US and Russia race to become energy world leader

The discovery of shale gas in the US and the breakdown of Ukrainian sovereignty has sent shock waves through international energy markets. New energy sources such as shale and methane hydrates are putting pressure on major energy players such as Saudi Arabia and Russia to cut their prices to competitive levels. But with more European countries eager to free themselves from Russian energy dependence following the civil unrest in Ukraine, the US could very well be the next world energy leader.

Domestic production of natural gas and crude oil in the US is growing, with crude oil production approaching the 1970 historical high of 9.6 million barrels per day. According to an early release of the 2014 Annual Energy Review from the US Energy Information Administration (EIA), annual oil growth will average 0.8 million barrels per day through 2016. More impressively, natural gas production is growing steadily thanks to the rise of hydraulic fracturing, with a 56 percent increase predicted between 2012 and 2040, when production will reach 37.6trn cubic feet.

The US path to energy mastery is further strengthened by the closure of European refineries: 15 have shut in the past five years, with one more due to close in 2014. This has allowed the US to make the transition from being dependent on European fuel to being its main importer. Furthermore, cheap oil from the Rocky Mountains, where output has grown 31 percent since 2011, is allowing the US to cut back on imports of pricier oil from countries such as Nigeria, Saudi Arabia and Venezuela. Nigeria, for example, used to send a dozen super tankers of crude oil a month to the US and now ships fewer than three.

The “shale gale”
Most of these good tidings come down to the exploitation of shale, which has led to an impressive energy windfall for the US. Advances in extracting oil from shale rock have led to a 39 percent jump in US production since 2011, the steepest rise in history, according to the EIA. However, drilling in shale is more expensive than traditional energy development methods and many environmental concerns are still left unanswered.

For instance, a recent report on the environmental impacts of shale gas extraction in Canada revealed: leaks around boreholes remain an “unresolved problem” in the shale gas industry; that not enough monitoring has been conducted around shale gas wells to properly assess the risk of natural gas leaking into groundwater; and that potential human health risks associated with shale gas development “are not well studied”, particularly in the US, where gas extraction has proceeded in large and relatively populous areas.

However, despite concerns about the environmental impact associated with shale extraction, the prospect of an infinite supply of gas is encouraging the US to become less energy-dependent. The EIA even went so far as to call shale gas a “game-changer” for the US energy market.

“The US could become a leading provider of natural gas, beating Qatar, but an oil resurgence in the US is not as likely,” explained Edgar van der Meer, an analyst at the global energy consultancy NRG Expert. “However, as Canada develops oil fields and oil sands exploration more, the US could become a throughput for other forms of energy than gas.”

The US is investing more money in energy development than in any other US job sector. Earlier this year, President Obama approved a terminal for liquefied natural gas exports. The first LNG port is due to start shipping to the UK, Spain and other countries in 2015, and dozens more are petitioning for export licences and clearances to build the specialised terminals. Even after including the costs of liquefaction and transport across the Atlantic, US gas prices will still be considerably lower than Russia’s at point of sale.

Beating the Russian winter
The shale boom and potential exports to Europe are particularly relevant now as the Ukrainian crisis continues to put pressure on Russian energy deliveries. Moscow currently supplies Europe with roughly a third of its energy, while many Baltic and central European countries rely almost entirely on Russian gas, oil and coal. Political analysts have suggested that Russia’s energy dominance is reason enough for Europe’s hesitation to impose sanctions following the Ukrainian invasion.

While the US has blacklisted dealings with certain Russian energy players, the EU balked at sanctioning any of Putin’s business connections for fear of the legal, diplomatic and economic consequences if Russia were to freeze energy trade. “There’s still a lot of nervousness in Europe about heading in that direction,” a senior European official involved in the EU sanctions debate told The Wall Street Journal. “They don’t want to burn bridges with the Kremlin.”

However, with the US soon able to export shale gas and oil to Europe, taking market share from Moscow could prove easier than expected. Energy accounts for as much as a quarter of Russia’s GDP and 60 percent of its exports. A stronger, energy-exporting US would diminish Russia’s political leverage and weaken its petro-centric economy.

“The US will certainly be a major pla-yer, but there are cost elements to this,” says van der Meer. “US gas cannot be piped to Europe, whereas Russian gas can. Of course, European governments may look at decreasing reliance on Russia, but this may not necessarily be replacing Russia as a supplier, but a general shift away from reliance on natural gas in the first place. The US could serve as a bridge, or a stop-gap in this case, while Europe transitions, but it’s clear that the market landscape will be changing.”

Fracking reserves have slashed natural gas prices in the US to $4 per million British thermal units in the past five years. This is less than a third of the price Gazprom charges most of its European customers for Russian gas, and well below a fifth of the rate in much of Asia.

