NS4960 Spring Term 2018 Natural Gas Becomes More Like Oil

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Presentation transcript:

NS4960 Spring Term 2018 Natural Gas Becomes More Like Oil Windfall: Behind the Oil Price Plunge Chapter 3

Overview I Historically in the U.S. natural gas has been seen as inferior to oil One gallon of gasoline has more than three times the energy of a standard cubic meter of gas or A barrel of oil has nearly a thousand times the energy of a barrel of natural gas Gas is also much less convenient to produce, transport and store A barrel of oil can move without difficulty by truck, rail, pipeline and is easily stored along the way Natural gas requires expensive infrastructure Pipelines Liquefaction facilities Storage facilities – often underground

Characteristics of Natural Gas I With natural gas, much different relationship between producer and consumer than case with oil For oil – barrel often changes hands many times Relationships do not need to be forged between producers and consumers as long as markets efficiently handle transactions Given huge up-front infrastructure expenses natural gas, companies usually only make investments with long-term contracts of twenty-years or more Over long term period both parties want some sort of mechanism to determine price

Characteristics of Natural Gas II Manner in which producers and consumers of natural gas are tied together creates conditions for politicizing that do not exist in oil markets If Russia refuses to sell oil to Ukraine, Ukraine can buy it elsewhere In 2006 when Russia curtailed shipments of natural gas to Ukraine that flowed through extensive pipelines, country could not easily buy gas elsewhere because needed infrastructure not in place Realities surrounding natural gas trade can also empower the buyer in certain circumstances Russia’s treatment of Ukraine also called into question reliability of Russia as supplier to Europe Russia is building pipelines to Europe that avoid Ukraine

Characteristics of Natural Gas III Because natural gas has traditionally been transported via pipelines, gas markets have been divided by geography. Three distinct markets have emerged The Americas Europe and Asia In addition to physical location these markets differ in how they have traditionally priced natural gas U.S. has a very competitive market Prices established at Henry Hub – storage and transit center in Louisiana where multiple pipelines meet Here spot prices determined by supply and demand

Characteristics of Natural Gas IV In Asia prices set in term of oil prices or oil indexation Europe uses a combination of these two mechanisms. Oil also has advantage of being viewed as a strategic commodity Gas not seen this way There are still few substitutes for oil where it is most critical – transportation Natural gas originally used for heating, cooking and electricity Only later did it become a major industrial input In each area, natural gas is not essential for the task – other fuels can substitute if necessary Even today much natural gas is wasted by flaring

Characteristics of Natural Gas V Situation changing for natural gas Becoming more like oil Countries like Japan are becoming major gas consumers following nuclear accident and shut-down of nuclear plants. Technical advances have also made natural gas more abundant and accessible – even to those outside reach of pipelines. Also has much less carbon than coal or oil so is considered “clean” Also complements solar and wind, so a good way to increase renewable power

Characteristics of Natural Gas VI Other developments Leverage is shifting from producers to consumers New energy abundance and technological advances have exerted downward pressure not only on oil prices, but natural gas as well One implication – natural gas trade in many ways harder to politicize

Golden Age of Gas? I In 2011 IEA asked whether we were in a Golden Age of Gas In its optimistic scenario The use of natural gas grew rapidly Will require roughly three times the amount of gas produced by Russia (second largest producer) to meet demand With unconventional gas expanding, world able to meet demand while keeping prices down In US, China and India natural gas replaces some coal in power generation and makes roads into transportation and industry As a result of these developments world will come closer to meeting climate goals

Golden Age of Gas? II World seemed ready to go down this road In 2012 China released its Shale Gas Five-Year Plan for a major expansion of gas production that Involved attracting foreign investment Creating incentives for shale development and Supporting technical research related to shale In US Companies rushed to get approval for more LNG terminals to export natural gas Major new offshore discoveries in Israel and Mozambique

Golden Age of Gas? III By 2015 clear that in the U.S. new gas era was ahead of schedule U.S. natural gas production at levels IEA had not anticipated before 2035 In mid-2016 spot price for natural gas in U.S. one seventh of what it cost a decade earlier In U.S. natural gas displaced coal on a major scale In 2000 coal accounted for more than half fuel used for power generation – natural gas a fifth In 2016 natural gas overtook coal as generating most power in U.S.

