Donald Trump tweets on Qatar: consequences for gas consumers

Three tweets of Donald Trump have deepened the diplomatic isolation of Qatar. Earlier, Saudi-Arabia, Bahrain, the United Arab Emirates, Egypt, the Maldives, and Yemen started the Qatar-bashing by cutting diplomatic ties and closing their borders and air and sea connections. The fact that the US President is choosing sides in this conflict is a complete turnaround from earlier US policy aimed at promoting unity among Arab countries. Trump is also dealing a remarkable kick to a key ally of the US in the Middle-East. Many analysts and politicians commented today that the US happens to have its military headquarters and thousands of soldiers in Qatar. A basis from which they have just launched the offensive on Raqqa, the de facto capital of IS in Syria.

It’s of course not the first time that Donald Trump’s tweets are a source of surprise and uproar for US politicians, diplomats, and officials. But what caused him making such a remarkable, uncontrolled, and unchecked turnaround in the minefield of Middle East policy? Well, many observers have remarked that Donald Trump often displays classic playground bully behavior. And which kids get chosen as targets by the playground bullies? The weakest of the pack.

Unfortunately for Qatar, that’s just what they are. The small country has just 2,5 million inhabitants, and just 500.000 of those are Qataris, all the rest are immigrant workers. Nevertheless, in geopolitics, Qatar has played a disproportionately big role for many years. It could do this, thanks to the following:

• No country in the region has managed to exploit its fossil fuel wealth as well as Qatar. Sitting on large natural gas reserves, they developed a large capacity for producing and exporting Liquified Natural Gas (LNG), an achievement that none of the other Arab countries have been capable of copying. This brought them economic ties to many countries across the globe which resulted in political leverage. Moreover, it brought in loads of money.
• Qatar invested some of that money in initiatives that gave them a large international audience. Think about the world cup soccer that it will host in 2022. Or top class airline Qatar Airways. And most importantly, think about Al Jazeera, the leading source of information in the Arab World, meaning that Qataris spread the news.
• Qatar consciously searched for backing by the world’s superpower US for supporting its larger-than-life geopolitical ambitions by allowing America to build such a strong, crucial military presence inside its borders.
• But as a small, militarily weak country, Qatar has also tried to be friends with everyone. They have simply shared the diplomatic bed with too many partners. In the Middle-East this makes you vulnerable to accusations of “supporting terrorism”. One of Mr. Trump’s tweets suggests that this is what the other Arab leaders whispered in his ears when he visited them. This caused him to give the thumbs up for the diplomatic isolation that was put in motion earlier this week.

Mr. Trump’s move on Qatar might also have been inspired by his economic reasoning. I think that he’s been right in pinpointing the main weakness of the US economy, namely its large trade deficit. To make America great again, he wants to import less and export more. And what does he want to export? Definitely America’s fossil fuel wealth. Think about his coal policy. He must know very well that the extra coal produced in the US will not be burned in US power plants. The low natural gas prices make it much more profitable to produce electricity in gas-fired plants and coal prices have to drop a long way before beating gas. So the extra coal will be exported, continuing a trend of rising US coal exports that started a few years ago. Coal will help to fill the trade gap.

Donald Trump hasn’t revealed much yet about his thoughts on natural gas. But as the US has just started to develop its LNG export business, we can easily see how the prospect of selling more liquid gas to the world fits perfectly in Mr. Trumps ambitions to reverse the trade deficit. And who will the American LNG sellers meet as fierce competitors in the LNG markets? Qatar indeed.

Donald Trump’s tweets on Qatar should be seen in the light of his tweets on China and Germany. His eagerness to make the US an export rather than an import success story easily turns into envy when it comes to countries that have written an export success story of their own. An envy that results in poisonous tweets.

US diplomats and officials are scrambling to undo the consequences of Mr. Trump’s 74 words, written in the nightly hours. Economically, they seem to be a reversal of the Carter Doctrine to which the US has adhered for almost four decades. Under this doctrine, the US seeks to promote unity and peace in the region to safeguard the free passage of energy. It expresses a deep belief in global free markets being in the best interest of the US economy. Now we seem to have a more protectionist and dirigist president, adhering to the Putin doctrine of using political leverage to push America’s economic interests. “Free trade” in the Donald Trump dictionary seems to mean: “Americans sell everything to the rest of the world”. Competitors are to be blocked with import taxes and accusing tweets.

