The end of ‘speculation spring’?

In 2009, 2010 and 2011 energy prices were in a bullish trend by this time of the year. Certainly for electricity, there was a returning pattern. Year ahead prices rose during the first six months and then dropped back in the second half. We dubbed this phenomenon ‘speculation spring’ at E&C. During the first six months, the year ahead is still far in the future. This gives the market ample possibilities for speculation about the disasters that might affect the supply – demand balance by the time the year ahead is near. However, as the end of the year approaches, reality sets in. That cold winter that year ahead bulls counted on, doesn’t materialize. Governments across Europe shut down less nuclear power plants than expected. Demand for energy doesn’t recover in line with the economic recovery. The disasters don’t materialize and prices start to fall. Such speculation in forward energy markets is supported by the fact that market participants seem to systematically underestimate the price lowering effects of certain evolutions:

1. As I have commented earlier, there is a dogma of rising energy prices. Analysts systematically underestimate the combined effects of delocalization of heavy industry and increasing energy efficiency on natural gas and electricity demand in North-West Europe. We recently saw another example of this. Carbon dioxide emissions of ETS companies dropped by 2,4% in 2011 whereas the market had expected a maximum 1% drop and some even a 1% increase. If carbon dioxide emissions of ETS companies drop, this clearly means that large industrial consumers of energy are reducing their consumption.
2. The price moderating effects of increased inter-connection is also often under-estimated. Specifically in large countries, analysts tend to look at supply and demand conditions in their own country only. This is specifically true for analysis of gas markets which is largely focused on conditions in the UK.
3. Everybody has underestimated the rapid growth of renewable energy production in Europe. Even legislators are surprised by the developments and struggle to adapt policies as output outstrips their targets (see my previous blog). Many power market analysts predicted supply shortages for this period due to the closure of nuclear and older power plants. They never thought that the combination of increasing renewable production, more interconnectivity and rapid growth of renewable would be able to fill the supply – demand gap.
4. Gas storage capacity in North-Western Europe has been expanded by more than 60% in the past five years. Due to this, seasonality in the gas markets has been reduced as more gas from storages is available in the winter time and more gas to fill the storages is needed in the summer. Still, markets continue to worry over the effects of a cold winter on gas demand. The seasonality in the forward gas market is often exaggerated if you compare to the actual difference between summer and gas prices in the spot markets. As gas prices are the main driver of power prices, a similar mismatch of forward and spot seasonality can be seen in the electricity markets.

In most discussions with representatives of energy companies, you are consistently bombarded with scary stories of future energy shortages. Same stories on conferences. Even our new Belgian state secretary of energy Wathelet spread a scare story last week. At current low power prices, there would not be sufficient investment in gas-fired power stations which would lead to power shortages in Belgium, he remarked. A great display of policy consistency, I would say, as that same man had a law voted to freeze energy prices at current levels a week earlier. Ask any man in the street whether he thinks energy shortages are around the corner, and a large majority will say yes.

Energy shortages do occur … sometimes. During those few cold days in February, for example. However, have you remarked how short-lived the price spike was? If you look at the average spot price levels for North-West European gas and electricity of the past four years, you can only conclude that during most of the time there was more than enough energy.

Spot prices don’t lie. In most of our markets, spot price determination mechanisms have been installed that make sure that the price is a correct reflection of supply and demand of energy at that moment. It is much harder to speculate against spot markets, specifically in electricity markets where storage capacities are non-existing and gas markets where they are very limited. Because speculation in the spot market can only be physical speculation. Producers or traders have to consciously withhold capacities from the market to drive up prices. If you own a gas-fired power plant, and the electricity price that you can get is higher than your gas costs, you can turn in money by producing. You can’t say, I’ll produce and keep it in store for when prices are higher. Average spot prices in the gas and the electricity markets in the past years have consistently been lower than the average forward prices. This means that there has been sufficient supply to cover for the (declining) demand.

Forward markets are much more subject to speculation. Basically, if you sell on a forward basis you make a trade-off against the future spot prices that you expect. That opens up the possibility of speculating about supply – demand tightness. The further into the future, the more room for speculation: so many things can happen between now and the end of the year. This explains the “speculation spring” phenomenon” on the heavily traded year ahead contract. By the second half of the year, we saw in the past three years how reality kicked in. The supply reductions and demand increases didn’t materialize. The spot price remained at relatively low levels over the summer months. And if you are the 15^th of December and your spot price for power is still around 50 euro per MWh, it becomes hard to make your case for 60 euro per MWh for supply of power in the year that starts in two weeks. It is a law written in stone that as a forward contract gets near expiry, it will get closer to the spot market level.

