The Trans-Atlantic Trade and Investment Partnership (TTIP) currently being negotiated between the European Union and the United States may deliver significant benefits not just in terms of greater economic competitiveness, but also as regards energy security and even environmental sustainability, writes Carlo Stagnaro, senior fellow at the Italian think tank Istituto Bruno Leoni and advisor to Italy’s Minister for Economic Development. According to Stagnaro, there is no reason to believe that TTIP will have a negative impact on greenhouse gas emissions; if anything, rather the reverse. “Closing a deal as soon as possible is therefore in the common interest.”

The TTIP which is being discussed between the EU and the US is no doubt a landmark treaty that will have important repercussions on the economy of the two blocs and indeed the global economy. And energy trade is an important part of it. Both European and American negotiators seem willing to get to a conclusion. As far as the EU is concerned, TTIP has been set as a top priority under the Italian Presidency, as the country’s Minister for Economic Development, Federica Guidi, emphasized in her first hearing before the Italian Parliament.

But is this TTIP a good idea? There is, in fact, little discussion among professional economists about the healthy consequences of free trade. Indeed, if negotiators fail to reach an agreement, each party would immensely benefit from unilateral trade liberalization, as Prof. Heribert Dieter argued recently in The Wall Street Journal.

There are several reasons why closing a free trade agreement (FTA) would be preferable, though. Bilateral (or pluri-lateral) liberalization is more likely to gain political support than unilateral market opening. Reducing barriers to trade, while resulting in more economic efficiency and ultimately increasing the available income on both sides of the Atlantic, may cause short-term adjustment costs. If two countries achieve greater economic integration, each of them would specialize in the productive processes at which it is comparatively more efficient. At the same time, the industries that are comparatively less efficient will suffer and there may be closings or layoffs. Therefore a strong political effort is required to smooth the transition. Moreover, mutual market opening entails larger opportunities and gains.

True enough, TTIP (and, on a different negotiating table, the Trans-Pacific Partnership between the US and 11 countries from the Pacific region) may look like a step backwards from the glorious (but eventually unsuccessful) season of WTO-sponsored multi-lateral negotiations. Yet, TTIP may well become a game-changer in the history of trade negotiations. It is exceptional in several ways.

On the one hand, the size of the involved economies would make it the largest bilateral trade agreement ever. The US and the EU together account for about half of global GDP. On the other hand, differently from most trade agreements of the past as well as those being discussed right now, the American and the European economies are already fairly integrated. Their per capita GDP is comparable and social and environmental standards, despite many differences, are more similar than in most other cases. For example, the differences between the US and the EU are orders of magnitude lower than those between the US and countries like Vietnam, with whom Washington is negotiating under the umbrella of TPP.

For this reason, the focus of TTIP is substantially different from that of most others trade agreements (including, for example, TPP itself, but also GATT, NAFTA, and the sinking Doha Round). While in most cases free trade agreements are about reducing tariffs and introducing protection for a number of macro-areas like intellectual property, with TTIP the focus is much more on removing regulatory and other non-tariff barriers. That does not make the task easier, quite the opposite: negotiators will have to reach agreement on a large array of details, rather than setting easily measurable targets such as the reduction of the average level of tariffs.

On top of that, given the size of the economies and the scope of the treaty, despite being formally only a bilateral agreement, it is very likely that it would kick off a process whereby a global standard is set. It would be very difficult for any other country to call for a change in the trade rules, if they are accepted and enforced by such important countries/blocs as the US and the EU. In other words, TTIP may have spillover effects that may end up being almost as important as the treaty itself.

Putting energy in the TTIP

As of now, the trade in energy commodities between the US and the EU is quite limited. According to the BP Statistical Review 2014, in 2013 Europe[1] imported 496,000 barrels of oil per day from the US (compared to total consumption of some 14 million barrels per day, i.e. some 3.5%), while exporting 674,000 barrels. In the same period there was no relevant gas (LNG) trade. This is partly due to market reasons – particularly for oil – but it is also due to significant regulatory issues.

Even a superficial look at these data suggests that free trade would open a major window of opportunity. On the one hand, the US is experiencing an oversupply of natural gas, as a consequence of the “unconventional revolution”. Depressed domestic prices might make the development of shale gas uneconomic, unless more of it is exported. On the other hand, the crisis between Russia and Ukraine is making the debate on the EU’s energy security more heated than ever.

On either side of the Atlantic a genuine debate on the underlying risks and opportunities of EU-US oil and gas trade is often buried by political noise and more or less hidden agendas. Yet it is hard to deny that Europe provides a potential market for some share of US natural gas production; and that supplies from the US can help Europe to address some of its security concerns. As often happens, most commentators frame the question in a kind of “black and white” way, as if US exports could offset Russian supplies and solve any problem that the EU has with dependence on foreign gas (and as if external dependence was a problem per se). By the same token, some American commentators fear that US natural gas prices may skyrocket because of TTIP. Both views are naïve.

