Natural gas as the game-changer in world energy and geopolitics

by Mehmet Öğütçü | Kalem Journal

"Natural gas as the game-changer in world energy and geopolitics: Implications for, and actions from, Turkey" was prepared by Mehmet Ögütçü for the Marmara Group Foundation roundtable, conducted in cooperation with Kalem Journal, titled "Natural Gas as the Game Changer", held on January 24, 2013 in Istanbul.

Over the past twenty years we have gone through a series of fundamental “game-changing” developments in almost every domain of our lives, be in economy, geopolitics, security, technology, and values. Yet another one is now breeding and has the potential to “revolutionise” the world energy sector, generating profound implications for, and need for prompt responses from, Turkey.

The transfer of power from West to East has now become a cliché and is quickly gathering pace. As a result, not only the game itself, but also the players and rules of the game in energy have been changing. In this process, Turkey is poised to become one of the key players and influencers, particularly as far as the shaping of the Eurasian/Middle Eastern energy game is concerned.

Today, China is the most obvious power on the rise, likely to dethrone the US as the world’s economic superpower over the next two decades if things progress as widely predicted. But Beijing is not alone: India and other dynamic Asian economies now boast growth rates that could outstrip those of major Western countries for decades to come. Many in the West are already aware of Asia's growing strength. This awareness, however, has not yet been translated into preparedness in the form of either effectively challenging or accommodating it.

Let’s not forget: major shifts of power between states, not to mention regions, occur infrequently and are rarely peaceful. In the early twentieth century, the imperial order and the aspiring states of Germany and Japan failed to adjust to each other. This conflict resulted devastated large parts of the globe. Today, the transformation of the international system will be even bigger and the rising new powers are nationalistic, seek redress of past grievances, and want to claim their place in the sun.

Competition over scarce resources

Signs are in favour of more confrontation than collaboration, particularly over resources as the gap between supply and demand widens. Additionally, most resource-holders want to change the balance of interests with international extraction companies in order to maximize their gains through the so-called “resource nationalism”.

It is not only resource-rich countries that are gaining the upper hand in the new energy game. Industrialized importing countries are also resorting to what is called “economic patriotism” to protect their strategic sectors. The expansion of government-owned companies from hydrocarbon importing developing countries such as China and India into oil and gas exploration activities on a global scale is gaining added momentum.

The uneven distribution of energy resources among countries is a constant source of friction, giving rise to significant vulnerabilities such as the ones that occur in the Straits of Hormuz, the Malacca Straits, the East China Sea, the Caspian Sea, the KRG vs. Baghdad, and the Eastern Mediterranean as well as the domestic instabilities triggered by the Arab spring, the Nigerian labour strikes, the attacks in Algeria, the breach of contract sanctity in Kazakhstan and the ongoing Iraqi unrest). They all vividly illustrate how the above-the-ground factors could inhibit the hydrocarbon development.

The trade patterns are also changing in world energy. A quarter of Iraqi oil, about 2.5 mn barrels a day, will be heading for China by 2035.  Saudi Arabia is now a major supplier to Beijing. This relationship is part of a shift that is tipping the balance of power in the energy world. As its oil demand grows and its own reserves deplete, China is becoming increasingly dependent on crude imports from the Middle East. That is coinciding with an equally historic process in the western hemisphere – North America’s gradual transition towards self-sufficiency in energy and its waning reliance on imported oil.

Global energy demand is on an upward trajectory, expected to grow by 35 to 46 % between 2010 and 2035. Most of that growth will come from the new engines of the world economy - China, India, and partly the Middle East, where the consuming class is growing rapidly. About 1.4 billion people worldwide are still without access to energy.

Keeping pace with the demand growth, the new suppliers appear on the horizon. Of particular importance is the resurgence of US oil and gas production, particularly through the unlocking of new reserves of oil and gas found in shale rock. One should also count on the Arctic region, Brazil, Australia, Central Asia, the East Mediterranean, and East Africa as the additional suppliers.

A golden age for natural gas

In 2011, after the Fukushima nuclear accident, the IEA heralded the arrival of a 'golden age' of gas during the period to 2035, due to enormous economic growth in China coupled with significant gas consumption, a low share of nuclear energy in electric power generation, an increase in the use of gas in the transportation sector, and a boom unconventional gas and its low prices.

In developing renewable energy sources as well in particular for the needs of the electric power industry, natural gas could become the backbone of the entire system as an ideal back-up fuel, at least until technology enabling highly efficient storage of electricity is discovered and commercialized.

The real game-changer in this new age is the rising gas production in the US from shale basins, which is transforming the global gas market. The widespread adoption of techniques such as hydraulic fracturing and horizontal drilling has made those reserves much more accessible, and, in the case of natural gas, resulted in a vast glut that has sent prices plunging.