Citizens in Doha are currently stockpiling food, which shows their fear of further derailing of this conflict. In this highly militarized part of the world, the danger of armed conflict is always luring. An escalation in military terms or an economic blockade of Qatari LNG exports would have devastating effects on the world’s gas markets. In 2015, Qatar exported 106,4 billion cubic meters of natural gas of the world’s 338,3 bcm. Removing that gas from the world market would have serious consequences. It might be good news for US LNG exporters. But China has just announced that it plans to triple its LNG imports by 2030. We could surely use Qatari gas for that.

Qatari gas is of particular importance to European gas consumers. They are the marginal MWh’s. When the ships from Qatar come, gas prices in Europe drop. When they sail to Asia instead of Europe, our prices increase. We should therefore carefully watch this conflict and hope that it doesn’t derail further.

Price transparency, the key to more effective energy price management in the US

Not all large U.S. energy consumers manage their natural gas and power prices in the same way. For natural gas, many have adopted a more advanced approach, buying with contracts that allow for advanced price management techniques such as layered purchasing. For power, most U.S. customers take a different approach – taking either a fixed price or a spot price, and limiting their ability to actively manage their budget through price fixings in the process. Why even opt for this second approach? One major factor is the lower degree of price transparency in U.S. wholesale power markets compared to Henry Hub for gas. That said, there is no logical or economic reason for approaching power price fixing differently. As one client remarked recently: “We’re spending twice as much money on power than on natgas, and 80% of the time we spend on energy pricing, we’re talking about the gas bills”.

How U.S. industrial energy consumers can improve their natural gas price fixing practices

Deregulated natural gas prices in the U.S. are almost always linked to Henry Hub pricing. Those industrials opting for fixed prices contract can simply follow the ups and downs of Henry Hub forward prices on NYMEX. For those gas consumers that want a more managed approach, contracts can be set up whereby prices are layered-in – in other words, consumers can lock-in a certain percentage of their volume – for a certain period – at NYMEX-traded prices for those periods.

Buying natural gas is a tricky business because it involves a double moving target. Not only do you have to deal with the volatility of Henry Hub pricing, but you also have basis pricing to worry about. Your end price depends on the pricing differential between your local hub and Henry Hub. Depending on where your gas is produced or imported, supply / demand dynamics will be more or less favorable compared to the conditions at Henry Hub, resulting in a lower or higher price for the gas. This differential is then reflected in the basis price.

In recent years, for example, we’ve seen basis pricing for West-Pennsylvania and Ohio drop to negative levels due to the shale gas production. Moreover, gas marketers need to book the physical capacities on the network to bring the gas from the production site and these costs are added to the basis pricing. This gives rise to important differences in regional gas prices that change over time. During the Polar Vortex, for example, the increase in Henry Hub commodity pricing was amplified by huge increases in basis pricing in certain regions.

Many US gas consumers are only vaguely aware of the impact of basis pricing on their natural gas spend. All their attention goes to hedging their Henry Hub price and they completely neglect basis pricing. But as you can see from the graph above, basis pricing adds as much volatility risk to your final price as the Henry Hub component.  A sound natural gas price management strategy will therefore take into account basis pricing as well as Henry Hub. It can take some time, but you can often find wholesale market information that gives you a good indication of what basis pricing you should expect. This can help you to select different moments for hedging your basis risk, which often doesn’t coincide with a good moment to layer in hedges on Henry Hub. Moreover, suppliers offer solutions where you can hedge basis in layers, in the same way you spread your commodity buying decision to reduce risk. With some efforts, both of the double moving targets involved in gas pricing can be effectively managed.

How power can be managed in the same way as natgas

Whereas natgas has a pricing system with one reference price for the whole country and basis pricing for different locations, power pricing is based on different wholesale price references. In the State of Texas, for example, there are no less than 4,000 different spot prices. Many of the consumers we speak to have no clue to what specific wholesale price reference their power price is linked to. They are equally unaware of the myriad of forward pricing products suppliers base their fixed price offers on. Many of them are also oblivious to the fact that, just as for natgas, suppliers offer the possibility of layering in power prices, allowing for more active price management.

