LNG Prospects and Gas Supply Security in Europe

LNG Prospects and Gas Supply Security in Europe Can LNG reduce Energy Security Risks such as Supply Interruptions and Gas Producer Cooperation? Presentation at thePolitical Economy of Energy in Europe and Russia (PEEER) WorkshopHigher School of EconomicsMoscow State University Moscow, 15 September 2009 Marcel Dietsch,MPP (Harvard)DPhil StudentInternational RelationsUniversity of Oxford

‘Energy Security’ and Core Questions • Energy Security: the absence of physical delivery interruptions of reasonably-priced energy supplies. • Does LNG contribute to Europe’s energy security overall? • Can LNG reduce short-term risks such as physical supply interruptions? • Does LNG contribute to more competitive (usually means lower) gas prices in the short- and long-run?

European Concerns about Security and Affordability of Gas Supplies (I) • Long-standing dependenceon gas imports from(super-)giant fields • European indigenous gasreserves and productionin decline – holding only 2% of world gas reserves • growing demand andhence even higher importdependence on Russia,the Middle East and Africa

European Concerns about Security and Affordability of Gas Supplies (II) • growing gap between consumption and production in Europe covered by imports from very few countries • Most imports via inflexible pipelines - problematicsince Russo-Ukrainian gas disputes in 2006, 07 and 09 Net EU imports in by country of origin Chart: European Commission Report, July 2009

1. Mitigating the Risk of Supply Disruptions? • LNG considered a valuable tool to diversify European gas imports in addition to winning new suppliers (e.g. Iran, Turkmenistan, …) and establishing alternative pipeline routes (Nabucco) • Geopolitical distribution of LNG suppliers different from pipeline supplies, which is both good and bad news • LNG share of gas imports is still low at about 47 bcm or 15% in EU - hence LNG adds to, but does not dominate, the supplier base

Western Europe: LNG beneficial... • Largest LNG consumers in EU are France (about 25% of imports) and Spain (approx. 50%) - both countries least affected by recent gas cut offs, not just because of their location • Hence: in some countries LNG contributes to diversification of energy supply; acts as backup supply and improves security of supply • Increased use of LNG buys Europe time to finish Nabucco pipeline to access Middle Eastern and Central Asian resources

... but only up to a point (I) • Regasification capacity expansion until 2015 mostly predicted to be at existing terminals mostly in the UK, France, Spain, Italy and Germany Projected LNGRegasificationCapacityAtlantic Basin, bcm Jensen Associates

... but only up to a point (II) • Most of the LNG quantities come to Europe locked up in long-term contracts; less than 20% is non-committed LNG • These flexible, tradable quantities (3% of Europe’s gas needs) could increase security of supply to the extent that buyers in Europe could outbid others, especially the US, Japan and South Korea  depends on the competitive situation • Construction of regasification capacity worldwide far ahead of liquefaction capacity  existence of regasification terminals does not always mean availability of actual supplies

Eastern Europe – LNG nonexistent • Eastern European states are highly or fully dependent on one gas source (Russia) and one transportation method (pipeline) • Considered highly undesirable especially after repeated gas cut offs in 2006, 2006 and 2009 - regardless of whether Gazprom, Ukraine or both are to blame • Yet, no existing LNG regasification terminal, partly because countries are landlocked or there is no easy access to the Atlantic or the Mediterranean • Need for diversification to reduce impact of supply disruptions – LNG not a suitable solution?

Share of Russian Gas for ImportingCountries’ Consumption Needs LNG receiving all via pipeline, for 2008, in bcm terminals in Europe

Eastern Europe: increasing security of supply without LNG • Diversification through use of LNG or different pipeline suppliers not possible/optimal • Instead: integration into European gas grid, investment in interconnectors (with reverse flow technology) • Eastern European countries and the Baltic region remain at the periphery of the European transmission system • July 2009: European Commission initiates Baltic Energy Market Interconnection Plan and includes €310 million in EU Infrastructure Spending plan for regional gas interconnection projects linking Slovakia-Hungary; Slovenia-Austria; Bulgaria-Greece; Slovakia-Poland; Hungary-Croatia; Bulgaria-Romania and Romania-Hungary.

Initial question: Can LNG reduce risk of physical supply interruptions? • Yes, to an extent, mainly in Western European countries • Especially in countries with existing receiving facilities since capacity expansions are expected to be realised at existing terminals rather than through the construction of new terminals • Not in eastern Europe since there is practically no LNG infrastructure for various reasons • Integration into European grid by building interconnectors between countries more important • Overall: LNG useful, but no a panacea for European energy security in general

2. Gas Pricing and the Geopolitics of Supply • Algeria, Norway and Russia derive some market power—i.e. being able to sell gas above their (marginal) production cost—due to two factors • 1. high market concentration in their export markets (Russia as quasi-monopolist in Eastern Europe, oligopoly structure elsewhere except UK and Netherlands) • 2. inelastic demand for natural gas as a result of widespread household use (cooking, heating)  gas prices above competitive level • Does LNG contribute to more competitive gas prices in short-run? • In the absence of a fully integrated European gas grid: differences between those EU members states with LNG access and those without

