Windfall
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The third role OPEC has assumed is shaving off the peaks and troughs that might have resulted had the market been the only arbiter of supply and demand. In fact, from 2000 to 2005, OPEC had a formal policy of defending the price within a certain “price band.” When prices were edging close to the top of the band, OPEC would bring more oil to market; when they were heading south, it would do the opposite. In this third case, U.S. tight oil is likely to take up the mantle of OPEC or Saudi Arabia reasonably well. A relatively small increase in prices will invoke a fairly quick production response, mitigating the need for prices to spike high to curb demand and incentivize investment until supply rebounds. There will be some jaggedness when compared to Saudi Arabia’s execution of this task. But in coming on and off the market in response to price in relatively short order, American tight oil may effectively keep global oil prices in a band, where the upper and lower reaches are defined by the varying breakeven costs of producing this resource in different shale formations across the country. The more tight oil produced—in the United States and other countries—the more effective tight oil will be in playing this role.
Nick Butler, in the end, looks to be right that “sex and technology” will take on the most important role in determining the oil markets. Even if OPEC is not out of the game, it is a much diminished player on a more crowded field. Unlike any other time in the history of oil, the market—not a government, institution, or cabal of companies—could be the dominant arbiter between supply and demand. The unique characteristics of U.S. tight oil will help mitigate some of the extremes that could be expected if OPEC were to fade from the scene in other circumstances; it is likely to help keep prices within a band at a moderate price level for some time. But tight oil is unlikely to be able to help the world anticipate or react immediately to geopolitical calamities, as Saudi Arabia and OPEC often have. And it will exacerbate, not ameliorate, the problem of price volatility—creating new challenges for countries and companies looking to navigate the contours of this new energy abundance.
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It is tempting to view the tumult in the oil world beginning in 2014 as just another cycle in a notoriously cyclical industry. But in our changing energy landscape, relying on past experience to predict future outcomes is risky. While some elements of the new energy landscape are familiar, there is plenty that is new. Fears of peak oil, and the actions they have motivated, will be defunct for the next decade or longer as tight oil and advancing technology help meet rising global demand. Uncertainty about demand, moreover, at least introduces the possibility that available supply exceeds demand in the future, further reinforcing the new energy abundance. OPEC is wounded, perhaps not mortally, but enough to relinquish the role it has sought to play in the market for the better part of half a century. In this new world, we can expect the occasional price spike, lower prices on the whole, and certainly more volatility. But much of this new oil landscape is uncharted territory—for the energy industry, those who watch it and make money from it, and, most importantly, for the countries that have shaped their foreign policies and international behavior either around securing oil or using it to advance other national security agendas.
THREE
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Natural Gas Becomes More Like Oil
Natural gas was long considered a second-class citizen in the world of energy. An old wildcatters’ joke says it all. A geologist returns from the field to report on the drilling of a recent well. “I have good news and bad news,” he declared. “The bad news is we didn’t find oil. The good news is we didn’t find natural gas either.”
There were a few reasons why natural gas was viewed as the lesser fuel. Compared to oil, natural gas packs less of an energy punch: one gallon of gasoline contains more than three times the energy of a standard cubic meter of natural gas. Put another way, a barrel of oil has nearly a thousand times the energy of a barrel of natural gas.
In addition to being less energy dense than oil, natural gas is also much less convenient to produce, transport, and store. The reason for this difference is self-evident: oil is a liquid; natural gas is . . . a gas. But the ramifications of this simple distinction are enormous. A barrel of oil can move without difficulty by truck, rail, pipeline, boat, or even rickshaw and is easily stored along the way. From the beginning, natural gas has been more complicated. It cannot be barreled right out of the well like oil. Once captured, it requires a massive infrastructure to transport and trade. In some cases, this takes the form of purpose-built pipelines. In other cases, special liquefaction facilities are used to cool the gas to the point where it can be transferred into a tanker. After shipping, the product must then be regasified. Storing natural gas is also much more complicated than husbanding away oil: whereas oil is easily housed in tanks, natural gas storage generally involves underground facilities—be they depleted reservoirs, aquifers, or salt caverns.
