The Iran war and the energy transition: what happens when the world is focused on supply security, not emissions

0:00American LNG and Qatari LNG don't meet these strict regulations and they're not going to. So something's got to break and I don't think the Americans and the Qatari's are going to break. I think Europe will have to break. The price of gas in our modelling still spikes. It doubles from$7,$8 to$16,$17 per MCF. And this is because there's simply not enough. We don't have enough verifiers. We don't even have authority bodies defined within the European Union. If I look at the gas, Europe will struggle this winter. It can be complicated. And at the end of the day, what we have seen that the market does in those situations is increasing the price just to destroy the demand.

0:50And this is what I think that if nothing is sorted out in the coming months, we may face this in this winter. We are sending a signal that methane performance matters. And that is the beginning of the development of a global differentiated market that helps increase transparency.

1:18Hello and welcome to The Energy Gag. a discussion show from Wood Mackenzie about the fast-changing world of energy. I'm Ed Crooks, and this is the first of two special episodes that we're going to be bringing you from Wood Mackenzie's conference on gas, LNG, and the future of energy. And on this first episode, we're going to be talking about energy security and emissions. The war in the Middle East and the disruption of the flow of exports of oil and gas through the Strait of Hormuz has sent energy security right to the top of the agenda around the world. Decarbonisation, reducing emissions, has been clearly deprioritised.

1:50But could the crisis in the Middle East actually help accelerate the adoption of low-carbon technologies? To discuss the interaction between energy security and emissions, I spoke to Anita Adedra, who is the Senior Vice President for Strategy and Market Access at the LNG company Mid-Ocean Energy. And I also spoke to my Wood Mackenzie colleague Valentina Vanya-Kretschmar, who is a Vice President in our consulting team. I started off by asking Anita about Mid-Ocean's business. So MidOcean is a pure play LNG platform. We have assets in Australia, Canada, Peru, and we're diversifying also in other assets around the globe as we speak.

2:27Our shareholders are EIG, Saudi Aramco, Mitsubishi, Idomitsu, and so a very diverse shareholder base. We very much believe in the progression of LNG, and our aim is to build a fully integrated chain across all of our assets and a portfolio-traded position. Right. So as you say, you believe in the progression of LNG, developing the LNG industry and the market. That market has suffered a very significant shock this year. I've heard people describe it as the most significant shock in the industry's history because of the war in the Middle East and the closure of the Strait of Hormuz, about 20 % of global LNG supply has been taken off the market.

3:11What effect is that having on your business and how do you think that's changing the LNG market globally? So specifically, breaking your question up into two, what effect has it had on mid-oceans industry? It's actually highlighted the importance of geography and having assets that aren't subject to choke points. So our assets, Canada, Australia, Peru, perfect locations without any natural choke points. So that's a really important strategic differentiation for us. It doesn't mean that we're only going to have assets without choke points, but currently the ones that we do have are. So that gives us a really good platform within which to say to buyers, look, we have a diversified platform and we're going to be a continuous, reliable supplier to you.

4:04Now, your second question, the impact on the industry, that's a bigger question. What we've seen in this particular episode, I'm not sure it's the biggest impact on the energy industry. Prices were actually higher during Ukraine. Right, so that's in the aftermath of Russia's invasion of Ukraine in 2022, you mean? Yeah, and it was much more prolonged as well. What we've seen, we did see a spike at the beginning of the Iran conflict, but we've actually seen prices come down quite a lot from that panic peak, as I call it. And what we're seeing is we've seen America turn up as the swing supplier. It can go anywhere.

4:45And it does have the Panama choke point, but that doesn't stop it from going around the Cape. It just means more shipping, a little more cost. And what we've seen is China as the swing buyer. So China's reduced its demand, and it is reselling LNG to other players. And therefore, we're seeing these two huge players, the largest supplier in the market, the largest buyer in the market, actually balance the market. Unfortunately, we've also seen the impact on very price-sensitive countries, which have absolutely no way to manage this sustained volatility. They've gone through Ukraine. They're now going through Iran.

