Prepare for the global gas tsunami

23 Sep

Global gas markets will be transformed in the next years, and this will affect Europe as well. This transformation will start on the liquefied natural gas (LNG) market and this post focuses on how the market has functioned so far and what events might turn it upside down.

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LNG today

The transportation of natural gas – compared to crude oil – is burdensome and costly. Building pipelines demands time, money and political risk-taking. In addition, connecting all the gas producing countries with the consumers by pipeline would simply be infeasible… The other option is liquefaction: under high pressure and low temperature, natural gas becomes fluid. This way it can be transported with tanker ships around the globe. This option needs infrastructure as well: a liquefaction plant, special tanker ships and a regasification LNG import plant at the place of consumption.

Liquefaction made it possible for some countries to become major gas consumers: where there is not enough domestic gas production and it’s costly to build pipelines, LNG is the only viable option. Such countries are Japan (importing LNG since the 70s), South-Korea and to an increasing extent China. Growing demand attracted a number of countries to enter the LNG market, such as Qatar, Malaysia or Nigeria.

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Global LNG trade in 2014. Source: BP

Global LNG trade in 2014 was 330 billion cubic meters of gas. 200 bcm of this was both produced and consumed in Asia. In essence, most of the European countries count on LNG only in an emergency situation: if there is any problem with pipeline gas, they can import LNG.

The Anglosaxon gas tsunami: emerging LNG exports from the US and Australia

The US imported was still an importer of LNG in 2011, it imported some 10 bcm (which is around the whole Hungarian gas consumption). Between 2016 and 2019 however, the US will become the world’s largest LNG exporter. No one expected this happening a couple of years back and this is giving a huge push for the transformation of global gas markets.

This change of role in the US is primarily due to the shale gas revolution. This new technology has made it possible to produce a lot more natural gas (see our previous post). LNG import terminals became unnecessary and new supplies lowered the price of gas on the domestic market. In addition, prices in East-Asia skyrocketed after 2010: the price of gas in the US was USD 150 per thousand m3, whereas in Japan USD 400-600. Prices in Europe also increased to around USD 300-400. This obvious arbitrage opportunity was quickly recognized and companies started building infrastructure to export natural gas to high-price high-demand East Asia. And the US had another advantage: it was easy and cheap to turn LNG import terminals into export terminals.

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The prices of the three natural gas markets diverged after the 2008 crisis, and the European and East-Asian met again after the oil price decline last year. Source: Bloomberg

But it was not the US alone who bet on exporting gas. Australian gas exporters started building infrastructure already in 2008 – so by far before the US. They drilled rigs in the middle of the country, installed pipelines thousands of kilometers long to the sea and there built liquefaction plants in the middle of nothing. All these with high-costs and significant cost-overruns. Moreover, building their terminals took quite long, 6-7 years, so they will be operational just when (partly due to the oil price decline) Asian prices are already down and US terminals are also about to start production.

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Approximately 160 bcm new LNG export capacity will come online between 2016 and 2019: around half of it in the US, the other in Australia. This increases global LNG supply by 50%. Once construction has already started, projects are costly to shut down: prior investment is sunk cost, and they would not have the option to make profit if prices increase again later.

Now the biggest question is who will buy this new gas.

Failing demand

High East Asian prices were caused by the gas appetite of China and other Asian countries: they needed more and more gas and they were ready to pay even a high price for it (LNG prices were usually indexed to oil, just like in pre-crisis Europe).

But by now, prices started plummeting due to the decline in oil prices, the increase in supply and to failing demand: the pace of Asia’s gas demand increase has become much more uncertain.

The biggest question is the economy of China. The official 7% yearly GDP growth still looks good, but most likely it is fabricated. Both real indicators (for example the drop in country-wide power consumption) and the current money market weakness show that such high growth cannot be sustained. Smaller GDP growth (maybe recession) will lead to smaller demand for LNG – or at least demand growth will be smaller than it was previously predicted.

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Demand growth for LNG in the next 5 years: high uncertainty, we are more on the pessimist side. Sources: IEA, PIRA, own calculations

Another factor is that a couple of years ago the market sentiment was that most of the emerging economies in Asia will switch from coal to gas in power generation to reduce CO2 emission. This is a political decision: is it worth building and operating a more expensive gas power plant so that citizens would live in a less polluted environment? For long, China’s answer seemed to be a definite ‘yes’; however, due to decrease in the price of solar panels today it is far from certain that they would switch from coal to gas.

Japan is planning to turn on its nuclear power plants again after shutting them down due to the Fukushima disaster. They switched back on only one so far, and it is unsure when next ones will be ready. The faster they succeed, the less LNG the country needs, decreasing global demand for LNG.

Even if China avoids an economic downturn, there will be no demand for the 50%+ new LNG (assuming current prices).

Market mechanisms in action

If there is a lot of new LNG on the market and there seems to be no demand for it, the price of LNG will decrease. Low price will either lead to producers shutting down production or increased demand for LNG. Since the operational costs of an LNG terminal are rather low and therefore supply will keep up, it is more likely that increased demand will balance the market. The most obvious new demand is European gas power generation (these power plants have been idle for long due to depressed electricity prices). This will happen only if the price of gas drops further; or the increased price of CO2 emission makes coal generation more expensive. Cheap gas can also speed up switching from coal in Asia. Apart from these two places, however, there are no more places where LNG can go in the short run due to insufficient import capacities.

In the next five years, we expect a strong downward pressure on Asian and European LNG and natural gas prices.

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