The American Henry Hub price dropped down last year to a level of $2/Mbtu, its lowest level for the past decade while the European average spot price and oil-indexed price have fluctuated in a range of $8-10, and Japan around $17.

This success story has inspired other many countries, such as Argentina, China, Poland, South Africa and the UK to develop their own reserves. Shale development in China, home to the world’s biggest unconventional gas resources, has been slower than predicted by the government. China may produce 6.5 billion cubic meters of shale gas by 2015 and set a target of 60 billion to 100 billion cubic meters by 2020, according to the National Development and Reform Commission.

However, as yet, no other country has what could be termed a shale gas industry—gas production from tight and shale plays is still negligible outside the US. Most of the production increases will only come after 2020, as countries need time to develop a commercial unconventional gas sector due to various geological, technical and regulatory challenges.

  

Is Russia on the losing end?

While the US is on the way to replacing Russia, the world’s gas superpower, as the leading gas producer in 2015 (coming close to Saudi Arabia as a leading oil producer by 2017), Russia seems to be on the side of those who will suffer most from the game-change in energy.

What happens to Russia in the face of these unfolding developments is critically important for Turkey given Moscow’s predominant role in Turkish energy supply security, be gas, oil, coal and nuclear, as well its geopolitical standing in the broader Eurasia.

As things stand, Gazprom’s unparalleled prosperity and dominant market position have been seriously upset by the “shale energy revolution” and emergence of new suppliers/competitors. The rapid increase in the extraction of cheap shale gas and the construction of factories where this gas can be liquefied before being shipped to Europe represent a real threat to Gazprom.

75% of the Russian company’s revenues come from exports. Initially, Gazprom took a skeptical view of this threat and ridiculed it. Later, the company came to see it as something far off in the long term. Suddenly, however, this threat is close at hand. According to the Ministry of Economic Development, Russia will have problems selling gas to Europe as early as 2016. Last year, it lost market share in Europe.

Gazprom is facing other challenges in Europe. The EU authorities have accused Gazprom of unfair pricing, splitting the gas market and blocking diversification of supply. Gazprom could be fined as much as $13.1 billion. Europeans consider the price of Russian gas to be unjustifiably high and its long-term contracts unwarranted — especially since shale energy from the US is on the way.

Gazprom’s deals with Norway’s Statoil and France’s Total to jointly develop the Shtokman field fell through last year. The market situation changed, causing doubts about the profitability of the project, which could cost over $40 billion to realize. Russia has also lost to China a great deal of its influence in Central Asia or “near abroad”.

The new gas production coming on-stream soon in Azerbaijan, Turkmenistan, Australia, Tanzania, and East Mediterranean may further aggravate the gas glut problem for Gazprom, drive the prices downwards, and change the geopolitical dynamics.

Gazprom’s problems are not limited only to the foreign markets. Its domestic competitors too give Gazprom a hard time. The share of gas supplied by independent producers has increased to 25%. Novatek (Russia’s largest independent producer of natural gas) has put an end to Gazprom’s monopoly on gas exports by signing a 10-year contract with Germany’s EnBW Group that is worth 6 billion euros. Rosneft too is a new significant power to reckon with for Gazprom.

Europe at a crossroad

Europe is missing out on the natural gas boom that is transforming energy use in the US and Asia, instead burning cheaper, dirtier coal imported from America. A European boom in shale gas extraction remains highly unlikely in the near future due to low levels of support among politicians and the public. Bulgaria and France have banned exploratory drilling that employ controversial hydraulic fracturing technology. Similarly perplexing information is also coming from Poland, an advocate of shale gas in Europe, where ExxonMobil recently declared an end of exploratory work due to insufficient commercial quantities.

European utilities’ preference for burning coal to generate electricity is pushing up carbon emissions even after the region invested twice as much in renewable energy as the US since 2004. In Europe, gas costs three times as much as in the US, cutting competitiveness at industrial users such as Germany’s BASF, the world’s largest chemical maker. It will not be surprising if major European energy-intensive industries decide to relocate to the US.

Gas is becoming too expensive a fuel for Europe. With gas demand further down, it looks like the major producers will be compelled to agree to alternative pricing. More than half of Europe’s supply of the fuel is bought through long-term contracts linked to the price of oil, and that will remain the case until 2014. (Please note that Brent crude has climbed 72% over the past four years).

Even after a wave of renegotiations, most prices for gas from Gazprom, which meets about a third of the EU’s needs through contracts tied to oil, were revised down no more than 10%. Disputes remain with RWE, Germany’s second-largest utility, and the Polish gas company known as PGNiG.

