Global Themesan issues brief series of the Dallas Committee on Foreign Relations‘‘

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Global Themesan issues brief series of the Dallas Committee on Foreign Relations‘‘

DCFRDallas Committee on Foreign Relations

May 24, 2011Issue No. 1

“‘The question is whether we are entering the golden age of gas—or is gas going to be the fuel of the future, and always will be?’ In order for gas’ potential to be realized in this golden age, we need huge steps forward in finding new supplies, infrastructure develop-ment to move that gas, and developed markets.”

Global GasChanging trade routes and geopoliticsBy Jennifer Warren, President of DCFR

Introduction The narrative of global gas begins in Texas. But what started in Texas didn’t stay in Texas.

In fact, the fairly recent discoveries and production of shale gas in North America have led to more self-sufficiency in the U.S. We will no longer need to import liquefied natural gas (LNG) to the degree that we once did. This has been called a gas rush, gas gale, a black swan event, a game-changer…

A robust U.S. supplied with its own natural gas resources has implications for Europe and Asia. Europe benefits from this in several ways. Its relationship with Russia as a primary supplier might change in the future. Top importers such as Japan and Korea also benefit from greater U.S. resources. China and India are aided more from U.S. technical know-how as they learn to exploit their own potential resources with global energy firm’s knowledge, partly gained from U.S. shale developments and innovations.

The market for natural gas is said to be evolving into a global one versus the original trading blocs of the past. Natural gas prices are quite low in the U.S.

Who benefits from expanded gas supply, and for how long? What is the future outlook for past, present, and future trading partners?

From the first of a three-part series about global gas, sponsored by ExxonMobil, DCFR President Jennifer Warren interviewed panelist Mikkal Herberg, research director on Asian energy security at The National Bureau of Asian Research (NBR). The interview with Mikkal Herberg of April 8, 2011 follows.

Natural Gas and Energy SecurityJW: How does the increased use of gas in Asia change energy security equations? MH: Asia is deeply dependent on both oil and coal. There are many historical factors related to this. Oil is easy to move around and easy to use; coal is in abundant supply in Asia. The biggest and fastest growing markets are China and India, but also Southeast Asia. With respect to electric power generation, oil and coal conveniently fit the bill. In particular, natural gas utilization is relatively low compared

to other regions and that’s because gas is expensive to transport over Asia’s long distances. Gas accounts for only 11% of Asia’s energy use compared to 24% globally. If Asia can expand its gas use, then hopefully this reduces the expected growth in coal consumption and even oil consumption, particularly for power generation use. Gas diversifies Asia’s energy slate and diversification of the energy slate means stronger energy security. Gas is a reasonably priced, cleaner, and a readily available fuel that improves Asia’s energy security and leads it toward a lower-carbon energy future.

China’s StatecraftJW: How might the use of natural gas in China impact their pursuit of relationships with large oil-producing countries?

MH: I think oil is viewed very differently in Beijing. From my perspective, they view oil consumption as a particularly acute energy security issue, which relates to economic security. Gas is relatively new to the Chinese, but they are expanding gas use rapidly, which is a good thing.

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It now represents just 4% of their energy mix, but is growing dramatically.

Natural gas doesn’t really compete with oil directly in most marketplaces. Expanded gas supply is unlikely to impact oil demand significantly, at least in transportation, which is where oil is the key fuel source. My guess is that the Chinese will continue to push hard in acquiring oil fields, mergers, and acquisitions to expand their supply portfolio and sources of oil. Much of what drives this kind of apparent state push to invest abroad is driven not by strategy or political leadership, but really by the national oil companies (NOC) themselves. They are pursuing commercially- and competitively-driven strategies that make sense for any large oil company. Then these NOCs often bring the government along to provide extra trade, aid, and loans that help the NOCs seal the deal. So often it’s the companies leading the states, not the states leading the companies. It is a collaboration.

Diversification and SecurityJW: What are the implications for US and European security given this paradigm shift with gas usage?

MH: For many countries, given the extent to which gas becomes a bigger part of the energy mix, countries have a global energy slate that is more diversified. That’s good for everybody. The most important trend relative to energy consumption is that gas can help slow the growth of coal consumption which is rising dramatically in Asia. Gas can really make a material difference because coal and gas compete in power generation, heating, and industrial use.

Additionally, greater use of compressed natural gas, such as natural gas used for transportation, can help diversify energy use. Natural gas comes from a slightly different set of producer countries. For the Asian region, Australia, Malaysia, Indonesia, and Brunei are major exporters of liquefied natural gas

(LNG), and in the near future Papua New Guinea and Timor Leste will also become LNG exporters, meaning less global reliance on the Persian Gulf. Greater use of natural gas offers a more diversified slate of suppliers as well. Much of the global oil supply is coming from places that are unstable, often unfriendly, or are members of OPEC, which restricts supply to maintain high prices.

JW: Do you think there will be a balance of power shift eventually from OPEC oil to the gas producers?