Compared to oil, the relatively complicated processes for producing and transporting natural gas create a totally different relationship between the producer and buyer when we look at cross-border trade. A barrel of oil may relatively easily change hands many times, literally or figuratively, from the time it leaves its original producer and arrives at its ultimate consumer. As a result, relationships do not need to be forged between producers and consumers, as long as both put their faith in the market that handles the transaction.
Given huge, up-front infrastructure expenses for natural gas, companies generally have only been willing to make investments with a long-term contract of twenty years or more in place between the producer and the future buyer. Over such a long period of time, both sides also want some agreed mechanism to determine price. Once they make these comparatively complicated arrangements, the producer and buyer are bound together by contract and physical infrastructure. Until roughly the year 2000, this commitment frequently meant a huge network of pipelines for natural gas traded across national boundaries. A long-term relationship, of some nature at least, was essentially inevitable. The difference between buying oil versus natural gas has been somewhat like renting an apartment versus building your own apartment complex in a foreign country. You get a place to live either way, but the second option is far more involved and cumbersome.
The manner in which this expensive infrastructure profoundly tied the consumer and producer together also created conditions for politicizing the natural gas trade in ways that do not exist in oil markets. If, say, Russia refused to sell oil to Ukraine, Ukraine could relatively easily import the oil from elsewhere. While it might pay a small premium owing to higher transportation costs, the fact that the single global market sets the price for oil could give Ukraine some confidence that it could meet its oil needs without being gouged. But when, in 2006, Russia curtailed shipments of natural gas to Ukraine that flowed through its extensive pipeline network, Ukraine was in a tougher spot. It could not easily buy gas from other massive global producers such as Qatar or Australia because the needed infrastructure was not in place.
As a result, natural gas can easily become a tool of foreign policy—and sometimes a more effective one than oil. Compare the 1967 Arab oil embargo (not the better-known 1973 embargo) against countries supporting Israel with Russia’s 2006 decision to cut off natural gas to Ukraine. In 1967, given the fluidity of global oil trade, countries and companies were quick to redirect oil shipments to the embargoed countries from other producers; there was little economic damage and no political effect. In contrast, Russia created immediate difficulties in 2006 for Ukraine—and to a lesser extent Europe—when it curtailed natural gas sales to Ukraine as part of an effort to get the new, more pro-Western government in Kiev to pay higher prices. Although the disruptions were minor, Russia was still successful in negotiating a more favorable position for itself.
The realities surrounding the natural gas trade can also empower the buyer in certain circumstances. The subsequent 2009 crisis between Ukraine and Russia provides another vivid example.
Although Russia’s decision to cut off gas to Ukraine hurt Kiev, it also had—in this case lethal—implications for Russia’s customers further downstream. At the time, 80 percent of the natural gas Russia exported to Europe flowed via Ukraine. So not only did Ukraine feel the pinch, but so did Romania, Bulgaria, Macedonia, Greece, and Turkey. This episode in particular called into question the reliability of Russia as a supplier of natural gas to Europe in a way that had not occurred in decades of natural gas trade. Recognizing that the transit of its gas through Ukraine leaves it somewhat at the mercy of the Ukrainians, Russia has prioritized building infrastructure to deliver Russian gas more directly to Western Europe; it has vowed that none of its gas will transit through Ukraine by 2019.
Because natural gas has traditionally been transported via pipelines, gas markets have also been divided by geography. Three largely distinct natural gas markets emerged over time: one in the Americas, one in Europe, and one in Asia. In addition to physical location, these markets also differ in how they have traditionally priced their natural gas. Since deregulation of natural gas markets in the 1980s and 1990s, the United States has had a liberalized and highly competitive market. U.S. prices are established by Henry Hub—not an individual, but a storage and transit location in Louisiana where multiple pipelines meet. Here, supply and demand in effect determine the price of natural gas, much as the price of oil is set. Prices set this way are known as “spot” or prices determined by “gas-on-gas” competition. Asia, in contrast, has customarily set natural gas prices in relationship to oil prices in a practice known as “oil indexation.” The European market has employed a combination of these two mechanisms.
