How our energy future has been fracked

The U.S. energy/national security establishment believes shale gas has the potential to transform the world's energy and geopolitical landscapes.

This, of course, is the essential point I've tried to make in Revolution in the Desert, my report on how shale gas could affect Australia and benefit Australian investors.

But in all the share market excitement of the last few weeks – and there's been a lot of action on the ground in this new industry – it's easy to forget just how large and world-changing this story is. I was reminded of that this week.

The full geopolitical implications of the shale revolution are on display in a document published by the James A. Baker III Institute for Public Policy at Rice University. The document is called Shale Gas and U.S. National Security. You can click on that link and peruse it at your leisure. Or you can read the condensed version I've taken the liberty of compiling below.

I think you'll find, as I suspected, the emergence of shale gas is the single most important geopolitical energy event since the discovery of oil in commercial quantities in Saudi Arabia in 1938.

America's Most Powerful Energy Insider

The Baker Institute report claims, among other things, that shale's rise could mean the end of OPEC...reduce global political risk thanks to increased energy supply diversity...marginalise strategic adversaries of the United States, such as Russia, Venezuela, and Iran...mitigate climate change...and even reduce America's deficits by lowering its reliance on energy imports.

I'm not providing you with the American perspective on shale because I'm an American myself. But the way the U.S. energy establishment views shale is telling.

Even if shale gas doesn't develop in the rest of the world like the Americans expect, it will most certainly develop in America. And that will fundamentally change the world's energy markets.

Make no mistake; this report is the view of the U.S. energy establishment. For one, Rice University is right on Main Street in Houston, Texas. I drove past the university when I was in Houston in May for the Offshore Technology Conference. Houston is the energy capital of America, and Rice is its most prestigious university.

The Baker Institute itself is named after one of the ultimate energy and political insiders of the last 50 years in American politics: James A. Baker III. Baker was White House Chief of Staff for presidents Ronald Regan and George HW Bush. He served as Treasury Secretary for the first Bush.

Where oil and politics intersect with war and foreign policy, that's where you'll find Baker. He was the Secretary of State largely responsible for putting together the coalition against Saddam Hussein in the First Gulf War in 1990–91. You might also recall that Baker was the chief legal representative for George W. Bush in the Florida recount during the U.S. presidential election in 2000.

Mind you, the report isn't Baker's report. But it is from his institute in Houston. As such, I think it gives you a very good idea of how the U.S. energy establishment views shale gas from a strategic and geopolitical perspective. Some of its important conclusions are that shale:

• Combats the long-term potential monopoly power of a "gas OPEC", or a single producer such as Russia, to exercise dominance over large natural gas consumers in Europe or elsewhere.  
• Reduces competition for LNG supplies from the Middle East, thereby moderating prices and spurring greater use of natural gas, an outcome with significant implications for global environmental objectives.  
• Reduces Russia's market share in non-Former Soviet Union Europe from 27 per cent in 2009 to about 13 per cent by 2040, reducing the chances that Moscow can use energy as a tool for political gain.  
• Reduces the future share of world gas supply from Russia, Iran, and Venezuela; without shale discoveries , these nations would have accounted for about 33 per cent of global gas supply in 2040, but with shale, this is reduced to 26 per cent.  
• Reduces the Chinese dependence on Middle East natural gas supplies, lowering the incentives for geopolitical and commercial competition between the two largest [energy] consuming countries and providing both countries with new opportunities to diversify their energy supply.  
• Reduces Iran's ability to tap energy diplomacy as a means to strengthen its regional power or to buttress its nuclear aspirations.

I won't expand on all those points. But in order for you to see how critical shale is becoming to U.S. energy and foreign policy, I will quote a few sections in more detail. The key points are how shale helps the U.S. marginalise what it considers its strategic adversaries. And how the growing importance of natural gas in energy markets erodes the power and influence of oil and oil-producing countries.

On the geopolitical ramifications of the shale gas boom:

Shale gas will play a critical role in diminishing the petro-power of major natural gas producers in the Middle East, Russia, and Venezuela and will be a major factor limiting global dependence on natural gas supplies from the same unstable regions that are currently uncertain sources of the global supply of oil. In this way, shale gas can play a critical role in averting a reinforcement of the political risk we currently face in the global oil market.