5:25They can't afford these high LNG prices. And so they've retreated back to coal. That's a problem because price sensitive countries are the engine of growth for the LNG industry. And so we have to find a way to make LNG more affordable, reliable for these countries so that they remain in the LNG space rather than turning away entirely. Right, because then if, as you say, some of those price sensitive countries are driven away from importing LNG by high prices at the moment as a result of this shock, what's going to happen to them? They're going to use more coal, are they more renewables, more nuclear?

6:04Which direction will they go in? A variety of directions. Coal is the obvious choice. It's abundant, it's cheap, it's available. Unfortunately, it's dirty and it's impacting these countries even more than before. and that the reason they moved to gas was to try and clean up their air, India being a case example. And Pakistan, again, trying to get ahead of the curve by putting in FSRUs. FSRU being floating storage and regasification units. So this is sort of a vessel that you can use to import LNG, basically. Absolutely, yes. Have been priced out of the market. Those volumes simply go somewhere else to somebody else who can afford them.

6:43And so they've retreated back to coal. We have nuclear, modular nuclear coming into play in lots of these developing nations. Ultimately, they will have to now look at much more stable diversity. LNG will remain part of their mix because it's available and they have the facilities, they've invested the capex. But on a long term basis, if they're seeing ongoing volatility, and it's not just Iran, it was Ukraine. and prior to that it was the pandemic. And so I think in this conference we've seen that volatility isn't something that's just going to come in short bursts. This is now the way that our world will continue to evolve.

7:25Lots more volatility, geopolitical volatility and the energy space is going to suffer from all of that. So they're going to diversify in all sorts of energy sources. So Vanya, what's your view on this then when you think about these longer term trends then and the ways that energy demand might be changed by the current crisis. And as Anita was saying, that since the volatility in these gas markets, the oil market as well, is not a sort of a short term phenomenon, it's kind of endemic now, it's something that everyone is going to have to live with in the long term. How does that change the way you think about the energy transition, the transition in general to lower carbon energy sources?

8:07Yeah, I think it's a very fragmented world when we talk about the energy transition. So I think this crisis comes at the, you know, really the middle of this declining energy transition trend in the West. Sorry, declining in the sense of? Declining in the way that, or rather decelerating rather than declining. So decelerating energy transition trend. And this is because it has been very much in the West, has been very much driven by the regulatory pressure. And this regulatory pressure, I would say, sort of we reached our peak ESG in 2021. Since then, you know, we had obviously post-COVID Ukraine focus on security of energy supplies.

8:55All of that has really decelerated the trend. Now, with this latest crisis, there are a lot of voices that are saying, OK, so this is our opportunity to actually really improve resilience in the system. We have to go back to accelerating this trend again, sort of to invest, we need to invest more in renewables. However, let's not forget the core reasons, the real reasons as to why this trend decelerated. In the West, many of the clean technologies really have never reached escape velocities and returns on these technologies were really not satisfactory for investors. So allocation of capital became increasingly the problem for many investors.

9:52So there's one reality and this is the reality that in the West this has been sort of always a real problem. Because these technologies relied on policy support. Because technologies rely on policy support, regulatory pressures, rather than the actual fundamentals that enable these technologies to grow, as we are seeing in China. Right. I mean, you've been talking about the West and kind of a broad sense. Are there not very significant differences between the United States and other countries? In the US, clearly, we've had this very, very sharp pivot in policy from the Biden administration, which prioritized climate policy and was very keen on accelerating the transition through the Inflation Reduction Act and a whole host of other policies.

10:41So the Trump administration, which is very much deprioritized climate policy and wants to develop fossil fuel industries as much as possible. There has not been such a dramatic shift in Europe or in other developed economies, has there? Well, that's correct. And I think the transatlantic gap always existed. It was much narrower between the US and Europe, including the UK, before President Trump. but now it has really deepened and widened for all the reasons that you've just said. But in the UK and in the European Union, we still have really the same pressures that continue to push companies towards decarbonisation, towards disclosures.

11:35And the one actually regulation that's very much going to affect LNG and gas industry is the EU methane emission regulation. That is very much is going ahead as far as the European Union is concerned. Right. So explain that. What is that regulation and what effect is it going to have? So the EU Methane Emission Regulation, or the EU MER, requires all importers of gas, LNG, crude, and coal to be compliant with the EU MER regulation or OGMP, which is Oil and Gas Methane Partnership 2.0 Level 5. This is your gold standard, top level standard. And that means really, in essence, that all your measurements, the bottom up measurements, have to tally up with top down measurements.

