Worldwide Gas Markets in Motion

A new era of accelerated growth in gas demand may arise in the mid-term as gas competes to overtake coal in power generation. European gas markets could look like ‘normal’ commodity markets; position of wholesalers under pressure.

Amsterdam June 16 2010 – A recent update of Booz & Company’s analysis of worldwide supply and demand in natural gas markets suggest that markets look to remain in oversupply for at least five more years. Consequently, spot market prices are likely to remain under pressure for some time and the current gap between spot market prices and (long term and oil-indexed) contract prices in European and Asian markets becomes more structural. Booz & Company highlights that growth in demand may return on an accelerated path when gas is likely to replace more carbon-intensive fuels such as oil and coal in power production, giving rise to a future cycle of price rises. If European markets move away from the traditional long-term oil-indexed contracts to spot prices, price volatility may increase as prices than are more driven by supply demand dynamics, like we have seen in common commodity markets like oil. These are the major findings of Booz & Company’s most recent report on the developments in the international gas market.

World-wide natural gas markets have experienced an unprecedented reduction in demand over the last two years due to the economic recession. This combined with a faster than expected expansion in unconventional gas in the U.S., resulted in a global oversupply which sent spot gas prices sharply lower. Analysis of worldwide supply/demand dynamics indicate markets can remain in oversupply until at least the middle of this decade. This is one of the findings of Booz & Company’s report: "The Next Cycle: Gas Markets Beyond the Recession" on trends and shifts in the world-wide gas markets and their implications for key stakeholders.

If US price levels spread to Europe an accelerated shift to gas in power production may occur

The US market prices natural gas in the 6-7 USD/mmbtu range for the duration of this decade. In the oversupplied LNG market these price levels may very well spread across Atlantic to European spot markets. In such a scenario, today’s pressure to restructure the traditional European and Asian long-term oil-indexed supply contracts will continue or even intensify. With oil prices having recovered to levels around 80USD/barrel, a significant gap of around 40% has opened between spot gas prices and those in oil-indexed contracts. On the other hand, persistent lower gas prices can accelerate the Energy Shift: the shift from carbon-intensive fuels like oil and coal to low-carbon natural gas. In this scenario marginal costs for producing electrical power from gas and coal are comparable driving up utilization of existing power plants, and investments in new gas-fired power plants are more favorable than those in coal-fired plants. ‘Gas could become the preferred fuel in decisions on building new plants. If this scenario materializes world-wide gas demand would return to levels predicted before the recession by the second half of the decade, ‘says Otto Waterlander, partner at Booz & Company.

European markets may become more alike common commodity markets

The accelerated demand growth would only be possible if power producers can access sufficient quantities of gas at spot price levels. Yet if the pressure on long-term contact conditions remains in the scenario of enduring oversupply, producers and buyers are more likely to find agreement on more flexibility in their contracts on minimum take-off volumes, and with more price flexibility. Under these conditions a larger part of the market would then see price levels set by supply/demand dynamics then today, turning European gas markets into a more common commodity market, resembling for example the oil market.

Large users such as electrical utilities may turn to gas

Large users such as utilities need to decide how to take advantage of their new-found market power and assess optimal supply portfolios, striking the right balance between contracted and open positions and determining the optimal mix of contracts and suppliers. More exposure to structurally low spot prices can be attractive, but also brings more exposure to supply shocks , short term price volatility and potentially long term price rises. Utilities need to review their power generation portfolios and strategies in the new situation, both utilization rates in the installed base and fuel decisions in new build projects. A thorough understanding of the impact on coal prices in a situation where utilities will turn to gas is crucial here.

Wholesalers position is eroding as large users and producers connect directly

Wholesalers need to find a balance between the value of gas supply security at a higher cost versus the advantages of lower priced spot gas, but with the risks of short term supply shocks and price volatility. Many established importers and wholesalers with long term contracts are squeezed between contact commitments at oil-indexed prices and a market where end users can obtain gas at lower spot market prices. Contracts must be re-considered while re-assessing the optimal supply portfolios. As both producers and users such as utilities will aim to connect directly more and more, the wholesalers need to review how they can continue to create value for their customers through offering added services such as seasonal and short cycle flexibility, risk-management or increased off-take flexibility.

Infrastructure providers

In the short run infrastructural providers are reviewing the need and profitability of the projects in their portfolios. In the mid-term opportunities may arise. Holders of LNG receiving capacity could benefit from a portfolio of capacity in different locations to capture regional price arbitrage. Structural changes in gas pricing may increase gasification and connectivity of regions where this was previously uneconomical, potentially creating opportunities for pipeline companies. The demand for storage capacity will see different opposing drivers. Storage players need to carefully assess how demand may develop and what innovative business models can be developed in the changed gas market.