By managing basis pricing for natural gas and using advanced price management techniques for power, U.S. companies can optimize the way they manage their budgets. While it’s true that floating with the market has often been the better choice given the bearishness of energy markets these past few years, it should always be kept in mind that going on index doesn’t offer any protection when markets turn around. Many customers were reminded of that during the Polar Vortex, when their monthly energy bills exploded. This is especially harmful for so-called ‘budget risk’ clients, businesses that do not have the option of passing on higher energy costs to their customers. For them, it’s a good idea to have contracts with layered forward purchasing features in place for when markets turn bullish. At historically low prices and with the US self-confidently increasing its production year after year, it is tempting to believe that low prices are here to stay. They will not – what comes down must go up. And if they do, many US customers will feel sorry that they didn’t lock-in some of the current low prices for future years.

 

 

How to deal with the volatility in the oil markets

Written by Frederic Grillet

These last few months we’ve seen oil prices bouncing up and down. Intraday movements between 5 and 10% were not uncommon. Current price levels, which are approximately 70% lower than their peak levels in june 2014 and are the lowest that we have seen in 10 years, seem to cause investors to overreact to every rumour in the market.

Brent front-month prices started January at a price level of 37.28 $/barrel and dropped 34% to 27,88 $/barrel on 20 January, only to rebound 25% by the end of the month. The main causes of the price surge were a vague statement by ECB-President Mario Draghi hinting on potential monetary measures to boost the EU economy and a rumour that OPEC & Russia were discussing a potential production cut.

Despite the fact that oil markets have always been quite susceptible to speculation, which amplifies any trend in financial markets, this volatility seems to edge on irrationality. The oil market has a structural problem of oversupply, with production having exceeded demand with 1 to 2 million barrels per day (depending on the source) over the past years. The US Energy Information Agency has indicated that it expects an average oversupply of 1.75 million barrels/day for the first half of 2016 as well, while crude inventories in the US are at record highs above 500 million barrels. An agreement amongst global oil producers, which is looking very difficult due to a variety of reasons, could of course address the issue from the supply side, but the demand outlook remains weak with major economies, including China, showing signs of a slowdown.

Although the downward trend in oil prices was strong in the past months and has reached historically low levels, the fundamental issues in the markets have not yet been resolved and no solution seems to be in the making for now. The very strong upward and downward movements despite the lack of changing fundamentals shows that price levels have entered a territory in which trends are mainly caused by speculators hedging their long and short positions.

Impact on other commodities

EU gas & electricity markets are generally shaped by a variety of factors, though for January, the trends showed that the main driver for prices were the oil prices. Markets in all countries have therefore seen a very rocky start of the year. The main question here from a procurement point of view is whether this volatility marks the start of a structural trend change after last year’s general downward trend and whether it is necessary to start taking bigger positions.

So when do you hedge?

Volatile times like these prove the value of the combination of market analysis and a strong purchasing strategy. The market analysis allows us to identify the opportunity moments, i.e. when markets start turning around. However, as the last months have shown, it is never a sure bet whether that is only a temporary or a fundamental turn of the trend. Hence the importance of spreading your hedging decisions and fix in small incremental amounts. In the end, how much you hedge and how far into the future should depend on your strategy. If your main risk is budget variability over the long term, than you can take large positions for many years into the future, although you should always do that in small incremental amounts. If your main risk is having an uncompetitive energy price, you should be much more prudent and make only small opportunistic fixings.

A long downward trend, as we have seen in the EU energy markets, tends to spark an urge to take bigger bets in the markets, e.g. by opting for fixed energy prices for years ahead, Although a bet can sometimes turn positive afterwards, it remains a bet and should have no place in a professional business. Therefore, although it would be a good idea to check whether the current movements in the markets make it necessary to take a position in your portfolio, it remains very important not to be seduced to overreact to an overreacting market.

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Declining oil price: geopolitics or just plain economics?

The main event in 2014’s energy market has been the sharp decline in oil prices in the second half of the year. In the first six months, geopolitical tensions regarding Ukraine & Russia still caused hick-ups in the oil markets, with Brent prices reaching 115,06 dollars per barrel on the 19^th of June. But then the barrel started a bear correction that even brought it below 60 dollars per barrel on the 16^th and 18^th of December. Even if oil pricing has lost much of its importance for European industrial energy consumers, due to the decoupling of natural gas from oil prices, I obviously want to share some thoughts on this sharp bear trend.