12:37And it's quite challenging to achieve for many companies. And according to our assessments, there's quite a lot of gas that Europe needs that simply does not comply with this regulation. This regulation really kicks in in earnest from January 27, which will leave a lot of players that are actually importing these commodities into Europe non-compliant. So, Anita, how are you thinking about these issues and this new regulation at mid-ocean? Are emissions something that you're focused on? Are you trying to drive down emissions through the value chain? And do you think it's going to be possible to meet this European regulation so you can continue to export gas into the EU?

13:30I think sustainability is important for all companies. So I think let's give that a baseline. So the problem that Europe is facing is that it has weaned itself off Russian gas. It still has Russian LNG imports, which definitely don't meet that regulation, by the way. and it's still looking for a lot of LNG from America as part of the trade discussions it was having with President Trump and it relies on American gas. America is now the largest importer of LNG into Europe. American LNG and Qatari LNG don't meet these strict regulations and they're not going to and if Europe insists on them, they won't get that LNG which then is an existential crisis for Europe because it doesn't have Russian pipeline gas anymore.

14:21So something's got to break. And I don't think the Americans and the Qataris are going to break. I think Europe will have to break. And Europe will not be able to sustain these levels of regulations. So what I think is that Europe is not going to break because they also realize that these countries are not compliant. You know, the LNG that's coming into Europe is not compliant. So they understand that. and what they're trying to do is they're trying to mitigate it by not imposing fines on importers. However, that means that where does that leave the importers? That leaves the importers like, okay, we can import this, but we are not compliant.

15:08So what are the legal implications, reputational implications of this? and for many of them it's simply not an acceptable position. So I have to say it surprises me a little bit that the US industry is not compliant and I'm interested in your views on how far it is away from being compliant because we hear such a lot about how the upstream industry in the US is reducing emissions all the time. There's a huge amount of effort going into stopping methane leakage, identifying what they need to do to reduce their emissions. And famously, these are changes that companies can often make at very low cost or even at a negative cost in the sense that if you stop the gas leaking, then you can capture it and sell it so it has positive value and that will more than cover the costs of the changes you need to make to stop those leaks.

16:03So, as I say, it's surprising to me to hear you say that this is actually going to be a problem for US companies seeking to export to the EU? So when I say they're not compliant, I don't necessarily mean that US gas or Qatari gas, or in fact, other gas, are not able to mitigate emissions. They all attempt to mitigate emissions. And I think the US, even under President Trump, who pulled away all these regulations, individual companies continued to do the right thing. because ethically we're all human, we all live on the planet and we want to do the right thing. So I think that is going ahead. The challenge with compliance to a regulation is it's prescriptive.

16:45And if you're saying to a company, I need you to verify every single molecule of gas that came through your LNG chain, that's not possible if you're buying off the grid in America because you can't go back to find which molecule came from which basin. Now, if you come from dry gas in the Haynesville, you are almost 100 % compliant if you can trace it back to the Hainesville. If you're associated gas in the Permian where there's still some flaring going on, then maybe you're not. But ultimately, trying to pin everything down to the prescription of a very, very detailed and extremely punitive regulation means you're not compliant.

17:25Right, got it. So it's those traceability issues, that transparency that's really important. It is a traceability. However, again, I think the EC understands that they can't live without the US LNG or Qatar LNG. So there are a lot of conversations right now where they're saying, even though it is written into the primary legislation, right? So traceability element is there. They're yet to change it. But what they are saying is, OK, we are going to allow certified gas. And to be clear, what is certified gas then can kind of demonstrate its emissions and it has some carbon intensity that's below a certain threshold, something like that?

18:08As long as there's enough certified gas in the US that is equivalent to the amount of LNG exports, then it will be seen as compliant. however and sorry just before you get on to however just again just defining terms so certified gas is that the same thing as responsibly sourced gas which is another term i hear are they those kind of two things interchangeable or from a non-esg specialist for me they're interchangeable if you can show that you've responsibly sourced your gas then presumably there is some form of identification and verification of the provenance of that gas. If you can't describe the exact place, the general provenance was acceptable.

