The geopolitics of natural gas

At a time when oil prices are around their all time highs it may seem odd to be thinking of how lower hydrocarbon prices will affect the world. But there is a growing sense in the US that longer term prices will fall because of a rapidly rising supply of non-conventional oil and gas in north America. And just in the last week there has been news of large natural gas finds in east Africa.

The real story is gas. Even if the shale gas boom turns out to be constrained by the very severe environmental cost (mainly the huge amounts of dirty water you end up with after blasting the gas out of the rock), there is likely to be far more gas about than previously thought, and in many more locations. Natural gas (methane) was previously thought to be heavily concentrated in Russia, Qatar and Iran, which is not ideal from a customer’s point of view. The BP annual Statistical Review of World Energy put 43% of global proven gas reserves in Europe and Eurasia in 1990, most of that being in the (then) Soviet Union. Another 30% was in the Middle East.

The estimates for 2010 were 34% in Europe and Eurasia and 40% in the Middle East. But those estimates omit the rapidly increasing estimates of shale gas. The US Energy Information Administration estimated technically recoverable reserves in the continental US of 750 trn cubic feet, or 21 trn cubic metres. That compares with BP’s figure of proven reserves of 181 trn cubic metres. And shale gas is found in many other countries (though recently Poland, a favourite of shale gas optimists, has sharply reduced its estimates – to “only” seven decades worth of national demand). Now technically recoverable is not at all the same as economically and politically recoverable. But this is still potentially a major new source of supply.

Meanwhile conventional natural gas is appearing in many other countries too. The oil and gas boom in Brazil (geologically the same region as west Africa) is revealing huge new fields of oil and gas. And there has been a steady stream of positive news from Mozambique, Tanzania and Kenya.

World oil prices are currently help up by a combination of strong demand from China and other industrialising countries, plus the short term risk of an attack by Israel and/or the US on Iran. Demand is likely to keep growing but supply is now beginning to catch up after a long period of slow growth, mainly because of slow production growth in the countries where the state-owned oil companies control things – Russia and the Middle East.

Gas prices in the western hemisphere have plummeted on the back of the new shale gas production. Atlantic gas is now an integrated market, because liquefied natural gas (LNG) allows transport of surpluses from the US to the UK or back, depending on where  the price is highest. Therefore prices are equalised (net of transport costs) by trade. This is not yet the case in Asia and continental Europe because gas is still mainly sold on long term contracts where the price is linked to oil. These contracts were necessary to fund the construction of the gas pipelines. But there is no reason for that gas/oil price linkage to continue. Gas is used in power generation, oil is generally not. So the cheap gas is going to put pressure on these contracts. Eventually Asia will join the Atlantic in having a spot gas market and lower prices. That in turn means two things.

First, a shift from coal to gas in power generation, which is mostly a good thing because gas has a much lower carbon content. But it also undermines the economics of very low carbon power sources such as nuclear and renewables.

And second, a big threat to the traditional gas exporters. I’ve argued before that Russia is not really a developing economy like the other BRICs, because it’s a hydrocarbon economy with relatively high living standards. Russia is the country most at risk from a global glut of gas, especially if current high oil prices also turn out to be unsustainable.

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