Get Ready for Trans-Pacific Energy Trade
Even though oil and gas is the most traded product in the Asia Pacific region, there is virtually no energy trade across the Pacific. A new report released today in Washington, D.C. by the Pacific Economic Cooperation Council (PECC) suggests that this anomaly could soon be corrected, resulting in an export bonanza for North America, more secure supplies of energy for Asia, and lower greenhouse gas emissions for the region.
Trans-Pacific trade in energy products (oil, gas, and coal) accounts for only 1.4 percent of global trade in those products. The segmentation of energy markets between Asia and the Americas is seen in the steep price differential for natural gas between the two regions, and – more recently – in a price differential for crude oil as well.
A number of developments in recent years have raised the possibility of trans-Pacific trade in oil and gas, and the emergence of a more integrated and competitive market in energy products in the Asia-Pacific region.
These developments include a) the discovery of massive unconventional (shale) gas deposits in the United States and Canada which are creating a gas glut in North America, b) increased demand in Asian countries for less carbon-intensive energy sources, in particular a shift away from coal to natural gas, c) concerns about nuclear power following the Fukushima Daiichi disaster and the resulting search for clean alternatives to nuclear energy, d) the changing energy balance in Southeast Asia, particularly Indonesia and Malaysia, which will soon be net importers of natural gas, and e) rapidly growing investment by Asian national oil and gas companies in North American energy assets, especially in the Canadian oil sands.
Asian countries are highly reliant on fossil fuels, with hydro-electricity, renewables and nuclear energy typically accounting for less than 20% of overall energy use. Oil is the fuel of choice in most Asian economies (the key exception is China which relies heavily on coal), accounting for 40% or more of energy needs.
The basic patterns of energy use in Asia region are unlikely to change materially in the foreseeable future. Even under an assumption of new national policies to reduce greenhouse gas emissions, fossil fuels will account for 60-80% of the energy mix in most economies. The share of coal, however, is expected to decline sharply, especially in China, which will see a fall from around 70% in 2010 to 38% in 2035. On the other hand, the share of natural gas in Asia’s energy mix is expected to double by 2035, reflecting its status as a cleaner fossil fuel.
The effect of the North American gas glut coupled with a surge in Asian demand has been to widen natural gas price differentials between North America and Asia. Historically, natural gas in Asia has been priced at a premium relative to North American natural gas because of limited competition, long-term contracts, and indexation to oil prices. In recent years, the price differentials have widened considerably, with the current gap between the Japan contract price and the (North American) Henry Hub price in 2011 at an astonishing $12.50/MMBtu.
Even taking into account the higher cost of shale gas production, the substantial investments required to build pipelines and liquefaction plants, and the transportation cost of shipping LNG across the Pacific, North American gas could be competitive in Asia against existing suppliers, or at the very least serve as an secondary source of supply for Northeast Asian countries looking to diversify their energy imports or seeking more secure sources.
At current prices, the break-even export price is estimated to be around US$9.60/MMBtu for US Gulf Coast terminals and US$7.40/MMBtu for Canadian export terminals, both of which are comfortably below the recent Japanese contract price of US$16.70/MMBtu.
The report also points to the possibility of North American oil exports to Asia, with shipments from Canada seen as more likely than exports from the US. “Currently Canada is almost entirely reliant on a single market …, with exports to US accounting for close to 98% of its overall oil exports. Exporting oil to Asia would provide Canada with the benefits of diversification and reduce its reliance on a single market for oil”.
The report goes on to point out that Canada faces a price discount selling crude oil to the United States and that the differential between prices obtained in the United States and world prices has risen to as much as US$25/barrel. Considering that Canada exports about 2.5 million barrels a day to the United States, the potential “lost” revenue would add up to a cool $28 billion a year.
Even with favourable economics and positive environmental outcomes for the world, there is no guarantee that trans-Pacific energy trade will become a reality. First Nations support is critical for pipelines to be built, and for oil and liquified natural gas tankers to be allowed to enter the waters off British Columbia. There are also regulatory and environmental risks that have to be addressed, as well as a need for massive investment for infrastructure development. Canadians will want to be assured that these investments are made with sensitivity towards affected communities, and that the risks to the environment and livelihoods are considered as carefully as possible, and adequately protected against.
Time is not on our side. The opportunity for Canada to tap into Asian energy markets will last only as long as other suppliers (including Russia and Central Asia, plus current sources such as the Gulf states and Australia) are unable to fulfil long-term Asian demand. Even the United States could emerge ahead of Canada as an exporter of energy to Asia. If that happens, and Canada is still only a continental supplier of energy, our resources will be doubly penalized – by the discount of selling to the Americans, and by the lost opportunity of not selling to Asia.
Yuen Pau Woo is Coordinator of the Pacific Economic Cooperation Council’s State of the Region Report 2011-2012. To read the report and the supplement in full, please click here.
This piece was first published in The Globe and Mail on September 29, 2011.