Brent price in euro per barrel at an all-time high

Have you recently visited a petrol station somewhere in a Euro country? Shocked by the price level? Well, unnoticed by the press, the cost of oil has risen to its highest nominal level ever. The Brent price ended the day at 120,11 dollar per barrel on Thursday the 16^th. This is well below the Brent-in-dollar peak of 146,08 on the 3^rd of July 2008. However, the euro was then trading at almost 1,6 dollar, whereas now the euro trades below 1,3. The consequence is an all-time high Brent-in euro price of 92,52 euro per barrel. That is the reason why filling your car these days is a costly affair on Europe’s roads.

Fortunately, Europe has managed to significantly reduce its dependence on oil products. Due to fuel efficiency standards, cars guzzle less fuel. Residential heating has been switched away from oil products thanks to environmental policy and the expansion of the gas grids. And environmental policy again, has reduced the usage of oil for industrial and power producing purposes. The consumption of oil in Europe is displaying a steadily declining trend ever since 2005.

High oil prices would have been bad news for almost every continental European consumer of natural gas three years ago, as they all had contracts with the price of natural gas pegged to oil prices. Fortunately, the end market in North-Western Europe is now massively switching to the gas-to-gas pricing of Hub markets (NBP, Zeebrugge, TTF, NCG, Gaspool, PEG). True, these gas prices have also risen in the past year, but not as much as oil prices. With the oil-indexed gas contracts of the past, natural gas would have cost more than 40 euro per MWh by now, just as it did in 2008. At the forward Hub markets, gas consumers can now fix prices below 30 euro per MWh and spot prices haven’t risen much above 25. However, natural gas consumers in countries where access to Hub markets is difficult (Spain, Portugal, Italy, Eastern Europe), have every reason to look worryingly at oil market developments.

High energy prices are particularly bad news for Europe at this moment. Financial markets continue to worry about the potential cataclysm that Greek bankruptcy could cause in Europe’s banking sector. Partly due to this fear, economic growth has stalled. This week Germany published a -0,2% figure for the last quarter. Policymakers across Europe are hesitating between austerity programs to reduce budget deficits (right wing) and policies to support economic recovery (left wing). High energy costs might push struggling businesses over the bankruptcy line. Other companies might have possibilities to pass through higher energy costs in the prices of their products. But is this increasing inflationary pressure a good idea at a moment that consumer confidence drops due to the fear of a Greek tragedy? We should all hope that the combination of a recovering US economy and a weak euro supports export-oriented businesses. But it is clear that the record high Brent-price is bad, bad news for Europe.

The reason for increasing oil prices is simple. OK, here in Europe we reduce the consumption of oil. And yes, the US is reducing as they have also embraced the reduction of fuel consumption by cars. However, such declines are completely undone by developments in emerging economies where the consumption of oil doesn’t stop from growing. On a worldwide scale, we consume more oil year after year. There is enough of if left for the time being. But producing it comes at ever higher costs, which explains the increasing oil price. Squeezing petrol out of the oil sands of Alberta simply is a much more expensive affair than drilling holes in the Arabian dessert. Of course, there is some risk premium added to the price, as the markets ponder the consequences of an oil embargo on Iran and the increasing risk of military conflict in the Persian Gulf. Of course, the forces of speculation are also back. But beware of under-estimating the underlying problem. The increasing demand in oil cannot be met with cheaply produced stuff. The marginal cost economics of oil markets explain the high prices and volatility.

Even if the world’s economy is growing at a slow pace at this moment, it is still growing in the emerging economies, and faster than anywhere else in the world. And countries like China, India, Brazil or Russia, haven’t managed yet to decouple economic growth from oil consumption increases. So, unless we get a repetition of the financial-economic catastrophe of 2008, there isn’t much chance that filling your car will get much cheaper in the near future.

Filed under: Market analysis, Natural gas, Oil, The economy, The market today

Lybia and the day that oil prices were almost 120 dollar

It is with increased horror that I look at the images of Lybia. This shows the true face of dictators, they shun no crime in their lust for power. However, living in the West, I also feel shame. We live in our shelter of a free and democratic society. And we don’t protest when our politicians befriend these dictators. We don’t mind the foreign policy of “rather a dictator that is our friend than a democratic government that is hostile” . The hypocrisy of Western policy in the Middle East and Northern Africa was clearly illustrated by British PM David Cameron’s latest trip. He visited the Tahrir square in Cairo to express his sympathy with the pro-democracy protesters in the region. He was joined by British defense industry people that where on their way to a Defense expo in Abu Dhabi where they will try to sell their weapons to the Middle East’s autocratic regimes. What is the message here? We support your protest for democracy, but we also sell the weapons to shoot at you? (For more on this controversial trip, read the Huffington Post.)

