Gas markets are likely to remain in over supply for the next five years according to Boo & Company’s latest report, The next cycle: Gas markets beyond the Recession, published on 22nd June. This means spot market prices are likely to remain under pressure for some time while contract prices in European and Asian markets become more structural.
In the second half of the decade gas is likely to replace more carbon intensive fuels such as oil and coal in power production and this will lead to price rises.
Jake Leslie Melville, Partner at Booz & Company said, ‘if European markets move away from the traditional long term oil indexed contracts to spot prices, price volatility may increase as prices are more driven by supply demand dynamics. We have seen this in common commodity markets such as oil.’
Worldwide natural gas markets have experienced an unprecedented reduction in demand over the last two years due to the economic recession. This, combined with a faster than expected expansion in unconventional gas in the US, resulted in global oversupply which sent spot gas prices sharply lower. An analysis of worldwide supply/demand dynamics shows that markets could remain in oversupply until at least the middle of this decade.
If US price levels spread to Europe an accelerated shift to gas in power production may occur
In the US market natural gas is expected to be priced in the US$ 6 – 7 /mm but range for the duration of this decade. In the oversupplied LNG market these price levels may spread to European spot markets. In such a scenario, today’s pressure to restructure the traditional European and Asian long term oil indexed supply contracts will continue or even intensify. With oil prices having recovered to levels near US$ 80 /bbl, a significant gap of approximately 40% has opened between spot gas prices and those in oil indexed contracts.
However, persistent lower gas prices could accelerate the Energy Shift i.e. the shift from carbon intensive fuels like oil and coal to low carbon natural gas. In this scenario marginal costs for producing electrical power from gas and coal would be comparable.
‘This would mean that gas could become the preferred fuel in decisions on building new plants. If this scenario materialises worldwide gas demand would return to levels predicted before the recession by the second half of the decade,’ said Jake Leslie Melville.
European markets may become more like common commodity markets
The accelerated demand growth would only be possible if power producers can access sufficient quantities of gas at spot price levels. Yet if the pressure on long term contract conditions remains within the context of ongoing oversupply, producers and buyers are more likely to find agreement on more flexibility in their contracts re: minimum take off volumes, and with more price flexibility. Under these conditions a larger part of the market would then see price levels set by supply/demand dynamics than today. This would turn European gas markets into a more common commodity market resembling, for example, the oil market.
Large users such as electrical utilities may turn to gas
Large users such as utilities need to decide how to take advantage of their new found market power and assess optimal supply portfolios. They should strike the right balance between contracted and open positions by determining the optimal mix of contracts and suppliers. More exposure to structurally low spot prices can be attractive, but also brings more exposure to supply shocks, short term price volatility and potentially long term price rises.
Wholesalers’ position is eroding as large users and producers connect directly
Wholesalers need to find a balance between the value of gas supply security at a higher cost versus the advantages of lower prices spot gas, while taking into account the risks of short term supply shocks and price volatility.
Many established importers and wholesalers with long term contracts are squeezed between contact commitments at oil indexed prices and a market where end users can obtain gas at lower spot market prices. Contracts must be reconsidered while reassessing the optimal supply portfolios.
As more and more producers and users such as utilities will aim to connect directly, the wholesalers need to review how they can continue to create value for their customers through offering added services such as seasonal and short cycle flexibility, risk management or increased off take flexibility.
In the short run infrastructural providers are reviewing the need and profitability of the projects in their portfolios. In the mid term opportunities may arise. Holders of LNG receiving capacity could benefit from a portfolio of capacity in different locations to capture regional price arbitrage. Structural changes in gas pricing my increase gasification and connectivity of regions where this was previously uneconomical, potentially creating opportunities for pipeline companies. The demand for storage capacity will see different opposing drivers. Storage players need to carefully assess how demand may develop and what innovative business models can be developed in the changed gas market.
Read the article online at: https://www.hydrocarbonengineering.com/gas-processing/22062010/oversupply_of_gas_expected_on_the_market_for_next_five_years/