18:52Right, good. And I think it's the likes of MIQ that have already done a lot of work on gas certification, especially in the US, and they are now expanding into other countries. However, and I have to plug our brilliant modeling abilities in Woodmac, we have been really able to model global gas flows using global gas model as well as crude refining model and the impact of this regulation, MER regulation on security of energy supply for Europe, but also impact on other flows. And even if we assume, this is like, you know, really benign scenario, if we assume that the European Commission, European Union, allows top 10 importers of gas and crude just to bring everything in, make them compliant.

19:49The top 10 importing countries, you mean? Yes, yeah. The price of gas in our modeling still spikes, you know, it doubles from, say, you know, seven, eight to 16, 17 dollars per MCF. And this is because there's simply not enough. I mean, what we are talking about is MRV compliance. So monitoring, reporting, verification. This kicks in in six months time. We don't have enough verifiers. We don't even have authority bodies defined within the European Union. Only nine countries within the European Union have actually defined who their authorized bodies are. I think it just needs more time. It needs more time for importers to really find their way around it.

20:41I don't think that actually importers are generally against this regulation, but I think everyone is really worried that they may become non-compliant with all the consequences, legal and reputational consequences that will come with that, simply because they have not been given a chance to find the right channels to do it. Right. So taking a step back from this specific EU regulation that we've just been talking about, how do you think these markets and these regulations are going to evolve over time? When I think about this whole issue, I sometimes think that there is a sort of a contradiction in, as you say, talking about responsibly sourced gas or certified gas, in the sense that if a market customer really wants to push towards decarbonisation, they will stop using gas altogether.

21:35And they will go to renewables or nuclear or maybe hydrogen one day or whatever it might be. And if a customer really wants gas, they just want gas, and they want it at the lowest cost possible. As you say, Anita, a lot of customers are price sensitive, and so they don't really care about the emissions, and they're not going to pay a premium for gas with low associated emissions. So there's a kind of, there's an excluded middle. You're talking about a product which would fit kind of in the middle there, which is gas, but with lower emissions. Long term, is there really going to be a market for that?

22:08I wonder. I mean, what do you think, Anita? So in one of my prior roles, I was working for a development company in the United States that was trying to build an LNG facility to deliver into Europe, primarily because of the location. And this was at the height of ESG. So this is how long ago? This is between 2018 and 2021. So this was the peak ESG period. Immediate aftermath of the signing of the Paris Agreement. So we were told you need to include these very lengthy ESG clauses in your contract and you have to comply with this, this, this and this. And we had our own upstream position. So we were actually thinking, OK, we can probably comply with all of this and we can probably do it.

22:53But it came at a cost. And when we presented that cost, they didn't want to pay it. they simply did not want to pay more for this particular responsibly sourced gas so my view is that um these are these are sort of virtuous things that you want uh they cost more money but you don't want to pay for them because then you become uncompetitive if you bring in gas into europe at a higher price to to manufacture steel you're not going to compete with india who is not willing to pay that higher price gas to manufacture steel. So at some point there has to be a balancing. And I think it's coming. Right.

23:40So that's interesting, though, because then the other point, which is very clear, is that if you look at the history of climate policy, it has been on a pendulum certainly since the 1990s, been swinging backwards and forwards. It's swung in one direction, away from climate action essentially, and swung quite some distance in the past few years. At some point, it's going to swing back, I guess. Climate change hasn't stopped happening. Climate is still changing. In particular, depending on how this El Nino system plays out, we may see another surge in temperatures globally. We may break new records.

