U.S. LNG exports have potential geopolitical and foreign policy implications. To what degree can U.S LNG exports be a foreign policy tool?

I spoke to a conference of the National Association of Regulatory Utility Commissioners (NARUC) on July 14, 2014 about liquefied natural gas (LNG) exports in the context of US foreign policy. These exports are possible given the success of the Shale Gale in North America, and they are moving ahead rapidly. Following is a distillation of those remarks.

Any discussion of LNG could benefit from a little context. For example: • The LNG trade is only about 10% of global gas consumption. • Global liquefaction capacity today is about 294 million tons (mt), or about 39.5 billion cubic feet per day (Bcf/d). LNG consumption is around 240 mt (32 Bcf/d). By comparison, the interconnected US and Canadian market is expected to be about 80 Bcf/d this year. • This market is expected to increase to around 350 mt (46 Bcf/d) by 2020. • To serve this growth of 110 mt (15 Bcf/d), we have a global liquefaction project inventory of 783 mt (almost 105 Bcf/d), of which 122 mt (16 Bcf/d) of capacity is under construction. • Well over a third of those projects are in the US alone. While there will be capacity that retires in the meantime, largely where the reserves behind the facilities have been depleted, this means that there is not much more room for additional liquefaction in the market between now and 2020. • New potential competitors in the LNG game include Canada, the nations of East Africa, Russia, and even Australia on a brownfield basis. The US is not the only game in town. • Russia also delivers around 15 Bcf/d into Europe, and is arguably the low cost provider of gas supply to Europe, where some US LNG will likely be delivered. Of course, it is important to recognize that this gas is not sold at cost. • LNG projects are very much long term investments. They are capital intensive, costing billions of dollars. These projects are typically not built without the support of long-term (20 year) contracts from credit-worthy offtakers. Once these deals are set, they are iron clad.

The question at hand is: to what degree are LNG exports useful as a foreign policy tool for the US? That is not a simple question. But let's peel this onion and see what we get.

First off, the potential for LNG exports can have influence so long as there is a decision in hand. If an export permit has not been issued, if a potential customer does not have a free trade agreement with the United States, if FERC has not approved construction - in other words if the buyer needs the US government to sign off on the deal in some way - then it would seem that the government has a great deal of leverage. How the government would exert that leverage through an open US regulatory proceeding is an unresolved question. However, given that there are many competitors for space in the market, it is uncertain how much leverage can be exerted through this means. Once the decision to export has been made, the potential for influence drops significantly. Even if the legislative authority exists (DOE has said that it has the authority to revoke export permits but does not plan to use it), it will be extremely difficult to revoke or suspend a permit without serious repercussions.

Influence might be exerted if a reason can be found to terminate a free trade agreement (FTA), or to create one where none currently exists. However, most capacity likely to be built in the US will have permits to deliver LNG to non-FTA countries, so it is again uncertain how much influence can be exerted through this means.

Actual exports can strengthen relationships with recipient countries. Likely recipients include countries like South Korea, Japan, or countries in western Europe. US relations with these countries are generally good. Exports might be more beneficial to US relations with certain Latin American or Asian countries.

There are two real reasons the question of what degree LNG exports can be a foreign policy tool is being asked. They are Russia and China, both of whom have been more assertive on the world stage of late.

As noted, Russia exports some 15 Bcf/d into western Europe. This gas at present cannot be delivered to other markets, though some of it no doubt could be consumed domestically. This is generally low-cost conventional gas supply.

What would happen in the event of a significant US LNG push into Europe? Russian exports have already had to deal with competition from pipeline gas from Norway and Algeria, and from Middle Eastern LNG. Russia has made some very practical changes in contractual terms as a consequence, and it remains the largest source of gas supply for western Europe. If past is prologue, Russia can be expected to fight to keep its market if it feels there is a long-term threat.

It is highly unlikely that US LNG supply could displace Russian gas from Europe, and it is unclear whether Europe would really want it to. However, US LNG could take a portion of the growing European import market, which might negatively affect Russia's revenue from such sales. In this regard, it is also worth remembering that the current list of gas exporters to Europe who would be similarly affected includes some US allies.

China is expected to be the largest source of demand growth for LNG in the years ahead. China's economy needs energy, and China's air quality cries out for energy derived from gas. Moreover, China is a large holder of US debt, and runs a large trade surplus with the US. The US could supply LNG to China, help its environment, redress the trade balance a bit, and be able to use the LNG trade to influence China, right?

As it turns out, Chinese buyers are interested in North American LNG, but they have thus far been wary of US LNG. Chinese buyers have a strong presence in the Canadian market. They have little presence in the US market, no doubt owing to concerns about the reliability of the US as a supplier.

Whether or not the US is willing to export LNG to China, and at present there is no apparent impediment to such exports, it will be difficult for the US to use LNG exports to influence China's international position if China is unwilling to import the LNG in the first place. The irony here is that the one place where US LNG exports to China might influence China would be in the case of China's rare earth export policy. Exporting LNG to China would give the US moral leverage on this issue - certainly in the court of world opinion.

In general, cutting off LNG exports to a customer on what appear to be political grounds would most likely hurt the US foreign policy position. Again, there is a precedent. In January 2006, Russia cut off gas pipeline supplies to Ukraine. A Russian observer would likely say that this was a commercial dispute. European observers, particularly in light of recent events, might respond differently. Indeed, many European countries interested in LNG imports - any LNG imports, not strictly US LNG imports - are interested precisely to avoid the prospect of a supplier using them to exert political leverage. While supplies were restored to Ukraine in 3 days back in 2006, the perception of Russia as a supplier is still tarnished 8 years later.

Given these issues, our conclusion is that LNG exports would have some positive impact on US foreign relations, cementing and perhaps improving relations with recipients. It demonstrates a commitment to open economic relations for the long term.

Exports may change gas pricing conditions in international markets, which may or may not be a plus for US foreign relations.

Given the damage to US interests that would follow a cutoff of LNG exports, we conclude that this is not a useful instrument for tactical purposes. It is not something that can easily be calibrated. It is a blunt instrument at best.

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.