MH: I don’t think so anytime soon given long-term trends. Oil demand is

going to grow another fifteen million barrels a day over the next twenty years. The supplier base is still going to be very narrow. We will still rely on OPEC for a major share of world oil supplies. The OPEC share of 40% today will probably be 50% in the future, particularly the supplies coming from the Persian Gulf which will increase OPEC’s power over pricing. Gas is a very different game. There is a loose gas coordination group called Gas Exporting Countries Forum (GECF). But gas is a much more complicated industry; markets are complex, and transportation of

gas long distances is expensive. It includes both LNG and long-distance pipeline gas, with a whole different set of geographical issues. I believe it will be very difficult for the gas producers to develop a cartel similar to OPEC.

Asian Gas Consumption: China and IndiaJW: Why has pipeline gas development been more limited in Asia versus in the U.S. and North America? Is it just the money?

MH: It’s what’s often called “the tyranny distance”. There are huge maritime distances around the Pacific region to transport gas. This means either sub-marine pipelines are required, which are particularly

expensive beyond 600-800 miles, or gas must be cooled to an extremely low temperature to liquefy it for transport in expensive LNG tankers. Long pipeline distances in Asia and the Middle East tend to slow gas development and use. In China and India, the barrier has been more policy oriented. Until recently they have not been sufficiently incentivizing the private or state sectors, or providing the types of investment terms that will encourage building pipelines and developing the markets.

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JW: What are the political implications of natural gas as a base-load power source in countries such as India and China? MH: Natural gas is a vital diversification of their supplies to a cleaner source. Right now coal dominates the market for electricity generation. About 80% of China’s power is fueled by coal, and electricity demand is expected to double over the next 15 years. Anything that brings gas into the picture offers both diversification and pollution reduction advantages. This is where gas can make such a difference. Until recently, a key barrier has been that governments want to keep electricity prices very low, which makes it difficult for gas to compete with cheap coal. This continues to be a problem in both China and India. But they are in the early stages of addressing these problems.

JW: You discuss India’s gas, regional pipeline and competitive constraints in your recent paper on natural gas in Asia. India has a tough road ahead. Does that add tension for India as others countries increase their gas consumption?

MH: They recognize they need to use more gas, for all of the beneficial reasons we have discussed. They have had a major recent discovery offshore in the Krishna Godavari Basin on the East coast, which will help them boost gas use in the future. But inevitably India will rely increasingly on imported gas; currently they already import 30% of their gas. For India to increase gas use, they will need to increase their imports of LNG and need to access large regional gas supplies via pipeline like China has done with Turkmenistan, potentially Iran, and Myanmar.

India’s problem is that of being in a geopolitical box. The effort to access Iranian gas via the Iran-Pakistan pipeline is blocked for a number of reasons. Most importantly, they don’t

want to rely on Pakistan as a transit state. The potential for Turkmenistan gas flowing to India faces the same problem—it has to cross Pakistan and also a very unstable Afghanistan. New Delhi had hoped to access Myanmar gas from the East, but the Chinese offered Myanmar a better deal and that gas will go north to China now. There’s more gas being developed in Myanmar, so it is quite possible that India may yet be able to access Myanmar gas supplies. But so far their efforts in trying to access the big regional gas supplies have been frustrated. LNG is going to grow gradually in India, but much depends on continuing to reform energy pricing to justify relatively expensive LNG.

JW: So how do Beijing and New Delhi incentivize their national oil companies and foreign investors? What kind of challenges do you see for them in expanding gas supply?

MH: In my view, the problem is first the wellhead price being paid for gas. For a producer the wellhead price is critical to making the investment in new supplies possible. Although they

have recently been moving towards more realistic pricing, both China and India have kept wellhead gas prices extremely low.

There are also pipeline security issues. Will pipelines be built where they need to be built? Additionally, pipeline infrastructure tends to be dominated by state companies. There is a lack of coordination among the various governments’ bodies. Finally, China and India’s respective domestic gas markets have not been sufficiently developed by their governments to a large extent. Tariffs, transportation, regulation, and distribution systems to move gas into large urban areas need to be addressed. Market development is complex and has been slow.

Both countries have only begun to understand the great potential for gas. Building the pipeline infrastructure takes time and investment and production returns have not been very attractive. Put that all together, and you have very limited activity. Shell is one exception with a large sour gas project in China and new gas development is beginning to accelerate. Some activity

“Gas is more complex and difficult than oil. With gas, there are relatively expen-sive pipelines, which require market development, tariffs and regulation—the software of market development.”

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exists in China, where Chevron and other firms are developing China’s sour high-pressure gas, for which the Chinese lack the technology.

Gas is more complex and difficult than oil. With oil, the resource can be put on a tanker and transported pretty much anywhere in the world for less than $3 per barrel. With gas, there are relatively expensive pipelines, which require market development, tariffs and regulation—the software of market development. Gas is infinitely more complex. Producers can’t invest in exploration and development if the market is not developed. If the supplies are not sufficient, then governments don’t move to develop the market. These things all must be done simultaneously and require strong coordination between government policymakers and the industry investing in new supplies.