Rising prices in the first six months, bear correction in the next six months. We saw this pattern three years in a row. Obviously, in our struggle with the unpredictability of energy markets, we are tempted to call this pattern eternal. If only life would be that easy. If only prices would be at their best level at the same moment year after year. Buying energy would become the easiest job in the world, just wait for the pre-determined moment and buy. If only … This year’s development, with speculation spring not taking off shows us once again that the reality is more complex. And we need to continue to be careful. Maybe in 2012, it will be the other way around. Maybe we will see a bull market in the second semester. Nobody can tell, it will depend on the extremely complicated equation of energy supply and demand.

Filed under: Energy demand, Forecasting, Market analysis, The market today

Gas markets Europe 2010 – 2011

The past month has been a bit low in blogging activity, due to my being busy creating a report on the European gas market. Research of supply and demand figures brought me some surprising insights. You can read an extract of the report by clicking on the link below. Please read the executive summary of the report below. Contact me at benedict@eecc.eu if you want to receive a full copy of the report.

Executive summary

• ‘Energy can only get more expensive’, is a common belief among energy buyers. However, we have recently seen that natural gas prices remained relatively low, even when the economic activity picked up. Oil prices rose, so the gas prices on the Hubs became structurally lower than oil-indexed gas prices.

 

• The biggest natural gas reserves in the world are to be found in the Middle-East and not in Russia. However, the Middle-East are currently only the world’s fourth largest producer of natural gas, meaning that huge reserves are untapped. Gas production in gas reserves giants Qatar and Iran has started to rise exponentially in recent years. This explains the presence of excess gas volumes in the world markets.

 

• The US has increased its production of natural gas by 16% due to the development of shale gas. In 2009 they were the world’s biggest producer of natural gas, bigger than Russia. We have always known that beyond conventional gas reserves, a lot of gas was trapped in this shale layer. Only, it was always thought that it was impossible to produce gas from these layers without excessive costs. Recently production techniques have been improved, and the energy companies claim that it is now possible to produce shale gas at a cost that is lower than the production of conventional gas. The possibility to economically produce shale gas boosts the gas reserves of the world.

 

• Shale gas production has already had an impact on gas prices, as it made more LNG available to the European market as less was needed in the US. If the US continues to expand its gas production, it might even start exporting LNG. There is also potential for shale gas production in Europe and in China. If all this shale gas production is developed, the world’s gas supply situation will look completely different. However, this whole shale gas development could be turned back due to environmental impact of the shale gas production. It is too early to decide what the further development will be.

 

• As of 2011, the Nord Stream gas pipeline will bring additional gas from Russia to Germany, 22,5 billion m³ of capacity in 2011 and 45 billion m³ in 2012.

 

• Natural gas demand in Western-Europe peaked in 2004 and then started to fall. This is contrary to popular belief that energy consumption is continuously growing.

 

• Although the growth rate of power consumption is slowing down, it is still growing. Deployment of electric cars would speed up this growth of electricity demand. Most of these extra MWh’s of electricity are now produced from renewable energy sources. But the growth of demand is faster than the growth of renewable. This means that extra power plants will need to be built. Plans to shut down nuclear power plants in countries like Germany, Belgium, the Netherlands and UK have been turned back, meaning that fewer power plants will need to be built. How much of the new power plants will be gas-fired will depend on whether new nuclear and (clean) coal-fired power plants can be developed. Which plants will be built is subject to political decisions. It is therefore madness to try to predict how much extra gas will be needed for new gas-fired power plants.

 

• A multitude of factors will determine whether gas supply will continue to grow and/or gas demand will continue to fall. Therefore, it is impossible to predict whether the current situation of over-supply will continue or not. The important news is that it is not unthinkable that we might see some decades ahead with abundant natural gas available to our markets, resulting in lower gas and electricity prices. Therefore, corporate energy strategies based on the adagio that energy can only become more expensive, should be adapted. Guidance on how to do this can be found in the conclusion of this report.

