Concerns about energy security have shot to the top of the political agenda in Europe. But the US has no intention of letting the EU down. “The United States will be working with the EU to develop a plan for the mid- to long-term evolution of a more energy-secure future”, said US Secretary of Energy Ernest Moniz at a conference of the Atlantic Council in Istanbul. At this summit, top US officials and energy experts showed themselves surprisingly positive about the progress the EU has made reducing its dependence on Russia. “A few years ago, we couldn’t have solved the Ukrainian problem. Now we can.” With US LNG exports under way, the “monumental” Southern Corridor under construction, and Gazprom’s South Stream project increasingly under pressure, Europe’s position will only get stronger. Karel Beckman reports from Istanbul.
In his opening address at the Atlantic Council’s Energy and Economic Summit 2014 in Istanbul (19-20 November), President and CEO Frederick Kempe immediately made it clear the Atlantic Council is playing for high stakes. “Europe is in the middle of an inflection point of its history”, he said. 2014 “is every bit as dramatic as 1815 – the year of Versailles”. Or, he added, 1989, the year of the fall of Communism. “The future of the international liberal order”, said Kempe, “is at stake”.
Actually, listening to many of the presentations at the Istanbul summit, the mood among the Americans recalled not so much of a specific year, as a period in history: the Cold War. Clearly for the Atlanticists – and it’s probably fair to say that the bipartisan Atlantic Council represents the conventional geopolitical look of the Washingon DC establisment – with the “resurgence” of Russia the Cold War is back all the way.
And at the heart of this New Cold War – even more than in the Old Cold War – is: security of energy (read: oil and gas) supply. When discussing international energy developments, the Atlanticists routinely speak in terms of their “friends and allies”. They also make no bones about who is the common enemy: that’s you-know-who. Even as mild-spoken and renewables-friendly a man as US Secretary of Energy Ernest Moniz said in Istanbul that “it is important that we look at energy security in a collective framework among allies and friends”.
In fact, for the Atlantic Council the new Cold (energy) War should feel comfortably familiar. As its name suggests, the Council is an offshoot of NATO. It was founded in 1961 to “promote public understanding and support [in particular in the US and Europe] for the policies and institutions that would build collective security and peace.” After the fall of communism, the Atlantic Council “began to examine the transition underway in Eastern Europe and the former Soviet states, the long-term impact of the conflicts in the Balkans, efforts toward European integration, and nuclear security.” Its current Chairman is former US Ambassador to China Jon M. Huntsman, previous Chairmen include former Secretary of Defense Chuck Hagel and at least two former US National Security Advisors: James L. Jones and Brent Scowcroft.
The Energy and Economic Summit was held for the first time in 2009 and has quickly become the Atlantic Council’s “flagship international event”. It is no coincidence that for the fifth time in a row it was being held in Istanbul, which, as Kempe put it, is a “pivotal” state when it comes to international (energy) security. Turkey is the NATO country where energy supply from the East meets energy demand from the West. It offers the only non-Russian overland oil and gas supply route from the Middle East and the Caspian region to Europe. No wonder the Atlantic Council has every intention of keeping the Summit in Istanbul in the years ahead, as Kempe said.
Thanks to its shale revolution, the US itself has of course become much less dependent on external sources of energy in recent years. But that makes no difference to the policymakers and advisors in Washington. European energy security is every bit as important to them as US energy security. Indeed, in many ways the Americans seem more concerned with European security of energy supply than the Europeans themselves.
Robin Dunnigan, Acting Deputy Assistant Secretary for Energy Diplomacy at the US Department of State, said “the US cares deeply about Europe’s energy security”. Her colleague Amos Hochstein, Acting Special Envoy and Coordinator for International Energy Affairs, went a step further. “We have to make sure that everywhere around the world countries are not dependent on a single supplier”, he said. “Our view continues to be global.”
He added that “when there is a region that is growing in energy demand, but lacks an integrated market in gas trading, in interconnections of pipelines or grids, and where you have countries that are energy poor next to countries that have a surplus, that is an area we have to work together as international community to put an end to.”
