The way out of the global gas glut
Efforts to resist the world's gas-supply overhang are futile. Exporters should embrace the glut and reap the long-term rewards of cheap gas, writes Derek Brower
THREE years ago, an unlikely supplier was on the lips of bureaucrats in Europe worried by Russia's gas-export strategy. Iran, they said, could break Gazprom's stranglehold. The strategic imperative was sufficient to overcome worries about Iran's nuclear programme. And anyway, would it not be better to engage with Iran than ostracise it?
As a measure of the shift in supply and demand fundamentals since then, now, no-one mentions Iran's gas for Europe. The second-largest reserve in the world remains out of bounds. Recession, plunging demand and the arrival of new gas-export facilities planned when older fundamentals made them look sensible has turned geopolitics, and much else, on its head.
In November, the International Energy Agency (IEA) confirmed for the world what anecdotal evidence has, for 18 months, been telling the industry. We are in a gas glut. In 2011, the over-supply will reach 200bn cubic metres (cm) – almost equivalent to the entire demand of Africa and South America last year. In Europe alone, says IHS Global Insight, a consultancy, the overhang in 2010 could come in at 110bn cm.
Even under its New Policies Scenario – which assumes governments impose some limitations on carbon emissions – the IEA believes the oversupply will "take several years" to end and could even last until 2035.
It could also get worse. The IEA says that "even if no new pipeline or LNG (liquefied natural gas) project is commissioned before 2020 beyond those projects that have reached a final investment decision – which is highly unlikely – unused capacity would still total more than 150bn cm." The utilisation rate – the amount of capacity needed to meet demand – would "still be only 80% by 2020" (see Figure 1).
This outlook is deeply troubling for the world's gas exporters. The price slump during the recession was bad enough (see Figure 2), but long-term supply abundance will devalue reserves. The bigger they are, the harder this will afflict them. Russia, Qatar and Australia, the three most ambitious gas exporters, must adjust their expectations.
Much of this is bad timing. In 2008, Gazprom predicted the price of its gas in Europe would triple, to around $1,500/'000 cm. A couple of months later came the sub-prime collapse in the US, and the start of economic meltdown. Next year, Gazprom's gas will go for $308/'000 cm, says export chief Alexander Medvedev. Plans to develop the Shtokman field, in the Barents Sea, and export its gas by pipeline and as LNG are on hold. The government is now looking to ease taxes on Gazprom. In 2009, Medvedev told Petroleum Economist the company would control a quarter of the world's LNG market by 2020. This dream lies in tatters.
For LNG exporters the glut is severe – and growing. Global LNG capacity is now 283m tonnes a year (t/y), according Petroleum Economist's LNG Data Centre. Import capacity is 483m t/y. But the bulk of this is in Japan, South Korea and Spain, or spread among other rich countries: consumers that will offer only tepid demand growth, says the IEA. Meanwhile, by 2013, another 100m t/y (or 130bn cm/y) of supply is due on stream. Another 30m t/y could follow by 2015.
This is bad timing and its biggest victim is Qatar, whose LNG output capacity will soon reach 77m t/y, giving it almost 30% of the world's seaborne gas trade and pumping even more gas into the global bubble.
Qatar's achievement in reaching the target is up there with any in the world's energy sector in recent decades. In oil terms, its output is equivalent to 5m barrels a day, a statistic said to be politically important to Qatar's ruler. LNG has made Qataris wealthy, with per-capita GDP exceeded only by Liechtenstein. LNG accounts for about 40% of hydrocarbon revenues, about the same proportion as oil sales.
But it has also exposed Qatar to the vagaries of the gas market in a way it never expected. The record 2.9% drop in global demand last year has depressed the market for prompt gas. Long-term contracts signed before the recession offer some protection to exporters, but even Gazprom has allowed weak spot-price elements into contracts with its biggest clients.
