Liquefied natural gas has become a geopolitical tool in international relations and energy diplomacy. The Ukraine-Russian war has reshaped the global energy map and brought a new geopolitical dimension to LNG.
The LNG market is now almost as affected by international relations as it is by supply and demand. So, how have recent market events accelerated LNG playing a role in the tool kit of foreign policy and energy diplomacy?
Unintended Consequences of Weaponizing Gas
The Ukraine-Russian war has highlighted the inconvenient reality of Europe’s historical reliance on Russian gas. Prior to the war, Russian gas flows to Europe accounted for approximately 45% of EU gas imports. Natural gas is deeply embedded in the economies of the European Union as it accounts for 23% of energy consumption, according to the European Commission.
The timing of gas curtailment was critical as Europe headed into the winter heating season and there was not enough time to secure gas supply from other sources. The market uncertainty pushed gas prices to extreme levels and generated very high levels of volatility. Subsequently, this raised energy costs and placed pressure on European economies and individual consumers.
Russia has historically exercised a strong hand over the structuring and pricing of energy exports in support of its strategic plans. But after the war broke out, the situation escalated to a geo-economic standoff and energy leverage was pushed to an extreme level. Russia breached contractual agreements and cut gas exports to the EU by 75%.
The EU perceived the halting of gas pipeline deliveries as a blackmail attempt intended to inflict significant economic harm. The Kremlin denied these accusations, although later in September 2022, it announced that “Russia will not resume in full its gas supplies to Europe until the west lifts its sanctions against Moscow.”
Without a doubt, the EU has faced considerable challenges in its pursuit of independence from Russian gas, but the impact of the sudden rupture was lessened due largely to warm winter conditions and the rapid ramp up of LNG imports, mainly from the U.S.
Europe was the primary destination for U.S. LNG exports in 2022, accounting for 64% of total exports. France, the UK, Spain, and the Netherlands imported 74% of U.S. LNG exports to Europe, according to the U.S. Department of Energy.
Unexpectedly, the events ended up accelerating the decoupling of Europe’s reliance on Russian gas and strengthened the role of the U.S. as the de facto global energy leader. The conflict brought U.S. and European energy policy closer than ever before.
How Did the U.S. Pull off This Rescue Mission?
U.S. LNG exports helped Europe through the winter of 2022 and strengthened its role in energy security for its western allies.
U.S. LNG exports are driven by market forces rather than politics. The U.S. LNG industry is competitive, funded by private capital, and driven by entrepreneurship. LNG trading is typically based on the laws of supply and demand, and the geopolitical dimension manifests itself only where there are political or geographic considerations. Unlike in many producer nations, the role of the U.S. government has been solely to define the regulatory/policy framework and to conduct energy diplomacy.
U.S. Henry Hub Natural Gas futures prices are more competitive compared to prices in Europe and Asia. The U.S. benefits from the maturity of the Henry Hub futures market, which is characterized by its price transparency and high liquidity. The daily volume of Henry Hub futures and options complex averaged 626,839 contracts in April 2022 which is an increase of 49% compared to April 2021. The futures contract is listed on a monthly basis for the next 12 years, allowing visibility of market expectations for future gas prices. This allows commercials and LNG project developers to structure financing and hedge their long-term LNG agreements using the forward curve.
U.S. LNG prices play a crucial role in anchoring gas prices and represent a price celling for competing projects overseas. According to S&P Global Commodity Insights, the U.S. contracted approximately 75% of the global LNG capacity in 2022.
The European gas benchmark, located at the Dutch Title Transfer Facility (TTF), saw month-ahead gas prices skyrocket 500% compared to Henry Hub Natural Gas futures and to the Platts Asian Japan/Korea Marker (JKM), reaching a high of €185/MWh on September 23, 2022. This price difference between Henry Hub compared to destination markets drove U.S. LNG export cargoes to Europe instead of Asia.
This energy crisis in Europe has positioned the U.S. to reach some key milestones: First, position America as a reliable and strategic energy ally; second, loosen Russia’s grip on European gas; and third, enhance the U.S. ability to claim global energy leadership.
Petrodollar vs. Petroyuan battle
China executed its first yuan-settled LNG purchase from French major TotalEnergies in March 2023. The trade is part of China’s plan to challenge the dominance of the petrodollar system that has been in place since the 1970s.
The use of non-U.S. dollar currencies in an LNG trade is far from simple. Rejecting the dollar exposes both parties to additional costs due to exchange rate risk and currency mismatch since most of the exporters are transacting and structuring their projects in dollars. Such moves also complicate hedging strategies. It remains to be seen how this will play out in the long run as China exerts increasing influence as the world’s largest LNG buyer.
The current geopolitical tensions over Ukraine have also accelerated the Chinese-Russian rapprochement in energy, including in the arena of LNG.
LNG trading is increasingly viewed through a geopolitical lens due to its strategic importance to energy security and international relations. While the U.S. appears to be on good footing considering its trade with Europe, the Russian-Chinese rapprochement and its impact on LNG trade will be interesting to watch in the near future.
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