“triple whammy” in - global lng hub · “triple whammy” in global pricing for natural gas:...
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“Triple Whammy” in
Global Pricing for Natural Gas:
Practical Implications
Energy Dialogue IMEMO RAS
October 24, 2017, Moscow
Sergei Komlev Head of Contract Structuring and Price Formation Directorate
Gazprom Export*
*Views expressed in this presentation are the author’s sole responsibility
and do not necessarily represent that of Gazprom Export
© ZMB 2
Statements to be Made in This Presentation
Time has come to evaluate results of the buyer-side efforts to impose pricing mechanisms based on supply and demand instead of the traditional forms of pricing in Europe and Asia, which have proven their efficiency. “Gas should be priced at a price of gas and not that of oil/oil products”, say critics of oil-indexation in the LTCs.
Despite all the attempts to change pricing paradigm, global gas prices are still a reflection of scarcity of oil rather than gas both in Europe and Asia, while in the USA a linkage to oil reinstated itself in an exotic way over a course of shale gas revolution.
Although a strategic goal of putting supply and demand instead of oil in a driver seat of the natural gas price developments was not achieved, reforms created the malfunctioning hybrid pricing mechanisms. Still dependent on oil, hubs make a situation with low oil prices even worse. Hub prices do not represent real value of natural gas and leave investment projects in the industry out of money, thus creating a risk of missing the next investment cycle.
Producers and exporters of gas should come to common assessment based on an unbiased analysis of the problem and work out practical measures to resists negative trends in pricing.
© ZMB 3
Natural Gas Market is the Only One of its Kind:
Three Special Features
There are three main features of natural gas as a commodity which require special attention:
• Market prices of natural gas are set up by two forms of competition – gas-on-substitute (interfuel) and gas-on-gas competition. No other global commodity is characterized by this duality.
• LTCs play a leading role in the global natural gas supply and here to stay for years ahead, while a move to exchange-based pricing in other commodities is associated with elimination of the long-term contact arrangements or their radical transformation.
• Simultaneously functioning different pricing mechanisms in natural gas have direct effect on hub price, making it a hybrid product both on macro and micro level.
Assessment of these specific characters of natural gas as a commodity represents not only an academic interest but has sensible practical business-related implications.
© ZMB 4
Competition with Other Hydrocarbons Locks Natural Gas in
Price Envelope
4 Source: Shell Source: Shell
© ZMB 5
Interfuel Competition at Work: Oil Price Sets a Resistance Level for Natural Gas Prices
•
Source: BP, Gazprom Export
© ZMB 6
Interfuel Competition at Work: Coal Price Sets a Support Level
for Natural Gas Prices
•
Source: BP, Gazprom Export
© ZMB 7
Depressed NA Natural Gas Prices are Competitive with
„Expensive‟ Grades of Coal Only
* Coal and natural gas prices compared on an equivalent energy content and efficiency basis
© ZMB 8
Special Arrangements are Required for Gas to Outcompete Coal
4
35 98 141
106 157 204
194 221 240
247 214 155
250 230 195
227 189 165
247 214 155
181 104 57
121 170 38
0
100
200
300
400
500
600
US
D /
mcm
NBP actual price Switching price
0
100
200
300
400
500
600
US
D /
mcm
NCG actual price Switching price
NBP compared to UK coal-to-gas switching price
NCG compared to German coal-to-gas switching price
Sources: Argus, Platts, IEA
*NBP day-ahead **NCG day-ahead
© ZMB 9
Interfuel Competition at Work: Gas Price Corridor Width is Determined Mainly
by Oil Price Volatility and Stretched from Nearly Zero in 1988, 1995 and 1998 to 12
USD/MMBTU in 2013
9
Source: BP
Source: BP, Gazprom Export Source: BP, Gazprom Export
© ZMB 10
Asian Market: Two Simultaneously Pricing Mechanisms
Represents Represent a “Toxic” Hybrid Structure There are two pricing mechanisms simultaneously functioning in Asia. Asian supply is still dominated by oil-indexed LTCs (Slide 11). Hubs in Asia are in the stage of initial formation, but there is OTC trading. The Platts’ Japan Korea Marker (JKM) index serves as proxy for the price of spot LNG trades.