Future of Global GasJW: So it’s a huge infrastructure undertaking to use more gas for these countries?

MH: The crux of this issue is the challenge of domestic development to expand gas use, especially for electricity generation. LNG receiving facilities have to be built; pipeline and distribution systems must be built, and market prices and regulatory systems must be created. All of these things have to fall into place in a relatively coordinated fashion. Oil is different and fundamentally easier and less expensive to transport and use. That’s why oil use grows rapidly in developing economies and why gas use tends to lag. JW: So these are all of the practical issues and obstacles that must be considered by the supporters of natural gas expansion?

MH: Fatih Birol, chief economist of the International Energy Agency (IEA), recently suggested we may be entering the golden age of gas and the

IEA is releasing a major new report on this in June. My response, during our recent conference: ‘The question is whether we are entering the golden age of gas—or is gas going to be the fuel of the future, and always will be?’ In order for gas’ potential to be realized in this golden age, we need huge steps forward in finding new supplies, infrastructure development to move that gas, and developed markets. JW: So are parts of Asia like the oil markets in the U.S of the 1950s, say six decades ago?

MH: In a lot of ways, yes, in most of the developing countries around the world, and in developing Asia. However Japan and Korea are different with their more developed markets for gas. But the real growth forecasted is in developing Asia, in China and India particularly. Indonesia has been a massive LNG exporter for decades, yet Indonesia is experiencing gas shortages (which also happened in the U.S. during the late 1970s). There are many reasons for shortages, often prices are too low to justify new supplies.

Personally, I believe we are headed for tremendous growth in gas use, particularly in China. But it’s going to be slower than people might think. Firms need investment terms that make sense; governments to follow through on promises; stable contracts, and confidence in sustained market development.

JW: If Beijing continues increasing its gas use, with China relying traditionally on coal for electricity and huge employment in the coal industry, how might this affect social stability? MH: In a sense, gas use in China will be largely incremental demand for power generation and residential and commercial uses. China is growing at such a rapid rate on such a huge scale that even with a significant expansion of gas use in power generation and an expansion of nuclear and hydroelectric, this is unlikely to undermine reliance on coal and the coal industry. China’s problem is that of mining enough coal. They must transport coal on already overloaded rails and build power plants fast enough and efficiently to keep up with economic and energy

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demand growth. Growing gas use will slow the growth of coal use—but not stop it.

JW: How long do you think it will take India and China, respectively, to raise their gas use toward much higher international averages? Is China one decade off and India two?

MH: I think the big story is that China is ramping up its gas consumption on a scale that’s hard to believe. In 2009, they consumed about 90 billion cubic meters (bcm) or roughly 3.2 trillion cubic feet (tcf). Their consumption rose by 18% to 105 bcm in 2010, and the target for the 12th Five-Year-Plan is to reach 250 bcm in 2015, a two-and-a-half fold rise in just five years. They plan to increase gas usage to about 400 bcm (14 tcf) by just 2020. Growing from 3.2 tcf to 14 tcf of annual consumption in the space of one decade is ambitious. Consumption in the U.S. is only 23 tcf, and we are the largest consumer in the world. Chinese gas use targets have risen dramatically in the past few years. They will be supplied by imported gas from Central Asia, Myanmar,

Australia, Indonesia, and possibly Russia’s East Siberia, probably post-2020. The Chinese are building 12-15 LNG receiving terminals along the east coast and three are currently operational. So there is massive incremental growth in LNG supply, coupled with rising domestic gas development that is moving quite fast. Over the next decade, China’s gas usage seems likely to boom. India’s gas usage will grow strongly as well, although somewhat more slowly. Domestic gas production will help and both LNG and pipeline gas imports are likely to grow. JW: How does Russia fit into this global gas market that’s expanding? MH: As you know, Russia is a big supplier to Europe, and that’s the big story. They are the world’s largest gas exporter, supplying about a quarter of Europe’s gas, half of which is imported gas. Russia has the potential to be a much bigger supplier if they develop new fields in the northern Yamal peninsula region. They have huge reserves in East Siberia. But the Russians are extremely difficult to

work with. They’re intent on holding on to their share of the European market. They are building other gas projects and promising more gas supply and pipelines to Europe in the future. However, the investment is not forthcoming for the new fields that can fulfill the promised supply. Their old fields are mature, and maybe even the largest in decline; they have to start developing the new fields. This is a big worry for the Europeans—are they investing enough to meet their future commitments? The Russians express that they have never missed a commitment yet.

The Russians have worked very hard to control Central Asian gas, making sure that gas supply travels through Russia, which also supplies Europe. While Russia is a major supplier, the uncertainty is whether they are investing enough. Their pricing policies tend to be tough as well, again reinforcing the challenges of working with the Russians.

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