The planned construction of LNG export terminals in Australia and the US in 2015 should lead to an increase in the security of supplies to Europe but the overall positive effect on European prices is questionable as LNG is more expensive than pipeline gas. LNG prices must fall if it is to be affordable for buyers in the EU, India and China. A price of $9 to $11 per mbtu is needed if the fastest-growing consumers are to be able to stop subsidizing the fuel.

The Southern Corridor is important for Europe in terms of diversifying its gas suppliers and routes – particularly away from Russia.

What implications for, and actions from, Turkey?

The natural gas as a game-changer has profound implications for Turkey’s energy, global competitiveness and geopolitics. For a country aspiring to become one of the top 10 economies in the world by 2023, energy remains the Achilles’ heel. Energy-poor Turkey depends heavily on oil (92%) and gas (98%) imports for sustaining its economic growth.

Turkey should respond promptly to these changes through government and business actions in order to reap tangible benefits flowing from the new gas game that is unfolding:

Greater choices of gas supply and price flexibility

The years to come will witness sharp competition with supply exceeding demand, and prices will be likely to decline—especially after the expansion of the spot free market, with the participation of Qatar and Russia.

One of the main benefits for Turkey is the availability of options to secure conventional and unconventional gas supplies from a multiple of sources including Russia, Iran, Azerbaijan, the Kurdish region of Iraq, the East Mediterranean and LNG exports (i.e. Qatar, Nigeria, Algeria, the United States and possibly Tanzania). This situation provides, no doubt, a competitive advantage in re-negotiating current long-term and “take or pay” contracts.

If successfully handled, Turkey will reap great benefits in terms of avoiding the supply disruptions, easing the burden of high energy prices on its international competitiveness, curbing the current account deficit and enhancing people’s purchasing power.

Positioning as a regional gas hub

What Turkey possesses to compensate its energy supply deficiency is the best geographic position between the world’s second largest natural gas market, continental Europe, and the substantial gas reserves of Russia, the Caspian Basin and the Middle East. This provides Turkey with the opportunity to be the major European gas hub and a vital actor in gas politics across the whole region. Caspian, Russian, Iraqi, Mediterranean, Balkan, and Black Sea gas developments will all be affected by what policymakers decide in Ankara.

As the web of regional gas projects grows ever more complex, Turkey will likely become more and more influential as a link – or a blockage. Turks are not content only to be a simple “bridge” over which energy flows; they aspire to becoming a regional “hub,” extracting greater value for the oil, gas pipelines and power interconnections, and turn this role to economic and foreign/security policy gains.

Being a regional energy hub is of course not just having pipelines crisscrossing your territory. For Turkey to function as a gas hub, it must be able to import enough gas to satisfy both domestic demand and any re-export commitments as well as provide enough pipeline capacity to transport Caspian and Middle Eastern gas across Turkey to Europe.

The country’s inherent geography – its classic position as a crossroads between east and west, between north and south – makes it natural to become a giant center for trading in oil, gas and petrochemicals. But its attitude – the accumulation of its foreign policy, its approach to energy transit and to internal energy development, and its own uncertainty as to its place in the world in general and its involvement in Europe in particular – tells quite a different story.

Easing geopolitical tensions

For decades, one of the US’s key strategic imperatives has been to protect the vital sea-lanes linking oil suppliers in the Middle East to the rest of the world. But the US is changing and shows signs of a new isolationism as a result of the reduced public appetite for an aggressive foreign policy. This has coincided with the shale revolution, a development, which is only reinforcing the disengagement of the US from the outside world.

This is in contract to Turkey’s expanding external energy outreach - starting from China’s northwestern province of Xinjiang Uyghur Autonomous Region and extending to the North African tip of the Mediterranean, as well as from the Straits of Hormuz, all the way to the Arctic. The new circumstances may require Turkey to play a more proactive role in its own region than hitherto was the case in preventing volatility, defending the sea-lanes and guarding crucial choke points in the broader Middle East and Eurasia.

However, geopolitics, if not well managed with Moscow, Tehran, Baghdad/Erbil and Baku, may stand on the way of Turkey becoming a real gas hub. The serious setbacks in its signature policy of “zero problem” are already poisoning its engagement with the three major oil and natural gas giants of the region, Russia, Iran and Iraq. Its relations with Israel, Greece and the Greek Cypriots are also troublesome and inhibit the possible joint development of the recently discovered rich hydrocarbon reserves in the Eastern Mediterranean basin.

No matter what the political or economic problems are, Turkey should continue maintaining its credibility as a country over which energy flows will not be disrupted due to political disputes. Any misuse of Turkey’s energy transit and hub role could diminish its value. Overplaying Ankara’s hand could, moreover, backfire and cast doubt on Turkey’s reliability from a business perspective.