... in the short-run • LNG creates competition to Russian pipeline gas in Western Europe for two reasons • Countries in western part of EU are relatively far from Russian fields (cost advantage of LNG only over very long-distance pipelines) • UK, Netherlands, Spain and France already have infrastructure in place • increased use ofLNG could wellstrengthenbargaining powerof some EU gasimporters vis-à-vispipeline suppliersby reducing de-pendence on pipe-line gas $/MMBTU $4.00 36" LP Offshore Gas Line (1,000) Single Train LNG 56" LP Onshore $3.00 36" LP Onshore Gas Line (3,085) Transportation costs and the effects of scale Gas Line $2.00 Crude Oil Tanker $1.00 Onshore Crude Line $0.00 0 2,000 4,000 6,000 8,000 MILES Jensen Associates

Gas Pricing in the Long-Run – LNG cartel? • LNG contributes to the globalisation of regional gas markets – increasingly susceptible to cartelisation? • Important to look at global distribution of gas reserves and production – and to examine the potential for cooperation among LNG producers and exporters • Russia, Iran and Qatar control about 55% of global gas reserves • EU Commission notes: “Iran holds the second largest reserves of both oil and gas worldwide, with 11% and 16% respectively. Russia, Iran and Qatar might be the only large providers of gas worldwide by 2030. So far, the geopolitical implications of such a scenario do not seem to have been subjected to a thorough study.”

Cooperation among Gas Producers • “An association of some kind among LNG exporters is likely.” (Daniel Yergin, CERA) • Unclear if and when such an association can be effective since gas trade is different from most commodity markets (storage, transportation costs) • Current gas price collapse might be catalyst (Jonathan Stern, OIES) • Motivation for closer cooperation perfectly understandable from producer point of view: raise or maintain high prices to extract value from their resource • Loose cooperation beginning to take shape in the GECF (next page)

The GECF • Gas Exporting Countries Forum (GECF) created in 2001 • Gathers the world’s leading gas producers to promote mutual interests • Includes measures aimed at maximising the value GECF member countries can derive from their gas reserves • GECF members exchange views and information on project development, supply and demand balances, exploration, production and transportation costs, etc • GECF’s share in global pipeline gas trade at about 38% • More impressive share in LNG production and exports: around 85% (2007) GECF observers GECF members

GECF and LNG in Europe • All of the EU’s LNG suppliers are part of the GECF • European Commission report argues that the “likelihood of GECF being able to exercise control over all gas movements worldwide seems unrealistic [...] but the Forum might take quite a firm grip on LNG.” (July 2009) • GECF does not engage in OPEC-type quota setting at the moment, but measures to achieve greater control and “preferred” price levels, the GECF may use “softer tools:” • Managing capacity expansion (Saudi-style spare capacity too expensive) • (re)-introducing destination clauses • Pursuing vertical integration • Using delivery swaps to use price arbitrage opportunities •  Medium- and long-term risk (especially for highly import-dependent EU consumers) of cartelisation of LNG market

The known Unknown: Unconventional Gas Resources in the US • Significant changes in the gas resource base in the US: discovery of new shale gas formations and arrival of new technology to exploit shales (hydraulic fracturing) • US reserve-to-production ratio previously at about 10 years, between 30 or 40 years (EIA, June 2009) • Consequence: growth of US production reduces LNG import needs • Indication of unconventional impact: operator of a LNG regasification terminal in US earlier this year tried to change the licence to a liquefaction facility • If US can exploit new unconventionals as planned1, this may render GECF completely ineffective • Why? For long time, it looked like US was going to depend on LNG imports, but now may become exporter again after new discoveries • Safe to assume that the US would counteract any cartelisation efforts by other LNG exporters 1depends on US Federal and State regulations since hydro-cracking affects groundwater supply

Gas Pricing - Summary • LNG is a competitor for pipeline gas in Europe and (may) contribute to the erosion of market power that Algeria, Norway and Russia enjoy in parts of Europe • Global distribution of gas reserves highly concentrated • Cooperation among gas producers and exports, especially those using LNG for transportation, likely and taking shape in form of GECF • GECF countries control 85% of LNG exports worldwide and all shipments to Europe • Risk of cartelisation of globalising gas market in medium- and long-run (and hence higher prices – above the competitive level) • Possible mitigating factor: US re-emerges as an LNG exporter as a result of unconventional gas reserves that are now exploitable

European Energy Security: Natural Gas Geographic Sources • Diversification LNG contributes to geographicdiversification by making available sources previously not accessible bypipeline (e.g. Qatar, Nigeria, ...) • 1. Reliability(low impact of physical inter-ruptions) • 2. Affordability • Liberalisation Transport Routesand Modes • Infrastructureand Storage As a new form of transportationfor natural gas, LNG provides a flexible alternative to pipeline

Discussion / Q&A Marcel DietschMPP (Harvard)DPhil student, International RelationsUniversity of OxfordUniversity College, Oxford | OX1 4BH | UK www.marceldietsch.commarcel.dietsch (at) politics.ox.ac.uk

LNG Prospects and Gas Supply Security in Europe