“It’s the economy, stupid”

 In general, the press is always quick in looking for geopolitical explanations of oil price trends. Even seasoned oil traders often have one eye on CNN and the other on their trading screen. However, a look at supply and demand dynamics of 2014’s oil markets is telling much more than the images of war and political leaders that color the many ‘the world in 2014’ retrospectives that we currently see on television. First of all, demand is not growing as fast as before. Economic growth in Europe and Asia is sluggish, and the one economy which is doing well, the US, is switching towards other fuels and higher efficiencies. Moreover, the US is producing more and more of their petroleum needs themselves. According to the International Energy Agency, the US have grown their oil production in the first nine months of 2014 by 3,5% compared to the same period in 2013. The US is now solidifying its position as the world’s biggest producer of oil. And they’re not there yet, but they could be heading for the enviable position of net crude exporter.

The increase of oil production in the US is caused by the rapid development of shale oil production, the petroleum equivalent of shale gas. This boom is obviously attracting much attention. But we shouldn’t forget that oil production booms are happening in other countries as well. Still according to the International Energy Agency, Canada has grown its oil production in the first nine months of 2014 by 6,5% compared to 2013, thanks to the development of oil sands. And the deep sea oil production of Brazil, causes that country to report an 11,5% increase of oil production in October compared to one year earlier (source: Forbes).

Is Opec waging a price war?

All that increasing production in non-OPEC countries should obviously provoke a reaction from OPEC countries. Traditionally, we expect OPEC to cut supplies when prices hit historical lows. But that’s not what it is doing. On Monday the 22^nd of December, the Saudi oil minister, Saudi-Arabia still being the most important OPEC-member, announced that OPEC would not cut supplies, however low the oil price would drop. This strongly confirms the decision at the latest OPEC summit at the end of November not to cut.

A hawkish interpretation of OPEC’s policy of not cutting supplies sees it as a price war. OPEC is consciously dragging down prices, hoping that it will undercut the economics of that new oil production in the US, Canada and Brazil. We’ve seen OPEC (and Saudi-Arabia) attempting similar price wars in the 1980’s, then mostly hoping to stop the development of North Sea and Gulf of Mexico offshore oil production. It failed spectacularly, with the competitors continuing their development and the Saudi budget fatally hurt by low oil prices. Price wars are a tough game. Mostly because of the way that supply and demand dynamics or price elasticity work. For understanding them, you need to make a firm distinction between fixed or investment costs and variable or operating costs.

Short term price elasticity is mostly influenced by operating costs. If the price of a product drops below the operating costs, producers will stop producing the product. In terms of crude oil, if the price of crude drops below the variable costs of operating a well, the producers will shut down production from that well. Now, as far as oil production is concerned, we need to make an important remark here. Operating costs of oil wells are often quite low. Wells are often quite expensive to drill, causing a high investment cost. This is especially the case for the US shale oil and Brazilian deep sea offshore wells. But once drilled, the costs of letting the oil flow out are not very high. To understand this, look at the situation of Brazilian oil producer Petrobras. They have just invested hundreds of billions of dollars to develop their deep sea offshore oilfields. Why on earth would they stop producing from those wells now? Of course, they and their American shale oil colleagues would prefer getting the 110 dollar plus prices for their oil of a few months ago. But the less than 60 dollars that they get at this moment is still giving them some return on their massive investments. Stopping production and getting 0 dollars per 0 barrel is not paying back anything.

With its combination of high investment and low operational costs, the oil market is not a good place to see short term effect in a price war. Price warlords should therefore aim for the long term effects of lower oil prices. Investors in the US, Brazil and Canada could be frustrated and stop investing in the oil developments in those countries. Lower stock prices of oil companies seem to point in that direction. This could have only limited effect on large scale developments like those that we’ve seen in Brazil. However, it could be more effective in hurting the US shale oil development. Shale oil wells typically have steep production decline curves, meaning that most of the oil is produced in the first years after drilling the well and then the production volumes per well drop rapidly. So, you need to maintain investment in drilling new wells to keep up the overall production rate. If lower prices would cause a decline in investment, the expansion of US shale oil production could be slowed down or even reversed. However, experience in the shale gas industry has shown that investment has been more resilient to lower prices than initially thought, especially since a fall in natural gas prices coincided with a drop in the investment costs due to the falling cost of the newly developed horizontal fracking technology. Therefore, it’s all but certain that a conscious price war by OPEC (and/or the Saudis) against further investment in new oil production could produce results.