Golden Age of Gas? IV In other parts of the world, natural gas usage lagged In Europe slow growth dulled potential demand for natural gas In China (and Europe) government support for renewable energy slowed gas usage Resurgence of cheap coal because of falling Chinese and U.S. demand, tempered demand for natural gas in Europe and elsewhere

Golden Age of Gas? V Also problems on the supply side No countries outside North America except China and Argentina reached commercial production of shale gas May increase in other countries, but obstacles such as Regulatory barriers Logistical hurdles, Institutional deficits Mineral rights and High costs All more difficult to overcome than initially expected China cut forecasts of production by half Environmental considerations impeded development in Europe

Golden Age of Gas? VI Despite production lag in many parts of the world, markets became awash in natural gas for other reasons Gas projects in the works added new output to market Slower economic growth and Competition from renewables Both caused demand to be weaker than projected Now many are predicting a deepening glut as more U.S. and Australian LNG exports come online. In future natural gas looks like a good bet for expanded use especially with growing concern over climate change Still IEA’s golden age of gas has not arrived on a global scale

Technology Transforms I In addition to the innovations leading to the extracting of natural gas from shale another development – floating storage and regasification unit (FSRU) have opened up possibilities for natural gas use. Enables countries to address gas shortages more quickly than if they had to build new infrastructure Effect has been to make natural gas more like oil. Countries such as Egypt, Pakistan and Turkey have built FSRUs Helped number of countries importing LNG to increase from ten to thirty-five between 2000 and 2016 During this period LNG trade more than doubled

LNG Trade

Technology Transforms II Future of LNG looks even more promising than its past, particularly if the price decline stops In the next two decades IEA projects volume of LNG trade will more than double again Possible that by 2035 LNG will account for close to half of all globally traded gas Output of LNG will be led by the U.S. and Australia The U.S. EIA forecasts that in 2020 U.S. will Have nearly one-fifth global liquification capacity and Be the third largest LNG exporter in world after Qatar and Australia LNG also resembles oil due to its price decline in recent years.

Gas Prices

Pricing of Gas I Another significant development in recent years has been in gas pricing. For long time European prices set by “oil indexation.” or tying the price of natural gas to that of oil Made sense at one time because gas often substituted for oil in home heating . Russia found it advantageous to keep the oil indexation formula. With more competition from U.S. LNG, European utilities acquired leverage to negotiate a price formula that placed more weight on “gas-on-gas” pricing and less than price of oil. From 2005 to 2015 amount of natural gas trade in Europe that was indexed declined from more than three quarters to less than one half In Asia, shift less dramatic, but still significant

Pricing of Gas II The gas markets are also becoming more integrated because of Transportation Infrastructure and Other costs However, these markets will never completely merge into one market like oil Still what happens in one market is increasingly affecting what happens in the other two As piped gas accounts for a smaller percentage of overall trade, gas is flowing more easily from one market to another, meeting demand as needed.

Assessment I Developments in the natural gas industry have altered a number of patterns and relationships Natural gas is likely to be a less effective political instrument than it has in the past In loosening tight relationship between many producers and consumers, the consumer is now favored over producers New realities are changing geopolitics In U.S. the shale gas boom and imminent shift from being a new importer to a net exporter of natural gas brings America both hard and soft power opportunities In Europe these energy dynamics have created challenges for Russia and reinforced that country’s desire to turn east

Assessment II China no longer needs to tether itself to Russia in interest of gaining access to sufficient natural gas resources China now has upper hand in negotiating pipeline projects with Russia