Section 3 - Prospects for transpacific oil and coal trade

In general, prospects for transpacific oil and coal trade are relatively muted in comparison to natural gas trade. According to IEA’s projections, the share of coal in the energy mix of all the major Asian economies will decline substantially, as we saw in Figure 2. On the other hand, in absolute terms, Asia’s coal consumption is projected to increase substantially (from 2601 Mtce in 2008 to 4081 Mtce in 2035), driven by increases in coal consumption in China, India and Indonesia. While consumers of coal have not been as reliant on imports as oil and natural gas consumers (recall that only 14.9% of the Asia’s coal needs are met by imports), the importance of imports to coal has been rising in this region, with China becoming a net coal importer in 2009 for the first time. By contrast, OECD countries such as the USA and Japan will reduce their coal demand over the next 25 years (World Energy Outlook 2010, International Energy Agency), thus increasing the supply of coal available for exports in such countries. The combination of the growth in demand in Asia (largely China and India) and the increased net supply in North America (largely USA) raises the possibility of transpacific coal trade, with the USA potentially selling coal on a major basis to China.

However, the Energy Information Administration (2010) points out a number of reasons why a significant rise in US coal exports to China is unlikely. The main reason is that the US produces coal at a relatively high cost, and is thus a “swing” supplier in the international coal trade market, only exporting to other countries when the price increases. Geographical factors also come into play- the global coal market is effectively segmented into the Atlantic and the Pacific regions, and the US is only a marginal player in the former whilst rarely participating in the latter. Exporting coal from the West Coast, an attractive idea in theory since it would result in reduced transportation costs, is rendered unlikely by the absence of a large dedicated coal terminal on the West Coast. As for China’s new status as an importer, it is likely to import its coal requirements from Australia, Russia, Mongolia and Mozambique, rather than from the US.

Prospects for transpacific oil trade are somewhat more upbeat, in particular for Canada which has plentiful oil sands deposits in the state of Alberta. In fact, according to IEA, even the US has the potential to become an oil exporter, with an additional production of 500,000 barrels a day from oil shale fields in Texas and North Dakota (New York Times, 16 Jun 2011). However, given that the US continues to import significant quantities of oil from the Middle East, Africa and Latin America (see Figure 3), increased US oil production is more likely to be substituted for imports rather than exported. Canada seems the more likely candidate to export oil to Asia. Canada can increase its oil production by 1.3 million barrels a day according to IEA, so supply is certainly not an issue. The key choice for Canadian oil producers is between exporting oil south to the US and west to Asia. Currently

Canada is almost entirely reliant on a single market- the US - for selling its oil, with exports to US accounting for close to 98% of its overall oil exports (BP Statistical Review of World Energy, June 2011). Exporting oil to Asia would provide Canada with the benefits of diversification and reduce its reliance on a single market for oil.

There are also purely economic reasons favoring export of oil from Canada to Asia. Firstly, the costs of transporting oil to China, Japan, S Korea and Chinese Taipei (via pipeline and tanker) are lower than the costs of transporting oil to US (via pipeline). Secondly, while crude market prices generally tend to match each other quite closely, in the past year or so a differential has opened up between WTI prices and crude oil prices in the rest of the world. Starting from 2010, the JCC crude price has inched ahead of the WTI price. The new oil price differential (a result of the relative oil supply glut in North America and in particular Canada), though small in relative terms, also favors Canadian oil exports to Asia. The economic advantages of Canadian oil exports to Asia, however, must be balanced against the fact that oil produced from oil sands is less fungible than sweeter grades from traditional sources.

The biggest obstacles to Canadian oil exports to Asia, however, have to do with environmental and regulatory issues. There is domestic and international opposition to the oil sands in general due to the environmental impacts, even though these concerns are highly unlikely to bring further development of the oil sands to a complete standstill. The more immediate roadblock is opposition to the proposed Northern Gateway Pipeline that would transport oil from the Athabasca oil-sands in Alberta to Kitimat, British Columbia on the Pacific coast, for onward shipment to Asia.

If North American crude oil exporting capacity can be achieved, it is likely that there will be a narrowing of the differential in WTI and Brent/JCC crude prices, similar to the reduction in natural gas price differentials between North America and Asia. The price spread in crude oil is a relatively recent phenomenon, but it is a function of the same fundamental causes that affect gas price differentials, namely surplus energy supply in North America coupled with the very limited ability (especially for Canada) to export oil to destinations outside the continent. In recent months, the spread between Brent and WTI prices has widened to as much as US$25 a barrel.

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