A more useful way of looking at the issue is by focusing on what happens at the margin. America’s gas will unlikely be plentiful and cheap enough to significantly change Europe’s situation as an importer from its traditional suppliers, once transportation costs are properly accounted for. But if more US natural gas is made available for export, it can be very useful – and perhaps convenient – to solve potential crises at the margin. Since this is a repeated game – i.e. Europe imports natural gas all the time, and it needs to increase its external supplies by late winter in particular – the mere availability of more LNG in the market makes crises (either geopolitical or otherwise) less likely to occur and less costly to tackle. For the same reason, as we shall see later on, TTIP’s impact on US prices would arguably be limited.

There’s more. Despite the obvious uncertainties, it seems fair to argue that the unconventional revolution played a major role in containing, and then reducing, America’s CO₂ emissions. This is why US President Obama, who made the fight against global warming one of his political (and rhetorical) priorities, also became a strong proponent of fracking as a way to solve energy-related security, climate, and competitiveness problems altogether. The lively debate that resulted from the White House’s endorsement of fracking as a component of a pragmatic environmental policy testifies that, at the very least, the US approach to climate and energy issues is evolving rapidly.

But, there is a but – or, to state it differently, there is hidden side of fracking that should be also taken into adequate consideration. Cheap natural gas in the US displaced coal as a fuel to generate electricity, and by so doing it flooded non-US markets with cheaper coal than ever before in the past few years. As BP’s Chief Economist Christoph Rühl wrote here at EnergyPost.eu, “Last year [2013] the US… not only had the world’s largest increase in oil and gas production, but also recorded the largest decline in CO₂ emissions worldwide – because of a massive displacement of coal in power generation with cheaper shale gas. In the EU, in contrast, carbon emissions fell only marginally and only as a result of the economic recession. Carbon intensity – the amount of carbon emitted per unit of energy – rose, as Europe’s economies replaced gas in power generation with cheaper coal, imported from the US”.

This paradox is easily explained: there isn’t yet a global market for natural gas, but there is a global market for coal. As a consequence, low natural gas prices do not migrate from one region to another, while low coal prices do. Luckily, the unconventional revolution is only one of two revolutionary movements that are re-shaping natural gas markets: the other one – perhaps still understated by many observers – is the LNG revolution. LNG allows a global, spot market for natural gas to gradually emerge. Regions that used to be segregated from each other can now become connected. While the LNG market still accounts for a relatively low share of natural gas trade worldwide, it is rapidly increasing despite a recession-driven slowdown in the past couple of years. Again, the change is happening at the margin – where its consequences are magnified. The two revolutions of unconventional gas and LNG may really change world energy markets as we know them – and we are just at the beginning.

Here is where TTIP comes into play. Exporting LNG from the US requires a burdensome licensing process. While the White House seems to be supportive of any development in that direction – as is shown by the recent permits for the construction of new export facilities – the country still relies on heavy procedures that were designed at the time of oil shocks, when exports were (erroneously) believed to be harmful to America’s energy security. If a free trade agreement is closed between the EU and the US, and if such an agreement includes energy commodities, the process would instantaneously become easier and get streamlined. Negotiators on both sides of the Atlantic seem to be aware of this, as emerges from a leaked “non paper” that addresses precisely, and unambiguously, this problem.

Environmental opposition to TTIP

So, is the deal done? Not at all. Not just the negotiating process is far from being concluded, but strong opposition is emerging both in the European Union and in the United States. Ironically, some of the opponents wave an environmentalist flag. For example, the Sierra Club’s Ilana Solomon argued that TTIP would be bad for the climate. Her thoughts are clearly detailed in an article featured by Energy Post on 3 September.

Ms Solomon’s argument is related to both oil and gas. As far as oil is concerned, it doesn’t seem that TTIP can have relevant consequences, except perhaps on marginally changing Europe’s import mix. World oil markets – differently from natural gas markets – are “one great pool”, as the late Morris Adelman said. “The price is the same at every border [he went on]. Who exports the oil Americans consume is irrelevant”. In his seminal 1984 paper, Adelman argued that, given the nature of oil as a commodity, price shocks in any region are rapidly transferred to any other region. Therefore the effect of selective treaties (particularly embargoes or cartels) is much less relevant than one would expect. That also applies to bilateral free trade agreements. Who exports oil to America is as irrelevant as who imports American oil. The effect of TTIP on global oil prices is likely to be negligible. But if the price does not change, all else being equal demand is not likely to increase either. True, there may be some relocation in production, with more drilling in the US and less drilling somewhere else, but that is likely to be a second-order effect, with little impact on total consumption, emissions, etc.

The issue of natural gas is trickier. On the one hand, a global market is developing that in this respect makes natural gas more similar to oil than ever before. Yet, the size of LNG trade – as compared to pipeline trade – is still too small to result in one global price for natural gas. Therefore there are still huge price differentials between regions, as is evident by looking at natural gas quotations at European and American hubs. For example, in 2013 the average price for natural gas was as low as 3.71 US$/MBtu at Henry Hub, as compared to more than 10 US$/MBtu in Europe. TTIP can make a difference, although not a substantial one in the short run. What are the environmental implications?

