April 15, 2019

Adapted from comments given by The Honorable Paula Stern, Ph.D. at the Atlantic Council IN TURKEY Program's “New Regional Gas Market Dynamics under LNG Expansion & the Shale Gas Revolution” conference on February 26, 2019, with contributions from Ben Perkins.

Last March the Economist ran the headline, “Global powers need to take the geopolitics out of energy.” It may be true that World Trade Organization (WTO) rules, and those of its Generalized System of Tariffs and Trade (GATT) predecessor, have never applied to trade in energy, but energy has always played a starring geopolitical role and probably always will.

Both the geopolitics of the United States and histories of former empires—especially, for example, the British Empire—are hard to fathom unless you trace the role of the supply and demand for various sources of energy. Many colonies and protectorates back in the day served as “coaling stations,” and many current problems relating to Iran originated as Great Powers’ efforts to assure access to that country’s oil.

Liquefied Natural Gas (LNG) imports and exports are not new. What is new is the shale revolution, which triggered surging gas production in the United States. There is so much newly tapped gas that it is outstripping the existing pipeline capacity for getting gas to traditional overland markets in the United States, Canada, and Mexico. Beyond that, liquefaction terminals for shipping gas overseas can handle only a fraction of potential exports. Today, a multitude of giant infrastructure projects, notably LNG export facilities,  have been newly built or are awaiting approval. Demand for LNG has helped motivate enterprises to push forward these giant infrastructure projects.

The world is experiencing geopolitical shifts that reflect dramatic changes in the patterns of energy trade. The US is enjoying technological breakthroughs in exploration, production, and transportation that are unlocking access to the country’s natural endowments of carbon energy, especially natural gas and shale oil in both the Permian basin and Pennsylvania. The question is: what does the existence of all this new production and potential in the US mean?

In his 2019 State of the Union, US President Donald Trump proclaimed an era of American “energy dominance.” That is an exaggeration in a world with many substantial energy producers who also have great potential. The US, a technological leader in this space, certainly has “unleashed a revolution in American energy.” And the president is right about one thing: the US is now the number one producer of oil and natural gas in the world. Becoming number one again, as we were during World War II, is a nice indicator of progress, but oil and gas production are less important now, due to other competitive and rapidly changing producers, as well as breakthroughs in renewables. Furthermore, if President Trump’s promise of “energy dominance” is measured by one of his favorite metrics—US bilateral trade surpluses—his vision is a long way from realization.

The reemergence of the US as an energy leader will significantly change the balance of power in the international energy economy. The balance that has prevailed since well before the energy crisis of 1972/3 is already changing. Almost fifty years ago, the world experienced the so called “Arab oil embargo” when Organization of the Petroleum Exporting Countries (OPEC) members, steered by Saudi Arabia, in effect sanctioned the United States and others. The cut-offs caused long lines at gas stations, drove a memorable spike in inflation, and had important political implications in the US. Today, OPEC and Saudi Arabia simply could not embargo the United States for a host of obvious reasons.

US geostrategic planners and politicians, who since the 1950s, have pined for “energy independence,” are today reveling in the fact that the United States is the number one producer of oil and natural gas in the world, with vast reserves.

Over the last decade, increases in US oil and gas production related to US-developed fracking technology have brought substantial diversification to international energy supply and diminished the role of OPEC. The US shale boom and LNG-related technological breakthroughs are unlocking gas and oil for domestic and overseas markets, while natural gas is “backing out” coal in electricity production in many world markets. The world economy continues to need oil and gas in great quantities, despite increasing pressure to reduce greenhouse emissions, but the energy market is changing for a host of reasons. The United States is playing a new role as exporter in what most people hope is a transition toward renewable technologies.

It also remains to be seen whether the Trump Administration can pull off the simultaneous imposition of sanctions on both Iranian energy exports and Venezuelan exports (of heavy oil), while also pursuing a trade war with China, the world’s second largest economy, largest importer of oil, and second largest importer of natural gas. The dynamics of the market are changing at an accelerating pace, and US policy makers must be cognizant that China may position itself to take a leapfrog advantage in renewables.

US LNG—More Global Trading

This surge of LNG production in the US—combined with technological advances in liquefaction, storage, and shipping vessels—will make liquified gas a more globally traded commodity. It may never be quite as fungible as crude oil, but we will see much less price disparity around the world as liquefaction technology improves and investments in LNG terminals and tankers begin to pay dividends.

One of the biggest effects of this LNG revolution is the ability of a country to obtain competitive or alternate shipments of natural gas in spite of preexisting geographical limitations or political pressures. The implications of this change are not simply economic, but geostrategic. Although it may prove difficult for other nations to replicate the pace of the US shale boom, the LNG revolution will likely have benefits for other countries well beyond US borders.

Europe and Russia—the United States as an Alternate Supplier

Russia has reemerged as a geostrategic adversary to the United States. The Kremlin is using its control of the Eurasian gas market to keep Europe from effectively opposing Russian re-occupation of Crimea, the Donbas in Ukraine, and elsewhere. Europe has been largely dependent on Russian gas: other European sources (North Sea through Norway, the United Kingdom, and the Netherlands) are not projected to grow in the face of rising demand and some projections even show North Sea gas production declining.

