Akin to oil, gas reserves are held in places where it is not heavily utilized and are controlled by a few governments. With 46% of reserves concentrated in Iran and Qatar, 20% in Russia (iea.gov) and the remaining distributed across N. America, Western Europe and the rest of the world, Natural Gas is a commodity with high geopolitical significance. However, the major producing countries are Russia, Canada and the United States, showing that reserves are not reflective of production capacity and thus require a lot of investment in infrastructure to fill the gap. With a 1.5% annual growth rate, and a projected 3% increased share in primary energy demand by 2040 (WEO, 2016), Natural gas is the fastest growing fossil fuel. Recent developments such as the Paris agreement, which highlight Natural gas as the transitional fuel to switch to renewables and the rise of floating LNG carriers (FLNG) have been driving forces for this growth.
The Story so far…
In 2009, the rise of Shale gas made the the United States the top Gas producer ahead of Russia, resulting in ascending oil prices and a divergence from gas prices. Between 2010-2014, the Natural Gas market was very much a sellers market due to high LNG demand triggered by the Fukushima Nuclear catastrophe, which induced Japan to diversify its primary energy source away from Nuclear power to Natural Gas primarily and doubled global Natural Gas demand. This rapid increase in demand resulted in high spot prices in Asia and an overall price increase in the global market. This also led to less LNG being transported to Europe that was being diverted to Japan and the Asia-Pacific region, which induced Russia to invest in and develop the Sakhalin II project on its Pacific coast, targeted at supplying gas to these regions in an attempt to diversify away from its conventional Western European consumer market.
Around mid-2014, Demand in Asia reduced significantly due to a high amount of new projects arising to accommodate LNG demand which increased supply, partnered with sharp declines in crude oil prices between August and January 2014, meaning that crude oil was now repositioned as a substitute for gas, leading to a convergence of prices.
The current market for Natural Gas is oversupplied due to a significant number of LNG projects in the works with 86 projects in operation, 88 proposed and 47 in speculation (BP World Energy Outlook, 2016) totalling 25 BCF/day, about a third of United States production (IEA, 2016). China and Japan are set to remain the major importers from 2016 to 2023, when demand is projected to be in equilibrium with supply (McKinsey Insights). The role of gas in China will be determined by government policies, imports from Eastern Europe (Russia and Turkmenistan mainly), the extent of infrastructural developments and domestic production; while in Japan, the uncertainty lies in the pace, efficiency and extent of developing and utilising nuclear power in the long term. The major supply is set to come from the United States and Australia; however, the World energy Outlook 2016 predicts broadening output from East Africa, Iran and China amongst others.
How is Natural Gas Priced?
Between 2005 to present, gas prices have fallen from $13/MMBtu to about $3/MMBtu depending on the region (oilprice.com). Gas is generally traded on term contracts (of 6 months or more), which are indexed to crude and petroleum product prices although the market has been drifting towards de-coupling from oil indexing since 2009. An increasing amount of gas is now being traded through spot transactions with approximately 15% of global LNG being traded on the spot market in 2015, of which 75% is accounted for by the Asia Pacific region (Wall Street Journal, 2016).
Even with a continually developing spot market, there is currently no globally integrated market for natural gas, meaning that pricing mechanisms very regionally. The North American market predominantly utilizes gas-on-gas pricing (also known as Hub pricing) centred on Henry Hub, which depends solely on gas rather than pricing off oil products. Europe and Asia-Pacific markets rely on oil indexing and formula pricing based on oil products as benchmarks, such as in Japan where gas is priced off of the Japanese Crude Cocktail (JCC), although the United Kingdom’s National Balancing Point (NBP) is adopting the Henry Hub pricing style. The Middle East, particularly major producers like Iran, determines prices using a social and political regulation (RSP) mechanism due to its high population with strong cultural, tribal and religious beliefs. Africa on the other hand prices more than half of its gas using below cost regulations (RBC) such as fuel subsidies, as governments attempt to make gas more affordable for consumers.
There have been efforts made to launch derivatives underpinned by US Gulf LNG exports that will make trading more cohesive and potentially revolutionize the natural gas market in the same way that Brent and West Texas Intermediate (WTI) did for Oil. The Chicago Mercantile Exchange (CME) and Intercontinental Exchange are the front-runners following increasing shipments from the US Gulf and Sabine pass to the Asia Pacific and South-east Asian region (Bloomberg, 2016) as well as new infrastructure by Cheniere Energy, which have helped create a substantial spot market, a necessity for launching futures markets.
My 2 cents…
The major competitor for Natural Gas, particularly in the Asian markets is Coal, which requires significantly less capital expenditure and is geographically widespread, thus eliminating transportation costs contrary to LNG. Floating LNG carriers will play a key role for smaller, geopolitically unstable countries such as the Baltics and Equatorial Guinea while pipelines will become relatively less significant over the coming decade, even with new pipelines being laid due to geopolitical risks and LNG availability.