EU GAS MARKETS Oil & Gas Prices: A temporary separation or divorce?
SPOT GAS PRICES weakened significantly in 2009 and the first half of 2010, relative to oil prices, reflecting two revolutions on the supply side: the surge in LNG capacity, which will see liquefaction capacity growing by 47% between end-2008 and end-2013, and the unexpected boom in unconventional gas production in North America. With demand for gas dropping heavily in the face of recession, a sizable glut of gas has emerged. Gas demand is expected to recover in 2010, but less rapidly than oil demand, which is being driven mainly by China and other large non-OECD economies that tend to be much less dependent on gas. The result of this gas-market imbalance is that a large
and unprecedented gap has opened up between the prices prevailing in the competitive markets of North America and UK, on the one hand, and those in Continental Europe and Asia-Pacific, where gas prices remain largely indexed to oil prices under long-term contracts, on the other. In 2009, the spot price averaged US$4 per million British Thermal Units (MBtu) at Henry Hub in the US and US$5/MBtu at the National Balancing Point in Britain, compared with around US$9/MBtu in Japan and continental Europe. This regional gas price de-coupling is already putting
pressure on buyers of gas under oil-linked contracts in Europe to seek changes from their suppliers to their pricing terms – a development that the IEA predicted last year. Gas buyers are caught between their long-term contractual obligations and the pressure from their customers, in particular industrial, to supply gas at more competitive prices. Russia’s Gazprom has already granted some important concessions on pricing, partially moving from oil to spot gas price
indexation over a three-year period, with prices falling as a result in key markets like Germany. This has led to a narrowing of the gap between spot and contract prices in Europe. Take-or-pay clauses have also been eased, giving more flexibility to buyers as to when they are required to lift contracted volumes. The 64-million-dollar question now is: what will happen to the traditional oil-gas price linkage on European continental (and Asian) markets? The suppliers claim that recent pricing concessions are merely temporary. Whether the use of spot gas price indexation remains beyond the three years, and is extended to other contracts, or traditional oil indexation fully returns will depend on the global supply/demand balance and on the evolution of the gap between the different spot and oil-linked prices. For as long as the gas glut persists – and IEA analysis suggests it will for several years – the pressure to move further away from oil indexation will remain, especially for new long- term contracts. Ultimately, full contractual de-coupling between gas
and oil prices could occur, were sufficient momentum to build, though the dynamics of inter-fuel competition are likely to ensure a continuing degree of correlation between fuel prices. Contractual price de-coupling would not necessarily mean weaker gas prices in the longer-term: as the gas glut gradually dissipates, gas prices are likely to come under renewed upward pressure relative to oil prices, with the rising cost of supplying gas from remote and difficult locations. World Energy Outlook, November 2010
there is certainly going to be some resistance to renegotiating these clauses. This resistance will introduce some inertia in the system as importers with large portfolios of oil-indexed contracts will need to convince the producers to open up these contracts, requiring them to provide up-front compensation for making any change. As the incumbents found when the UK was liberalising its gas market, such compensation levels can be substantial. The main question remaining is: have the
been increasing moves to gas-on-gas pricing, with northern European gas hubs beginning to improve in terms of liquidity. It does seem as if we may have
finally arrived at a tipping point at which European gas finally starts
major downstream importers arrived at a place where there is a commercial necessity to renegotiate their portfolio of long-term contracts? Specifically, given the importance of Germany as the natural focal point for a continental gas market, is E.ON Rhurgas, the country’s largest importer (about a 50% market share), ready for contract renegotiation from a position of weakness? To summarise, the liberalisation of the German gas market has
started to erode the market power of the incumbents, although the process is far from complete. The lack of enough new entrants, due in part to complex third-party access rules, is one of the main reasons the wholesale market remains underdeveloped. A necessary condition for more widespread gas-to-gas pricing
competition is the emergence of liquid gas spot markets. These are needed to provide an alternative pricing point for long-term contracts with some form of indexed pricing and to provide a basis on which to structure and price forward contracts. There have
... we may have finally arrived at a tipping point at which European gas finally starts to be priced in relation to its own supply and demand fundamentals
to be priced in relation to its own supply and demand fundamentals, although the process is likely to be gradual through the increasing of spot exposure into the indexed contracts. What still needs to happen is the evolution of a more effective and liquid gas market in Germany. •
The following is an excerpt from European Gas Oil – Indexed Link, The Long Goodbye from Barclays Capital, (27 October 2010).
By Trevor Sikorski.
www.barcap.com
December 2010 45
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