The imminent addition of Qatar's two new mega-trains will probably force another dip in spot prices. In turn, this will exacerbate the problems for suppliers to large markets such as the EU. Gazprom's exports to southern Europe are in free fall and total exports to Europe and Turkey fell by 25% in third-quarter 2010. It has revised down its production targets and the 140bn cm export target for this year looks "optimistic", says one analyst.
Algeria's new 8bn cm/y Medgaz pipeline to Spain, meanwhile, adds another chunk of capacity to the European mix (PE 11/10 p9). This should be good for Spain's consumers, who can choose between LNG and North African gas. But it adds to the risks for Algeria. Complicating the exporter's strategy still further, officials believe the country has vast unconventional gas reserves, says one source. Suddenly, Europe may be surrounded by gas it will not need.
Unconventional reserves in North Africa are not a prospect foreseen five years ago. But North America's shale-gas revolution has changed expectations. The US' success has been spectacular, with shale output soaring from 12bn cm in 2000 to 45bn cm in 2009, says the IEA. Unconventional production will meet most of the country's supply by 2030, says Ziff Energy, a consultancy. Reserves continue to be added. The Marcellus field, in the northeast, could alone hold 14 trillion cm, says Penn State University, making it the world's second-largest deposit.
This has ended the US' need for LNG imports and underpinned the supply side of the glut. And if some developers have their way, exports from the US would add another slug of LNG capacity to the world total. Freeport LNG, a Texas venture that was banking on imports when it opened its receiving terminal in 2008, and Australia's Macquarie bank hope to export about 10m t/y by 2015.
Cheniere Energy, another US LNG importer, plans an even bigger export project, targeting shipments of 20m t/y by the same date from another Gulf coast terminal. Meanwhile, LNG exports from Kitimat, on British Columbia's west coast, would see Canadian gas join the glut as soon as 2014 (PE 3/10 p18).
The application of hydraulic fracturing and horizontal drilling techniques created this boom in North American supplies and ended worries about gas scarcity. Now many developers believe they will do the same globally. Apply the drilling methods elsewhere, runs this theory, and, presto, North America's shale abundance will be the world's too (see p33).
Eastern and central Europe, where consumers have been daunted by Russian domination of their gas supplies, is crawling with hopeful developers. Shales in Poland, Ukraine, Austria, Germany look promising, even if their true potential may not make a "material" difference for a decade, says Rhodri Thomas, an analyst at Wood Mackenzie.
China's ambitions are even greater. The government wants shale-gas production to reach 30bn cm/y by 2020 (see p31). This would be equivalent to less than 10% of its demand by then. But total unconventional production, says Wood Mackenzie, could rise to 112bn cm/y a decade later – accounting for 25% of consumption. (The IEA expects Chinese output to rise more modestly, to 137bn cm/y by 2030, against demand of 331bn cm/y.)
A big jump in unconventional production outside North America would hit LNG exporters and exacerbate the supply overhang, especially if cheap pipeline supplies to fast-growing markets such as China's continue to be developed. Qatar's hopes of securing long term-contracts with China, for example, will face competition from Turkmenistan's piped gas (see p27), as well as Australia.
So what can a producer do? Having awoken to the glut, some are fighting back against a perceived threat. Despite its sales of spot cargoes, exports that have helped flatten prices, Qatar has spent recent weeks arguing that gas's oil-price index should be preserved, along with long-term contracts. This would bring "stability" to international markets, says energy minister Abdullah bin Hamad al-Attiyah. It would also guarantee supply, "instead of having exporters switching destinations of their exports" when they have a better offer.
Yet consumers – and some producers – have sought more liquidity in gas supplies for years. The IEA points out that while US Henry Hub prices averaged just $4/m British thermal units (Btu) in 2009, continental European and Japanese prices – linked to oil – were more than twice as expensive (see Figure 2). "As long as the gas glut persists," says the agency, "the pressure to move further away from oil indexation will remain, especially for new long-term contracts." Now that they command a buyer's market, consumers will not happily retain the oil-price link just when it looks certain to crumble. With oil prices soaring, the idea has even less appeal for importers.