Increased competition among world natural gas suppliers due to shale gas developments also reduces the threat that a Gas-OPEC can be formed, and it will trim the petro-power of energy producing countries such as Russia, Iran, and Venezuela to assert themselves using an 'energy' weapon or 'energy diplomacy' to counter US interests abroad. In particular, shale gas' role in global markets will greatly reduce Russia's leverage over Europe, eventually limiting Moscow's share of the non-FSU European market to less than 13 percent, down from its recent peak of 26 percent in 2007.

On the marginalisation of Russia:

The dramatic lessening of Europe's dependence on Russian gas will likely reduce Russia's ability to unduly influence political outcomes. European buyers will have ample alternatives to Russian supplies, thereby reducing Moscow's leverage in the balance of power between Russia and the EU.

Russia has already had to accept lower prices for its natural gas and is now allowing a portion of its sales in Europe to be indexed to sport natural gas markets, or regional market hubs, rather than oil prices. This change in pricing terms signals a major paradigm shift.

On Iran's nuclear program:

Given global market economics under a full development of shale scenario, the commercial window for Iran to export large amounts of natural gas is likely to be closed for an additional 20 years, making it easier for the United States to achieve buy-in for continued economic sanctions against Iran.

Shale gas development lowers the chances that Iran can use its energy resources to drive a wedge in the international coalition against it.By delaying the need for Iranian gas, the United States buys time to find a better solution to the Iranian nuclear problem and leaves open the possibility that political change will take place in Iran before its influence as a major global natural gas supplier grows.

In addition, the long delay in the commerciality of Iranian gas means that Tehran will have trouble moving forward with the development of pipelines to India or Pakistan until at least the mid-2020's, thus reducing a potential source of tension between the United States and India.

The rise in U.S. shale gas supplies thereby leads to significant delays in Iran's ability to tap natural gas resources as a means of energy diplomacy, giving Tehran less leverage to use in the short run to counter U.S. diplomatic efforts at containment.

On the global implications of shale gas:

Shale gas, by displacement, not only has spatial impacts on the global gas market, but also temporal impacts. More specifically, shale gas delays for well over a decade the world's reliance on regions that have historically been volatile and greatly reduces the chance of any individual or group of producers exercising decisive monopoly powers.

The emergence of shale will not only limit the market influence of Russia and Iran but it also limits the near-term possibility of a successful natural gas cartel by increasing the elasticity of supply of natural gas in countries outside the Gas Exporting Countries Forum (GECF), thereby reducing the monopoly power that can be exerted by GECF countries. Thus, shale gas yields security benefits more broadly than just to the United States.

On the world's changing energy mix:

Natural gas stands to play a positive role in the global energy mix, making it easier to shift away from more polluting, higher carbon-intensity fuels and increasing the near-term options to improve energy security and handle the challenge of climate change. The ample geologic endowment of shale gas in North America and potentially elsewhere around the globe means that natural gas prices will likely remain affordable and that the high level of supply insecurity currently facing world oil supplies could be eased by a shift to greater use of natural gas without fear of increasing the power of large natural gas resources holders such as Russia, Iran, and Venezuela.

 

On the big strategic winners from the emergence of shale:

"The recent developments around shale in the United States are also having another, potential market structuring altering, effect. Revelations about the existence of technically – and possibly commercially – viable shale gas resources are also occurring in other regions around the world, with shale gas potential being discussed in Europe, China, India, Australia, and elsewhere. To be sure, the enormity of global shale gas potential will have significant geopolitical ramifications and exert a powerful influence on US energy and foreign policy.

You can see that the U.S. perspective on world affairs has been dramatically altered by the emergence of shale gas. This is precisely the shift in focus that I outlined in Revolution in the Desert. It's what is diminishing the importance of the U.S.–Saudi relationship. And it's the driving force behind the new "energy superhighway" between Saudi Arabia and China.

In fact, what's telling about the Baker report is how little Saudi Arabia is mentioned at all. And how little attention China gets. It's as if the U.S. energy establishment believes shale is a geopolitical game-changer that has revolutionised the world's energy markets... and changed the strategic picture for good. I agree with this, of course, which is why I wrote Revolution in the Desert in the first place.