Guzman is a director of Global Gas at the Rapidan Group, an independent energy market, policy, and geopolitical consulting firm, and a non-resident fellow at Columbia’s Center on Global Energy Policy.