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Gas markets enter a new era as high demand continues

The era of high demand for gas will continue, as an abundance of fresh conventional and unconventional supply keeps prices low and its lower carbon emissions make gas an attractive alternative to coal as a power feedstock

The Discovery of huge reserves of unconventional gas in shale deposits and coal seams, together with the development of technology needed to unlock the resources, has revolutionised the potential of natural gas.

With the world’s unconventional reserves now believed to be at least as large as conventional resources, gas – a fuel once thought to be dwindling fast – could supply the world for the next 250 years at present consumption rates, according to the International Energy Agency (IEA).

Meanwhile, the nuclear crisis resulting from the Japanese earthquake and tsunami of March 2011 has caused a reappraisal of nuclear energy in Japan and other big economies, such as Germany. That may result in a long-term increase in gas consumption for power generation – particularly of liquefied natural gas (LNG).

The rapid expansion of the LNG market is helping to turn gas into a globally traded commodity more like oil. Gas produced in Australia and Qatar can now be snapped up by eager customers in Beijing, Tokyo, London and Amsterdam.

All of this supply will help consuming countries to keep the lights on and the boilers running, while also stemming carbon emissions. Gas produces about half the carbon emissions for the same amount of energy produced as coal, which is the main alternative as a power feedstock in many regions. Advances in turbine technology are making gas an even more efficient feedstock.

Gas also has another role to play by aiding the development of renewable energy. Gas-fired power stations are highly flexible, able to ramp up and down rapidly to compensate for oscillations in output from intermittent sources such as wind and solar power.

Further adding to demand will be formerly niche applications such as the use of compressed natural gas in vehicles, as well as the development of gas-to-liquids plants to capitalise on the price differential between oil and gas.

Upbeat forecasts

The improved outlook for both supply and demand has prompted energy-sector analysts to develop more upbeat prognoses for gas. The IEA unveiled its Golden age of gas outlook in June 2011. Over the next two decades, it foresees a more-ambitious gas-use policy by China, lower growth in the nuclear sector and greater use of gas in road transport, against a background of ample availability that keeps gas prices lower than previously forecast.

In its prediction, the global gas glut, caused by over-supply at a time of weak demand during the recent economic downturn, will disappear by 2015. Global primary gas demand will increase to 5.1 trillion cubic metres (cm) in 2035 – a rise of 1.8 trillion cm, or more than a third, from today’s levels. In this vision of the future, gas would provide 25% of the global energy mix in 2035, compared with 21% today, overtaking coal by 2030 (see Figure 1). As today, most demand for gas would come from the power sector, but there would also be demand growth in industrial, transport and buildings sectors.

In common with all energy types, most of the impetus will come from China, India and other parts of the developing world, rather than the slower-growing industrialised economies (see Figure 2). Chinese demand could rival that of the EU in 20 years’ time.

Unconventional surge

The ability to produce shale gas commercially has revolutionised prospects for the sector in the US – a country that was preparing for large-scale energy imports just a few years ago is now considering gas exports.

According to the US Energy Information Administration (EIA), US shale-gas output grew at an annual rate of 17% between 2000 and 2006, largely a result of cracking deposits in Texas’s Barnett Shale. With further exploration opening other, even larger, plays domestic supply is set to expand further.

In its business-as-usual prediction, the EIA forecasts US gas production will grow by a quarter to 745 billion cm in 2035, from 600 billion cm in 2009. Over the same period, US shale production will almost quadruple to 345 billion cm to comprise almost 50% of total US production, up from just 16% in 2009.

Similar stories of rising unconventional-gas production can be expected around the world, as countries from Europe to Australia seek to tap shale gas and coal-bed methane (CBM) reserves.

Australia is a world leader in CBM, while the US leads the way on shale-gas, but countries such as China, India and Indonesia are also moving to develop their own unconventional resources. Those efforts largely focus on CBM, although China and India are also looking at shale-gas. Companies including Shell and Chevron are already working in China on preliminary shale-gas exploration. The country was reportedly preparing its first licensing round for shale-gas acreage in mid-2011.

Questions remain

There are some caveats to this rosy picture, however – not least that estimates of the extent of the world’s unconventional-gas reserves remain speculative, as are their economic viability.

As the EIA notes in its Annual Energy Outlook 2011: “Estimates of technically recoverable shale gas are certain to change over time as new information is gained through drilling, production, and technological and managerial development. Over the past decade, as more shale formations have gone into commercial production, the estimate of technically and economically recoverable gas resources has skyrocketed. But increases in recoverable resources embody many assumptions that might prove incorrect in the long term.”

One potential problem – often cited in relation to estimates of peak oil, but also applying to gas production – is that the difficulties involved in exploiting both conventional and unconventional gas deposits of all types will increase as the most easily accessible reserves are used up. If technological advances keep pace – and if the cost of the technology is not prohibitive – then these difficulties may be surmountable. If not, then the cost of unconventional-gas production could grow far higher, potentially threatening the economic viability of the sector.