Filed under: Belgium, Energy demand, France, Germany, Market analysis, Natural gas, UK

Fuel for the dragon

Last month, figures were published that made clear that China has surpassed the US as the world’s largest consumer of energy.  Economic pessimists will probably interpret this as another sign that the Western economies are being surpassed by the Asian economies. It is true that for many years now, the economies of the east have grown faster than our economies. However, you are only surpassed when your competitor is becoming bigger than yours. And if we are discussing economic performance, you should watch for per capita figures rather than absolute figures. If you only watch absolute figures, the tiny country of Belgium that I live in, would never be good in anything. If you look at the energy consumption figures in that perspective, it still means that US energy consumption per capita is four times bigger than the Chinese. So, once again, we should remark that China is catching up rather than surpassing. In the past decades, this economic miracle has lifted 400 million Chinese out of poverty. Who can be against that?

The dragon economy of China has recovered more swiftly than that of any other country from the perils of the 2008 financial crisis. Moreover, it looks like they are managing to reduce the dependency on export (and American credit-based consumption) by stimulating inland demand. As the Chinese become richer (and wages are rising fastly), they buy more and more consumer goods. They also move into higher added value goods, which is a logic step. Being the world’s cheap labor workshop is not a source of sustainable economic growth. The counterside of that economic growth is of course the rise in energy consumption. And this gives rise to some important reflections:

1. Since hitting their lowest point in the beginning of 2009, oil prices have more than doubled again, fueled by the rapid recovery of Chinese oil demand growth. Coal prices didn’t grow as much, as increasing demand was matched by increasing supplies.  However, the evolution of oil prices shows that increasing Chinese demand has an important impact on commodities that are traded on a worldwide scale. This is also obvious in other commodity markets with tight supply such as copper.  What does this mean for natural gas markets, now that they are becoming more and more worldwide markets due to the LNG boom? Will China dash for gas and tap into the reserves of Russia, Southeast Asia and the worldwide LNG markets? And will the newly tapped reserves of shale gas be able to fuel an increase in worldwide gas demand? Will China itself be able to increase its production of gas due to the shale gas evolution?

2. Chinese energy demand growth has a big impact on the global carbon dioxide balance. China is growing fastly in renewable energy and for wind and solar power, it is a key market. But this renewable energy is unable to compensate for the even larger growth of coal-fired power plants. With its newly won status of being the world’s largest consumer of energy, the pressure on China for taking more responsibility in terms of reducing carbon dioxide emissions will be bigger than ever.

3. Even if China is obviously the most important factor in determining oil prices, the market is still looking mostly at the US for its analysis of prices. See this previous entry for more on that. This is due to the lack of good quality data on Chinese oil consumption. In the past two years we have seen the market surprised again and again by unexpected growth in Chinese oil demand. It is clear that an improvement in Chinese energy statistics would make the markets a lot more transparent.

We will have to see in the next years if the Chinese economy can continue its economic success story. Anyhow, it is clear that we will have to look East for information about the energy markets.

Filed under: Climate change, Energy demand, Energy history, Natural gas, Oil, The economy

Hubbert’s peak or just a bump?

In the past five years, I have hardly met anyone who wasn’t convinced that energy prices could only increase. Most buyers of energy were strongly convinced that we had reached the point where demand growth is outstripping the growth of supply and discovered reserves. This point is called ‘Hubbert’s peak’ after the US geologist M. King Hubbert. The man successfully predicted the decline of US oil production since the 1970′s. He then went on to predict a similar future for the world’s oil production. He gathered an enthusiastic group of followers called the ‘peak oil theorists’ (www.peakoil.net). Mister Hubbert also predicted that live past the peak would be characterized by the high prices and increased volatility that we suffered in energy markets in 2005 – 2008. This made many people believe that peak oil theory is indeed correct. To them, the backdrop since July 2008 was due to the economic crisis. It wasn’t a fundamental reversal of the longer term rising trend. ‘In the long term, it can only rise’, is a phrase that I often heard in the past one and a half years.

The energy procurement strategy in line with such bullish sentiment is a strategy at securing long term energy prices. Many buyers have fixed prices for volumes up to three, four years into the future. Recently, I ran into one of the largest buyers of energy in Germany and observed that they were also following such a strategy of securing prices for the long term because of their fear that energy prices could only rise. This long term – rising trend conviction even made some buyers fix prices for large volumes when the oil price reached record highs of near 150 dollar per barrel in June 2008.