It is hypocrisy, but it is also understandable. The Middle East and Northern Africa have an immense economical importance for the West. They produce the bulk of the oil and the natural gas that fire our economies. The recent unrest has pushed these prices through the roof. The gas price for 2012 is already trading around 25 euro per MWh and Brent oil prices traded near 120 dollar per barrel on the 24^th of February. Everyone of us will feel the consequences of the rush for democracy in the Arab world the next time that we fill our car. Is it therefore surprising that we sometimes prefer the stability of a dictatorship? As Berthold Brecht told us ‘Erst das Fressen, dann die Moral”, it is human to put economic interests before ethics. The current situation in Lybia should inspire modesty in the West. We are not the super-ethical beings that can impose our moral superiority upon the rest of the World. We were shaking Colonel Kadhafi’s hand in exchange for his oil. We even got fascinated by his extravagancy, the tents and camels and female bodyguard that he brought in his many recent visits to our capitals. I am not judging anyone. I am only observing that we are only humans. And that we sometimes confuse madness with bling.

The 2008 financial crisis confronted us with the madness of financial markets. Politicians claimed that they would curb the extravagancies of speculative behavior on the markets. And what did we see yesterday morning? A seven dollar price increase in 20 minutes. This reminded us of 2007 – 2008 when similar crazy price moves were observed in the oil markets. What have we learned from the financial crisis? The manic-depression-like movement of energy markets continues. Buyers of energy continue to be confronted with volatility and unpredictability. Until one month ago, we warned energy buyers that rising gas prices should not be taken for granted. There are sufficient gas reserves on this planet for gas to be cheap for some decades to come. But we also warned that supply interruptions from the Middle East could push up prices. Of course, nobody could say then that a few weeks later the whole region would be on fire.

It is not madness that energy prices rise when revolutions brake out in the region that has the largest energy reserves of the world. We are particularly worried about gas prices. We are now in the last weeks of the coldest winter in decades in North-West-Europe. However, our gas prices didn’t rally to previous heights. This was due to LNG ships unloading gas nearly every day in our import terminals. Eight in ten of those ships came from Qatar. These were the marginal MWh’s that kept the system sufficiently supplied. So far, no trouble has been reported in the gas-soaked emirate of Qatar. But trouble in the Suez Canal or in the Strait of Hormuz, the sea passage between Iran and the Arabian peninsula could mean that the LNG ships fail to reach Europe.

However much we sympathize with the protesters in the Arabian countries and in Iran, from an economic point of view this is bad news. Continuing instability will affect the output of the oil and gas industry, as is now already seen in Lybia. This will cause rising energy prices. Moreover, the economy of the region is coming to a standstill. This is bad news for the recovering world economy. These countries are huge importers of consumer goods (the lack of jobs in domestic industries is one of the main reasons for the fiery protests). If people in that region buy less, this will affect the economy. China, whose growth has powered the recent economic recovery, exports ¼ of its goods to the Middle East and Northern Africa. We are starting to fear the disaster scenario of stagflation. Energy prices that continue to grow due to supply cuts while the economy is going into recession. If supply drops faster than demand drops due to economic recession, we will enter this scenario. Both from an ethical and from an economic point of view, we sincerely wish that all these countries make a rapid shift towards a peaceful democratic government. But how likely is that? Therefore, as an energy buyer, you better prepare for a continuation and worsening of the current market situation. We obviously cannot predict the outcome of the current political crisis. But we fear that a swift return to normality is idle hope.

In the longer term, the current situation should be another motivation for Western governments to promote energy independence. Promote the widespread usage of the energy sources that we have in our own region, such as renewable energy and shale gas. In that perspective, the peoples of the Middle East might be shooting in their own foot. But would you care about the longer term economic consequences when you are fighting for your life in the streets of Tripoli?

