Tuesday, November 10, 2009

Shale Ripples Across the Pond

The impact of shale gas on the supply of natural gas is starting to show beyond the shores of North America.  The Wall Street Journal reports that the International Energy Agency has released a report that a natural gas glut is looming.  The IEA says the oversupply could have “far-reaching consequences for the structure of gas markets and for the way gas is priced in Europe and Asia-Pacific.”  The Financial Times has another good article on the report and its implications.

We've already seen this materialize to a certain extent in the U.S.  The combination of lower demand from the recession and increased supply from shale have altered the supply and demand mechanics and thus the pricing of gas in North America. In the U.S., gas is priced as a free standing commodity.  In Europe, 70% of gas is sold at a price indexed to oil's price, most of this under long-term contracts.  (In the Asia-Pacific region 52% of gas is oil-indexed.)  This works great for gas suppliers, especially Russian companies like Gazprom, that provide about a quarter of Europe's gas via pipeline at prices that are rising based on oil's pricing properties.

But on the supply side, there has been a huge increase in natural gas.  In the U.S., shale gas has flooded the market, driving down spot prices.  While the U.S. doesn't export much gas (yet), it quickly has become a less attractive place to sell LNG.  The other supply change is the huge amounts of gas liquefaction capacity coming online in Qatar and Yemen that will create prodigious amounts of LNG.  As the U.S. becomes a less attractive place to sell gas, uncontracted LNG goes to Europe and Asia, driving down prices on their spot markets.  The differential between the declining spot and the oil-indexed contracted prices is causing great agita among gas consumers, especially in Europe. 

This seems like a natural occurrence with the increase in LNG capacity.  As natural gas becomes more of a worldwide commodity, it should be priced independently of oil.  Companies like Gazprom want to hold onto the old system, and why not?  They have grown fat selling high priced gas to Europe and Asia.  If the fundamental pricing mechanism changes, these companies will be stung.  Gazprom in particular will be in a tough spot, as it needs huge amounts of capital (and foreign expertise) to develop new gas resources in difficult to reach areas.  Just yesterday, Gazprom announced its quarterly earnings.  Revenues dropped - as expected with lower commodity prices - but costs remained high, much to the consternation of analysts.  Here is another article from Bloomberg about this situation (especially the second half) and an interesting suggestion from Gazprom that the company might buy a U.S. shale producer to gain access to shale expertise.  Now that would be interesting.

Ultimately, this will be a market-driven situation.  If European gas users have a cheaper viable alternative to Gazprom gas, they will move their purchases away from companies like Gazprom and the link between oil and gas pricing will break. 
While it's not Haynesville Shale gas that is directly causing this global market shift, it is playing a part by taking the U.S. out of its role as a gas importer, thus increasing pressure on the existing worldwide pricing mechanisms.  Not quite a butterfly flapping its wings in the Amazon and causing a typhoon in Asia, but it's still quite interesting to be impacting the worldwide energy market from our little corner of the world.

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