“In ten years, Ukraine will not be forced to import gas anymore”
Secretary Moniz explained the reasoning behind this kind of thinking: “When we have allies, friends that have significant energy insecurities, the influence on their freedom of action influences what we can do with them in a whole variety of contexts”, he said. “We really need to have this view of united responsibility in energy security.”
Although the Atlanticists seem very careful not to criticize the EU – they certainly don’t sneer at “Brussels” – they did lay stress on the fact that, thanks to shale, the US has its own energy house in order. And not just in terms of security of supply: they are convinced shale gas is also making a positive contribution to limiting greenhouse gas emissions by enabling a switch from coal to gas in power production.
Their gentle hint was picked up by EU Climate and Energy Commissioner Miguel Arias Cañete, who made his first “international” appearance at the Summit, and who lamented that “because we have fierce opposition, from environmental organisations, from towns, it is quite difficult to develop shale gas in the EU”. He added that since EU member states have the right to choose their own energy mix. “we don’t have the ability [as EU] of establishing an ideal European energy mix.”
Lower import bills
So where then does Europe stand with regard to energy security? And how do the Atlanticists see the US-EU relation develop in this context?
Surprisingly perhaps the consensus at the Summit was that Europe is actually in a better position now than it was a few years ago, certainly when it comes to the gas market . As Carlos Pascual, Fellow and Senior Research Scholar at the Global Energy Policy Center, Columbia University, and a former ambassador to Ukraine and Mexico, put it: “Europe has made a massive investment in LNG infrastructure. It has also made a massive investment in interconnecting pipelines. It has introduced legislation, the third Energy Package, that does not let any party own supply, transport and distribution. As a result, a competitive gas market in Europe has emerged that has driven down prices and has forced Gazprom to renegotiate contracts. If we had not been in this situation, we could not have solved the Ukrainian problem.”
Jason Bordoff, Professor and Director of the Center on Global Energy Policy at Columbia University, and a former special assistant to the President and former Senior Director for Energy and Climate Change on the Staff of the National Security Council, made the same point. “We are already seeing the success of European energy security policy”, he noted. “The gas stress tests show that most of Europe is secure. This is because the EU has spent a lot of money on reverse flow and interconnections. And because we have a Third Package that underpins the legal rules of the market.”
The main challenge for Europe now, said Bordoff, is “how to reduce its vulnerability to disruptions. That’s a different question [than the question of market dominance].”
But the improvement in Europe’s position on the gas market was not only due to measures taken by the EU. The US shale gas revolution has also had a beneficial effect, albeit indirectly. Bordoff: “Merely the fact that the US is not importing gas whereas everyone had expected it would be, has freed a lot of gas to go into the world market. This has led many renegotiations of long-term contracts. The share of gas-to-gas pricing in the European market has jumped from 10-15% five years ago to 50% today.”
And once the US really starts exporting, the situation will become even better for Europe. “US exports won’t fundamentally change how much Russian gas will go to Europe”, said Bordoff. “Most of the gas will go to Asia. But it will have a profound effect on prices. We have calculated that US gas exports will ultimately lower Europe’s import bills by $21 billion a year, assuming 9 bcfd (billion cubic feet per day) of US exports.” (For more information on the potential impact of US LNG exports on European and global gas markets, see Alex Forbes’ seminal article on Energy Post, “Exporting a revolution: why the US LNG stampede will change the gas business forever” (14 October 2014).
Conversely, for Russia, despite its apparent dominance now in the European gas market, the outlook is much less positive, the Atlanticists believe. According to Bordoff, US LNG exports “will reduce Russia’s gas export revenues by $24 billion a year. That’s a 27% reduction, pretty significant.”