Filed under: Energy policy, Market analysis, Natural gas, Oil, The economy, 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

German Court deals a (small?) blow to oil-indexed gas pricing

It was a long ride yesterday from Berlin back to Frankfurt, and my German colleague Arne and I threatened to run out of conversation topics. But then the radio news gave us a topic that kept us busy for the remaining two hours. A courthouse in Karlsruhe has decided against oil-indexed gas pricing practices by two German suppliers, Rheinergie from Cologne and Stadtwerke Dreieich from Hessen. I’ve heard about this court case in Karlsruhe a month ago and was watching anxiously for its results. The court ruling isn’t the definitive blow to oil-indexed gas pricing that some had hoped for. The judge hasn’t outright forbidden oil-price indexation for gas. That’s probably for the better. Where do we go when judges decide upon micro-economic realities such as gas price indexation? The ruling, to my opinion, will not be without consequences, like some German papers imply this morning.

Before we go into the details of the ruling some background. When we started consuming natural gas in large quantities in the 1960′s, two different market models developed:

1. In the United States and the United Kingdom, pricing systems were created that we call ‘Hub markets’ or gas-to-gas pricing today. The principle is simple and economically wise. Supply and demand of the natural gas itself determine the price. Such pricing obviously calls for a competitive gas market on the supply side to avoid misuse of market power to push up prices. It is therefore not surprising that the first liberalized gas markets developed in the US and the UK. Such a market model demands a fundamental (Anglo-Saxon?) believe in the powerful force of markets. Security of supply is guaranteed by open access to markets in this model and not by political protection of energy rights. (Although the role of the UK and the US in the Iraq war shows that they are not always such firm believers of this principle either.)

2. In continental Europe, belief in the power of open markets has always been much less. Therefore, a different model was developed, that of the long-term oil-indexed pipeline gas deals (what a mouthful). European politicians of the consuming countries, such as Germany, France, Belgium, Austria, Spain, Italy, etc., negotiated long term supply contracts with the producing countries such as Russia, Norway, the Netherlands or Algeria in the South. Large pipelines were constructed to which only the companies that had invested in them had access rights. Long term contracts were made, guaranteeing the off-take of certain minimum (take-or-pay) quantities of natural gas for up to 30 – 40 years. If you make such long term contracts, you obviously don’t want to go for a fixed price. And as no liquid market with gas prices was available, the habit grew of linking the price of gas to the ‘first nearby’ energy product: oil. There was even some economic logic for doing this. At that time, natural gas was still fighting for its place as a substitute for heating oil. By linking the gas price to heating oil prices, the producers and resellers in the countries of consumption could ensure that the gas price was developing unfavorably compared to the competing heating oil.

In the then regulated markets, the official tariffs reflected the underlying costs of the monopolistic suppliers, i.e. of the prices going up and down with the oil prices. So we have all grown accustomed to the fact that our gas prices rise, not because of supply and demand dynamics of the gas itself, but because of what is happening in the oil markets. But if you think about it, it isn’t exactly logic. It’s a little bit like selling potatoes for the price of tomatoes. They are both vegetables, but if the growing season for tomatoes goes wrong, this doesn’t necessarily mean that the growing season for potatoes was also a failure. So if you have linked your potato price to the tomato price, you will inevitably find yourself sooner or later in a situation where you find yourself paying a high price for a product that is in abundant supply (i.e. when the tomato and not the potato growing season went wrong).

Since the middle of 2008, we find ourselves in exactly that situation in the gas markets, which brings oil-indexed gas pricing in an increasingly difficult situation. Whereas the oil prices have doubled after hitting their lowest point in February 2008, the gas prices on the Hubs have fallen since the middle of 2009. The gaspool Hub price for German gas published by www.eex.de has fallen by 63% compared to June 2009. This falling gas-to-gas price reflects fundamentals, namely the increasing inflow of LNG into the UK and the increasing supply of gas to the world markets due to the shale gas developments in the US. Many observers cite decreasing demand due to the economic crisis as a main reason, although that isn’t completely correct. We come out of a winter with record high demand due to the cold weather, and in that winter the spot price for gas never was much higher than 17 euro per MWh. This clearly shows that increased supply is an important gas price driver at the moment.