Another issue in terms of maximising supply is that countries with large quantities of both conventional and unconventional gas reserves may be reluctant to invest in unconventional reserves, when conventional resources are much cheaper to produce.

Russia, for example, could have 17 trillion cm of recoverable CBM, according to the Oxford Institute of Energy Studies (OIES). But senior research fellow Anouk Honoré says there is “a significant question mark” over whether these resources would be fully explored. Russia holds the world’s largest conventional gas reserves – estimated at 49 trillion cm by Cedigaz – so has little incentive to tap its unconventional resources, for now.

Fracking doubts

Another stumbling block could be environmental issues surrounding unconventional gas that are already holding up development in some parts of the world. Doubts remain over the effects and safety of extracting gas from shales using hydraulic fracturing (fracking), the process – injecting a mixture of water, sand and chemicals down, then horizontally, into the rock at high pressure, to fracture it and release the gas – that has helped make production economically viable.

South Africa and France declared moratoria on shale-gas drilling in 2011 until more safety studies have been conducted. Issues range from possible water contamination and lowering of the water table, to earth tremors. In June 2011, shale-gas drilling in northwest England was suspended after activities were linked to a small earthquake in the region, which provoked public concern. If such problems mount around the world, a reappraisal of exploitable unconventional reserves may be needed, especially in highly populated or environmentally sensitive areas, where public opinion may run against the industry.

Gas producers acknowledge the problems. “Shale gas has been a revolution in North America. But other regions will face different challenges,” says Ajay Shah, head of global LNG at Shell. Europe in particular could lag behind other regions in the development of unconventional gas, in part because of greater public apprehension over possible environmental damage and tighter environmental regulations. Much will hinge on the outcome of a series of studies into the environmental effects of shale drilling in the US and elsewhere.

Another uncertainty relating to gas use is the possible tightening of carbon-emissions standards that may require power generators to use expensive solutions such as carbon capture and storage. That issue has received less prominence in recent months as the world has focused on measures to stimulate economic growth after the downturn, but its profile will be raised as the next round of climate-change talks get under way.

And while nuclear power may not be a popular option in the immediate aftermath of Japan’s disaster, sentiment towards that source of energy may change over time, leading to higher nuclear generation – and, potentially, less gas use – than some forecasters are predicting.

Slow pipeline growth

Gas pipelines dominate global supply, but they may struggle to keep pace with demand. A few big pipelines are being built to provide increased and more diverse gas supply to big markets such as Europe and China. In Europe, governments are keen on new pipelines to reduce dependence on imports from Russia. In Asia, soaring energy demand is driving construction.

Progress in launching long-discussed pipeline projects has been slow, with efforts to build Russia-China links dogged by pricing disagreements, for example. And just two big pipelines were commissioned between late-2009 and mid-2011 – Medgaz, from Algeria to Spain; and part of the Central Asia Gas Pipeline, linking Turkmenistan to China.

But the IEA says slowly improving regulatory and market regimes governing cross-border gas trade, together with escalating energy demand in some markets, should encourage further investment in international pipeline infrastructure in coming years.

LNG supply

New long-distance, cross-border pipeline supply will come into increasing competition with the global LNG trade, whose rapid expansion is behind much of the optimism over future gas sector growth. It is expensive to produce and ship LNG, but it does mean that the economic viability of gas reserves are no longer dependent on their location – as long as there is enough gas to warrant the building of a liquefaction facility. And with the development of floating LNG (FLNG) technology, even isolated offshore reserves can be developed for export.

Growth in the LNG sector has been limited by the huge expense and logistical intricacies of building the supply chain. Big LNG export projects, such as Australia’s Gorgon, can cost upwards of $50 billion.

But despite the cost, momentum is gathering. Increased LNG supply will cause a shift in the balance of world gas trade, with LNG accounting for more than 40% of gas trade by 2035 (see Figure 3). New processing plants are coming on stream in Australia and Papua New Guinea, Russia, Qatar and Nigeria; while import terminals are being developed wherever gas is needed. The UK, which used to meet its needs from now-diminishing North Sea reserves, has opened two import facilities in recent years and now imports a third of its gas as LNG, mainly from Qatar.

Growth in LNG supply was hit by the economic downturn, but is picking up. “Despite lower levels of spending on new LNG facilities, resulting from projects being delayed by the recession, the market is expected to recover and spending on LNG facilities in 2011-15 will total over $93 billion,” says energy consultancy Douglas Westwood. It sees an uptick on the demand side too, reporting a recovery led by Asian consumers: Chinese LNG demand grew from around 1 billion cm in 2006 to 13 billion cm in 2011.

Australia cashes in

Few countries are set to benefit from expanding LNG trade as much as Australia. The country’s massive gas reserves, both conventional and unconventional, would largely be uneconomical to exploit without LNG. Australia has a relatively small local market and has relied on huge, easily accessible domestic coal for power. Meanwhile, the country is too far from the big Asian markets for gas pipelines.