Pascual noted that Russia currently has no alternative than exporting to Europe. “Russia has 220 bcm [billion cubic metres] of pipelines going into Europe. It’s exporting 165-167 bcm per year. They can export only 14 bcm to Asia – LNG exports from Sakhalin. They have no other markets.” Russia of course did sign a gas export deal with China – actually two deals, one for 38 bcm and one for 30 bcm per year, but it will take many years to build the infrastructure for those supplies, said Pascual. “Russia will diversify in time. So now is the time for Europe to diversify further.”
Alan Riley, Professory at City Law School of City University in London, agreed that “the only real destination for Russia for a long time to come will be Europe”. He noted that the deal with China may also look better than it is. “There is a notional deal on price. But there is no agreement on construction of the pipelines. It will take many years to complete this project.”
Riley predicted that Russia’s position in the European gas market is bound to come under increasing pressure in the coming years. South Stream, Gazprom’s prestigious pipeline project that would reduce Russia’s dependence on Ukraine for transit, looks a very tall order at the moment, said Riley. “First, there are the sanctions. No CEO of a European company can afford to get involved in this right now. Then there is the EU’s ownership unbundling law. Gazprom can request an exemption for that, but only if the pipeline improves Europe’s security of supply – and it doesn’t, since it’s a diversionary pipeline, not an additional one. It is significant that Gazprom has not applied for an exemption yet.”
In addition, said Riley, there is the ongoing EU antitrust investigation into Gazprom, which he expected to move to a prosecution sometime early next year.”
“The Southern Corridor is not one project, but a series of megaprojects”
Pascual noted that the US and EU sanctions have been designed precisely to put the squeeze on the Russian energy sector. “Oil represents 70% of Russia’s export revenues, oil and gas income represent 52% of the Russian budget. So if you are able to put a sanction on the development of shale, on deepwater development, on the Arctic – on all new aspects of Russian energy – you start to bring into question the future potential of Russia’s energy sector. As a result, the cost of financing or refinancing debt will go up. This wil have an impact on the exchange rate and a broader impact on the economy. That is what we are seeing today. The rouble has depreciated. Inflation is rising. The Russian people are poorer. Will this lead to a change in policy in Russia? We are likely to see more pain, more sanctions, until that translates into a different set of policies.”
As to Ukraine itself, its situation is hardly hopeless. Today, said Pascual, “Ukraine consumes about 42 bcm of gas on an annual basis (this used to be 50 bcm, but has been reduced because of the war). It produces some 20 bcm, and can get 7 bcm in reverse flow from Eastern Europe. It has some 10 bcm in storage. So that leaves a gap of only about 5 bcm. So if you wonder why the Ukraine-Russian gas deal brokered by the EU is for 4 to 5 bcm, this is why.”
In future, said Pascual, “if Ukraine becomes a unified state and restores its productive capacity, it can reduce its gas consumption to 45 bcm through energy efficiency measures, increase its domestic production to 30 bcm and expand reverse flow to 15 bcm. In ten years Ukraine will not be forced to import gas anymore. What is more, its storage capacity can become a foundation for a stable Eastern European gas market.”
What is needed, though, said Pascual, is that the solution to the Ukrainian crisis “has to be embedded in a wider European solution. Ukraine can solve its problems if it’s part of the wider EU market.”
The Southern Corridor: “an extreme amount of good progress has been made”
Joe Murphy, Vice-President Southern Corridor at BP, gave a very upbeat presentation on the prospects for the “Southern Corridor” in which his company is taking a leading role.
The Southern Corridor is not one project, said Murphy, but “a series of megaprojects. A series of integrated gas pipelines, 3500 kilometres in length, starting from the Shah Deniz platforms in the Caspian Sea, going through Azerbaijan, Georgia, Turkey, Greece and Albania into Italy. $45 billion will be invested. And BP has a stake in all parts of the value chain.”
The Southern Corridor pipeline system will deliver 16 bcm of gas per year, “all of which has already been sold for the next 25 years”, said Murphy. The full capacity of the system is 30 bcm, but that can only be filled if other sources of gas become available, he added.