Now let’s go back to the Karlsruhe court case. This is a clear case of consumers complaining that they get potatoes sold at the price of tomatoes. And of course, a judge cannot outright forbid the practice. But the ruling does say that oil-indexation cannot be used as a justification of price rises if the underlying costs for the suppliers haven’t risen equally as much. This could have some important ramifications. Gas suppliers currently win a lot of money on oil-indexed vs Hub-indexed gas arbitrage. For example. If the Hub price is low, as it currently is, they only buy their minimum obligation (take-or-pay volume) from the gas producer. If the total sum of consumption of their clients is larger than that take-or-pay level, they buy the extra gas on the Hub and sell it against oil-indexed prices to their clients. The Karlsruhe court ruling puts such money spinning based on oil-indexed end contracts in question.

Moreover, the big German gas suppliers seem to have understood that the current decoupling of gas and oil prices could continue. They have therefore renegotiated their Gazprom contracts and the Russian gas giant is now indexing part of its gas prices to the Hub prices. However, in the retail market, the big suppliers continue to encourage clients to buy gas at oil-indexed prices. Isn’t that another example of what the Karlsruhe court ruling calls a price rise based on oil-indexation that is not supported by the real cost structure of the suppliers?

It remains to be seen whether the court ruling could have any short term practical consequences for industrial consumers that are frustrated with their oil-indexed gas contracts.  But I am convinced however that it could have some longer term consequences:

1/ As large European gas resellers try to renegotiate terms with Russians and Norwegians to include Hub components in the gas price indexations, the court ruling will help them in stating their case,

2/ It draws consumers attention to the ambiguity of oil-indexed gas pricing, which many large industrial consumers, especially in Germany, take for granted. They are easily convinced by suppliers’ arguments that oil-indexation is ‘safer’. Many think that the Hub market is a spot market. IT IS NOT ! You can buy gas for 2013 today based on Hub pricing. That’s not exactly my idea of a spot market. Still, today, in almost every German newspaper I read, I find that the Hub markets are described as spot markets and spot markets are more risky. The raw facts, however, are there. If you have chosen an oil-indexed gas contract 12 months ago, you pay a lot more than if you have chosen that ‘risky’ Hub price. Moreover, if you had chosen a Hub contract five years ago, you would have suffered spikes that never went much higher than oil-indexed price spikes and your average gas price over those five years would have been substantially lower. The Karlsruhe court ruling might help consumers to have a fairer assessment of hub prices. I found out at least one German client today where the articles on the court ruling were being mailed around.

3/ It will draw politicians attention to the problems of continuing with oil-indexed gas prices if Hub gas prices stay where they are. The papers cited several German politicians that pleaded for ending the oil indexation, the long term contracts along with it and go for a fully liberalized gas market. That is very remarkable in a country where a former chancellor hammered out the North Stream pipeline deal (all very long term and very oil-indexed contracts) and was rewarded with a top job at the company constructing it.

The decoupling of gas and oil prices is an extremely interesting event. We are not predicting that it will continue. However, if you look at reserves of natural gas and oil, you cannot deny the potential of it continuing. If it doesn’t, it is because somebody blocked the import of extra quantities of gas into Europe. Long term oil-indexed pipeline gas deals are an excellent instrument for doing so. The Karlsruhe court ruling could be an important milestone in fighting such blocking of the markets by oligopolies. Let’s hope it will turn out to be so.

Filed under: Energy history, Energy suppliers, Germany, Natural gas

Shale gas: mankind’s second chance?

In the past five years, it looked like we were coming very close to the point where we would have to say, “We’ve done it, we’ve spoiled the earth’s riches”. As a larger share of mankind took its part in the global wealth, the consumption of energy rose steadily. Production of energy was unable to keep pace. The oil price peaked to almost 150 dollar per barrel. Peak oil seemed to move from theory to fact. On top of that, scientific consensus grew that burning all that fossil fuel was destroying a fundamental characteristic of life on earth: the climate. The end of fossil fuel burning seemed near. Oil, gas and coal would become increasingly scarce and unwanted because of their environmental impact. Many industrial consumers of energy told me in those past five years: “In the long term energy prices can only rise”, and adopted an energy buying strategy with such long term bullishness in mind.

It looks like the earth is prepared to give mankind a second chance, or at least a few extra decades to look for a good energy solution without burning hydrocarbons. Recent technological developments have opened up a vast reserve of those fossil fuels that have the lowest impact on climate change: natural gas. Engineers have found out ways to tap into unconventional gas sources such as shale gas, tight gas and coal-bed methane. It’s not that we have discovered a new reserve of energy wealth, it’s just that we have developed technologically so that we can extract more from the soil than we previously could. And this is not some technology which lies ahead of us in the future. Thanks to shale gas production, it looks like the US surpassed Russian production in 2009 !

