Time for a gas Opec?

21 April 2010

Falling gas prices have revived interest in a gas producers association

Liquefied natural gas (LNG) has been hailed as the catalyst for the development of international gas markets. Over the past three decades, the sector has grown from a niche industry into a major contributor to global energy supplies.

Countries around the world have rushed to build re-gasification terminals that allow them to import LNG from diversified sources. But as a wave of these projects came on stream in 2008, the global economic recession caused the supply-demand balance to swing from shortage to surplus. Prices fell accordingly.

But while the recession has dragged down demand for LNG in the US and Europe, it appears has not resulted in a reduction in global production.

Worldwide production

The oversupply situation has been caused by a combination of factors: An increase in US and Canadian gas production due to increased production from unconventional sources; Reduced demand for natural gas caused by the recession; And a surge in LNG supply coming on stream from new projects sanctioned in the early part of the century.

According to US-based LNG industry tracker Waterborne Energy, global LNG production increased to 183.6 million tonnes in 2009, from 173.4 million tonnes in 2007. Its forecast for 2010 production takes the figure up to 237.6 million tonnes, an increase of 29 per cent on the previous year.

LNG global production in 2009 increased to 183,549,000 tonnes, from 173,372,000 tonnes in 2007

Waterborne Energy, LNG industry tracker

Most of the estimated 54 million tonnes that is projected to come on stream in 2010 will come from the Middle East. The majority state-owned QatarGas III and IV projects producing 7.8 million tonnes a year each from July, and the Yemen LNG project, operated by France’s Total, 3.3 million tonnes a year from May.

New markets

Asia’s emerging economies are expected to take up much of the slack from the recession, absorbing millions of tonnes a year of the newly installed LNG capacity. Volumes previously earmarked for Europe and the US have been diverted eastwards to service China, India, Korea and Japan.

The shift has taken time, but since the beginning of 2010, Asia has shown a greater appetite for Middle Eastern LNG. India demonstrated the potential of its growing demand with the visit of Qatar’s Energy & Industry Minister Abdullah al-Attiyah to New Delhi at the end of March.

India currently imports 7.5 million tonnes a year (t/y) from Qatar under a long-term contract with Qatar’s RasGas. But the Gulf state has committed to increasing shipments by 4 million t/y. By 2011, India will receive 8.5 million t/y, increasing to 11.5 million t/y by 2014, putting it almost level with China, which is expected to import 12 million t/y also by 2011.

No one will reduce production for the reason there are no assurances everyone else will

Jonathan Stern, Oxford Energy Institute

India is at the top of Doha’s agenda, Al-Attiyah told delegates at the International Energy Forum in Delhi in January, where he held talks with India’s Petroleum Minister, Murli Deora.

Prices may prove a sticking point, however. New Delhi has been reluctant to increase its reliance on contracted Qatari imports, preferring to service immediate demand with on-the-spot deals. With a global LNG supply glut, spot prices have collapsed. Meanwhile, oil prices have risen above $80 a barrel in 2010 leaving deals on the open market significantly cheaper than the oil-formula-based contracts proposed by Doha.

While India is keen to negotiate a fixed price, Qatar wants to base prices on a crude oil formula, specifically between 13.5 and 15.5 per cent of the Japanese government’s energy benchmark, the Japan customs-cleared crude (JCC) price.

Between January 2004 and January 2009 Indian state gas firm Petronet was paying RasGas $2.53 a million British Thermal Units (BTU) for its LNG. Since 2009 it had been gradually moving towards a JCC-based formula.

To accommodate the additional 4 million t/y, Petronet is building a new LNG receiving terminal at Kochi and state power firm Dabhol’s
second terminal at Gujarat. This will increase the country’s degasification capacity to 20 million t/y by the end of 2012 from 7 million currently.

“I do not expect India to need as much gas from Qatar as they have said. They will take the 7.5 million tonnes already agreed and a little bit more,” says Jonathan Stern, director of gas research at the UK’s Oxford Energy Institute.

“For now, all the new LNG from Qatar will have to compete with domestic Indian gas production, which is priced at about $4.30-4.45 a million,” he says.

India’s negotiating position is relatively strong. Qatar’s enormous LNG carriers are being diverted from the US, where prices are based on the Henry Hub gas index, which averaged $4 a million BTU in April.

Spot prices in the Atlantic market for LNG are below $4 a million BTU and $4.5 a million BTU in the Pacific, according to Stern.

There are few other countries for Qatar to turn to who have invested in receiving terminals, and have the domestic demand to absorb its volumes.

Qatar’s gas producers, however, forecast a fast economic recovery and subsequently stronger demand by at least 2015. They will not want to be tied into lower priced contracts for the sake of easing short-term pain.

Gas cartel

As with all market-traded commodities, gas prices are cyclical. From 2006 to 2008, LNG sat at the top of the cycle with prices above $14 a million BTU and massive investments in new production. With prices falling below $4 a million BTU in 2010, reducing production would appear to be the only way to firm up prices.

But having invested billions, producers will be loath to close the taps.

“No one will reduce production for the simple reason that there are no assurances that everyone else will reduce production. Producers have spent hundreds of billions of dollars on developing their capacity,” says Stern.

Whenever the gas industry sits at the bottom of the cycle, the prospect of a gas producers’ cartel raises its head.

At the Gas Exporting Countries Forum in the western Algerian city of Oran in mid-April, Algerian Energy & Mines Minister Chakib Khelil proposed that member states work together to regulate prices. The idea of an Organisation of Gas Exporting Countries (Ogec) – mirroring the petroleum cartel, the Organisation of Petroleum Exporting Countries (Opec) – was first floated by Russian President Vladimir Putin in 2002, but has since faded.

While Khelil has put this back on the agenda, whether the cartel is taken up seriously by key countries in the gas sector is unlikely.

“I am sure the Iranians will be delighted by the prospect of a gas Opec, but they don’t export any LNG and far off being able to develop it”, says Stern. 

Qatar, Russia, Algeria and Egypt  would be key to a gas Opec, but to proceed the industry will need to see serious proposals on production cuts, by how much and over what period.

“I tend to retreat into economic theory whenever this comes up,” says Stern.

“Cartels form when prices are low and producers feel they have to stick together. Expect some movement, but we are very far from a gas Opec.”

There are key differences between the oil and LNG markets, Stern explains, with oil transported by pipeline and LNG by ship. Then there are the long-term contracts and spot market, each with their own dynamics.

“This is LNG in a pipeline market and they have nothing in common”, says Stern.

Producers will have to bear the pain of low prices for some time. Most economists do not expect LNG prices to recover before 2012, depending on the pace of economic recovery. Rising energy demand may come in 2011, but producers will have to wait while LNG surpluses are eliminated before prices will increase. Increased exports to China and India will also have to wait until at least 2012, as imports will be constrained by receiving and regasification capacity limits.

“If you are really optimistic, then 2012 could be a good year, but we are forecasting that up to 2012 it will be grim,” says Stern.

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