Editorial: Balancing the world [NGW Magazine]
The prolonged cold spell in Asia has driven prices for spot gas to record highs – even higher than the Japanese utilities had to pay for emergency deliveries early last decade. But in those far-off days there were far fewer producers and traders available to sell the LNG to fire up the gas plants. Compensating for that, there was also a lot more talk about the importance of “long-term relationships” and “co-operation” between buyers and sellers.
It would have been risky to bet on today’s price spike six months ago, when liquefaction plant operators in the US were turning down their facilities in response to a lack of nominations from off-takers. Oversupply and negative netbacks were the talk of the market.
Normally, spot prices as high as this would be the classic ‘market signal’ needed to promote the building of more liquefaction capacity in the US, for example, where several major projects are waiting for final investment decision. Asian storage would be another solution, but impractical. Much LNG has therefore deserted Europe, leaving it to rely more heavily on Russian pipeline gas.
Consumers who have advocated market mechanisms in their long-term LNG contracting are paying up. They can expect winter shortages for several years longer, but no doubt the boot will be back on the other foot once spring gets under way.
Such wild seasonal swings benefit few in the market. But it is also important to remember that only a small percentage of the LNG traded actually fetches the prices that make headline news.
Anglo-Dutch Shell, defending the profitability of its LNG business while spot prices declined in recent years, says that roughly four-fifths of its sales portfolio is locked up in oil-indexed contracts, regardless of what the spot price does.
That argument may have looked weak when Brent was in the low $20s/barrel last summer. But those contract prices will be rising in a few months to more respectable levels, as the effects of the January 5 Opec+ agreement on crude supply output feed through into term deals.
On the other side of the scales though is the continuing uncertainty about the impact of Covid-19 and its various, even more infections mutations – a new variety has been identified, linked with Brazil, for example – while the necessary vaccination programmes are only now beginning and their efficacy unknown. Air traffic and industrial activity remain low. It is too early for oil producers to pop the champagne. Analysts talk of profit-taking.
Northwest Europe has also been experiencing a cold spell, and as is usual in such atmospheric conditions, wind generation has been very low, accounting at some peak hours for less than a tenth of the UK power mix, for example. At times like these, building more wind turbines will not mean more electricity will be generated; it would just mean more idle plant that has to be financed. And as for green hydrogen and electric vehicle charging….
Those operators with dispatchable capacity – mostly gas, as nuclear tends to run baseload when it runs at all, but coal has also made its presence felt – will be doing very well, thanks to circumstances beyond their control. They have only a limited window of opportunity though in which to turn a profit.
Again, market signals ought to indicate it is time to build more plant like that, but so far it has suited the market better to absorb these very high prices for short periods of time by stretching the system to close to the breaking point than to risk capital by building more, in an uncertain regulatory environment. There have not actually been any blackouts, even if the grid operator warned there could be some unless the market reacted. Who knows what subsidies will be available in a few years’ time?
One could perhaps see the global LNG market from a similar perspective: the flexibilities inherent in the full value chain may be exploited better, in terms of shipping, production and so on, as long as both sides accept that a perfect match between supply and demand in real time is an impossible goal. A certain shortage in winter and the resultant scramble for cargos might be a price worth paying to avoid an excess of steel and concrete in the ground in producer countries and value destruction for more of the year.
In the highly regulated UK power market, which provides an analogy of a kind, demand-side responses are among the solutions to the problem of avoiding a gold-plated system. Switching over to diesel or other generation, or turning plant off at peak hours, are among the legitimate means a major consumer has at his disposal to balance supply with demand in real time and be rewarded for it. Consumers are thereby protected from the costs of redundancy, and this approach has worked to the extent that there have been no blackouts proven to be a result of penny-pinching.
But in a partly import-dependent system, different capacity mechanisms in the exporting countries or different supply licence obligations could mean the marginal kilowatt-hour stays where it is generated, no matter how high the buyer bids. Power cuts have long been a political no-no in many countries so one must understand the seller’s position too.
At a much smaller scale, smart meters are intended to allow householders to do the same thing to avoid high electricity prices, except for the operation of white goods rather than blast furnaces. Making prices transparent hurts the incumbents but it solves a lot of problems, financial and environmental.