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Gas still bound by oil link in global markets

GDF Suez’s Jean-Marie Dauger explained to Kwok W Wan why diversity is key to gas’s golden age

The golden age of gas is coming but the global market will stay fragmented into three distinct regions, and prices will remain oil-linked, says French energy firm GDF Suez.

Gas supply and demand are expected to grow this century, but while liquefied natural gas (LNG) is set to be the fastest expanding form of supply, it won’t be enough to create a truly global market with a common price.

“When I started in in the gas industry, I used to present the world market as non-global. But at the same time we were all thinking that when US production decreases, when its gas consumption increases and LNG comes online, then the market gradually would become global,” Jean-Marie Dauger, vice president of global gas and LNG at GDF Suez, said.

“But it is not the case. Again it seems like we’re departing and the world market is not behaving as one but as several regional markets,” he told Petroleum Economist.

Before the huge increase in US gas production from shale, the world’s largest gas consumer was expected to import large volumes of LNG to offset declining domestic output. In 2004, the Energy Information Administration (EIA) energy outlook forecast US LNG imports to reach 812 billion cubic feet of gas a year by 2010 (17.5 million tonnes a year (t/y) LNG.)

But the US actually imported around 65,000 tonnes in 2010, a 96% drop compared to forecasts, and this was all due to the boom in shale-gas production.

Now there are three distinct markets, broken up in terms of prices; the way gas is traded; and growth expectations. The US is self-sufficient with a deep, liquid gas market. In Asia, LNG is bought on long-term contacts linked to the global oil price and gas demand is expected to rise. In Europe, there is mix of regional gas markets, LNG, and oil-linked Russian pipeline gas, with demand stable.

But European and Asian buyers have been questioning gas’s link to the oil price and if this new era of additional LNG and regional shale gas supply will loosen the way gas is traded.

Dealmakers

With the US looking to start exporting LNG linked with US Henry Hub gas market prices and European utilities renegotiating oil-linked contracts, the change may be happening but it may not be the significant structural shift that some expect.

“Some Japanese companies seem to be prepared to take Henry Hub risks to supply their markets because US gas (prices) are five to 10 times less than Asian prices. But on the other hand, there is nothing in the Japanese industrial sector that relates to Henry Hub. Nothing,” Dauger said.

Japanese trading houses – Mitsubishi, Sumitomo, and Mitsui – and utility Tokyo Gas have signed export capacity deals for the US Cameron and Cove Point LNG production projects. Sabine Pass also agreed supply deals with South Korean and Indian buyers based on Henry Hub pricing.

But Dauger does not see Henry Hub becoming the reference price, even if the US becomes the world’s largest exporter at over 100m tonnes a year (t/y), which is possible if all export projects are approved and built.

“Is it a substantial move from Asia that they will depart from oil? I don’t think so. Frankly, you can see no reason why Henry Hub would become the only reference price for Asia since Henry Hub prices only reflect US market balance, but it may become an element of risk mitigation,” he said.

The US is also unlikely to become a huge LNG exporter, due to energy policy, Dauger said. “Yes, there will be US LNG exports, but there might be a limit that may come as a political decision because US gas production will be first and foremost for America and export volumes will remain marginal compared with total US production.”

But in Europe, the transition away from oil, already underway, is expected to continue. For decades, utilities have been buying pipeline gas on long-term, oil-linked contracts, and selling at market hub prices. But while Brent crude oil has soared – reaching near all-time highs and staying above $100/barrel – gas prices have stayed relatively flat.

This has resulted in some gas importers losing billions of euros and led to renegotiation of contracts. Some utilities, including Germany’s E.On and RWE, are in the process of arbitration with Russian export monopoly Gazprom over the contracts.

“Importers with large portfolios of long-term contracts and limited ability to pass through procurement costs are suffering most,” Moody’s rating agency analyst Niel Bisset said. “Market changes are here to stay and imply an increase in business risk for the gas supply sector.”

But Russia is not likely to give up on oil-indexation easily, arguing that it is needed to secure long-term gas delivery. Gazprom argues that European market hubs are not liquid enough to provide a long-term price for gas, and it shouldn’t be penalised for its customers making bad decisions.

However, Europe is already slowly shifting towards hub (or gas-on-gas) pricing. “The trend is strongly towards a transition because fundamentally, the situation is currently unsustainable,” Howard Rogers, director of the natural gas programme at the Oxford Institute of Energy Studies, said.

“Gas producers will have to take investment decisions based on the market. It happens in other industries, mining for example, where they invest billions without a long-term contract in place.”

A new International Gas Union (IGU) Wholesale Gas Price Formation Survey also reflects the trend, showing the oil element for European gas contracts fell from near 80% of gas in 2005 to under 60% in 2010. Meanwhile, the hub pricing element more than doubled.

“By 2010 the share of gas-on-gas competition in Europe had reached over 36% compared with 15% in 2005,” according to the IGU report, which was prepared by Mike Fulwood, of consultancy Nexant. The report also noted that this was due to a larger spot-gas element being introduced into long-term contracts as well as the growth of a global LNG market.

French investment bank Société Générale estimates oil-linked contracts made up 58% of European gas supply in 2011, but could quickly fall under 50% if arbitration with Gazprom and renegotiations with Statoil are successful.

GDF Suez also sees a gradual change in Europe, but thinks there will continue to be a mix of oil-linked and hub pricing.

“In the discussions, everyone wants the best of both worlds. What Europe would like to have is long term commitments with the best of oil or market prices,” Dauger said. “We have always considered diversity is the answer and if you look at our portfolio, we have within our long term agreements different indexation – some oil- and some gas-market index. My impression is this balance may be kept if the spread between long term and short is not maintained too long.” Unlike oil, gas relies on pipelines to deliver from point A to point B, making it difficult to trade in truly a global market. Even with LNG, expensive infrastructure such as liquefaction/regasification terminals and refrigerated tankers restricts the number of participants, which in turn limits market liquidity.

But despite these issues, the way gas is priced is transitioning away from the oil price, although there will always be a balance.

The IGU says its report “confirms the continuing trend towards gas-on-gas competition in world markets and away from oil-price indexation.”

The global gas market, still an infant, is slowly finding it legs.

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