Finally, oil also had the advantage as being viewed as a strategic commodity, whereas natural gas was not seen in the same way. Oil has been the fuel that has powered militaries, won wars, moved planes, trains, and automobiles, and therefore lubricated trade and the global economy. The fact that, even in 2016, there are few substitutes for oil in the arena in which the majority of the world’s oil is used—transportation—adds to oil’s strategic dimension. Natural gas, in contrast, was originally used for heating, cooking, and electricity; only later did it became a major industrial input. In each area, natural gas is not essential for the task; other fuels can serve the same purpose as natural gas if necessary.
Given these characteristics, it makes sense that our geologist considered natural gas a punch line as much as an energy resource. It also explains why a shocking amount of natural gas is still wasted, flared or burned off, mostly in the process of producing oil. Anita George, former senior director of energy and extractives at the World Bank, estimated that if all the natural gas that was flared around the world in 2015 had been converted into power, it could have met the entire electricity needs of Africa. Even as late as 2016, Fred Julander, a wildcatter and relentless advocate for natural gas, lamented, “Gas is a wonderful fuel and it has been an unappreciated fuel for all of history. I wonder if this is going to be the case until the demise of gas.”
Today, however, things are improving for natural gas. This change is in large part because this underdog resource is becoming more like oil. In geopolitics, natural gas has already been elevated from the butt of jokes to the subject of presidential summits. In February 2013, Japanese prime minister Shinzo Abe visited Washington to meet President Obama. The agenda of the two leaders was packed with high-stakes items: Japanese participation in the Trans-Pacific Partnership trade talks, proposals to counter North Korea’s nuclear pursuits with financial sanctions, and heightened tensions between Japan and China in the East China Sea. But amidst a program primarily intended to assure the United States that Japan remained a first-tier power, Abe made certain to raise the issue of natural gas. In an unusual foray into the domestic politics of another country, the Japanese leader asked President Obama to approve applications of American companies wishing to sell natural gas to Japan. At the time of the summit, natural gas was in particularly high demand following the Fukushima Daiichi tragedy. Japan’s thirst for natural gas had skyrocketed when the country shut down its nuclear generators; natural gas became more attractive as concerns over the safety of nuclear energy grew worldwide.
The recent trend in favor of natural gas has been due to other factors as well. Technological advances, discussed in detail below, have made natural gas both abundant and much more accessible, even to those outside the reach of pipelines. In addition, natural gas is only half as carbon intensive as coal and a quarter less than oil, giving it a reputation as the “good” fossil fuel—at least in certain parts of the world. President Obama, in his 2014 State of the Union address, declared natural gas to be “the bridge fuel that can power our economy with less of the carbon pollution that causes climate change.” Moreover, the ability of natural gas—as a provider of 24/7 power—to easily complement intermittent solar and wind sources has also given the commodity a role to play in boosting renewable power. Scholars Maximilian Kuhn and Frank Umbach have dubbed natural gas “the triple A” fuel, given its widespread availability, its affordability, and its acceptability. Some industry experts, such as Oklahoma oil and gas pioneer Robert Hefner, implore their audiences to think of natural gas as a superior fuel to oil on account of these and other qualities of the resource.
While all this will be of interest to energy buffs, these changes also have major implications for geopolitics. Most notably, the leverage in natural gas trade is shifting from producers to consumers. As explained in this chapter, the new energy abundance and related technological advances have exerted downward pressure not only on oil prices but also on natural gas ones. Moreover, as is the case with oil, these new realities are changing the structure of natural gas markets in profound ways. One major implication of these changes is that the natural gas trade is in many instances becoming harder to politicize. As a result, while oil still claims much of the spotlight, equally dramatic changes are happening with natural gas.