Meanwhile, what do we observe in the markets?

1. With Chinese oil demand growing at record levels, the Brent price broke above the 80 dollar level in the beginning of January. It’s still very early to call ‘bear’, but today the Brent traded below 73 dollar.

2. European gas prices in the spot market have traded below 15 dollar this winter, even while demand has reached record highs due to the cold weather.

3. With Chinese coal demand back on its previous growth path, the coal price dropped back below 100 dollar this week.

4. Power prices in most European markets are back below 50 euro per MWh, which is half the level of before the correction in 2008. With European power demand getting back to previous level, the power prices show no sign of rising.

Of course, it all depends on how you define ‘long term’, but anyway, today’s market is not resuming the bullish path of before the 2008 – 2009 correction. Moreover, there are some developments on the supply side that undermine the vision that from now on, demand growth will continue to outstrip supply:

1. Some expect Iraqi oil production to ‘plug the gap’ in the oil market in the coming years (see my previous blog entry).

2. The bull trend in coal prices was mainly due to logistical issues which have been solved. Coal seems to be abundantly available.

3. The US has expanded its natural gas reserves figure to 100 years of consumption due to developments regarding the production of shale gas.

And how certain is the continuation of demand growth? We shouldn’t forget that oil prices were already falling in July 2008, two months before the financial crises broke out. Oil prices started to fall because of the fact that consumers in the US were adapting their consumption behavior, e.g. by buying less fuel-thirsty cars. How durable will that trend be? The Brussels car show has ended this weekend. Salesman told journalists that they clearly saw a trend of buying cars with better fuel economies.

In ten years time, we will be able to assess whether we were indeed standing on the wrong side of Hubbert’s peak in 2010 or whether the prices of 2005 – 2008 were just a temporary bump. In the meantime, I strongly recommend buyers to forget that energy prices ‘can only grow’. Adapting a ‘it can fall as well as it can rise’ attitude to buying energy simply breeds much better results. More on that in a next entry.

Filed under: Energy demand, Forecasting

Iraq: the next oil bonanza?

The oil market is buzzing with whispers over the future oil supply from Iraq. The Iraqi government is granting licenses for the giant Iraqi oil fields. The numbers are impressive: Zubair: 4 billion barrels, Majnoon: 12,8 billion barrels, West Qurna 12,9, Halfaya: another 4 billion barrels. As a comparison, Ghawar in Saudi-Arabia, the world’s largest oilfield, is said to have already produced 60 billion barrels. Still, the Iraqi government hopes that the production in these oilfields will allow the country to surpass Saudi-Arabia as the world’s largest producer of oil. They project Iraqi oil production to grow to 11 million barrels per day, five times its current production. Western analysts are more prudent and say that they would be happy if Iraq could grow to 5 million barrels per day.

The most important feature of these oilfields is that they are giant, conventional on-land oilfields at a normal depth and with satisfying pressure and water levels and that they are close to existing oil export infrastructure. This means that production from these oilfields will be cheap. Occidental Petroleum (US), Eni (Italy) and Korea Gas Corp, the three companies that team up for production at Zubair are happy to earn 2 dollars per barrel. They will invest 20 billion dollars in Zubair over the 20 years for which they have won a license. This is a completely different story than the tar sand or deep-sea off-shore oil fields of Canada, Venezuela or Brazil. Oil can be economically produced from these fields only at oil prices far over 50 dollars per barrel.

If the Western oil companies that have now been invited into Iraq manage to produce the oil bonanza for which the Iraqi government is yearning so much, this could mean a huge glut of cheap oil in the markets. The combination of increasing demand and diminishing supply from traditional cheap oil fields like Ghawar or China’s Daqing has produced the peak in oil prices of recent years. The fact that these large cheap oil fields were being replaced by much smaller and more expensive oil fields also caused the extreme volatility of oil prices which made oil prices double again in 2009. Will a glut of cheap Iraqi oil produce more stability and lower prices in the oil market?

The first question is of course whether they are indeed the bonanza that both the Iraqi government and Western oil companies clearly believe they are. After all, these are not newly discovered oilfields. Was it just the crookedness of the Saddam regime that made large-scale oil production from these fields impossible? Or are unexpected technical difficulties awaiting? And if oil production is technically possible, will the political climate in Iraq finally find the stability necessary to allow a stable flow of the oil out and the money in? Will the Sunnis, Shiites and Kurds find peaceful agreement over how to share the booty? Today, the US Marines are leaving Iraq. Is this signaling a final step for the country into a peaceful, prosperous future?