Maybe, what we are seeing is far from a conscious attempt by OPEC to wage a price war, but a simple struggle for market share. OPEC cannot idly sit by and watch the US, Brazil and Canada steal away its market share. Oil supply growth is currently outstripping oil demand growth, meaning that the oil market is currently a buyers’ market and not a sellers’ market. In such a market, price wars are usually not fought in an offensive attempt at hurting competitors, they are fought as a defensive strategy for keeping market share. In the end, at the sellers’ side everybody is hurt and only the strongest survive. The Saudis could be hopeful that they will prevail with their low cost oil production.

Are Opec and the US working together?

Amateurs of geopolitical explanations of the events in oil markets are pushing an opposite theory. Saudi-Arabia and the US are not fighting each other, they are collaborating. Flanked by the economic sanctions of the EU, they work together to lower the oil price down to levels that really hurt the Russian enemy. Early in November, Vladimir Putin himself put forward this theory by stating that he believed that politics were the cause of the lower energy price. Whether this global conspiracy theory is true or not, it is indeed effective, if you see the turmoil of the Russian economy and currency in the last weeks.

 

All in all, these events are showing once again how utterly unpredictable energy markets are. Six months ago, Russia, an important oil producing country was engaged in a deep geopolitical conflict, with concerns over the impact on supply causing oil prices to increase. Anyone that would have said then that by the end of 2014 the oil price would drop below 60 dollars per barrel would have been declared a nutcase. But it happened. We can make educated guesses about its causes: simple supply and demand dynamics, a conscious commercial policy by OPEC or a complicated geopolitical intrigue? Or a combination of two or even all three of these options? Which explanation we choose, probably depends more on our own personal convictions than on empirical reality. Which obviously shows that we shouldn’t attribute any predictive quality to our theories. What has happened has happened. The oil price is historically low, benefit from it. And prepare for the next move which will come just as unexpected as this decline.

Could the BP oil spill move us beyond petroleum?

For more than three months, oil has been spilled in the Gulf of Mexico. In these three months the world has been presented with an unprecedented flow of images of the environmental impact of the oil industry. Birds and beaches drained in oil were not limited to some beaches like we see after the crash of an oil tanker but came on an unprecedented scale. I am not an environmental specialist, but I guess that in the next months, we’ll be reading a lot of reports about the damaging effects of the spill on the local environment. It takes some time before the exact impact of such a massive oil spill can be measured.

For BP, the impact can be measured in terms of billions of dollars already spent on the clean-up, and likely to be spent in the future on further clean-up, damage repair and fines. Today it was announced that the total sum of fines could run up to 13,4 billion euro. And what will be the longer term consequences of the reputational damage for BP after being involved in such a massive environmental disaster? The company once tried to be a front-runner of greening the oil business with its ‘beyond petroleum’ campaign and its green flower logo.  It is now bound to be the public enemy n°1 of environmentalists for many years to come. If you open the website of the UK branch of Greenpeace, you get a pop-up that attacks BP (www.greenpeace.co.uk). The many parodies on BP’s beyond petroleum slogan that we currently see, make clear that as a company you have to be very careful when you launch a ‘look how green we are’-campaign. You have to make sure that you can live up to the expectations that you create.

For buyers of energy, the interesting question is: will the Gulf of Mexico spill help us to really move ‘beyond petroleum’? Could it be the big cathartic event that helps mankind to get rid of its petroleum addiction? And by what energy will petroleum be replaced? Energy not consumed due to energy savings programs? Renewable energy? Natural gas, of which we have recently found out that we may have more available than we thought? Nuclear energy?

I am not too hopeful about individual action. One of the television reports on the oil spill showed a woman from Louisiana who was railing against the government for not doing enough to stop the tragedy. The camera zoomed out and showed that she was speaking from the window of a giant SUV car. Usage of energy-rapacious equipment such as SUV’s have caused petroleum consumption in the US to continue to grow in the past decades. This consumption growth makes it necessary to drill for oil in difficult circumstances such as the deeper parts of the Gulf. However, most people prefer to blame the government rather than questioning their own energy-consuming behavior. ‘BP’ or ‘Obama’ are more likely scapegoats than ‘me’. So far, I have met with very few people that argued: ‘have you seen what happened in the Gulf of Mexico? I am considering to buy a more fuel-efficient car and reduce how much I use it by using my bike, the train or my feet more often’. Is there anybody out there that has cancelled the flight to his summer holiday resort because of the oil spill?