LNG changed everything. Massive offshore conventional reserves and CBM resources in Queensland state are now being fed to export terminals. The Australian Bureau of Agricultural and Resource Economics and Sciences estimated early in 2011 that the country’s LNG exports were set to increase by an average 19% annually over the next five years, reaching 41 million tonnes a year (t/y), or over 56 billion cm, in 2015-16. By 2018, the country could be challenging Qatar (77 million t/y) as the world’s largest LNG producer, according to consultancy EnergyQuest.

Buyers from across Asia, and further afield, have signed up to take supply from a welter of Australian LNG projects. Japanese investors were already participating in Australian projects before the Fukishima nuclear accident prompted companies to seek alternative energy sources in a hurry. Since then, they have signed up for fresh supply, putting new projects on an economic footing.

Demand is being met by a wave of confirmed new projects, including two CBM-supplied projects in Queensland with a combined capacity of over 16 million, as well as expansion of the Chevron-led 15 million t/y Gorgon project based on reserves offshore Western Australia. All three should be operational by 2014-15 and will account for combined investment of more than $70 billion. Other projects will follow, including two more CBM projects in Queensland.

Australia is also pioneering the development of FLNG. The world’s first FLNG production plant was approved by Shell, the developer, in May 2011. Prelude will operate 200 km offshore Australia, tapping 85 billion cm of resources. The gas will be liquefied on board a huge floating-production facility and then shipped to customers. Prelude is expected to produce 3.6 million t/y of LNG, from 2017.

If Prelude FLNG is successful, it may pave the way for a raft of similar projects, although this nascent technology requires bold investors. South Korea’s Samsung Heavy Industries, which is building the Prelude facility, says construction will cost some $3 billion.

Gas’s complex pricing picture

LNG is turning natural gas into a globally traded commodity. A gas shortage in one market can now lead to increased demand for the commodity in a producing region thousands of miles away. That is what happened when Japan went searching for energy supplies following the closure of part of its nuclear capacity in early 2011, after the earthquake and tsunami, causing a short-term tightening of global LNG supply.

But the cost savings of having gas on your doorstep and the big role pipelines will continue to play means pricing in the gas market will not be as uniform globally as that in oil markets any time soon. Gas markets will remain heavily influenced by regional considerations.

This is demonstrated by the disconnect between gas prices in North America and those in Europe. In the US, abundant domestic shale gas has supplemented existing conventional supply to suppress wholesale prices, while European prices are pushed higher by reliance on dwindling North Sea resources and expensive piped supply from Russia and elsewhere outside the EU. LNG provides diversity of supply, but producing and shipping LNG is not as cheap as consuming local reserves, so LNG imports will remain more expensive – although prices fall in periods of over-supply.

These factors contribute to a disparity that resulted in Henry Hub, the benchmark price for US gas trading at around $4.0-4.5/million British thermal units (Btu) in mid-June 2011, while the UK’s NBP benchmark was trading at around $6/million Btu.

The difference between US gas prices and those elsewhere have made it attractive for US producers to consider exporting production, prompting the US government to relax export rules and pave the way for the development of LNG export terminals in the US.

Upward pressure on gas prices will build as the gas glut – caused by over-supply when demand slowed dramatically during the global recession – gradually unwinds as economic expansion resumes. The IEA expects the glut to have dissipated by 2015, although the impact and timing will vary from region to region.

Gas pricing is further complicated by its continuing link to oil prices, which dates back to the days when the two fuels were more interchangeable as power-generation feedstocks than they are today and when gas was produced more as an associated product of oil production rather than being deemed worth looking for in its own right.

This persistence of this link means that when oil prices rise, upward pressure is still exerted on gas prices even when oil supply is tight and there is gas glut. While this linkage is becoming more tenuous, it is still there, especially in Asian markets, such as Japan, where a component of gas benchmark prices is derived directly from crude-oil benchmarks. According to the IEA, around a fifth of global gas trade is indexed to oil – around 500 billion cm in the OECD region, which includes continental Europe, Japan and South Korea: and 150 billion cm in the non-OECD countries.

“The appropriateness of oil-indexation in Asia-Pacific may be questioned in the future, in particular for the fast growing power sector, where oil is disappearing rapidly as an energy source,” the agency notes.

The link seems to be weakening in the US, where, in mid-2011, the oil price was more than four times that for gas producing the same amount of energy. Oil and gas had been similarly priced until their prices started to diverge in 2006, around the time when US domestic gas production started expanding rapidly.

In North America, the UK, Australia and parts of continental Europe, gas prices are determined by the market, which exposes buyers to price volatility – although consumers are protected from unexpected price swings to an extent, as much of the world’s gas is provided under long-term supply contracts. Nevertheless, as with oil contracts, gas contracts increasingly contain a variable element, based on price fluctuations across the length of the contract.

Price fluctuations are also being smoothed out by the development of gas-storage capacity worldwide, which enables consumers and traders to tap gas acquired cheaply at a time when the market is tight. 

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