If Iraq could finally come to peace with itself and its oil riches, the question is of course what happens in the rest of the world. The combination of growing oil demand (in China) and declining oil production in other parts of the world like Saudi-Arabia could outstrip the increase in production in Iraq. This is what James DiGeorgia, author of “The global war for oil” believes. If that would happen, that would be excellent news for the Iraqi government. They would cash in the extra dollars between the low price paid to the producers and the much higher price that they would get in a world market characterized by tightness. It’s cynical, but it would be a huge payback for Iraq for all the blood and tears of the past decades. That is, if the oil bonanza doesn’t cause another period of war and terror.

Impossible to see who will prove right, skeptics like mr. DiGeorgia or the Iraqi government. Anyway, with the Iraqi oil bounty looking for its way to the market, a future of rising oil prices looks less certain. In your energy buying strategy, you shouldn’t neglect the possibility of a future of cheaper oil.

Filed under: Energy demand, Energy history, Oil

2010: bullish or bearish for energy markets?

Energy markets have a terrible habit of rising during the New Year’s period. On the 6th of January of the new year, the oil price ended the day at 81,89 dollar per barrel, well above the 80 dollar barrier that had been a rooftop on the market for the last four months of 2009. In the week before Christmas, the oil prices traded as low as 72,99 dollar per barrel, meaning that we saw a more than 12% price rise during the Holiday period. It looks like some people in the oil market left the table early this year for their trading desk. And it looks like they were in a bullish mood. Such surprise movements at a time when most people are on holiday always feel nasty. It’s like the market not giving you a chance to do something. Fortunately, the bullishness in the oil market didn’t spill over into the other energy markets. And even more fortunately, the bull party was quickly over. At the moment of writing these words, the oil price is back below 80 dollars at 77,22.

What inspired these New Year bulls? I personally believe that it was a clear case of ‘turning the page’ optimism. 2009 was a year of deep economic gloom. But as the end of the year came near, the picture started to look rosier. In their end-of-the year reports, most economists agreed that in 2010 the economy would do better than in 2009. Dubai and Greece were scary, but so far, these issues seem to be brought under control. This ‘things can only go better’ attitude spilled over into the oil market and caused prices to rise. Apparently, this wasn’t supported by fundamentals. The call for extra oil in the physical market wasn’t strong enough to justify oil prices over 80 dollar.

The market of the first weeks of 2010 therefore looks unclear: a rapid bullish start with an equally rapid bearish correction. How will this continue?

For oil markets, the past year has learned us that they are inclined to rise rapidly with the economic outlook. Oil is commodity that is traded worldwide. The improving economy was mostly supported by developments in China, which is doing remarkably well in terms of economic recovery. China consumed record levels of oil in 2009 and this was the main support for higher oil prices. Moreover, the easy-to-produce oilfields have recently been replaced by much more difficult and expensive sources such as tar sands, deep-sea off-shore production or bio-fuels. This causes rapid price rises at even very small increments in oil demand.

For natural gas markets, the outlook is different. Natural gas consumption is much more focused in Northern America and Europe. And these are the regions where the economic recovery and gas demand growth are slow. This has caused an important gap between oil prices and gas prices. Lower gas prices were also supported by reports of expanding gas reserves in the US based on improved recovery techniques for shale gas.

With this jump up and down of oil prices, it looks like 2010 will be another interesting year in the energy markets. The big question on my whiteboard is: will the decoupling of oil and natural gas persist? I’ll keep you informed.

Filed under: Energy demand, Market analysis, The economy, The market today

The future of European natural gas supply

 

The ‘Berliner Zeitung’ of yesterday had an article on the availability of Hub gas in Germany. ‘Cheap gas attracts German customers’ was the title and the subtitle ‘The big suppliers have bought too expensively’. Surprising to see that this popular newspaper warns residential consumers that they should buy their gas on the currently much cheaper Hubs. In recent months, I have met with many large corporate gas consumers in Germany that ignored the existence of Hubs and preferred to stick with their traditional oil-indexed gas contracts.