24:24and that I'm sure will kind of bring the issue up the agenda in terms of people's consciousness. So how do you think that's going to play out there? And as I say, given the swing of the pendulum, people not being able to just ignore climate as an issue, we have to find some way through, don't we? We have to find some way through, but remember we're also in a very difficult social, political environment. all of these crises layered on top of each other in the last decade have actually reduced the standard of living in Europe and the UK dramatically the public cannot sustain more taxation industry cannot sustain more cost energy is the lifeblood of any economy and if you're paying more for your energy then you simply can't continue as a successful country and so whilst everything that you say is important climate change is important climate change is changing every day um we're going to have to learn to live with the effects of it because i don't think anybody is willing to pay for it banya what's your expectation how do you think i actually i actually think that very restrictive climate regulation has been very detrimental to the uptake of clean technologies and again talking about the western sort of hemisphere because you just can't force people to you know really support all the points that Anita made there and it made us in Europe really not very competitive and you know we talked the last couple of days about reduction in demand in the European Union, well, quite a lot of that is because we are de-industrializing.

26:20We are just like losing our industry to other regions, to the US and to China and other areas where actually energy is very, cost of energy is very low. I think where there is kind of real risk to the fossil fuel industry is in terms of substitution that will come from the energy transition mega trend that is driven by China. Low cost of technologies, deployment across Southeast Asia, Africa, real sources of growth of that demand could actually be displaced by very cheap Chinese clean technology. So that will have much more effect and impact on climate, warming climate, than I think any regulation can achieve.

27:15So we just had very, very different approaches to the energy transition. On one side, we had this really heavy-handed regulatory-driven approach. On the other side, just the lowest cost of energy, and we're just going to focus on scaling up these clean technologies. And they've succeeded. And now we completely depend on this Chinese technology. If we want to deploy our solar or wind here, we have to buy Chinese technology. Because otherwise we simply cannot make it economically ourselves. because our cost of energy is way too high. Pandya Kretschmar, Anita Rededra, thank you both very much indeed.

28:01I next spoke to Arturo Gallego, who is the global head of LNG at Centrica Energy. And I started off by asking him why Centrica had an LNG business. Centrica, kind of our oldest utility in the world, 1812 was founded, so hopefully people know about that. On the LNG, I mean, it's kind of an, I would say, younger business. So we started properly this business in 2014. and when thinking about what we wanted to do, it wasn't just kind of a start with developing more on gas, it was properly building an energy kind of a business. And so at the beginning, we said the same thing that we're saying now. Our strategy was to build a diversified web of assets within a controlled risk environment and with enough flexibility that traders could optimize.

28:45So we're looking at those three things where the first thing was diversification. I think at the end of the day, I mean, everyone is talking about diversification now, but it's important. And we're seeing that buying everything from the same project doesn't give you the same certainty that you are buying and selling from different places. Risk framework, critical as well. I mean, we're seeing what's happening now. We need to take risk. Our business takes some risk, but we need to control and know what risks are taken. And the third one is flexibility. I mean, we talked about flexibility in 2014.

29:14People are talking about flexibility now. People are even overpaying for flexibility. and I remember, I mean, when we built this business, we got some strategic advisors to the company and they were telling us that the only way of succeeding in this business was size. So we had to be 10, 20, 30 million tons of size. At the time we said, no, we think if you build the right portfolio with the right flexibility, you'll succeed. I mean, we have proven the word, right? I think a lot of people is looking at that now, but I think we started with that in 2014. So, as you were saying, everyone is thinking at the moment about security of supply, top of everyone's agenda because of the war in the Middle East and the disruption to exports through the Strait of Hormuz, the loss of about 20 % of the world's LNG supply, which I think amounts to about 3 % of the world's gas supply.

30:08We've seen gas prices spiking in Asia and in Europe. How can LNG help manage that kind of supply shock? I think there are two things. I think someone mentioned that in the conference yesterday. I mean, LNG is doing a great job. I mean, LNG is available. Even with the largest crisis we have ever experienced, I think LNG is there. So where the people that need it, LNG is available. So it's there. The problem is affordability. That is linked to that. But I think security supply, I think everyone needs to play a different role. And I think we as Centrica, I mean, the role we're playing is we're investing in long-term deals.

30:47I think at the end of the day, if we don't commit on long-term deals, projects cannot take FID. So at the end of the day, our role is to link those customers with the producers and just provide whatever each of them needs. So we're doing that. I think that the big, big push and the big, big responsibility lies on the governments as well. So I think it's make sure that they build the right infrastructure, they have the right incentives for people to take the risk. And at the end of the day, I mean, they are the ones that need to make this connection between producer and consumer easier. How do you see this crisis unfolding then?