This sudden glut of natural gas is not without consequences for energy prices. Since the middle of 2009, natural gas prices in Europe have decoupled from the oil prices. Whereas the oil price was rising, gas just kept falling lower and lower and lower. In the past winter, the coldest in 25 years in North-Western Europe, the spot price for natural gas (on the British NBP, Belgian Zeebrugge, Dutch TTF and German Gaspool market), never went much higher than 15 euro per MWh, to be compared with prices above 40 at the beginning of 2008.

Now, many will say that these lower gas prices are due to the decline in industrial and power production demand in the wake of to the economic downturn. But that is not exactly true. As I have said, the past winter was exceptionally cold. This has caused gas consumption to rise to record highs. Of course, these highs would have been even higher if the industrial demand was at its 2008 level. But they were record high, and despite that, no price spikes occurred. The reason for that? Every week LNG ships unloaded their cargo in one of the UK’s new LNG terminals or in the recently expanded terminal in Zeebrugge. All this LNG gas was available, not only because of investment in LNG production in e.g. Qatar, but also because of the lack of LNG demand in the US, where the shale gas was supplying the extra winter gas.

We should be very careful about shouting ‘bonanza’ in the energy market. Conventional gas producers and resellers will be quick to point out the risks of some backlash. This could for example be the environmental impact of the horizontal drilling and rock shattering necessary to produce shale gas. But with every article that I read about this shale gas thing, it looks more and more like this could be the big game changer. An illustration of this could be the situation at the Kitimat LNG terminal in Canada. Originally designed to be an LNG import terminal, it is now being refitted to become an export facility of LNG coming from shale gas sources. Instead of becoming a major importer, Northern America is preparing to become a major exporter of natural gas. This clearly illustrates that if this shale gas is becoming a reality, how deeply it changes the rules of worldwide natural gas economics. The massive flow of gas from Russia and the Middle-East to the US and Europe might not materialize. For Europe, it looks like there are vast reserves in Poland and maybe also Germany. China is hopeful about its underground holding shale gas as well.

I think that the world will gladly adopt natural gas as its main source of energy, for three reasons:

1. Natural gas is cleaner that coal and oil. So, if we replace coal and oil consumption at a faster pace than we use extra energy, the net result for the environment will be positive.

2. Gas-fired power plants and CHP’s are proven technology. Moreover, for a utility, building a gas-fired power plant is currently the cheapest option.

3. Gas-fired power plants are easy to fire up and scale down. Therefore, they are excellent peak-load producers. We need more such peak-load capacity as a back-up for the renewable power that we increasingly use.

If we continue to invest in wind, solar and other renewable energies like we do now, if we build gas-fired power plants as back-up facilities, if we don’t massively pull out of nuclear power production, if we keep improving the energy efficiency of our appliances, we could even switch to electricity for driving our cars and still reduce the overall greenhouse gas emissions. It is maybe my optimistic nature that makes me say this, but it looks like the doomsayers got it wrong (once more). More pessimistic natures will point out that the availability of cheap gas will slow down the development of renewable power production. I partly agree, we will need continued political will to support renewable. I even partly cheer that prospect, in as far as cheap gas will keep us from investing in those sometimes insane biomass projects that are currently running.

To me, the shale gas development looks like the most important event in the energy markets in decades. But as I’ve said, we should carefully watch out for any unsuspected backlashes that shatters the optimism to pieces. E&C will carefully watch this for you and inform you what it means for your energy buying.

Filed under: Climate change, Energy history, Energy technology, Natural gas, US

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

Transparency & the European gas market

Europe’s continental gas markets are slowly making the transition to a different market model. The Hub market model, known in the UK and the US for decades, is to replace the system of oil-indexed gas deals. Historically, gas in Europe has been sold in long term deals. These deals were between on the one side companies in producing countries, companies that we now know under the names of Statoil from Norway, Gazprom from Russia, Gasterra from the Netherlands or Sonatrach from Algeria. In the consuming countries, (predecessors of) companies such as RWE, E-ON Ruhrgas, Wingas, Gaz de France, Distrigas, Eni, Gas Natural or others were the receivers of these deals. This deal-making implied heavy political interference, as ministers were often directly involved in the negotiations. A famous example is the Belgian minister Willy Claes negotiating the contract that brought Algerian gas to Distrigas in Zeebrugge. The traditional companies in the consuming countries built the network infrastructure necessary to receive, store and distribute the natural gas. When the continental European markets were liberalized, they were forced to create separate grid companies to run this infrastructure. This ‘unbundling’ is supposed to create the necessary independence of interests to allow third parties an open and unbiased access to the grid infrastructure. Such third party access is a necessary condition for gas market liberalization to be a success.