Over the last five years there were upward and downward movements of the JKM depending upon supply and demand conditions in the uncontracted segment of the market. The JKM index tends to be higher than the Japan LNG price index in winter and then lower in summer but is still correlated to baseline LNG oil-indexed (Slide 13).
That kind of behavior does not make JKM a trusted price benchmark for the whole Asian market but only for its small segment represented by spot trading. As such it overreacts to minor, even “homeopathic” imbalances (Slide 14).
According to our estimates, an oversupply of 3 bcm was enough to cause a dramatic collapse of the JKM index in March 2014. Gas exporters should be extremely cautious in dealing with that excessively volatile market segment and its proxy index.
© ZMB 11
Pricing Mechanisms in Asian and Asian Pacific Gas Consumption
Pricing Mechanisms in Asian and Asian Pacific Gas Imports
Source: IGU
Oil-indexed contracts Gas-on-Gas Other Oil-indexed contracts Gas-on-Gas Other
Asian Markets are Still Dominated by Oil Indexes which Set
Baseline Trend for Spot Trades
© ZMB 12
Asian Demand is of Seasonal Nature
Source: PIRA
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JKM Prices are Highly Volatile: Could Drop 220 mmcm below and Surge
100 mmcm above the Baseline Trend Set up by Oil Indexed Import Prices
Source: JKM, METI
© ZMB 14
Asian Markets: Hub/Spot Prices do not Reflect Demand-Supply
Fundamentals when the Market is in „Oversupply‟ or in „Undersupply‟
Source: Compass Lexecon
© ZMB 15
Spot Prices in Asia Collapsed in March 2014 Due to Insignificant
Supply/Demand Mismatch in Uncontracted Segment of Market
Source: Bloomberg, Cedigaz, IHS, METI
0
5
10
15
20
25
JKM Japanese LNG Import Price
$/MMBTU
Gas Consumption in Asia
50,3 47,4
0
200
400
600
800
2013 2014
Bcm
Spot and Short-Term Trade* in Asia
* Contracts of a duration of 2 years or less
© ZMB 16
European Gas Market: Over-Contracting and Price Degradation in Place
• There is strong evidence that hub prices in Europe are still dependent on oil indexes, meaning that even now they are driven mainly by the fundamentals of oil market. This casts doubt on the conclusion of the last IGU Price Survey which points to nearly complete OPE mechanism elimination in Europe and NWE especially (Slide 17). According to Gazprom export estimate, oil and quasi-oil indexation still maintains its prevailing role in European gas pricing (Slide 18).
• That means that hub prices of gas are the derivatives of oil prices. We expect them to be within a corridor of USD45-55 per barrel in the foreseeable future, which equals to the breakeven costs of US shale oil. Gas/oil linkage is not a problem as such, the problem is an unjustified discount of gas to oil prices.
• LNG deliveries to Europe taken full costs of liquefaction (from USD3.3 to 5 per MMBTU) are loss–making and cast doubts on expectations of gas market globalization based on flexible LNG flows.
• The origin of gas to oil price discount is an artificial oversupply of paper gas which puts downward pressure on the hub prices. This market failure could be fixed by taking nomination rights away from the buyers. It could be achieved by eliminating volumetric flexibility in the LTCs and adjusting contract volumes to baseload.
© ZMB 17
Pricing Mechanisms in European Gas Consumption
Pricing Mechanisms in European Gas Imports
Source: IGU
Oil-indexed contracts Gas-on-Gas Other Oil-indexed contracts Gas-on-Gas Other
IGU Report Overestimates Role of Pricing based on Supply
and Demand Due to Ignoring Transitory Forms of Pricing Mechanisms
© ZMB 18
When Quasi-Oil Indexed Contracts are Taken into Consideration, Oil
Indexes Retain Their Dominant Position in European Prices
© ZMB 19
In Quasi Oil-indexed Contracts Oil-Linked Formula Stays on but Contract Price
is Placed in Corridor in Oder to Mitigate its Deviations from Hub price
Source: LONG-TERM GAS IMPORT CONTRACTS IN EUROPE. THE EVOLUTION IN PRICING
MECHANISMS.Luca Franza.© 2014 Clingendael International Energy Programme (CIEP). P.15.
