Operating models are the key to gas success
Global gas demand is certain to increase but exact predictions are impossible—so an end-to-end operating approach is required
Projections from some of the most reputed international energy organisations incorporate a 40-60pc growth in global gas demand by 2040, from c.3,750bn m³ today, to anywhere from 5,400 to 6,000bn m³. But what if those projections fall short of the true potential for gas growth?
At EY, we have tested the numbers in our Fueling the Future initiative, to help our clients understand the opportunities in the energy future in a quantitative way. Global gas demand in our baseline scenario will be 5,800bn m³ by 2040, towards the higher end of the consensus. At a conservative 5pc annual decline rate, that means 4,450bn m³ of new gas supply will be needed by 2040, around 120pc of the current supply base. However, we believe there is significant upside.
There is considerable potential in the push to electrify the developing world. If gas holds its share of the market—and that is a conservative projection because we know it will grow on average worldwide given its availability and low-carbon nature—in 20 years 85bn m³ of annual gas demand would have been added for every 0.1pc that the world economy grows more than expected. As a frame of reference, that is the current gas demand in Germany, or 20pc of the global LNG market today.
Furthermore, when it comes to power generation choices, nuclear power would seem to be an obvious way to bring energy to market without emitting CO2. Our baseline scenario assumes nuclear power generation will grow at 2pc per year. As nuclear seems to head for a global deceleration, if it were to fall by 2pc/yr in 20 years instead, 165bn m³ of annual demand would have been added. That is 1.5 times Japan’s gas demand, or 38pc of the current global LNG market.
It is the choice of the operating model today that will determine success in the future
Coal is the fuel of choice in key areas of the developing world. For the world to stand any chance of meeting its climate change goals, coal consumption must fall dramatically. Our baseline scenario assumes that coal generation falls, but if it were to fall 5pc/yr as in our most aggressive scenario, that translates to 435bn m³ of additional demand by 2040, which is almost the size of the Russian gas market or 100pc of the global LNG market today.
Much is being debated about whether gas will compete with renewables to electrify the world. We believe that, at least until 2040 if not beyond, the debate is moot. The International Energy Association (IEA) projects that gas will grow its share in the global primary energy mix from 22pc to c.25pc in 2040, even as renewables grow even more, from 10pc to c.14pc.
Gas’s enormous growth potential has not gone unnoticed, of course. Most IOCs and NOCs have significantly upgraded the importance of gas in their strategic plans, and therefore increased its share of their internal capital allocation. Gas investments could well exceed $400bn through 2040, with LNG projects underway for over $200bn, that would add 600mn t/yr to the global LNG liquefaction capacity over the next six years to the current capacity of 400mn t/yr.
As a result, most IOCs realise that gas, already a significant part of their hydrocarbon mix, will only grow. Many of them have realised they are in a race to establish a foothold in the global gas and especially LNG market, as the key subjacent for macroregional price formation dynamics and arbitrage opportunities. Their entry is starting to change the fundamental nature of the gas business, adding complexity and progressively a more generalised upstream merchant development approach. This will increase the commodity exposure, and volatility. That will attract traders and aggregators willing to take advantage on the increased volatility, both in exchange for expected higher returns. Leading analysts estimate that the IRR of gas and LNG investments will be on par with those in oil.
In this increasingly crowded, more complex and sophisticated gas market, it is the choice of the operating model today that will determine success in the future. Traditionally, IOCs and NOCs have approached their oil business ‘upstream-down’. That worked with gas before, but moving forward, the key to handling complexity and optimising the value of the gas assets is sophistication and flexibility at a much more micro level than before, driven ultimately by demand and consumer dynamics.
An end-to-end operating approach is required, changing fundamentally the traditional internal economic incentives and hierarchy of decision-making within the gas value chain of the company. As a result, knowing where to play, both in the value chain and geographically will be key, and not as obvious as before. The once solid fully-integrated models and dedicated upstream-to-shore, border or hub in the past, could be disintermediated in the future by agile aggregators who thrive in a market of increased volatility and liquidity, aided by technology, data and low-cost digital platforms.
This might eventually lead to the need for value-based products and services around customer needs beyond the hub. Way beyond the traditional comfort zone of many majors, it can help them in closing the low carbon transition loop, capturing opportunities to step into the traditional power and utilities turf and customer base, but only if they get the model right.