Natural Gas Euphoria
The new benchmark for enthusiasm about natural gas was set in November 2011, when the IEA released a report titled Are We Entering a Golden Age of Gas? With as much breathless excitement as a bureaucracy can muster, the report described a gas-friendly scenario for the future that it saw as feasible, although not inevitable. In this scenario, the use of natural gas grew robustly, requiring roughly three times the gas produced by Russia (the world’s second-biggest producer) in 2016 to meet additional demand. Yet, with unconventional gas of different varieties being tapped on multiple continents, the world was able to meet growing demand while keeping prices low. In the United States, as well as in China and India, natural gas replaced some coal in power generation and made further inroads into industry and transportation in this scenario. According to this vision of the future, the abundance of natural gas was one factor that helped the world advance marginally closer to its climate goals than the IEA believed would otherwise happen.
Although the IEA noted that the golden age of gas would depend on policies, technology, and market signals, the world seemed eager and poised to realize it. China embarked on an ambitious program to transform its massive gas shale reserves into natural gas output. In 2012, in its Shale Gas Five-Year Plan, the government announced an ambitious goal of producing significant quantities of shale gas; it aimed for the country to produce roughly the equivalent of 40 percent to 70 percent of China’s total demand for natural gas in 2012 by 2020. China launched many initiatives to support this goal, including opening up the sector to some foreign investment, creating incentives for shale development, and supporting technological research related to shale.
In the United States, companies clambered over one another to seek approvals to build or revamp liquefied natural gas (LNG) terminals to export U.S. natural gas. Leaders of countries from Israel to Mozambique delighted in major offshore natural gas finds, confident that global demand would be sufficient to transform their economic and strategic circumstances. Poland also had great expectations. In 2011,
Prime Minister Donald Tusk claimed, “with moderate optimism, that 2014 will be the beginning of commercial [shale gas] exploitation.”
In the four years following the 2011 Are We Entering a Golden Age of Gas? report, the new era arrived ahead of schedule in North America. Shale gas production boomed, with U.S. natural gas production in 2015 at levels the IEA report had anticipated would not be reached before 2035. Natural gas seemed nearly ubiquitous in the United States and, despite healthy demand from revived manufacturing and power generation, prices hit their lowest mark since the turn of the century. In mid-2016, the spot price for natural gas sold in the United States was just one-seventh of what natural gas had cost at its peak price a decade earlier. Consistent with the IEA’s gas-friendly scenario, natural gas had displaced coal in the United States—on a major scale. As recently as the year 2000, coal accounted for more than half of the fuel used for power generation, whereas natural gas generated less than a fifth. In 2016, largely as a result of declining natural gas prices, natural gas just overtook coal as the fuel generating the most power in the United States.
In other parts of the world, however, the golden age had yet to dawn. Europe’s economic performance was lackluster and China’s growth was also disappointing—both of which dulled potential demand growth for natural gas. In both places, continued government support for renewable energy also thwarted more robust use of natural gas. Additionally, a resurgence of cheap coal—because of slowing Chinese and falling U.S. demand—also tempered demand for natural gas in Europe and elsewhere.
Despite the sunny 2011 predictions of the IEA, efforts to develop shale gas outside North America also proved disappointing. In the first four years following the IEA report, for example, no countries outside North America apart from China and Argentina reached commercial production of shale gas. Expectations for future shale gas development remain, but regulatory barriers, logistical hurdles, institutional deficits, mineral rights, high costs, and other obstacles proved to be more difficult to overcome than initially expected. Just two years after rolling out its ambitious shale gas targets, the Chinese government was forced to slash them to just half of the original low-end goal. Environmental considerations have also impeded shale development in Europe, where political opposition to the development of shale gas has stymied the golden age of gas.