Globalization of the Natural Gas Market?

This was the week of almost $120 oil. it was also a week when much attention turned to natural gas - futures prices have almost doubled since last August and recently accelerated. Demand for Natural gas for power generation has been rising - and global demand may be changing market dynamics.

Historically the price of natural gas tracked that of oil. As recently as 2004, there tended to be a ratio of 6000 cf of gas for one barrel of oil. Since 2005, though this relationship seems to have broken down. Natural gas has been on its own timeline, zooming to record highs in the fall of 2005, before falling. For market actors, natural gas has tended to be a seasonal play - with summer surplus being injected for winter fuel. Is the rise a delayed reaction to the increase in the price of oil, or is it the result of innate aspects of the natural gas market?

Natural gas has been a regional market, and one with short pipelines, with neither producers or consumers having many options of alternative counterparties. Thus the Latin american market was separate from that of north america which was separate from Europe (and Asia was relatively in the cold because it receives most energy by boat. Yet technological change (the shift to LNG and the plants to liquify and regassify the fuel) could change that somewhat. At the same time, with rising demand for power generation, natural gas is more attractive and (for now at least) there are supply limitations and rising global demand. It is cleaner than coal which globally outstrips it for electrical purposes. Yet even carbon conscious European countries are returning to coal. CERA suggests that the advent of LNG, and the release of new supplies (up by as much as 30%), natural gas could finally become a global commodity, with transport made easier and new supplies not tied to a given consumer.  Doing so opens up new markets- but its not completely revolutionary. Regional pipelines still deliver most natural gas. And their routings and the contracts that go along with them will still deliver most supplies.

Asian demand is rising Like oil, the natural gas market is undergoing a geographic shift in its center of gravity in terms of consumption growth (increasingly in Asia) and its producers. Yet also like oil there are The countries with the largest proven gas reserves are Russia, Iran and Qatar. Russia is the current largest gas exporter but Qatar exports the most LNG - and hopes to double output within the next few years.

Asian countries used to have little opportunity to use natural gas. LNG is changing this, and natural gas is gaining a place in the energy mix, with many countries have been locking in contracts - even if it is at a higher price.

Yet prices are sticky. Natural gas still tends to be sold in long-term (minimum five year contracts) pegged to a given oil price. Given the difficulties of transporting gas, these pipelines have tended to be relatively short and until the advent of liquification, regional in scope, eg connecting the US and Canada, from Russia to Europe etc.

Convergence to Global Pricing?

Pricing too has tended to be regional. And prices may vary greatly on when contracts were negotiated. Now with a more global trade, prices might coalesce. the combination of long term contracts and regional dynamics does mean that prices vary widely. A recent piece by Ann Davis and Russell Gold in the Wall Street Journal details the domino effect of rising prices

Prevailing US prices remain well below the cost paid by Asian countries for their LNG shipments and with domestic natural gas production rising, imports are falling (now at a 5-yr low), shielding the US from rising global prices. Yet the North American market is not an island. So far though relatively ample North American supplies have shielded prices. Yet Wood Mackenzie suggests as more is absorbed on the continent (especially as Canadian production plateaus and the results of more US drilling are absorbed), the US will be forced to import more - and take the set prices.

Yet for now, the Federal Reserve Bank of Dallas suggests, inventories are high enough to keep prices relatively moderate and far below the normal link with oil. OPEC estimates that natural gas demand will almost double by 2030 - or almost 2.4% annual growth, outpacing demand for oil or coal.

How much new supply?

The real question is how much new supply and when. Qatar insists that despite some delays, its planned expansion, doubling LNG production to about 77mcf/yr and possibly even more by 2013. By 2012, many more countries will have the capacity to import LNG. Even before that some new supplies may be forthcoming. High prices support drilling in existing sites. For some countries new supply creates an opportunity to shift suppliers or change routes. The EU is looking for all options (Algeria, Qatar and Central Asia - for more on the latter see the post right before this. )

Some supply estimates might be over optimistic, especially if fast-growing emerging economies keep increasing demand, including the gas exporters themselves. Many might be as energy rich but power-less with real electricity shortages. Limitations on gas supply in the GCC could curb growth given that all of the megacities and petrochemical plants need electrical supplies - and could have spillovers on net exports. At present. Qatar consumes much of its production domestically and most of its neighbours have gas attached only to oil fields, making extraction difficult. but with prices rising more projects (such as a UAE sour gas project) become economically viable. A bloomberg article suggested that export restrictions and supply disruptions might decrease the output of much new supply from Nigeria and Egypt or delay its emergence.

Of course should gas prices continue to climb at the same time that producers increase output, we might may be talking about even more LNGdollars. After all estimates of Qatar's national wealth take into account its coming natural gas windfall.