This corresponds with an almost philosophical divide in approach of the ‘security of supply’ issue regarding natural gas for Europe. German policymakers believe that supply should be secured by long term gas deals between states. They want Mrs. Merkel and Mr. Putin to sit together and negotiate Germany’s gas supply for the next forty years. French energy policy is similar, but as France is less dependent on gas in its energy mix, French long term energy policymaking is more aimed at (nuclear) electricity. The logistical counterpart of a long term gas deal is a pipeline, creating a rigid market between producing and consuming countries. The financial counterpart is a long term gas pricing formula based on oil prices. This is the way continental European has functioned for decades. And it is the way most traditional European gas companies wish to continue functioning. Italian gas giant Eni announced this week that they will invest 20 billion in the South Stream pipeline that will bring Russian gas to Italy via Bulgaria. And a consortium of German and Russian companies headed by former German prime minister Gerhard Schroeder is building the North Stream pipeline that will bring Russian gas to Germany via the bottom of the Baltic Sea.

Opposed to this vision on security of supply is the Anglo-Saxon version. If you would ask somebody in the US what he thinks about having politicians negotiating gas contracts, he would probably ask if you are crazy. In their opinion, politics is a threat to security of supply, not a support. They believe that the best guarantee for security of gas supplies is a well-functioning, transparent and liquid open market. They have created ‘Hub’ markets which are easily accessible to a multitude of players both on the supplying and the receiving site. On these Hubs, the prices of gas are determined by the dynamics of demand and supply of natural gas itself. If demand rises, e.g. due to a cold winter, or if supply falls, e.g. due to falling production, the price will rise. This will give a signal to producers of natural gas to ship extra gas to that market. You don’t need a politician to meddle in this. Politics will only create imbalances and inefficiencies. The logistical counterpart of such a market organization is LNG infrastructure, the financial counterpart is a normal market with spot and forward prices determined on a daily basis by the forces of supply and demand.

As demand has dropped due to the economic situation and supply has increased due to new LNG infrastructure, prices in the UK Hub market have fallen. At the same time, oil prices have risen. This creates a strange market situation in continental Europe. On the one hand, the traditional suppliers have large quantities of gas for which the price is rising. This is their traditional portfolio gas, the gas that they are to take from the producers under the long term agreements. But they are suffering competition from the cheaper gas brought in from the Hubs. In Germany, Dutch gas suppliers challenge the big German suppliers by importing cheap gas from the Netherlands.

I’m not in the forecasting business, but just imagine that this situation continues. Bar a miraculous recovery of the EU economy, it might take a couple of years before gas demand is restored to its pre-crisis levels. And on the supply side, a lot of new gas production and transportation products are coming online. This brings us to a fundamental long term issue. Compared to oil, there is simply much more gas left on this planet that is easy and inexpensive to produce. The United States has seen its recoverable gas reserves increase overnight because engineers have developed techniques to recover shale gas, of which they have huge reserves. How much shale gas can be recovered from the North Sea? Will the North Sea see the earlier predicted decline in gas production? Talking about shale gas, a Dutch newspaper claimed that the Netherlands has a hundred and not twenty years of gas reserves left. This is totally different from the situation in the oil market, where the easy to produce oil is being replaced with more expensive stuff. I’m not saying that it will happen, but it is not unthinkable that the current gap between oil and gas might persist.

If that happens, traditional continental European gas suppliers will find themselves in an increasingly uncomfortable position. They will suffer increasing competition from suppliers that don’t have long term commitments and can source their total portfolio on the cheaper Hubs. Politicians will blame them for charging higher oil-indexed prices to citizens. In the end, the oil-indexed contracts will become obsolete and they will have no choice but to try to renegotiate their long term deals and try to base them on Hub prices also.

That is, if. Reasons why the supply gut might not persist could be:

- a rapid economic recovery,

- continuous cold weather,

- serious disruptions to the upstream supply of gas (e.g. long-term cut-off of gas supplies via Ukraine),

- ‘The gas Opec’ materializes. Gas producing countries unite and agree upon voluntary production cuts to push up gas Hub prices.

We are getting near to the end of an economically horrible year. All of us are hoping for a better economy in 2010. I can imagine that traditional continental gas suppliers wish this even more than the rest of us. They probably even wish for winters that are always as cold as what we currently see.

