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Tapping Into Asia’s Energy Leverage

by | published December 10th, 2013

For years now, energy deliveries to Asia have usually included a “premium.”

It refers to the additional amount of money Asian importers have to pay for the same crude oil over what it cost to deliver the product to places like Europe. That built in differential has traditionally made doing everything on the Asian continent a bit more expensive.

This premium still exists today, but not for much longer. In fact, energy pricing is about to experience some significant changes – especially when it comes to China.

These massive shifts mean we’re going to need to change how we invest in the energy sector.  In this case, the key for investors is two-fold.

Let me explain what I mean…

Here’s What’s Driving the Picture

First, Asian demand is beginning to drive the global sector as a whole. Every analysis being released these days tells the same story. It points toward the redirection of energy supplies to Asia.

That means Asia will remain the fastest growing destination for crude oil, while its increasing requirements for natural gas via pipeline and liquefied natural gas (LNG) tanker deliveries will redefine overall world transit.

Even the prospects for the acceleration of its domestic electricity production will not stop all the new plans to increase cross-border power grids.

Long story short: We are looking at a steady increase in Asian demand far outdistancing any other part of the globe at least through 2035.

The result is nothing less than Asia becoming the target for the primary changes in the way energy is moved. This new balance adjustment is going to fundamentally alter pricing expectations in other regions as well.

As for North America, it has the advantage of becoming energy self-sufficienct even sooner than initially anticipated. Current projections are putting that milestone at 2025 or even earlier. The reason is the combination of slow demand increases and the sustainable volumes of extractable unconventional oil and gas.

Even still, the U.S. will need to import about 30% of its crude requirement daily.  And virtually all of that will be coming down from Canada, either via by new pipelines or by rail.

Meanwhile, unconventional potential in other parts of the world is also improving.

As the first update in the Energy Information Administration (EIA) projections for global shale gas and tight oil noted this summer, there is upwards of 60% more unconventional sourcing than was initially reported.

In the revised figures, China, Argentina, and Algeria have more shale gas available than the U.S. – and the U.S. has enough for the next two generations (and building).

So in this case, the readjustment for conventional oil and gas will be clearly moving to Asia.

Despite the so-called “shale revolution,” traditional energies will continue to comprise a massive chunk of the international energy market. For Asia, that also includes a continuing reliance on coal.

Breaking the Grip of Premium Pricing

That brings me back to my second point which is this: Asia may finally be getting a break on premium pricing.

Holding the world’s demand lever is one reason.  But the second is coming from another direction entirely.

Here’s why.

The Asian premium has traditionally been determined by OPEC export directions in general and Saudi Arabia in particular. The entire oil market has based its pricing projections on the additional amount Asia has been forced to pay. This premium has also allowed Iran to charge more for the crude it sends, circumventing Western sanctions.    

And whether anything substantive results from the recently announced “agreement” on the Iranian nuclear program, the potential addition of a new source of oil to Asia is about to change the premium dynamics.

That’s because the flow of new oil from Russia is tipping the pricing scales in favor of Asia now that the major East Siberia-Pacific Ocean (ESPO) pipeline is finished. This pipeline allows for the transit of oil to Asia from a major terminal at Kozmino on the Russian Pacific coast.

An earlier completed ESPO spur at Skovorodino in Siberia has been sending Russian oil to northwestern China for years. ESPO allows Moscow to begin developing its vast reserves in Eastern Siberia.

But it has an even more important significance when it comes to Russian oil exports: It’s certain to result in a new benchmark crude rate.

Named for the pipeline itself, ESPO Export Crude will offer oil at a discount to what Asia currently pays for Saudi production. In addition, the oil is of better quality. The Saudi standard export has a higher sulfur content and costs more to process.  

All of this means the new ESPO crude will come to dictate much of the pricing in Asia and is quite likely to replace the current premium paid with an actual discount to what is charged elsewhere.

This is a significant double advantage to Asia. It is already coming to control the international demand curve and will also now be able to dictate lower prices. And what happens in oil also has an effect on natural gas and electricity tariffs.

Already, China appears to be succeeding in reducing the price of Russian pipelined gas in a deal still not finalized, while it has been able to purchase Russian electricity well below the rates charged for other importers.

And As Asia becomes the driving force in energy usage, it is also going to be setting the pricing levels for other regions.

In this case, look for previously unseen pricing premiums to emerge elsewhere – even parts of Europe are a possibility here – as Asia begins to control the wider energy picture.   

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  1. Bob
    December 10th, 2013 at 18:23 | #1

    Does this put Rosneft in the catbird seat, with its 25 year contract for oil for China? It remains the cheapest of the giant global oil companies.

  2. William f. Greene
    December 10th, 2013 at 18:44 | #2

    Does ESPO oil have promise as an investment like midstream here or is it just info on regional oil sourcing/pricing?

  3. Steve G.
    December 11th, 2013 at 09:11 | #3

    Do these developments imply higher oil and gas prices in the US?

  4. yngso
    December 20th, 2013 at 11:02 | #4

    Talking about North America: Mexico is culturally part of Latin America, but looking at the map one can see that geographically it´s part of North America. The most shocking fact about Mexico is that it´s importing hydrocarbons while it has huge undeveloped reserves of the stuff. Now Mexican energy policy is changing, so that country is going to be a much stronger player in the sector.
    Also Mexico has – like much of the world – too many poor people, and needs to develop its total economy enormously.

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