Speaking in glowing terms about the project, Murphy said “this is monumental in any way you look at it. It will bring a new supply of gas to Europe. It will offer a host of opportunities down the line to other countries to bring gas through a new route. And perhaps even more importantly, it will leave a legacy of agreements between countries, partners, buyers, all working together toward this common goal: to have security of gas supply for many years to come.”
Pretty strong statement
The American Secretary of Energy, Ernest Moniz (who, as one delegate at the conference said, rather looks like George Washington), made it clear that the US has every intention of supporting European security of energy supply going forward. He said that he regarded it as a “very important task now for the next half year or so to be working with the EU on a real vision of the integrated energy security picture.” And he announced he would be working “in coordination with the EU to develop a plan for the mid- to long-term evolution of a more energy-secure future”.
The US government, in other words, is already looking beyond the Ukrainian crisis. In fact, it is also looking beyond oil and gas. Moniz unfolded a comprehensive vision of what “security of supply” means, in addition to diversification of sources and routes: “Energy security includes developing alternatives to oil and gas. In the US for example 10% of our liquid fuel supply for vehicles comes from biofuels. It includes transparency of markets, and the infrastructure to support those markets. In Europe this is now part-way towards a resolution. Functioning markets are an important part of energy security, because they enable efficient allocation of resources in times of need. See the speed at which our shale gas resources have been expanded in the US.”
Another important element of energy security is energy efficiency, said Moniz. Moreover, a “vision for an integrated energy security picture must be integrated with the Road to Paris”, he said, i.e. with climate policy. Moniz was obviously pleased with the US-China climate deal the two biggest economies in the world concluded recently, although he was careful not to hype it. “If nothing else, China has acknowledged the responsibility and the need to address the CO2-issue”, he said.
With “the strong commitment already made by the EU, there is a pretty strong statement. Now we need to capture the momentum with other developing countries to get hopefully a successful Paris agreement, with differentiating but ambitious elements.”
Even more significantly perhaps, Moniz stressed to the fossil-fuel-minded audience that he was convinced a “major transformation” towards an economy based on “clean energy” woult take place. “I have no doubt this transformation will come. Its pace, scope and scale remain to be seen, but it will come.” One reason for this is that the impacts of global warming could already be felt by people, said Moniz. This would drive public opinion and policymakers to be ambitious in addressing climate change.
He also noted that “this transformation of the energy system is not going to be easy”. That has to do with some of the “fundamental realities” of the energy system: it’s a multitrillion dollar, highly capitalized commodity business, inevitably highly regulated. “Those characteristics are not the ones you would list for a system to enable it to respond quickly to innovation.”
Another complicating factor is that the energy transformation will see substantial reductions on the demand side. “This will make it more difficult for new players to enter the market.”
Nevertheless, Moniz noted that substantial progress is being made in cost reductions in clean energy, for example in utility-scale solar PV, car batteries and LED lighting. Now, he said, the biggest challenge perhaps lies in “business model innovation”. “We need to find ways to couple genuinely new services to consumers along with existing energy services.”
One could ask of course what the geopolitical consequences will be of this “major transformation” that Moniz sees on the horizon. How will it affect relations between the US, the EU, Russia, China and other powers? But that question seems a bridge too far for most people involved in the energy sector today. As Ian MacDonald, Vice-President Europe, Eurasia and Middle East E&P of oil major Chevron put it: “I am sure there are a lot of unknown unknowns. But you also have to deal with the realities of today. Oil and gas will still make up over 60% of global energy supplies in 2030.”
“Don’t expect the American oil industry to stop producing because of lower oil prices”
Former ambassador Pascual stressed that the US would continue to play a major role in international energy relations, regardless of developments in its domestic energy sector. “Some may believe that the American energy renaissance is a pathway to isolation, but that’s a false assumption.” Is energy then a “tool, a weapon to support our friends and hurt our enemies?” he asked. “If you want to use it in that way, you have to understand the [international] market. If you’re going to play in the world of the new geopolitics of energy, you have to understand changing supply and demand patterns, changes in the fuel mix, what happens to countries that do and don’t have access to energy.”
