Impact of gas prices
By Charles Ellinas
Not that long ago it was believed that energy sources were becoming scarce and oil was costly.
This and environmental concerns propelled natural gas to the forefront. In 2011 the International Energy Agency produced a report suggesting that fast-rising demand could lead gas to displace coal and seriously compete with oil by 2030. This, combined with high prices and rising demand in East Asia, especially China and Japan (due to Fukushima), encouraged many companies to invest into huge projects to produce liquefied natural gas (LNG).
But then a number of important developments happened with far reaching consequences:
● The expected global economy recovery never happened.
● Growth of China’s economy slowed down to 7% and demand for energy imports has almost halved.
● The shale revolution took-off in the US and new gas discoveries were made in East Africa, Canada and elsewhere and they also joined the LNG bandwagon. This, combined with a major expansion in Australian and Russian LNG, produced a glut of LNG.
● The shale gas revolution is expanding to include China, Argentina and other countries.
● Plentiful supplies of cheap coal and subsidised renewable are displacing gas in power generation in Europe.
● And Japan has taken the first steps towards a return to nuclear power.
By late 2013 – early 2014 global LNG and gas prices started coming down.
And then on top of these developments, during the last quarter of 2014 the oil price tumbled, again because of a glut in supply and sluggish demand.
Globally, most LNG is traded through long-term contracts based on the price of oil via an indexation mechanism. As a result, contract gas prices started coming further down, and it is expected that average LNG contract prices in Asia will drop another 30%-35% in 2015, to below $10 per mmBTU, from the current price of about $14 and $16-18 back in 2013.
On top of this as oil gets cheaper, it makes substitution by gas more difficult and less justifiable as we are finding out here in Cyprus.
As a result of the glut of LNG, buyers are taking advantage and are driving hard bargains. Last year Japan signed long term contracts for gas at around $16 per MMBtu. Now, contract prices are forecast to drop to $10 or lower and spot prices (ie short term) are going below $7 both in Europe and in Asia.
As a result, buyers now rely more on the spot market to retain flexibility and benefit from the plunge in energy prices.
Consequences for LNG
This drop in price is bad news for all of those planned LNG projects that were counting on rising demand, especially in China.
This applies to Australia which made large gas discoveries in the early 2000s, which led to huge investments to build new LNG export plants requiring prices of the order of $12-16 per mmBtu to be profitable. These projects could be facing losses as they go into operation between 2015-17, discouraging the building of new projects.
The shale-gas revolution placed the US in a unique position to benefit from LNG exports, with more than 40 LNG projects submitted for export approval. With shale gas prices of about $4 per mmBtu, these projects could deliver gas between $10 per mmBtu to Europe and $12 per mmBtu to Asia. However, the very low LNG prices make the commercial feasibility of many of these projects questionable.
The challenge is even bigger for LNG projects in the planning in Canada and East Africa.
Many proposed LNG export projects will be delayed, if not cancelled, as companies struggle to ensure profitability. Only less costly, well-located, projects in terms of security and distance to the final markets will succeed.
Russia has the biggest gas reserves and it is the lead gas exporter globally.
The crisis in Ukraine has had a major long-term geopolitical impact, with Russia turning its attention to Asia and China, which is now reaping the benefits. It has been said that: “China needs resources, and Russia has them. Russia needs markets and foreign investment and China has them.”
In May 2014 Russia and China signed a $400 billion, 38 bcm, gas deal and they are now building the world’s largest gas infrastructure project, the Power of Siberia pipeline. Later this year another deal is expected to be signed for 30 bcm gas supply through the Altai gas pipeline to China. The gas price is reported to be about $10 per mmBtu, now becoming the benchmark for Chinese gas imports.
In Europe the use of gas is being challenged with consumption declining due to even cheaper coal and subsidised renewables. Europe is also embarking on a drive for energy union, but this has a long way to go, facing country interests. It will be further challenged as Gazprom gas prices, being oil indexed, come down by about a third in 2015.
The lack of predictability in Europe will not help gas supplies or prices in the longer term. Europe should set an energy policy framework, but then leave it to the markets to apply and thus ensure the confidence of customers and investors. Gazprom says Russia provides one of the most affordable sources of gas, especially in light of the low price of oil, and it will still be one of the choice options in Europe.
According to the latest edition of the BP Energy Outlook 2035, global demand for energy is expected to rise by 37% from 2013 to 2035, driven by ongoing economic expansion in Asia, with 50% of gas supplies to be met by shale gas.
Most of the increase in gas demand will be met through increasing LNG supplies, particularly as we go into the 2020s. Over time, it can be expected to lead to more connected and integrated gas markets and prices across the world. But over the next few years, the World Bank says oil prices are expected to remain low, impacting gas prices, with considerable volatility in global oil and gas markets.
Impact on Cyprus
Such low gas prices challenge current negotiations to send gas for liquefaction in Egypt. Would Union Fenosa and BG be willing to sign possibly loss making long term gas supply contracts on the basis of current LNG prices in Europe? Or are they going to hold out longer? This will affect both Israeli gas and Aphrodite gas going to Egypt.
The need for diversification of gas supplies in southeast and central Europe, where gas prices are higher, is providing alternative export routes which merit serious consideration.
In the meanwhile, in addition to gas quantities being limited, low LNG prices have made an LNG plant at Vasiliko not viable. But the expectation that LNG will pick up in the 2020s keeps the hope alive, provided exploration continues and more gas is found.
Charles Ellinas is a hydrocarbons business consultant.
Source: http://in-cyprus.com/impact-of-gas-prices/