Contrary to what Ms Solomon argues, they are likely to be positive for the climate. More LNG trade between the EU and the US is likely to result in two consequences. Since natural gas markets are mostly regional in size, the effects on the US and the EU should be looked at separately. The basic assumption is that, by removing red tape on natural gas exports from the US, all else being equal the existing price differential will make it convenient for US producers to export some of their natural gas to Europe, even after transportation costs are taken into account. If the quantities involved are large enough there will be effects on prices. In Europe, an increase of LNG import will lower prices at the margin, making gas more competitive and its supply more secure, both in reality and in the operators’ and politicians’ perception. For this potential benefit to be fully captured, Europe should improve its domestic interconnections. For example, Spain’s LNG terminals are dramatically underutilized, and this is in part due to the lack of interconnections with the rest of the EU. The incoming EU Climate Action and Energy Commissioner, Miguel Arias Cañete, seems to be fully conscious of this point. But this is a separate issue that lies beyond the scope of this article.

At any rate, cheaper natural gas is unlikely to displace green energies, as Ms Solomon fears: the demand for renewables is driven by and large by the available (although declining) subsidies and by regulatory mandates. It is substantially shielded from market risks. For example, if the EU adopts a 30% renewable target by 2030, the available natural gas from the US will only impact how the remaining 70% is provided. It will have no effect on the green 30%. Even if such a target is not adopted, but a 40% reduction target for CO₂ is set, free trade in energy commodities with the US may or may not have an impact on renewable investments, but at the end of the day Europe’s energy mix will have to be such that carbon emissions decline by that amount. Therefore, even in the worst-case scenario more natural gas (and oil) imports from the US would have no impact on Europe’s ability to meet its target, provided that there is a credible commitment to do so. The opposite is more likely. US natural gas might displace coal in the European Union, as much as coal displaced gas in the past few years. From a CO₂ perspective, this is likely to result in less, not more, emissions. Climate activists should be happy and supportive of this development.

Alas, the opposite will happen in the US. If American natural gas is demanded in Europe, it will become relatively less abundant in America, driving prices up. This might in fact result in more coal becoming relatively more competitive, but that again seems quite unlikely. There are several reasons behind this. First, there is still a large potential for unconventional gas in the US: the alleged additional demand will be covered, at least in part, by additional supply. Therefore the effect on prices would be less than proportional. Luckily, this is not a zero-sum game.

Secondly, natural gas in the US is so abundant and so cheap that it is very unlikely that its prices will increase enough to make it convenient for power generators to switch back to coal. Thirdly, America’s generating fleet is also evolving towards a cleaner, natural gas- and renewables-based pattern: that involves large sunk costs that will have to be recovered, creating a strong incentive for generators to keep the existing CCGTs running despite a modest increase in domestic natural gas prices (and a correspondent reduction in their margins, if there is enough competition in the US electricity generation market). Fourth, according to the US Congressional Research Service, “some initial estimates projected a modest rise in absolute terms in domestic natural gas prices if all the proposed export projects are built, premised on a relatively flat supply curve for natural gas”. If the impact on prices is low, all else being equal the impact on demand will be low, too, making it unlikely that there will be an incentive for energy-consumers to switch from gas to more carbon-intensive fuels.

All in all, it seems reasonable to expect that the environmental consequences of TTIP, if any, will be benign: lower emissions in the EU will more than offset higher US emissions, and it is likely that US emissions will not deviate from the baseline anyway.

Conclusion

There is widespread evidence for the long-term benefits of free trade agreements. FTAs are not without costs ,but costs have mostly to do with managing the transition towards freer, more integrated economies. TTIP is unlikely to be an exception to the rule: in fact, if the United States and the European Union can agree on a comprehensive set of liberalization measures, this can create a major precedent in the history of trade negotiations.

TTIP is an exceptional deal by many standards, and most notably for the size of the involved economies and the focus on regulatory barriers to trade, rather than tariffs. Energy will be a relevant component of TTIP. Both the US and the EU have an interest to achieve greater integration that would allow the existing energy commodities to be better exploited as well as to reduce a number of energy security concerns.

All of the above must be carefully weighed against the potential externalities deriving from increased trade flows in energy commodities, with particular regard to the efforts to combat climate change. Despite some concerns raised by environmental groups, a closer look at the facts suggest that TTIP’s impacts on CO₂ emissions will be benign, especially in Europe. In fact stronger commercial links between the two sides of the Atlantic may contribute to offset natural gas price spikes at the margin, making natural gas more reliable and therefore contributing to contain the trend towards an increased dependency on coal that has been observed in the past few years in Europe.

Trade makes countries more prosperous and their economies more resilient. It is good to know that it can also help to make them more sustainable.

Editor’s Note

Carlo Stagnaro ([email protected]) is senior fellow at Istituto Bruno Leoni. Since April 2014 he serves as an adviser on energy and liberalization to Italy’s Minister for Economic Development. This article is written in his personal capacity.

[1] Here Europe does not stand for the EU. It represents the European members of the OECD plus Albania, Bosnia-Herzegovina, Bulgaria, Croatia, Cyprus, Former Yugoslav Republic of Macedonia, Gibraltar, Malta, Romania, Serbia and Montengro.