Turning up the Gas

There are many benefits of natural gas. It is the cleanest burning fossil fuel releasing 117pounds of carbon dioxide per million British Thermal Units (mmBtu) compared to oil (160pounds) and coal (200pounds). It is also a cheap and quick source of power generation as natural gas plants are cheaper and quicker to build than any other source of electricity including coal, nuclear, wind or solar. Recent energy market dynamics combined with natural gas’ inherent benefits are turning 2013 into an exciting year for the world natural gas market.

The New Energy Frontier?

 The shale gas boom has made the USA the world’s largest producer of natural gas. The NYMEX Henry Hub Spot Natural Gas is trading around US$3.50/mmBtu, a recovery from the drop below US$2 in 2012 after international oil companies (IOCs) - such as Shell, BP, and Exxon Mobil - reacted by changing their development plans to focus more on shale plays with a higher yield of tight oil and natural gas liquids (NGLs). Despite the recovery, the US price of shale gas should trade in a range of US$3.50 to $4.50/mmBtu this year. The USA is currently producing around 65 billion cubic feet per day (cf/d) of dry natural gas and total storage capacity utilization is at 90%. Even Hurricane Sandy in Q4 of 2012 did not disrupt natural gas prices sharply upwards. In addition, IOCs continue to supply natural gas even whilst the price remains below the US$4 profitability level due to the fact that dry gas is produced as a by-product of the development of NGLs. Technological innovations such as longer laterals, horizontal drilling, multi-stage fracturing and multi-well pads have reduced operating costs of shale gas wells and increased well productivity. The majority of the 19 recognized shale basins in the USA are also still in early exploratory or development stages. Clearly US natural gas supply is outpacing demand and will maintain Henry Hub spot prices at a range of US$3.50 to $4.50/mmBtu in 2013. The price should move towards US4.50/mmBtu as a result of greater demand from US refiners utilizing natural gas in feedstock as well as the development of new gas-fired power plants. Furthermore, the significant price disparity between US domestic natural gas prices and foreign prices has opened up arbitrage opportunities for IOCs to export liquefied natural gas (LNG). However, there will be a lag in the exporting of LNG as IOCs must apply for export licences with the US government. If granted, exports of 20 billion cf/d of natural gas would make the USA the largest exporter globally. The anticipation of US LNG exports should also help narrow the price disparity between US natural gas prices and foreign prices, putting slight upward pressure on Henry Hub.

However, present difficulties involving in transporting natural gas from one continent to another have caused the price in regional markets to decouple. Europe’s natural gas is sourced locally from major producers Norway and the Netherlands as well as through imports by pipeline from Russia and from the Middle-East. Current price of benchmark UK National Balancing Point of around £0.67 per therm, or US10/mmBtu, is around three times that of the US Henry Hub. However, impending developments should narrow the price disparity. Qatar had ramped up its LNG terminals in anticipation of shipping more LNG to the USA, yet the shale gas boom has forced them to shift their strategy to Europe. Moreover, the planned development of another pipeline from Algeria to Europe linked through Sardinia (to add to the Maghreb-Europe pipeline) should depreciate European natural gas prices. More recently, these developments, as well as the prospect of US LNG exports to Europe, resulted in Russia accepting a lower price as a result of a series of re-negotiations with some of their customers. It is anticipated that these future developments will put downward pressure on the natural gas price in Europe, yet we must make allowance for some sharp movement in the price in a region where there have been recent gas pricing and pipeline disputes between the EU, Poland and Russia.

Yet, Asia sees the highest current price for natural gas, around US$19/mmBtu, due to high demand from Japan, South Korea, China, India and Taiwan. In particular, natural gas is growing fast in China where it is seen as a way to reduce urban pollution problems. Meanwhile Japan is the world’s largest importer of gas as half of their energy requirements are dependent on the commodity. Liquefaction facilities, LNG tankers, and regasification facilities are very expensive and have not reached a large enough number of installations to transform natural gas into a truly world market. However in the next few years, we should witness a decoupling of the natural gas price from being oil-indexed due to several developments:

·         Presence of major shale gas reserves in China – in May 2010 Sinopec reported the successful extraction of shale gas in Guizhou province. Lack of bureaucracy and foreign acquisitions and JVs, initiated by PetroChina, CNOOC and Sinopec, to acquire expertise in shale gas should enable China to develop shale gas reserves quickly;

·         Australia is developing several LNG terminals and is set to be the world’s leading LNG exporter by the end of the decade;

·         A further 15 LNG import and export terminals are being developed in South-East Asia to open in the next three years;

·         Re-development of the Panama Canal will be completed in 2014, which should facilitate US LNG exports to major Asian consumers;

·         Russia is developing LNG production plants and testing navigation through the Arctic ocean in order to access Asian consumers;

·         Anticipation of cheaper natural gas prices has had an impact on suppliers – in November 2012 BP’s Singapore business agreed to supply Japan’s Kansai Electric Power Co with approximately 700,000 mm cf/d of natural gas for 15 years at a price linked to Henry Hub.

Oil price indexation was first introduced for natural gas because it was thinly traded so made economic sense as oil was a fuel substitute with similar delivered costs. The regional decoupling of the price of natural gas markets is starting a shift from negotiating oil-indexed contracts to contracts tied to regional natural gas prices. Further developments in LNG exports as well as the supply of US LNG pegged to Henry Hub will hasten this shift. However, with the increased supply of gas globally the Gas Exporting Countries Forum (GEFC) and Russia in particular (having earned US$66billion from natural gas in 2012) will seek to use their control of half the world’s export volumes to maintain higher prices. This is not expected to have much bearing on world natural gas prices. Unconventional shale gas resources now account for about half of the world’s natural gas resources. Combined with the estimate that the Arctic holds around 30% of the world’s undiscovered natural gas and concerted efforts to explore this region should ensure that world natural gas prices continue to converge on the US Henry Hub spot price in the next few years and trade at around US$4/mmBtu.