The European Union (EU) has long desired the ability to extricate itself from Russian control of natural gas, especially those states in Eastern and Central Europe that are heavily reliant on it. This strategic desire is offset by economic concerns: Russian pipeline gas is significantly cheaper than LNG from outside Europe.

This LNG moment in the United States, however, presents an alternate source of gas for Europe. American excess production has driven down the overall price of US-sourced LNG, and Europe is strategically in need of alternate sources to give it more bargaining leverage, satisfy its rising demand, and achieve its commitments to reducing greenhouse gases. Last summer, LNG played a key role in the US-Europe trade cease-fire hammered out by European Commission President Jean-Claude Juncker and US President Trump, who pledged to work on ways to increase sales of US LNG to Europe as part of a broader trade ceasefire.

The fact is that even though the United States now produces more natural gas than Russia, Russian gas travels to Europe through an established and growing series of relatively inexpensive pipelines. American gas must travel to coastal terminals in the United States through a yet-incomplete system of pipelines before undergoing a costly liquefaction process and being shipped to Europe. This means the price of US gas is still not competitive with Russian prices in Europe. However, as technological improvements and infrastructure investments reduce the cost of US LNG, it will incentivize European states that are already looking for alternatives to Russian gas. Lithuania has had an operational LNG terminal since 2014, and several other countries—Germany, Estonia, and Latvia—heavily reliant on Russian gas are beginning to construct import terminals for the first time. These new LNG terminals could be the foot in the door for US producers and work as strategic leverage for policymakers in Washington if US export capacity increases to match.

As US exports to Europe increase, Russia will have less leverage to threaten to hold its captive customers in Europe, among them US allies, hostage. Countries like Germany will likely never fully replace Russian gas, but their willingness to diversify imports by investing in LNG terminals is as much a strategic move as it is an economic one. Following price drops in Asia, US LNG saw a near fivefold spike in LNG sales to the continent, making Europe the top buyer of US LNG over the past five months.

In East Asia, Russia has one operating LNG terminal with plans to build at least one more. The Power of Siberia gas pipeline to Northeast China is scheduled to begin delivering gas later this year.

China

China, the number one import market for natural gas, is rapidly increasing its ability to import LNG. Chinese LNG imports are up by 43 percent year-over-year.

So far, China can respond to Trump’s trade war and manage its energy trade effectively by swapping import sources. China is reportedly planning to build thirty-four LNG terminals by 2035, which would quadruple its intake capacity. These projects are largely driven by popular demand for better air quality through “fuel-switching” from coal to natural gas, as part of China’s massive commitment to transition toward cleaner and more renewable fuels. No equivalent policy initiatives exist in the United States at the federal level, but several states and localities are driving the energy market and policies in the same direction.

President Trump’s threatened trade war features US tariffs on steel, aluminum, and possibly autos imported not only from China but from other countries as well, including the United States’ closest allies in NATO and Japan. Additionally, the United States has levied a 10 percent tariff on an additional $200 billion dollars’ worth of Chinese goods and China retaliated with its own tariffs. The prospect of an unresolved trade war between the world’s two largest economies and with US trading partners globally has dampened business confidence in bilateral and global trade growth. A survey released on January 28 by the National Association for Business Economists found that 36 percent of manufacturers in the United States have raised prices because of Trump’s trade policies, and 27 percent have delayed investments. Business groups such as the US Chamber of Commerce have urged the administration to take a less confrontational approach against China, as well as against US trading partners, allies, and neighbors—especially Canada and Mexico. The negotiators for the United States and China remain hard at work in search of a bilateral deal.

The United States and China had set a self-imposed truce ending on March 2, but President Trump pulled back and his threats to increase existing tariffs on $200 billion worth of Chinese goods from 10 percent to 25 percent, as well as impose duties on another $267 billion worth of Chinese goods, are still hanging.

China can play the trade war game skillfully. It has levied a retaliatory 10 percent tariff on US LNG while LNG imports from Australia and Qatar come in tariff free. In the LNG space, it has a diversity of options that limit US leverage.

Conclusion

President Trump believes that “trade wars are good, and easy to win.” As it turns out, trade wars are not so simple. However, this new reality has given the Trump Administration a significant opportunity, although it remains to be seen how it will leverage this LNG moment.

American LNG export capacity is still just emerging. The second wave of US LNG export capacity is in its initial stages. Export capacity is expected to double by the end of 2021 to over 10 billion cubic feet per day. As urbanization increases and pollution plagues growing cities worldwide, political leaders are under pressure from a rising middle class, especially throughout Asia, to deal with air pollution. Demand for LNG to replace coal or other carbon burning sources of heat and electricity will therefore only increase.

Consequently, US energy exports may not only help mitigate Russian influence, but they could play a new role in China if Presidents Trump and Xi can come to terms on the myriad of unresolved bilateral trade issues between them.

Will the Trump Administration capitalize on this LNG moment? The geostrategic implications may be of limited interest to the president, but the commercial aspects would help fulfill two key components of Trump’s “America First” campaign strategy: reducing the US trade deficit, particularly with China, and investing in America’s infrastructure—and liquefaction facilities where private companies have been slow to invest.


The Honorable Paula Stern, Ph.D. is founder and chairwoman of The Stern Group and a member of the Atlantic Council’s Executive Committee. Dr. Stern is a former chairwoman of the US International Trade Commission, during the Reagan administration. You can follow The Stern Group on Twitter @SternGroupDC