© ZMB 20
Hub-Based Gas Prices in Europe Move in Tandem with Oil/Quasi Oil-Indexed
Contract Prices
Even if oil-indexation elements are being substituted by hub ones, prices of LTCs exercise strong influence over hub prices and are setting up a trajectory for their movement by acting as “price anchor”. Hub prices are therefore not independent: they are derivatives of the contract prices that set a baseline trend for their behavior. Supply and demand only mutate their changes
Source: BAFA, Bloomberg, World Bank
© ZMB 21
ACER 2016 Report: Correlation between Oil and Gas Prices is
Still High
© ZMB 22
Correlation and Regression Analysis Indicates that TTF Price Dependence on LTC‟s
Prices is Increasing
Correlation
(TTF MA,
USD/mcm)
Time period Brent,
USD/barrel
Oil Price:
Six month
moving
average
Oil Price:
Nine month
moving
average
2008-2016 76.6% 85.5% 83.3%
2008-2013 69.9% 84.7% 81.9%
2014-2016 79.5% 87.3% 88.7%
R Squared
(TTF MA,
USD/mcm)
2008-2016 58.6% 73.1% 69.4%
2008-2013 48.9% 71.8% 67.1%
2014-2016 63.2% 76.3% 78.6%
© ZMB 23
*Demand Includes import contracts and indigenous production
Source: Cedigaz, Eurostat, IEA, Gazprom Export LLC Database
Overcontraction as Factor of Hub Price Degradation
560
578 577 589
604 601 583 579 575
562
587
609
559 553 546 557
522
561
506 494
486
431 449
486
400
450
500
550
600
650
700
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
bcm
Contracted volume Consumption
Under-contracted
market
Balanced market Over-contracted market
1
25 31 32
82
39
77 85 89
131 138 123
0
50
100
150
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Delta,
bcm
© ZMB 24
Illusion of Oversupply Created by Monetization of Contract
Commitments on the European Forward Market
© ZMB 25
North America Market: Shale Gas Became By-Product of Shale Oil and
Liquids Production which Led to its Oversupply and Underpricing
• On the US gas market price distortions have acquired a systemic nature and are only
getting worse. The outcome of these distortions is the lasting inability of price
mechanisms based on supply and demand to provide sustainable price signals that
support investment in dry gas production.
• As prices for shale oil are higher than prices for shale gas, producers are flooding the
market with the associated gas volumes ignoring the negative pressure on prices that
these volumes create. As a result value of gas is jeopardized in favor of oil.
• We can observe this dependency through noting that production of natural gas in the
US leveled off and started to contract for the first time since the start of the shale gas
revolution largely because oil-associated gas production has fallen (Slide 20).
• There is nothing extraordinary in the fact that companies in liquid-rich shale plays
responded right away to the dramatic drop in oil prices that resulted in prices below the
cost of production by shutting down production ten months ahead of natural gas-
oriented shale plays.
• A shift to oil/liquids rich planes made natural gas prices “an added bonus” to prices of
the former.
© ZMB 26
By-Product Nature of Shale Gas: Number of Gas Rigs Decreased while
Production Kept on Rising; it Stabilized when Number of Oil Rigs Dropped off
Source: Baker Hughes, IEA
© ZMB 27
Oil-Weighted Production Tilts Shale Play Economics*
*Sunk costs excluded
© ZMB 28
Although NA Gas Prices are Formally Disconnected from Oil, their Linkage
Reinstated itself in Negative Correlation with Tight Oil Production
Period
Correlation
Henry Hub price and American
tight oil production
2008-H12017 -53,4% 2010-H12017 -47,1% 2014-H12017 -72,8%
© ZMB 29
Available on the publishing house site for free under reference: http://demianagency.com/OIL_INDEXATION_THE_BEST_REMEDY_FOR_MARKET_FAILURE_IN_THE_NATURAL_GAS_INDUSTRY.pdf
For Research on Different Gas Pricing Mechanisms Interaction see the Last Publication by Sergei Komlev