Last week, traders in the continental European markets had complaints regarding that third party access. They specifically blamed lack of transparency regarding available storage and transit capacities for the slow development of continental European Hubs such as Zeebrugge in Belgium, TTF in the Netherlands or NCG in Germany. And indeed there are some solid reasons why transparency regarding storage and transit in these markets is low. The first reason is that some of the infrastructure is still in the hands of certain market participants. The big German gas suppliers are also the owners of the large storage capacities in Germany. The second reason is the fact that many capacities have been blocked by historical rights of certain suppliers. Unlocking these capacities is a difficult exercise. Many years ago, the governments supported companies making long term contracts for the supply of gas. Can those same governments make those contracts obsolete by taking away the capacities that those companies need to honor these contracts?

The underlying difficulty is that it proves extremely hard to transpose the English gas market model – without or with limited long term contracts – to the continent. An important reason for this is the difference in pricing models. The long term contracts have pricing based on oil prices. The Hub markets function with gas-to-gas pricing. It is supply and demand of natural gas that sets the gas price (which is much more logic). Since the summer of 2009, the Hub prices have dropped far below the oil indexed prices. If this trend continues, the holders of historic supply contracts face a huge problem. They will have the obligation to take gas from the producers at higher oil-indexed prices than the Hub prices at which they can sell in their home market. It is therefore understandable that they are not very enthusiastic in developing the Hub markets. Therefore, developing liquid and transparent continental Hub markets is the main challenge for European natural gas market policymakers.

Filed under: Belgium, Energy policy, France, Germany, Natural gas, the Netherlands, UK

The only way is up?

At the end of last week, the oil price broke through the 75 dollar per barrel level that had been the resistance level for some months. At the moment of writing these words, the Brent price is at exactly 77 dollar per barrel. At first sight the oil markets seem to share in the bullishness which has been observed in stock markets recently. On the other hand, the positive mood is much more prudent than the reckless upward shocks that we saw in 2007 and the beginning of 2008. The oil price is no longer racing uphill at a rate of 5 – 6 dollar per day.

This seems to be logical if you consider the current macro-economic context. Yes, there is some more positive news n the world economic front. But on the other hand, it is also clear that recovering from such a deep recession is not an easy, straight-line process. The small-step but continuous rise in oil price since February however has brought the oil price significantly higher. The 77 dollars that we see now is almost double the low of 39,55 that we saw on the 18th of February.

An important element to consider however, is the contango effect. The oil price that you read about in the papers is the month ahead oil price, i.e. the price of the futures contract for the next month for which futures contracts are traded. Today, with the 77 dollars, that is December 2009. In February, with the 39,55, that was April 2009. And what is important is that at that moment, the April 2009 contract had dropped a lot more than the December 2009 contract, which was trading at 46,28 dollar per barrel on the 18th of February. This is due to the contango effect that we have observed all year long in the oil markets, meaning that futures prices rise the further you go into the future. From this perspective, the oil price has not doubled, but risen by 66,9%.

Second element to consider for European buyers of oil and gas prices linked to the oil price, is the currency effect. On February the 18th, you could buy 1,2537 dollars with 1 euro. Yesterday, this had risen to 1,4939. This means that the December 2009 contract was worth 36,91 euro per barrel on February the 18th and it has now risen to 51,54 euro per barrel, a 40% rise. This explains why oil-indexed gas prices for 2010 have not doubled.

Still, a 40% rise is considerable. The reasons are unclear. It is provoked by falling dollar value. The correlation between euro/dollar rate and oil prices seems to be one of the few that has survived the crisis. Colder weather conditions in key consuming reasons could be another reasons. Or maybe, we will find out in a few months that the Chinese are consuming more oil again. I’ll let you know.

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

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