There are, however, other hopes for exporters. Andrew Neff, an analyst at IHS Global Insight, says Europe's supply overhang may be burned off by 2013. Gazprom has grown more "sanguine" about its prospects, too, which explains the discounts offered to trusty customers. Threatened by declining market share, Gazprom has adjusted its strategy, putting a priority on volume. It can ill-afford another price war of the kind fought with Ukraine – accommodation is a sounder strategy.
And China could ride to the rescue sooner than the IEA or other analysts expect. Philippe Boisseau, head of Total's gas and power division, has been touting his view in recent months that China's demand growth, which the IEA puts at about 6% a year, will be much higher. For now, it is constrained only by insufficient LNG import capacity, he argues. More than 13 new terminals will be built in the country in the next decade, he says. "The potential for gas consumption in China is much bigger than all the curves show for the future." On the back of this, the world would need 100m t/y more LNG than is planned.
The bigger hope for exporters, however, is also what now depresses them: price. Cheap gas should encourage more demand and more switching from coal – even if new carbon pledges made at the UN's climate-change meeting in Cancun do not bring a global mandate to eradicate its use. Coal is abundant, production costs are low and it is easy to ship, so it will remain the cheapest fossil fuel. But even small local measures to penalise pollution would see cheap gas displace some of coal's role in power generation.
This demand shift, like the one that came in supply, could be led by the US. Put a $30 a tonne price on carbon emissions, say gas executives in North America, and their fuel would knock out coal. Double it and other renewables, as well as nuclear, would also come into the mix.
This has obvious advantages in the US' quest to meet its climate-change targets – a 17% reduction in greenhouse-gas emissions by 2020 and an 83% drop by 2050 (both against 2005 levels). Despite the Republican resurgence in Congress, meaning incentives for renewables are less likely, President Barack Obama believes bipartisan co-operation could coalesce around increasing gas's share of the energy matrix.
"A large-scale US switch from coal to gas has become possible largely thanks to the increase in supply from shale gas," say Kevin Parker and Mark Fulton in a recent Deutsche Bank report. Replacing coal-fired generation with gas would be "the most secure, least-cost approach to lower emissions" – viable at a gas price of $4-6/m Btu. Ensure gas is sold through long-term contracts, Deutsche Bank argues, and generators would not need to worry about price volatility.
Some switching is already under way. In the past two years, the bank says, gas's share in the energy matrix has grown by 3%. While the IEA forecasts no growth in US gas demand in the next 25 years, Deutsche Bank says US consumption would rise by 20% under its plan (and gas in power generation by 40%), to 0.8 trillion cm in 2030.
This would not end the global gas glut. But, having helped cause it, the US could point exporters in the direction of what will end it. Cheap gas globally, combined with even modest measures to penalise emissions from coal and oil, could support much stronger growth in demand than the IEA expects for this cleaner fuel.
That is the multi-billion-dollar gamble many of the world's majors have taken. Gas projects, not oil ones, are dominating the portfolio of companies such as ExxonMobil. It spent $41bn last year buying US gas-producer XTO Energy. The rationale is plain: ExxonMobil believes gas demand will grow by 55% in the next 25 years – far higher than the IEA's 36.5% prediction. Shell, is also banking on gas demand, adjusting its assets and buying new ones to reflect its view of a 50% demand increase by 2030. Being long in gas will pay, the majors believe.
Producers in Qatar, Russia, Algeria and elsewhere seeking higher prices and less flexibility in their export contracts should beware bowing to short-term worries, or political pressure from the governments they subsidise. Now is not the time to squabble with buyers about terms or defend the artificial oil-price index. It is the time to sew up market share, encourage demand, and make sure they can meet it when it soars.