From the Editor: Europe’s LNG buyers face growing risks [Gas in Transition]
The pendulum has swung back heavily in favour of LNG producers when it comes to agreeing contract terms, but also politically in Europe in support of gas, at least in the short term. Oil indexation, destination restrictions and long contractual periods are all back in vogue, having experienced a period of retreat in which producers started to bear a greater share of the investment risk in new LNG capacity.
European buyers find themselves in a particularly invidious position. They need short and medium term supply, and governments are falling over themselves to facilitate it, but they are reluctant to commit to the long-term deals demanded by producers. Amid what some observers are calling a ‘capex supercycle’ for renewables, Europe’s buyers are unsure of the overall level of demand for gas in Europe ten or more years hence and equally uncertain of the mix of domestic production, pipeline gas and LNG that will be available to meet it.
There is a real risk that, if they commit to high-priced long-term deals now, they will lumbered in the future with volumes of gas they cannot sell, or LNG that is expensive versus a market which has returned to more ‘normal’ conditions. The harder producers push for tough contract terms, the greater these risks become for European buyers.
According to Chris O’Shea, CEO of UK gas utility Centrica, “Natural gas has been recognised as an essential transition fuel on the path to net zero just at the point geopolitical uncertainty is impacting the global gas market.”
The comment was made on the signing of a 15-year heads of agreement (HoA) with US LNG developer Delfin Midstream for the purchase of 1mn mt/yr of LNG from the company’s planned floating deepwater liquefaction port offshore Louisiana. Delfin a few weeks earlier also landed a 500,000 mt/yr sales and purchase agreement with Swiss trading house Vitol, making a final investment decision on the project later this year increasingly likely for first phase operation in 2026.
If the HoA is firmed up and a timely investment decision taken, Centrica will be committed to gas supplies from 2026 through 2041, a point at which European gas demand should be falling.
However, European domestic gas production will also be lower and the deal stops well short of the net zero target date of 2050. It is also likely that, in the event of lower European LNG import demand, Centrica will be able to redirect the committed volumes to other markets. The risk the company faces mainly revolves around price and whether the final terms agreed provide a supply of LNG which is price competitive over the full period of the 15-year contract.
The fact is that Asian buyers are snapping up much more of the new LNG capacity expected to come onstream than Europe. Cargoes, as currently, can be directed to Europe, if Europe is willing to pay up, but that is expensive. Moreover, these flows could fall sharply in the event of a harsh north Asian winter in which LNG supply becomes a security rather than price issue for Asian LNG importers.
Taking the plunge, as Centrica has, appears necessary, but is nonetheless risky.
Essential transition fuel?
But how true is O’Shea’s comment that gas has been recognised as an essential transition fuel?
The current wave of European investment in regasification capacity is the product of short to medium-term need, caused by Russia’s invasion of Ukraine and the political and economic impact of high gas prices on European consumers. Sourcing more LNG is critical to Europe’s security of energy supply today, but it doesn’t follow that it is now readily accepted as a part of the energy transition or that it will remain critical in the future; for many it is a necessary evil made essential by Russia’s aggression.
As a result, there could be a significant backlash once the current situation stabilises. The end state – net zero by 2050 – still looks the same in timing and content. It will be a much more electrified energy system powered predominantly by renewable energy sources, containing a mix of short and longer-term storage technologies.
Only a residual role for natural gas is envisaged, and it will have to be decarbonised, most likely via expensive and transitional carbon and capture projects developed in the late 2020s and 2030s. Yet gas needs to become cheaper not more expensive to retain a role in the energy transition – another reason why LNG producers should not push too hard on contract terms today.
A residual role for gas will not be the case everywhere. Energy transition progress is very unevenly spread and many countries have more carbon intensive points of departure and lack the capital or political will to address climate change which Europe enjoys.
Destination flexibility is therefore an absolute must for European buyers forced to accept longer-term deals than they might otherwise want.
The LNG market was on a growth trajectory on a global basis prior to Russia’s invasion of Ukraine, but exhibiting the boom and bust tendencies apparently endemic to industries with high capital requirements and long lead times, resulting in lumpy investment cycles.
It is now experiencing a demand bulge, which may over-inflate its supply capacity beyond what is required when the bulge fades, either as a result of more normalised European gas markets or as a result of energy transition policies, possibly both.
Outside of Europe, and perhaps OECD Asia, gas and LNG demand may continue to rise as countries pursue a combination of renewable energy construction and coal-for-gas switching. Energy transition progress and policies here may be what determines a hard or soft landing for the LNG market as a whole post-2030, if Europe successfully curtails its hydrocarbon use in line with its energy transition targets.
The fact remains, essential transition fuel or not, net zero by 2050 is still the end game.