News

SUBJECT: Outlook for gas markets.

SIGNIFICANCE: Gas demand had been expected steadily to outstrip supply in coming years. Instead, gas markets internationally are moving into a period of excess supply.

ANALYSIS: The international economic slowdown has shaken the outlook for gas markets. Until 2008, it appeared that – driven by environmental, cost and technological factors – demand in natural gas would grow strongly in the future, supporting the huge investment that the industry was experiencing.

Several factors supported this view:

Gas has relatively low emissions compared with coal – a gas-fired power plant produces roughly half the carbon dioxide emissions of a similarly-sized coal plant. Replacing either oil or coal with gas reduces emissions. Low emissions means that gas is a less risky investment in terms of future emissions legislation.

Gas as a replacement for oil remains a cheaper option. Gas prices are often linked to oil or oil product prices, but at a discount in terms of energy value, locking in the relative attractiveness of gas.

With the international rejuvenation of the liquefied natural gas (LNG) industry, gas became more widely available and the diversification of gas suppliers enhanced the fuel's attractiveness as a means of increasing security of energy supply.

The power sector has led the increase in demand for gas and this reflects the evolution of combined cycle gas turbine technology (CCGT). CCGT plant supplies large quantities of power and can be built quicker and for a lower capital cost than that fuelled by other sources. It has thus secured finance relatively easily.

Changed outlook. However, the outlook for gas has changed, at least in the short term:

Europe. Economic slowdown is reducing both industrial demand for gas and demand for power more broadly. Industrial power demand in Germany could drop by 20-30 per cent over the course of the year. Other estimates have suggested that European gas demand could fall 7-10 per cent, which would leave buyers with take-or-pay contracts struggling to secure storage. At the same time, new gas infrastructure has and is being commissioned; for example, new LNG terminals in the United Kingdom and Italy, and the Medgaz pipeline from Algeria to Spain.

Asia. In Asia, industrial demand is also falling. Demand for LNG in North-east Asia until recently has been supported by the combination of high oil prices and a lack of operating nuclear plant in Japan. However, with industrial demand stalling, and oil prices falling, spot demand from South Korea and Japan, the world's two largest LNG markets, has dried up. Storage is at very high levels and, having paid above 20 dollars per million British thermal units (MMBtu) for spot LNG during last year's winter (2007-08), north Asian buyers are now showing no interest at $7 -to- $8 per MMBtu, which is the parity price with oil at between $40-to-50 per barrel.

United States. In the United States, the gas market is experiencing strong supply growth on the one hand, owing to the success of onshore production from gas shale, and declining demand on the other, because of economic slowdown. From January to July last year, deliveries of gas to electric power consumers were above those in 2007, but August, September and October saw year-on-year drops of 24.3 per cent, 11.3 per cent and 11.0 per cent respectively. However, with the exception of September, production in each month of 2008 to October exceeded that of 2007. Even with some bitterly cold weather in the northeastern United States in January, the NYMEX February futures contract for natural gas had by end-month sunk well below 5 dollars per MMBtu.

LNG factor. The weakness of LNG, which can be taken as a proxy for a global gas market, was evident during the Russia-Ukraine crisis, which happened at the same time as major disruptions in LNG production:

Following a shutdown on Jan. 8, Qatargas declared force majeure on production from three of its LNG trains. Together, the trains normally produce about 10 million tons of LNG a year.

Algeria declared force majeure on LNG output from its Arzew plant in the fourth quarter of 2008, a status still in place when the Ukraine-Russia crisis broke, following a pipeline problem that emerged in October.

Nigeria's NLNG (Nigeria Liquefied Natural Gas) declared force majeure on Nov. 28 and it is still in place. The plant was shut down to repair pipeline leaks from the Soku gas plant caused by theft. Soku provides about 40 per cent of the Bonny Island plant's gas, and the plant itself produces 22 million tons of LNG a year.

Yet the Russia-Ukraine crisis had little impact on spot LNG prices. This was partly because, with the exception of Greece and Turkey, eastern and southeastern Europe has no LNG regasification capacity. The choice is pipeline gas or no gas. Western Europe, which does have regasification capacity was much less effected and the ability to pipe gas from LNG plants in western Europe to eastern Europe is poor – about 50 per cent of Europe's regasification capacity is in Spain.

With no spot buying in either Asia or North America, the Russia-Ukraine crisis created little extra demand for LNG. The crisis drove European hub prices sharply higher, but probably simply has served to mask temporarily European gas markets' move towards a period dominated by surplus supply. The market most able to absorb surplus gas is the U.S. Gulf of Mexico, which generally is seen as the market of last resort for LNG. This would suggest that domestic U.S. prices will come under further pressure from cheap LNG imports.

Seeds of recovery. While it may seem strange to expand LNG import facilities at a time of surplus gas supply, there are reasons to suggest the trend will continue: High LNG prices in an increasingly competitive market place caused some countries to slow their investment in LNG receiving terminals. Falling prices may reverse this trend.

The Ukraine-Russia crisis will cause European countries – particularly those in east and southeast Europe – to firm up plans already being considered for LNG regasification facilities for security of supply reasons.

Gas is still cleaner than coal and for countries like China and India, which are highly reliant on coal, represents a diversification of supply. Cheaper gas will spur the use of coal gas in China, for example, in order to reduce city pollution.

CONCLUSION: While falling industrial demand for gas will cause prices to fall, those lower prices will also consolidate natural gas's position as the hydrocarbon fuel of choice. Lower prices will also spur the development of LNG regasification capacity on security of supply grounds.

From the Oxford Analytica Daily Brief

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