Filed under: Energy demand, Energy policy, Germany, Natural gas

Why optimism is an economic duty

In the past weeks, we saw a lot of positive news regarding the economy.  The number one headline was the announcement that the US economy had climbed out of the recession in the third quarter with an annualized growth rate of 3,5%. Still, many observers were quick to dampen any euphoria that such news might cause. And with CIT, a large US bank and important lender to US medium-sized and small businesses, filing for bankruptcy, their arguments that the economy is still showing substantial weakness seem to be supported.

Still, such calls for caution slightly annoy me. You cannot deny that the outlook for the world’s economy looks a lot rosier than a year ago. Of course, the situation looks worse than say, two years ago, but what had you expected? That the world economy would return to pre-crisis growth rates just like that? In the past decades, the US built up a huge bubble based upon unsustainable credit largesse. Of course, it is going to be very painful to find an economic alternative for that in the US. We don’t want the US to just start blowing air into the burst bubble again, do we? Is it strange that a bank like CIT, depending on fragile companies paying back their loans goes broke? The reaction of financial markets, with no renewed sell-off, indicates that it was not surprising. Of course, recent growth was due to government economic support programs. And indeed, some of these programs expire or have expired. But were they ever meant to be a continued source of income for the industry? I don’t think so. They were supposed to kick-start the economic engine. And the 3,5% figure for Q3 seems to indicate that the policy has achieved that goal.

What annoys me about the cautious tone in the media is its effect on consumer’s psychology. If anything, the crisis of the past twelve months was a crisis of trust. Loss of trust in the banking system created the credit scarcity. And loss of trust with consumers created the backdrop in consumption that caused the industrial crisis. Therefore, all of us should hope that this positive news inspires trust in consumers. After months of quiet, the economic engine is producing some noise. We now have to pour in the fuel of extra spending to make it roar again. Will we spoil the successful kick-start by falling back to the economic gloom that we have grown accustomed to in the past year? My great inspirer Karl Popper famously said that optimism is a moral duty. I would like to add that today, it is an economic duty.

The most positive news that I recently heard came from the key steel sector. Mister Lakshi Mittal announced that he can start firing up more and more steel furnaces. And overall the steel sector expects demand to grow by 9,2% in 2010. If demand of steel is picking up, it is a clear sign that industrial output is on the rise again. The most positively surprising news comes from China. This country doesn’t stop surprising the world by doing better than expected. It has announced a growth rate of 8,9% for the thrid quarter of 2009! So, if you are looking for an explanation for rising oil prices, here you have one. Some observers even start to worry that energy markets become too dependent on Chinese growth figures.

If steel furnaces are producing again, if China keeps on growing, it means that worldwide demand for energy is rising. The bearish momentum for energy prices is weakening every day. We have already observed this in oil prices. European gas and power prices are still holding close to their historical lows. As always, the European economy is slower in its growth than other parts of the world. With many industrial companies still at very low output levels, the demand for energy is not growing fast enough for gas and power prices to react. But how long will this last?

Filed under: Energy demand, The economy

Can gas prices rise?

The deep fall of natural gas prices at the Hubs seems to have stalled for the moment. In the US, the deep fall of Henry Hub spot natural gas prices below 5 euro per MWh has reversed into an uptrend with prices already higher than 8 euro per MWh. UK NBP Hub prompt gas briefly traded over 10 euro per MWh last week. Does this mean that gas prices have started a new upward trend?

I don’t think so. First of all, it is not unnatural that prompt gas prices start to rise at the end of September as the weather is getting colder. We should take into account that prompt prices are still lower than the forward prices for e.g. nov/09 or Q1 10. It is therefore logic that the prompt prices rise as those forward periods approach. It is important to notice that the forward prices are not rising. At 15,41 euro per MWh, TTF Cal 10 gas is still close to its historic lows. As long as these forward prices are not rising, it would be deceiving to speak of a bull trend in gas prices.

Nevertheless, Hub gas graphs currently show the end of the downtrend. The question then is whether this could reverse into an uptrend. To answer that question we have to take a look at the fundamentals that have pushed the gas prices to such lows. The one reason was the decline in gas demand due to the economic downturn. European gas demand has been down 20% for most of 2009. Industrial gas consumers have reduced their production and hence gas consumption.                 And power producers shut down the marginal gas-fired power plants as demand for power has also fallen because of the downturn. The situation in the US looks similar or even worse. LNG ships have recently sailed to Europe to avoid even lower Henry Hub prices in the US. This has caused a supply glut that caused European prices to drop. Not even the biggest optimist on this planet expects the economy to recover swiftly in the next few months. Therefore, we shouldn’t expect the demand for gas from industrials and power producers to recover fast. The conditions for low gas prices could continue throughout the next winter.

