(Bloomberg Opinion) -- It is hard to differentiate a commodity, which is kind of what makes something a commodity. Every now and again, though, something happens that makes one molecule somehow worth more than another. Today, that thing is the war in Ukraine and the molecule in question is methane — specifically, U.S. natural gas.
The European Commission recently unveiled a proposal to slash the European Union's gas imports from Russian pipelines by about two-thirds by the end of this year and completely by 2030. The proposal is, to be kind, ambitious and, to be kinder still, preliminary in detail. Yet, faced with a murderously revanchist Russia, breaking Europe's dependency on Siberian gas isn't merely a choice. It's an imperative.
Meeting this year's target largely revolves around substituting Russian gas with supply from elsewhere. Most of that is in the form of liquefied natural gas, or LNG, which is shipped rather than piped, providing more options for supply.
To get one obvious thing out of the way, this isn't going to work. An extra 50 billion cubic meters equates to almost one-seventh of the entire LNG market in 2021; like all at once adding the demand of South Korea — the third biggest market in the world. At the very least, European buyers would have to bid extraordinary — probably recessionary — amounts of money to draw those cargoes away from Asia. Even if they could, exporting Europe's energy shortage to Asian countries in this way would hardly encourage them to stick with or join U.S. and European efforts to isolate Russia.
Asia would also be forced to use more coal. Which gets at the third element of Europe's energy trilemma, besides security and affordability: climate. In its communique, the European Commission stressed the importance of sticking with — and, indeed, accelerating — decarbonization plans. It's tough to square that with stoking hotter furnaces in other parts of the world.
To get another obvious thing out of the way, the U.S. cannot solve this in 2022. Its LNG export capacity is running flat out already, and those liquefaction terminals can't be built overnight. President Joe Biden's offer to “strive to ensure additional LNG volumes for the EU market of at least 15 bcm” comes with not enough gas and too many caveats.
Still, if perfection isn't possible, good will have to do. Europe needs extra gas supply as quickly as possible. And of the major LNG exporters, the U.S., NATO's de facto leader, can expand capacity fastest.
About 45 bcm of new U.S. export capacity is under construction and due to begin operation by 2026. Much more is needed. Nikos Tsafos at the Center for Strategic and International Studies points out that Europe's own gas production, including that of the U.K., has declined by 8 bcm per year, on average, since 2015. So even if an extra 50 bcm materializes relatively soon, some of it would replace lost output rather than Russian imports. Moreover, there is no guarantee that proposed increases in, say, biogas production or energy conservation will materialize at that scale in time. Extra U.S. LNG provides insurance.
And insurance comes with a premium. By this, I don't mean European buyers paying a war surcharge on top of the regular price. Instead, they can offer other inducements to bring in gas from the west rather than the east.
What LNG terminal operators require more than anything else is certainty of demand over a long period in order to make back their investment. It is less than 20 years since it was assumed that the U.S. needed LNG imports of its own, so operators may be understandably wary of buying into a new bull case predicated on geopolitics. Especially as a commitment to 2030 implies that a new plant might expect only a few years of actual revenue, rather than the couple of decades needed.
This is where Europe can play a crucial role. Analysts at Bernstein Research estimate that proposed U.S. LNG projects already approved by the Federal Energy Regulatory Commission add up to around 280 bcm of capacity. However, only about 60 bcm of that has been contracted, which is a prerequisite for laying the first brick on a new facility. European countries could boost that amount by signing long-term contracts, either directly with public money or by backing local utility buyers. They could also provide construction loans or debt guarantees to speed things along, if they were so minded.
But how can a continent committed to decarbonization sign multi-decade contracts for more fossil fuel? This predicament is similar to the one in which the Biden administration finds itself today, caught between tomorrow's climate objectives and today's pump prices and pushing for frackers to drill-baby-not-drill.
Yet, with a little imagination, this situation can be finessed says Tsafos at the CSIS. First of all, replacing Russian gas with American gas doesn't raise Europe's gas consumption; it just shifts the source of supply to a country that isn't threatening to invade/freeze/nuke it. On the thornier question of locking in long-term gas demand even as Europe targets net-zero emissions, one option would be to structure contracts in two tranches. Europe could take supply for the first decade, with Asian buyers contracting for later years, helping to displace coal in its last redoubt.
In addition, while Europe is what you might call a motivated buyer, its sheer size should provide scope for negotiating some conditions. After all, U.S. gas demand is expected to flatline through the 2020s, and LNG exports are the single biggest source of offtake for production.
Both LNG operators and frackers should welcome extra European sales, especially if they come with financing for infrastructure. In return, stringent targets on methane leaks should be a no brainer — as Charif Souki, an LNG pioneer who now chairs Tellurian Inc., acknowledged only recently. One of the things holding back U.S. LNG from realizing its full potential is a reputation for high emissions. Cargoes that could boast both security and environmental credentials would be truly competitive for years to come.
For Europe, this would come at a cost. Then again, energy rationing and chronic insecurity aren't cheap either.
More from Bloomberg Opinion:
- America's Oil Reserve Weapon Risks Misfiring: David Fickling
- Even in War, OPEC Wants Russia as an Oil Ally: Javier Blas
- Iron Curtain Comes Down on Energy: Liam Denning
This includes Sempra Energy's Costa Azul project in Baja California, Mexico. Despite the location, it will be using U.S. natural gas, and while it is positioned to serve the Pacific market, its LNG could free up cargoes elsewhere to sail to Europe.
"Global LNG: A new LNG paradigm as Europe turns down Russian gas," Bernstein Research, 28 March, 2022.
See Tsafos' recent article on Euractiv, "Europe needs a smarter way out of Russian gas,"March 28, 2022.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.
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