Building world-class “energy champions” and new sources of finance

As a major energy consumer and transit country, Turkey needs internationally competitive energy corporations, engaged in energy investments across the full value chain. As a real mover and shaker in the regional energy, Ankara should encourage the creation of new and reinforcement of existing energy groups in such a way that they can effectively play the game according to international rules and best practices in oil, gas, electricity, coal, wind, geothermal and solar energy.

Investors and entrepreneurs often identify project funding as the biggest barrier to sustainable energy projects and technologies. Private banks put heavy conditions for project financing, more often than not higher than the international average, while the government hesitates to offer the necessary support for start-up clean energy projects.

The need to incentivize private capital flow into clean energy development is greater than ever and will become more urgent with time. Subsidy supports are not expected to fall below today’s levels before 2035 at the earliest and could continue at high levels through to 2050. These costs need to be weighed against the wider benefits to the macro-economy and society. The big risk to power investment is that Turkish consumers could revolt and not pay for all of the decarbonization costs or that the costs will make Turkey uncompetitive.  

The establishment of a $50 billion “Turkey Energy Investment Fund” should be considered, with political support from the government. At a time when Turkey seems to be the height of its international prestige and investor confidence, such a fund could help bridge the financing gap in Turkey’s 2023 vision energy projects, drawing on resources from domestic, Western, Chinese and Gulf banks, sovereign wealth funds and investors as well as multilateral financial/development institutions.

Smarter industries, efficiency improvements and innovation

Turkey should be a pioneer, rather than a follower, in solar, geothermal, wind and hydro energy technologies. With the need to meet the rise in electricity demands, the necessity for the development of sustainable and viable renewable energy sources has reached a greater level of urgency than ever before.

The time has come to move beyond discourse and embrace innovation; Turkey should maximize its technological expertise towards a “smarter” and “cleaner” economy by retooling Turkish industry progressively to compete in a low-carbon economy and move away from energy-intensive and “dirty” sectors, such as iron-steel mills, cement, fertilizer and aluminum.

It is also important to tackle new issues for Turkey’s ageing grid network, which is incapable of integrating large amounts of decentralized energy.  

Energy efficiency improvements are the best energy security investment. Turkey should be able to adopt a specific target to reduce the energy intensity of its economy by at least 2.5% a year. There is a need to increase the effectiveness of its capacity to implement robust policies, market-based mechanisms, business models, investment tools, and regulations with regard to energy use and recognize that improvements in energy efficiency remain one of the most effective means of both cutting carbon emissions and improving access to energy.

Hammering out an integrated energy management and vision

If Turkey is serious about reaching its 2023 strategic goals in all sectors, energy has to play a pivotal role in driving its reform and growth engine.

Turkey’s energy policy cannot be formulated and treated in isolation from a wider government vision. It is closely related to taxation, environment, competition, industry and investment, trade policies, foreign policy and security strategy, and needs to be tackled in an integrated way.

Most actions require a timeframe beyond the life of a government. Therefore, a non-partisan should embrace the opposition, private sector, civil society and international organizations, based on shared goals.

Competitive energy markets facilitate the reduction of manufacturing costs, thus reducing the increase of fuel and energy prices. In this area the government should continue its efforts to resolve the problem of excessive dependence on the supply of gas and oil from one source, remove barriers for changing suppliers of electrical energy and gas, change the operating principles of platforms for trade in electricity and introduce market mechanisms in establishing energy prices.

Overall, the future of Turkey as a gas-trading hub lies very much in Turkey’s own hands. For such a hub to emerge will require Turkey to opt for domestic market liberalization and the necessary physical and legal infrastructure to be built without further delay. 

It is safe to conclude that the global game-changers in energy outlined above, particularly in relation to natural gas, will work to the benefit of Turkey if the right policies are put in place and prompt actions launched to lower the energy prices, raise funding from international investors, step up shift to smarter industries, focus on new technologies and innovation in cleaner energy, and pursue “soft” diplomacy in its geopolitical engagement with neighbours. 

Mehmet Ögütçü, former Turkish diplomat, senior IEA, OECD executive, and BG Group director, is currently chairman of Global Resources Corporation. He has recently been appointed as the “special envoy” of the Energy Charter Secretariat. Ögütçü sits on the boards of directors for Genel Energy, Invensys and Yasar Holding while at the same serving as strategic investment advisor for several multinational energy companies. 

Source: http://www.kalemjournal.com/News/1116-natural_gas_as_the_game_changer_in_world_energy_and_geopolitics.html?fb_action_ids=10152549798740089&fb_action_types=og.likes&fb_source=aggregation&fb_aggregation_id=246965925417366