The most important reaction to look out for, will be the political reaction. US as well as EU officials have already responded to the disaster by imposing moratoriums on deep-sea drilling for oil. Now that the hole has been plugged will these bans be reversed in a ‘back to business-as-usual’ scenario? I don’t think so. By plugging the hole, BP has avoided that the problem will become worse. But there is still a lot of rubbish in the sea and on the shores, and the negative consequences of the oil spill will continue to be in the news for quite some time to come. It is likely that any license for deep-sea oil drilling will at least be seriously challenged in the next years.

There is a danger, however, that a more critical approach of drilling licenses could create a worldwide Nimby, or ‘not in my backyard’ syndrome. We don’t drill for oil near our own shores, but we buy the oil drilled in countries where governments are less environmentally sensitive. This would mean that the West becomes even more dependent on importing oil from underdeveloped or developing countries. This could increase the risk of more conflict in the style of Iraq …

The only way of avoiding that is by having the drilling bans flanked by a policy for investment in renewable energy and fuel efficiency improvement. Blocking BP from drilling for petroleum in the Gulf of Mexico, Alaska or North-Sea will not move us ‘beyond petroleum’. A new vision on energy policy is necessary. And maybe, the Gulf of Mexico oil spill might help president Obama to sell such a policy to its countrymen. If this succeeds, BP will indeed have helped the world to move beyond petroleum. However, not in the way that it once imagined.

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.

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.

Short-sighted energy market analysis

Energy market analysts have recently been puzzled by the rise of oil prices. To many observers it looked like this rise was not supported by any fundamental shift in supply or – more importantly – demand. ‘Speculation’ is then easily blamed for the rising price. This was even done in the US Senate during debates over oil market manipulation (click here). As I have said before, I don’t believe that the forces of speculation are strong enough to shift the market direction. My natural reflex in such cases is to wonder whether there isn’t some change in supply and demand which we are ignoring. And more often than not, some piece of information pops up that does indeed show such a ‘hidden’ fundamental.

I was therefore not surprised to find the following piece of information through LinkedIn this week:

 “Chinese imports of oil in July hit a new record at 4.6 million barrels of oil per day, the equivalent of half of Saudi Arabia’s daily output. This eclipsed the previous record of 4.1 million barrels of oil per day set in the spring of 2008”, click http://wallstreetmess.blogspot.com/2009/08/china-commodities-and-financial-media.html for the full article by Tony D’Altario. (I don’t agree with the overall conclusion of the author that this means that the US is no longer the world’s economic superpower. Impressive though the 4.6 million barrels might look, the US is still consuming at least 4 times more oil. But micro-economic experience shows that it is growth rate rather than sheer size that often defines the economic attractiveness.)

Somewhere on this planet, oil consumption has been growing in the past months. Oil traders must have picked up that signal in the spot markets. Does this justify a 75 dollar oil price? I don’t think that we will ever be able to answer the ‘justified price’ question. If we could, everyone would calculate the price and the market would become sterile. I do believe though that demand growth in China justifies a reversal of the bearish into bullish mood.

Even if the author is perhaps a bit to polemic, I do agree with the conclusion that analysts tend to be too much focused on US data. We could even call much oil market analysis short-sighted as it doesn’t look beyond the reality of the US. This is a profound methodological issue. Oil prices are influenced by so many different aspects that it is simply impossible to keep track of all of them. This means that any analysis system will have some data selection mechanism. Now, as any scientist can tell you, this data selection entails a huge systemic risk. Get your data-set wrong and you get deceptive conclusions.

This short-sightedness of oil market analysis is not strange. I can even see it with the analysts that we have at E&C. The price is rising and the analysts are under time pressure for finding an explanation (as consultants are calling them because they want to inform their clients). The most readily available data is then more easily selected than the information that you have to go after. Fortunately, we are not in the forecasting business, so we don’t make any systematic data selection and we don’t give clients advices on whether to buy or not because we believe that we can calculate what the future price will be from the data that we selected. But for any market analyst on this planet, it is a constant effort to keep reminding ourselves that we need to look further than the information that is in front of our nose. And from what I hear from our clients, we manage to do so quite successfully at E&C.

That US oil data comes in focus is not surprising. No country in the world is better in providing oil market data than the US. Every Wednesday, two reputed institutes, the API and EIA publish data on supply, demand and storage. It is a market in itself. Days and hours before, the market price is being set as traders take positions in anticipation of the news. The moments before, the market seems to hold its breath as liquidity drops and the price stops moving. And then the reports come out and frantic trading activity takes place as computers programmed to give the ‘buy’ or ‘sell’ signal when they find certain words in the API and/or EIA reports start trading. The market takes a first initial direction, but the definitive direction becomes clear only hours of active trading later, when we start to see whether the majority of market players interprets the reports as ‘bullish’ or ‘bearish’ news.