Blockages in the pipe
Yet obstacles remain before the US can fully enjoy the benefits of its “shale gale”. Regulatory issues, such as the Obama administration taking its time to approve LNG export licences, can seriously hinder any income generated from shale gas. Under US law, gas can only be exported to countries that have a free trade deal with the US. Exporting firms can get around this by showing they would not harm US national interests, but this is a long and tiresome process, preventing investments in shale gas infrastructure. As a remnant of the oil shortage in the 1970s, the US also bans the export of domestic crude oil.

However, if a proposed bill – H.R. 6, the Domestic Prosperity and Global Freedom Act – makes it through Congress, it would permit liquefied natural gas exports to NATO countries, which is a start. What’s more, Obama vowed to “cut red tape” within the energy sector when he gave his 2014 State of the Union Address.

“Now, one of the biggest factors in bringing more jobs back is our commitment to American energy,” said the American President. “One of the reasons why is natural gas. If extracted safely, it’s the bridge fuel that can power our economy with less of the carbon pollution that causes climate change. Businesses plan to invest almost a hundred billion dollars in new factories that use natural gas. I’ll cut red tape to help states get those factories built and put folks to work.”

Beyond regulatory concerns, fracking is still in the early development stages and the US still doesn’t have the infrastructure to fully exploit its massive reserves of shale. Investments in development and technology need to be a top priority if the US wants to be an energy super-power, argues van der Meer.

“Where there’s a will, there’s a way… Right now, we are facing mainly technical limitations. The US producers are quite free to export to and trade with Europe. What’s holding them back is liquefaction plant and tanker capacity. In particular, facilities need to be built to convert to LNG and back to gas on the receiving end.”

Asian contention
Another much larger issue is the US’ ability to appeal to Asian energy markets in light of the new deal between China and Russia. With average regional growth in GDP set above six percent for the coming years and Asian countries currently importing 30 percent of their consumption needs, the region needs an ample supply of clean, affordable energy to continue its rapid growth, and it has turned to Russia to bridge its gap between supply and demand.

After a decade of negotiations, Russian firm Gazprom – the world’s largest extractor of natural gas – signed an energy deal worth a reported $400bn with China National Petroleum Corp at the Conference on Interactions and Confidence-building Measures in Asia (CICA) in Shanghai in May. With President Putin in attendance, the deal is an important milestone in the strengthening of Sino-Russia relations, despite reports China held the advantage because of Russia’s urgent need to find new partners in the wake of EU plans to reduce trade.

The deal is a major blow to Europe and the US for both political and economic reasons, especially if countries decide the Russian rouble and the yuan have better prospects than the US dollar. If that conversion is made, the US will struggle to deliver the political clout it does today.

To add weight to Asia’s energy plan, Japan has sought to come up with a new energy blueprint in the wake of the 2011 Fukushima nuclear disaster that led to a surge in imports of pricey, natural gas. Recently, the government has been looking into methane hydrate development – an alternative to shale gas.

Stored deep in the seabed, icy blocks of gas or methane hydrates could theoretically hold more gas than all the world’s conventional gas fields, with a retrievable amount said to be twice as much as all the recoverable natural gas resources in the world. Essentially, methane hydrates raise the possibility of another energy revolution that could dwarf even the “shale gale” in the US. It could also have big implications for other energy players banking on LNG exports, such as Australia, Qatar and Russia. Because Japan and South Korea are the first and second-largest importers of LNG globally, methane hydrate development is potentially a significant long-term threat to the gas industry.

Relative gains
Adding to all this, Obama’s recent diplomatic tour of Asia has had a less than positive outcome, as key relationships with China and the Philippines have soured. Many Asian allies were expecting deals that could ensure energy trade in time for the US shale exports to be unleashed. However, US regulation continues to hinder these trade flows and, as such, the ever-important Asian energy market remains unexplored. And that loss is Russia’s gain, says van der Meer.

“China, India [and] Japan, are all countries that are growing their energy needs and Russia is situated in a way that it could become a major supplier to these nations, if the infrastructure gets redirected.”

However, if the US manages to overcome its regulatory hurdles, the world’s energy markets could become a new playground for the superpower. Methane hydrates are still in a research phase, whereas the US will begin shale exports as soon as next year.

What’s more, Obama’s administration has every reason to fight for greater development in the US energy sector. According to the EIA, jobs in the oil and natural gas industry grew by 32 percent between 2007 and 2012, even as overall employment fell 11.4 percent. Shale is boosting the US energy industry, as significant investments from Europe continue to flow in, in the hope this can drive a new energy source for Europeans.

Ahead of the US presidential election in 2016, a win in the form of a significant shale-driven improvement to the struggling US economy could prove essential for the politicians backing US gas. It is also crucial for a world eager to see a new, cheaper energy market, free from Russian hegemony.