Hub gas prices could rise:

-          If this winter was very cold in Europe and/or the US, causing a spike in residential gas demand,

-          If industrial demand would unexpectedly pick up fast,

-          If supply from Russia would be cut due to the conflict over gas supply with Ukraine (the Ukrainians and Russians have been fighting over payments for most of the year).

This last if brings us to the supply side of the balance. Gazprom has announced that it will cut its supply to the lowest level ever. That is the natural economical reaction of any supplier. When prices drop, they rather keep the gas under the ground than sell it at the low prices. On the other hand, the current situation cuts deep into the flesh of gas producers. Many of them must be desperate to get some income by at least selling some gas. I therefore doubt if the totality of suppliers will be able to cut supply by more than the decrease in demand.

A lot of ifs, but you can count on us to observe whether they materialize or not. And the first place where we will read it, is in the price graphs.

Filed under: Energy demand, Market analysis, Natural gas, The economy, The market today, US

Down, down, deeper and down

On Thursday, BP has announced that it has found a gigantic oil field in the Golf of Mexico in the so-called Tiber field. The concern estimates the field to hold 3 billion barrels of oil and that it could recover 300.000 barrels per day from 2020 on. To give you an idea, the world’s consumption of oil stands today at approx. 84 million barrels per day, which means that with this new oil field, the worlds supply would rise by some 0,3%.

This percentage in itself shows clearly that we shouldn’t interpret such ‘Hurrah’ messages from oil producers as a sign that the shortfall in oil supply that peak oil theorist predict will not occur. On the contrary, if we look in more detail at what BP has discovered, we get a good image of what peak oil ages will look like. The field lies 11.000 meter below the sea surface, which is an unprecedented depth for Gulf of Mexico oil fields. We’ll have to go down, down, deeper and down to recover oil from places never visited before.

Three years ago I visited an energy convention in Groningen, the capital of Dutch gas production. Kjell Aleklett, the Swedish president of ASPO, the Association for the Study of Peak Oil and Gas, delivered one of the funniest speeches I’ve ever witnessed at such occasions. In a deliciously provocative style, the man came to tell the audience of 300 representatives of the energy industry that they better start looking for another job. With tons of data, the man supported his thesis that gas and oil production were entering their decline phase. Hydrocarbons would become so expensive that this would force the world into adopting other energy technologies.

If you look at the development of energy markets of the past three years, you might think that Kjell was not only entertaining, but also correct. We did indeed see supply / demand tightness in all three hydrocarbon markets and we did see the price spikes that this induces, especially when speculative money starts buying the peak oil idea also. But some peak oil adherents do paint a picture that is too infested with doom to be true. Too many books on peak oil theory have a cover with a photograph of the last drop of oil. They want us to believe that we will have to cue in front of the gas station in the near future.

I don’t believe that this is what will happen. There is still a lot of oil on this planet and even much more gas and coal. The trouble is that it will become ever more technologically challenging and expensive to recover them. This will have two consequences:

1. Temporary supply / demand crunches will occur, as producers hesitate to bring those far away oil fields into production. This will cause price spikes like we have seen in the past three years.
2. It will also gradually drive up prices. But this will not be in the straight lines that you see on the peak theorist’s graphs. They will shake up and down ever more violently. Volatility will increase even more importantly than price.

The big question then is: how fast will this affect the energy consumption patterns of the world’s population? How fast will we start driving cars fuelled by something else than oil? How fast will we reduce our industrial and residential consumption? From which sources will we produce electricity?

What we have seen in the past year is that demand corrections cause rapid price declines. Markets go down even faster than they go up. In the long term this is probably bad news for the supply and demand balance. Already, more than a third of all projected investments in oil and gas production have been shelved as they have become uneconomical at current price levels. The question then for BP (and for the many people that bought BP stock on the news of the oil find this week) is:

Can you produce 70 dollar per barrel per oil from a place 11.000 meter below sea surface?

Filed under: Energy demand, Energy history