US LNG: What it Means for Europe and Gazprom
US LNG loadings could begin at Sabine Pass this month and the first vessels arrive in Europe and Asia a fortnight or so later. This has been one of the hottest topics to engage the attention of the trade press, consultants and policy makers for several years.
But as the start date approaches, it is unknown what sort of a reception awaits the cargoes in Europe, or even if they will arrive in large numbers at all.
US LNG cargoes threaten to bring the biggest change to Europe’s gas portfolio perhaps since the mega-trains at Qatar LNG started up in 2009, but the US-Europe arbitrage opportunity has narrowed to a hair’s breadth. Looking solely at the price difference between the US and Europe, it might not even be profitable to bring LNG to market at the Dutch Title Transfer Facility, for example, except for a so-called ‘portfolio player’.
A trader such as BG/Shell, with spare shipping and regasification capacity and who can further improve the economics by turning down more expensive gas production or contracts elsewhere, is in a different position and it is mostly companies such as these, or with secure monopolies at home, who have signed up for long-term capacity deals with Cheniere Energy, the operator of Sabine Pass. Even so, the rich pickings that might have been available when oil was $100/b have evaporated.
One difference between 2009 and now is the fact that the companies selling that North Field LNG – majors such as Exxon, Shell, Total, and ConocoPhillips in partnership with the state of Qatar – were keen to avoid rocking the boat in Europe, where they already marketed so much of their equity production and where so much of the gas market beyond the UK and the Netherlands was still effectively controlled by a series of regional monopolies, many of whom still owned the pipelines.
US LNG on the other hand is certainly likely to be disruptive. Some commentators have even seen it as a means of weakening Russia’s grip on Europe, although it is possible that its arrival could instead force Russia, whose grip is already much weaker than it was a few years ago in some countries, to change its export strategy and end up in a stronger position than it is now. This is the theme of a new paper by the Oxford Institute of Energy Studies (see below).
Another difference between then and now is that the Qatari LNG has a long-term negligible production cost, whereas the US LNG cost structure starts off with 115% of the Henry Hub front month, a price that will range widely depending on supply and demand within the US itself and which will be beyond the control of the liquefaction capacity-holder. It will not therefore always make sense to liquefy LNG in the US, implying some money lost through cancellations.
On the other hand, Gazprom’s reserves, being so much nearer the demand centres than is the US Gulf, will still be able to respond quickly to price spikes in Europe.
And another difference is the fact that Qatar’s LNG supplies started in the last decade when a much higher percentage of Europe’s gas supply was still priced off oil, whereas now more than half of it is linked to hubs. And each successive arbitral award against the exporter weakens the oil linkage still further. So whereas before the oil price set the gas price, in these days of low gas demand it acts mainly as a ceiling for the gas price, and the availability of more supplies implies even lower prices. Even without that, US cargoes are priced uniquely transparently.
Let battle commence!
Gazprom will be able to see off this new competition as prices in Europe are already so low; lowering them a little more by upping deliveries, so that the margin vanishes for the US, would not be that bad, according to the paper titled: Gazprom – Is 2016 the Year for a Change of Pricing Strategy in Europe?
This would not have been the case when oil was above $100/barrel: Gazprom would have had to stand by and watch its buyers turn down their nominations as much as possible and backfill their supply with this cheap new source. But now, the paper’s author, James Henderson, says, “there may be some logic for Gazprom, as one of the lowest cost suppliers to Europe with spare capacity, in adopting a Saudi-like strategy in order to reinforce its long-term competitive advantage.”
Painful though it may be, Gazprom cutting the price would put gas back on the front-burner as generation and heating fuel, and trading it more actively at hubs will help ease the over-supply – redelivering gas downstream, rather than bringing more and more of it to market and destroying value unnecessarily.
The paper points out that the lower price option “can help to stimulate demand and establish increased sales of gas from Russia at a time when the COP21 agreement has raised the issue of un-burnable carbon reserves.” And later: Gazprom can “help to encourage the final removal of coal from the European energy system by completing the task that a carbon tax has so far failed to achieve.”
And moving away from oil to hub pricing, as a more active trading role implies, would bring Gazprom benefits in the longer term. Arbitral awards are costly and these days, judging by the announcements, the seller invariably loses them. Worse, though, they take a long time to resolve and during that period nobody knows the price of billions of cubic metres. “Indeed, in some instances this can lead to a situation where, if rebates are being offered, the price of Russian gas in Europe is unknown until the end of the year in question, when a calculation can be done to compare the oil-linked and market prices. This hardly leaves Gazprom in a strong position to compete with alternative gas supplies, let alone alternative energy sources,” the author writes.
Analysis leads the author to conclude that from a commercial perspective, raising volume by lowering price “would appear logical from a Gazprom standpoint, and an increased market share would certainly put the company in a stronger long-term position.” But he concedes that this approach will be unpopular in some circles.