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.

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