The quality of this and other economic data coming from the US is undeniable. And it stands in sharp contrast to the proverbial shadiness of Chinese statistics. The ‘short-sightedness’ of oil market analysis is therefore understandable. But is not justifiable. Any oil market analyst worth the name should presently be looking for sources for better grasping the dynamics of oil markets in emerging markets. And I refuse to believe that US oil market analysts refuse to do so out of economic nationalism.

Countering oil market speculation

The US Federal Trade Commission has issued a rule that aims to crack down on market manipulation in the oil market. It looks like US legislators are committed to giving the CFTC, the body that is to regulate commodity markets, extra powers to sanction unwanted speculative behavior. In itself, this looks like a good idea. Anyone interested in fair market conditions is glad to know that a strong regulator is there to enforce that fairness. Moreover, we observe that financial markets have become increasingly complex which calls for more sophisticated (enforcement of) regulation. The products that are being traded have been designed by financial engineering and have become so ‘sophisticated’ that even those to deal with them daily, fail to grasp there complexity and hence the risk that they pose. To me, that is probably the most important conclusion that we can draw from the credit crisis. We need some application of the KIS (keep it simple) principle. Moreover, the market has become much less visible. The days that businessmen came together at commodity exchanges to discuss prices are long gone. Trades have gone virtual and happen with a click of the mouse. This invisibility has been increased by the growing popularity of OTC trades. Traders consciously avoid the strict rules that govern exchanges by making their trades in less visible over-the-counter environments.

On the other hand, the arguments brought forward by US legislators to motivate this move towards a stronger CFTC regulation scare me, read http://www.cftc.gov/stellent/groups/public/@newsroom/documents/file/hearing072809_sanders.pdf for an example of that. We have also suffered from the recent rises in oil prices as we saw our client’s natural gas budgets (linked to oil prices in most European countries) rise along. And I know that it is tempting to blame the evil forces of speculation for rising prices. On the other hand, I have often reflected on that question: can speculators really determine the direction of the market? Do they have the power of driving up prices even if the supply / demand situation looks healthy? I have found insufficient proof or reasoning to support that idea. The recent price spikes did coincide with supply – demand tightening. Demand for oil (mainly in emerging economies) has gone up so rapidly in recent years that oil production was unable to follow. And even if we look at what happened in the past five months, it is clear that demand for oil from China was again growing and hence we can find some fundamental support for the (almost) doubling of oil prices since March. Moreover, we have seen two big corrections of that bull trend in the oil market, one in late 2006, January 2007 and the second one started in July 2008 and ended last March. In the first case, figures indicate that this coincided with some important rises in supply and in the second case, it was a drastic drop in demand that caused it. If you are willing to really look at worldwide supply and demand data, the argument that recent oil price development was not supported by fundamentals is countered. But of course, you have to look worldwide and not just at the US data (which is tempting as the US is the only country to produce systematically clear and reliable data).

My conclusion is that if speculation is able to drive up prices without any fundamental support, it can do so only for a short period. If the supply / demand balance looks healthy, i.e. there is enough product in the market, this will drive down spot prices. Spot prices don’t lie. If the product is there in large quantities, prices go down. Speculative spot market manipulation demands the actual withdrawal of physical volumes from the market. Hence, Opec production quota could be described as such speculative behavior. If the spot prices are driven down by fundamentals, futures prices will have to follow. Recent developments have proven this. My conclusion is that speculation cannot determine the direction of the market, it cannot in itself cause markets to rise or fall. What it can do however, is accelerate the pace at which markets are rising or falling. If, for some fundamental reason, such as a slight increase in oil demand due to a quick recovery of the Chinese economy, the oil price starts to rise somewhat, speculators will ‘jump on board’. They want to make some money on that rising trend and start buying futures (go long, to say it in their terminology). By doing so, they increase demand for those futures which drives up its price. The result is an increase in volatility. This is exactly what the CFTC has told US Congress: speculators increase volatility.