Indeed, according to Pascual, “the challenges that energy is presenting to national security and foreign policy are not going to go away. They are going to get bigger.” And he made it clear that the United States approaches these challenges strategically, with a long-term vision. “There was a point in the past in the last century when we were vulnerable as a result of our dependence, when we faced an existential threat as a result of oil dependence. We invested in technology, in foreign policy skills, in language skills, that allowed us to address this new reality.”
A note on the oil market outlook
How are we to look at developments in the oil market? Carlos Pascual of the Global Energy Policy Center of Columbia University said he regards the current decrease in the oil price as a logical outcome of market developments: “Supply has increased thanks to increased US production and to countries like Libya returning to the market.” Demand on the other hand, “has been absolutely flat in the OECD, partly as a result of higher energy efficiency, and demand growth in China has slowed down.”
With regard to the future, Pascual said, “I see as much probability of oil coming back to the market as oil going off. What if Iran and Iraq come back? If Brazilian pre-salt is successful? Saudi Arabia doesn’t look as if they are restraining their production. They are fighting for market share. The world shows a stable base of production and not much demand growth.”
As to US shale oil producers, Pascual said they would not be deterred by lower prices either. “American producers have become more and more efficient thanks to new technologies. Or some of them have. There are huge differences: the most efficient producers are 70% more efficient than the least efficient and 40% more than the average. In some cases the medium producers need $100 a barrel to break even, but in other areas they are fine with $60-70.” These differences in cost structure will lead to consolidation in the industry which will lead to costs going down overall, Pascual predicted. “Don’t expect the American oil industry to stop producing because of lower oil prices”, he concluded.
Lower oil prices may be more problematic for the international oil companies (IOCs). “One of the big consequences of [the market changes] over the last ten years is a big change in cost”, said Ian MacDonald, Vice-President Europe, Eurasia and Middle Eastof Chevron. “Projects nowadays cost a great deal of money. Chevron invests $40 billion a year. That’s what it takes to keep pace.”
Being increasingly shut out of the “easy”, conventional oil areas, IOCs have turned to more expensive, unconventional sources, such as deepwater, shale oil, tight oil and oilsands. The problem with many of these projects, said MacDonald, is that “unlike the large conventional projects, they have short production plateaus of 3,4, 5 years. Then they go into decline.” The IOCs are in a hard struggle against constant decline: “We produce a billion barrels a year. That means we need to find a billion barrrels a year just to stand still.”
Fatih Birol, Chief Economist of the International Energy Agency (IEA), who presented the results of the latest World Energy Outlook in Istanbul, suggested that there are reasons to believe that the lower oil prices cannot be sustained in the long term. He cited several reasons for this. The IEA expects oil demand to grow by 14 million barrels per day (some 5%) to 2030, mainly because of higher demand in the Asian transport sector.
In addition, like MacDonald he noted that the oil industry has to struggle merely to keep up production. “Of every three barrels of new production, two are needed to make up the decline of existing oilfields.” Birol added that this new production would have to come from the Middle East, in particular from (currently highly unstable) Iraq. “Without production growth in the Middle East we will have no chance of meeting demand, even in 2020”, he said. For the US he sees a production decline setting in around 2020. All this would imply that oil prices will start climbing again at some point in the future.
Whether the IOCs will profit from this, is another question. “The Middle East will be a significant part of production growth over the next 20, 30 years”, said MacDonald, “but whether IOC’s can get a big part of that is a big question”, he acknowledged.
One of the few bright spots for the IOCs is Kurdistan. “Kurdistan is exciting because it offers a [rare] opportunity of participating in successful conventional onshore oil wells”, said MacDonald. “Kurdistan could become a major regional producer of oil. It now produces 300,000 barrels per day. That could go to 800,000 in 6-7 years.” The Kurdistan government offers commercial terms that “are good enough”, said MacDonald. ‘They accept that investors have to be incentivized.” MacDonald acknowledged that it was the independents that broke open Kurdistan for the oil majors – ExxonMobil, Total, Chevron – who are active there now.