London – The economic downturn has the potential to profoundly change the global gas markets. Deeply negative forecasts for industrial output in developed countries will reduce world-wide demand for natural gas for the first time in its history in 2009 and possibly 2010, while potentially setting back the market for almost 10 years. This is one of the findings from the Booz & Company report: “An Unprecedented Market: How the recession is changing global gas markets.” Combined with new gas export developments already underway, the market will be in a position of oversupply of between 5 to15%.
Global gas markets will be set back by up to almost 10 years
Since the development of international gas markets in the 1960’s gas has been a highly desired fuel with sales volumes rising at an average rate of 4% annually between 1965 and 2007. Before the recession hit, analysts predicted world gas demand to steadily grow with on average 2% per annum for the foreseeable future, almost double the demand for oil. Demand for gas closely correlates with the development of industrial output in developed countries.Thus, the economic downturn with strong reduction in industrial output in developed countries will cause a significant reduction in gas demand for the first time in the history of the international gas markets in 2009 and potentially also in 2010. This drop is led by energy-intensive industries: according to analysts automobile manufacturing is likely to fall by 25% in 2009, output in the chemical industry, the basis for many value chains, will drop at a similar pace while output in the steel industry is declining by 30% in Europe as well as North America. “An unprecedented picture emerges for the natural gas markets as worldwide demand will be set back by almost 10 years,” says Otto Waterlander vice president at management consultancy Booz & Company.
Surplus to continue well into next decade
The implications for suppliers and buyers could be considerable. Due to the new demand uncertainty and reduced access to project financing a substantial number of new gas infrastructure development projects have been cancelled or delayed until demand growth returns. Shelved were for instance liquefaction projects in Russia and Bolivia, while projects in Iran, Nigeria, Australia, Egypt and Trinidad and Tobago are on hold pending final investment decision. However, based on the pre-recession growth outlook, a number of gas export infrastructure projects had already been approved and are currently under construction, such as additional liquefaction plants, export pipelines and increased production of gas from unconventional sources in North-America. Taking these developments together, Booz & Company expects worldwide natural gas supply-demand balance to be in surplus of 5 to 15%, a surplus expected to continue well into the next decade, and not seen before in this market.
Incentive for large exporters to cooperate
To reduce the market risks of oversupply such as pressure on prices and potentially even changes in pricing structures such as decoupling from oil prices, the leading gas exporters such as Russia, Norway, Algeria, Qatar would have a strong incentive to cooperate to manage market quality. In addition to reduced demand, profitability will be at risk if buyers seek to renegotiate contracts. Thus the large NOCs (National Oil and Gas companies) such as Gazprom in Russia, Statoil in Norway, Sonatrach in Algeria and Qatar should assess the implications of reducing production, and align their project portfolios with the new market realities. On the other hand they should take advantage now from the cost reductions in the markets for contractors, rigs and materials. Other options to consider are geographical swaps with other players to optimize logistical costs and expansion of capabilities by taking over specialized companies taking advantage of lower company valuations. The IOCs (International Oil & Gas companies) could meanwhile leverage the fact that they typically have international portfolios of gas projects.
Buyers might partner to access new sources and take advantage of lower pricing
For gas importers and buyers opportunities may arise to renegotiate prices and other contract conditions, as well as in benefiting from increased supply on spot markets. Nevertheless they should be cautious not to damage their long term relationships with NOCs as they will need these alliances in the long term. Buyers should also review their gas supply portfolios, and for instance consider the merits of partnering with other importers to secure new sources of gas, share risk and taking advantage of the current lower asset valuations, for instance by entering upstream.
Value of LNG projects will shift from volume to access
The main risk for infrastructure companies is reduced project profitability and reduced access to project financing. Customers for capacity on new LNG-infrastructure or pipeline assets may delay decisions in the current uncertain environment, placing risks on timing and financing for infrastructure projects. In addition, business models may change as the value in LNG regasification may shift from “volume-plays”, where companies seek to contract-out all capacity long-term, to“access-plays”, where players hold capacity available in multiple locations to be able to take advantage of potential geographical arbitrage opportunities. At the same time infrastructure companies should take advantage of falling prices for materials, labor and construction services to push down project costs.
Dutch investment plans for regasification, storage of gas to be reconsidered
For the Netherlands the demand destruction will mean reduced income from the production, sale and export of natural gas. This may challenge the budget for the National Government. Furthermore, important investments in infrastructure should address these new realities, says Waterlander: “The current situation means that the development of infrastructure projects, in particular LNG regasification and storage, may become harder to realize in the short term. This would delay the development of the Dutch Gas Round-about. We recommend that buyers actively assess the new opportunities to secure gas on the spot market, or even leverage this new market momentum to contract for new Pipe or LNG supplies on the long term. For the Netherlands that would however imply competition and a potential further challenge to the national budget. ”