A first important remark: this works both ways. The same thing happens when the price starts to fall, e.g. due to the economic crisis. The traders will start to sell their futures contracts and even sell futures contracts that they don’t even have (short-selling). By doing so, they drive down prices much faster than would have happened without them. In such cases, they even have a very healthy effect on the market. They make it difficult for producers of oil to stop the downward movement. This has been repeatedly said by Opec, the producer’s cartel which has seen its possibilities of stopping price falls by cutting supply reduced due to the sell-off of contracts in a downward market by speculators. Speculators add liquidity to a market, and by doing so, they make it more difficult for individual parties such as producers to exert market power. The Belgian power market is a good example of a market where some more presence of speculative parties could add some necessary liquidity.

But I understand the arguments of US legislators that this increased volatility is not in the interest of the US public. For consumers have a difficult time buying energy in a volatile market. Prices swing up and down so rapidly that deciding when to buy becomes extremely difficult. This certainly holds for industrial buyers, as they buy this energy in huge quantities. Just imagine that you have decided to buy 100.000 MWh of natural gas in May 2008 when the near 150 dollar oil prices resulted in European gas prices of over 40 euro per MWh.  Eight months later, the falling oil prices had reduced gas prices to less than halve that. It means that you have lost more than 2 million euro by that fixing that gas price in May. The same difficulty arises in private life. If you heat your home with heating oil, deciding when to fill the tank becomes very tricky. Even when you fill the car, you can get frustrated to find out the next day that the gasoline or diesel price has come down again.

The question is: can we stop this increased volatility due to the presence of speculative money in the market without throwing away the beneficial effects of speculation, i.e. the liquidity that they provide the markets with? It looks like the US is planning to do that by limiting the positions that speculators can take (http://www.cftc.gov/stellent/groups/public/@newsroom/documents/pressrelease/genslerstatement070709.pdf). This will inevitably affect the traded volumes. I believe that the possible negative effects of this on liquidity should be well researched before any decisions are taken.

In the past years we at E&C have often derided certain events in the energy markets, the oil market in particular. One of those was the practice that certain parties, known to have huge positions in the market, launched bullish ‘forecasts’ that clearly influenced the market. I am glad to see that US legislators clearly plan to tackle such behavior and are even naming explicitly Goldman Sachs as a culprit of this practice. Let’s hope that they find a way to make an end to the practice of building up big long positions and then ensure their profitability by launching bullish analysis reports. I hope so for all those energy consumers that were tricked into buying too much last year in May due to such a Goldman Sachs report.

Solar thermal: the energy of the future?

I’ve read an article in last week’s Economist on solar thermal power production. This is not the same as photovoltaics. With PV-cells you use electrochemical processes to produce electricity. Solar thermal uses the sun’s heating power to produce steam that drives a turbine. You need to concentrate the sun heat for that of course, so you need mirrors.

This makes me think of my childhood days. Together with my cousin, I used a looking glass to let small pieces of wood burn. In the heat of a summer’s day we would sit behind my grandfathers shed and then we took a piece of wood and kept the looking glass over it. After a few minutes some smoke came out of the wood, it started to color black and the air started to smell burned. Unfortunately, my grandfather caught the smell and severely scolded us for playing with fire. I should have answered, ‘we are experimenting with the energy supply of the future’.

Large-scale solar thermal plants were constructed in Spain and California right after the first oil crisis. Isn’t one of them the background of a scene in a James Bond movie? Anyway, as energy prices sank, investment in solar thermal was abandoned for two decades. With recent new oil price spikes and the climate change policies, interest in this renewable way of producing energy has reignited (yes, I know it is a word game). New plants are up for construction.

What strikes me about these plants is their size. A company called Brightsource Energy, based in California, plans to build 14 solar thermal power plants with a joint capacity of 2.600 MW. It takes a lot of PV-panels or windmills to achieve such a capacity! Another interesting feature of this technology is that you can create hybrids. You can link them to gas-fired power plants, using gas only when the sun isn’t shining. This brings us to a first downside of the technology. It only works when the sun shines. Therefore, it will mainly be implemented in sunny, warm countries. But the idea of desserts that produce electricity that is transported to industrialized areas is getting a bit closer again.

With such potential, and taking into account the simplicity of the basic technological idea, it is surprising that this technology hasn’t been implemented on a larger scale. The article says nothing about it, but I guess investment costs have something to do with it. But with current prices and politicians’ willingness to subsidize renewable energy, this should be a less important obstacle. So if you live in Spain or New Mexico, I guess it is more than probable that you will soon tap electricity from the sun’s heat. Isn’t it beautiful that we are returning to such simple and old energy producing technologies as using the power from the wind or the heat of the sun?