Gas price sinks, even as appetites change, as market shifts towards glut

02 August 2016 Consultancy.uk

The price of gas has, much like the price of oil, plummeted in recent years – falling to around $5 per mmBtu in Europe and Asia. The break even gas price for current and future projects stands at around 7.20 per mmBtu, suggesting that the sector is in for a rough ride. According to a new study, market conditions – even with an upturn in demand – are unlikely to see strong uptick in gas prices as a glut approaches.

The fall in the price of oil has had a dramatic effect on a range of industries and governments, with those dependent on the sale of the liquid finding themselves rapidly descending into the red. While the price of oil has picked up from recent lows, from lows of less than $30 at the start of 2016, the market is a long way from profitability for all but the most cost effective suppliers.

While the price of crude has in recent months garnered considerable global attention, the price of natural gas, which has also plummeted in price, has been less widely reported. In a new study by Strategy&, titled ‘Navigating the transformation of the gas market’, the consultancy firm considers the current natural gas market and a projection for its mid-term future.

Impact of regional trends on gas prices

Slashed prices
The price of natural gas has seen wild swings in recent years on three of the major global transfer hubs, the Dutch Title Transfer Facility, the UK National Balancing Point and the Japan Korea Market. The causes differ per hub. The Japan Korea Market for instance, saw a massive spike in the price of gas due to the closure of all of Japan’s nuclear reactors following the incident at Fukushima. Demand in the region remained relatively high until 2014, when, following the collapse in oil price, the gas price too plummeted.

In Europe a number of factors, including the high oil price, saw gas prices creep up to around $8 mmBtu, although spikes following an exceptionally cold winter in 2012 and a technical fault drove prices up briefly. The region also saw significant softening of the price following the drop in oil price. The US exchange has been isolated from the relatively high prices of Europe and Asia, although it too has seen a significant fall in gas prices since 2014.

Global LNG breakeven price by source

Making ends meet
The effect of the low gas prices may have considerable effect on the sustainability of a range of operations exploiting reserves. While Qatar is able to break even at less than $2 per mmBtu, the average breakeven price for the exploitation of gas reserves stands at $7.2. The implication, for many of the not yet sanctioned projects as well as a large number of sanctioned ones – most notably the shale gas boom in the US – the current price of natural gas, at $5 per mmBtu in Europe and Asia and $2.5 per mmBtu in the US, is that difficult sailing is ahead for a range of companies.

Global upstream gas capex

The effect of the reduced gas price environment is already seen within upstream gas capex, which dropped by around 16% between 2014 and 2015. The projection for capex into the sector for this year stands at around $150 billion, down 36% on 2014 when it stood at around $220 billion.

Future scenario
The current market conditions are, according to the firm, unlikely to see significant improvements over the coming decades. Four major trends are set to keep prices low, even while demand continues to increase for less environmentally damaging fossil fuels and policy shifts towards an almost completely decarbonised economy by 2050.

The research shows that demand for natural gas is increasing, even on the back of relatively low global economic growth. According to the firm’s analysis, Asia will continue to see the highest level of growth to 2035, where transportation requirements are set to increase by 200%, while demand from utilities will increase by 56% and demand from industry by 42%. Gas emits around 50% less CO2 than coal and around 30% less than crude, making it a considerably more attractive transition fuel towards a decarbonised economy. However, increased demand from utilities and transportation is unlikely to see the price of the gas rise considerably, as three forces continue to push prices down.

Convergence of forces affecting gas prices

One of the main considerations is that many long-term gas contracts are indexed to oil prices – which continue to be relatively low. If the prices stay where they are, then the knock on effect will continue to be felt for gas. According to the firm, even if the oil and gas contracts are decoupled, low oil prices may continue to hinder gas prices psychologically.

The oversupply of gas is another growing issue for long term price levels. New suppliers are coming online, while Australia is about to surpass Qatar as the world’s largest producer. Gas exports from the US will continue for some time yet, even if they are untenable in the long term. The effect is, according to JPMorgan estimates, that supply is set to increase by 8% per year while demand increases will stay at around 4%.

The trade of natural gas through trade hubs is also set to increase, creating considerably more global competition, which in turn, is set to see prices homogenise. According to the firm, “This evolution in global trading is producing more natural gas liquidity, price transparency, longer-term forward contracts, and gas-on-gas competition, which ultimately reduce contractual risk and facilitate hedging. In short, by globalising the LNG market, these hubs could increase commoditisation.”

For upstream companies, the firm has several recommendations, summed up by Andrew Clark, an oil and gas and chemicals advisor for Strategy& and a Partner with PwC UK, who explains that “With a growing glut in globally tradable LNG, all industry players — buyers, sellers, traders, and governments, to name just a few — will need to adjust their operating models. They should expect lower prices, more short-term trades, and demands for contractual flexibility. The right strategic response will vary from one player to another, and there is a great deal of risk and uncertainty. But any company in this industry can succeed by carving out a focused value proposition and developing the capabilities to deliver it.”

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