Triple Whammy in Global Pricing for Natural Gas: Practical Implications

Transcription

1 Triple Whammy in Global Pricing for Natural Gas: Practical Implications Sergei Komlev Head of Contract Structuring and Price Formation Directorate Gazprom Export* Energy Dialogue IMEMO RAS October 24, 2017, Moscow *Views expressed in this presentation are the author s sole responsibility and do not necessarily represent that of Gazprom Export

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 2

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 3

4 Competition with Other Hydrocarbons Locks Natural Gas in Price Envelope Source: Shell 4 ZMB 4

5 Interfuel Competition at Work: Oil Price Sets a Resistance Level for Natural Gas Prices Source: BP, Gazprom Export ZMB 5

6 Interfuel Competition at Work: Coal Price Sets a Support Level for Natural Gas Prices Source: BP, Gazprom Export ZMB 6

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 7

8 USD / mcm USD / mcm Special Arrangements are Required for Gas to Outcompete Coal NBP compared to UK coal-to-gas switching price NBP actual price Switching price NCG compared to German coal-to-gas switching price Sources: Argus, Platts, IEA *NBP day-ahead **NCG day-ahead NCG actual price Switching price ZMB 8 4

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 Source: BP Source: BP, Gazprom Export 9 ZMB 9

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 Gas exporters should be extremely cautious in dealing with that excessively volatile market segment and its proxy index. ZMB 10

11 Asian Markets are Still Dominated by Oil Indexes which Set Baseline Trend for Spot Trades Pricing Mechanisms in Asian and Asian Pacific Gas Consumption Pricing Mechanisms in Asian and Asian Pacific Gas Imports Oil-indexed contracts Gas-on-Gas Other Oil-indexed contracts Gas-on-Gas Other Source: IGU ZMB 11

12 Asian Demand is of Seasonal Nature Source: PIRA ZMB 12

13 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 13

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 14

15 Spot Prices in Asia Collapsed in March 2014 Due to Insignificant Supply/Demand Mismatch in Uncontracted Segment of Market $/MMBTU JKM Japanese LNG Import Price Gas Consumption in Asia Spot and Short-Term Trade* in Asia 800 Bcm ,3 47,4 Source: Bloomberg, Cedigaz, IHS, METI * Contracts of a duration of 2 years or less ZMB 15

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 16

17 IGU Report Overestimates Role of Pricing based on Supply and Demand Due to Ignoring Transitory Forms of Pricing Mechanisms Pricing Mechanisms in European Gas Consumption Pricing Mechanisms in European Gas Imports Oil-indexed contracts Gas-on-Gas Other Oil-indexed contracts Gas-on-Gas Other Source: IGU ZMB 17

18 When Quasi-Oil Indexed Contracts are Taken into Consideration, Oil Indexes Retain Their Dominant Position in European Prices ZMB 18

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 Clingendael International Energy Programme (CIEP). P.15. ZMB 19

20 Hub-Based Gas Prices in Europe Move in Tandem with Oil/Quasi Oil-Indexed Contract Prices Source: BAFA, Bloomberg, World Bank Even if oilindexation 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 ZMB 20

21 ACER 2016 Report: Correlation between Oil and Gas Prices is Still High ZMB 21

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 % 85.5% 83.3% % 84.7% 81.9% % 87.3% 88.7% R Squared (TTF MA, USD/mcm) % 73.1% 69.4% % 71.8% 67.1% % 76.3% 78.6% ZMB 22

23 bcm Overcontraction as Factor of Hub Price Degradation 700 Under-contracted market Balanced market Over-contracted market Contracted volume Consumption 150 Delta, bcm *Demand Includes import contracts and indigenous production Source: Cedigaz, Eurostat, IEA, Gazprom Export LLC Database ZMB 23

24 Illusion of Oversupply Created by Monetization of Contract Commitments on the European Forward Market ZMB 24

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 gasoriented shale plays. A shift to oil/liquids rich planes made natural gas prices an added bonus to prices of the former. ZMB 25

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 26

27 Oil-Weighted Production Tilts Shale Play Economics* *Sunk costs excluded ZMB 27

28 Although NA Gas Prices are Formally Disconnected from Oil, their Linkage Reinstated itself in Negative Correlation with Tight Oil Production Correlation Period Henry Hub price and American tight oil production 2008-H ,4% 2010-H ,1% 2014-H ,8% ZMB 28

29 For Research on Different Gas Pricing Mechanisms Interaction see the Last Publication by Sergei Komlev Available on the publishing house site for free under reference: BEST_REMEDY_FOR_MARKET_FAILURE_IN_THE_N ATURAL_GAS_INDUSTRY.pdf ZMB 29