Tightness Remains, but Interactions Grow in the World Gas Market
As we entered 2007, the gas world was in crisis mode. A year earlier, Gazprom temporarily reduced supplies to Ukraine, and in December 2006, Europe feared a similar gift for its New Year’s celebrations. Negotiations with Belarus, however, were successful and the crisis never came. In fact, the whole year was almost crisis-free. The trends in 2007 would not make headlines or force public dialogues; but they were important in elucidating the dynamics that will define the gas business in the next five to ten years.
On the supply side, Equatorial Guinea and Norway joined the ranks of the world’s liquefied natural gas (LNG) exporters, just as Gazprom finally picked partners for the Shtokman project in the Barents Sea. But the overall supply picture remained grim. More than a dozen LNG projects were originally scheduled to reach final investment decision (FID) in 2007, but only three did: Angola, Peru (technically in December 2006), and Pluto LNG in Australia. Projects were delayed for three reasons.
First, engineering, procurement and construction (EPC) costs have gone up across the board. The costs for Snøhvit, to give one example, rose to around $9.6 bn, up 50% from initial estimates six years ago. Companies have hitherto believed that cost increases were unique to them; in 2007, it became clear it was a broader problem. Commercialization options such as gas-to-liquids (GTL) suffered from cost inflation as well – so much so that it is questionable whether large-scale GTL has a future outside Qatar.
The second cause of delays was politics. Iran and Venezuela, two countries with gas export plans always on their drawing boards, were unable to persuade companies to confirm investment. Gazprom’s entry into the Sakhalin-2 LNG project through a heavy-handed approach created a heightening of investor distrust, though most companies are still keen to invest in Russia. And security in Nigeria was just as detrimental to its gas export ambitions.
The third problem for export projects was that more and more countries revisited an old gas debate – how much should they export and how much should they allocate to the domestic market to spur economic development. In Egypt, Qatar, Indonesia, Nigeria, Trinidad, and Algeria, governments want to allocate more gas to the domestic market to power and diversify their economies. Even Canada is seeing domestic gas demand grow to support unconventional oil production. Exporting is no longer the default choice for the world’s largest gas exporters.
As supply is becoming more constrained, demand keeps growing as we prepare for a carbon-constrained world. Warm weather led to consumption reductions in Europe, though demand increased in both Asia and North America. Gas demand in Japan grew, especially after the accident at the Kashiwazaki-Kariwa nuclear facility. The “LNG wave” into the US market finally came, though later than anyone expected due to the surprisingly strong response by US gas producers. According to the Energy Information Administration, LNG imports into the US rose by around 35% in 2007. Even smaller gas markets, such as Brazil, Mexico, and Chile, see LNG as a necessary supply source, adding pressure to a tight market.
It is China and India, however, which can really add to gas demand. Competition from coal has traditionally hindered gas demand; but in 2007, India and China turned to the spot market to supplement long-term deliveries, and both are showing a willingness to pay higher prices to get long-term supply, even as their own domestic supplies seem larger than hitherto imagined. In this respect, 2007 was a turning point for China and India’s gas markets.
Underlying this new supply and demand dynamic, however, is a changing market. In April 2007, the world feared the emergence of an organization similar to OPEC, though such fears proved unjustified and the words of those who cautioned that such a tool would be toothless anyway seem right for now. But the terms under which gas is traded are changing. Liberalization in Europe is leading national oil companies (NOCs) to move downstream and capture increased value for their hydrocarbons. Gas continues to trade at an energy discount to oil, just as it is entering new markets like transportation, especially in Asia and Latin America. And the re-entry of the US into the LNG market as a major buyer is forcing greater interaction.
The new gas map is all about interaction: the interaction of basins with different business traditions, competitors and pricing structures; the interaction of geopolitics, market dynamics and competitor strategies that can push back or bring forward projects in unexpected ways; and the interaction between gas and other fuels that will govern the long-term position of gas in our energy world. If 2007 taught us anything, it is that the gas world is complex.
Key Messages:
As we enter 2008, indications are that this complexity will grow. Dominant producers will increasingly use commercial and political leverage to force higher prices, while buyers will see maximum optionality to ensure security of supply. As a fuel of choice in a low-carbon world, gas has an attractive future; but only if the growing costs and risks of supply can be balanced by increased market demand and regulatory certainty.
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Lew Watts is the President and CEO of PFC Energy. For further information on this article contact Enews_lwatts@pfcenergy.com.