November 30, 2008

Future European Gas Supplies Challenged by Demand Growth in the United States

Stricter CO2 regulation likely to be introduced by a new United States administration is a key influencer of the supply-demand balance in the Atlantic basin. Europe will face increasing competition with the United States for securing gas supplies in the next decade. Investments in European LNG import infrastructure may not pay off if LNG from the Middle East and North-Africa is re-directed towards the U.S. Replacing these volumes in Europe might require additional pipeline gas from Russia and cause further dependency on Russia. European energy companies and governments need to develop a “Plan B” to secure their mid-term supplies.

Developments in the three—traditionally separate—regional gas markets of Europe, the Americas and ME/Asia must now be considered in a more integrated fashion, according to an analysis by the international management consultants of Booz & Company. So far, connectivity of gas markets between the three regions has been limited. However, competition for gas in the Atlantic basin will intensify, especially between Europe and the United States as LNG (Liquified Natural Gas) enters the markets. “Competition with the United States for gas supply might prove to be more relevant in the next decade for Europe than competition with emerging countries in Asia,” says Otto Waterlander, Vice President and energy expert at Booz & Company. 

International CO2 Regulation Key for Keeping Gas Demand in Balance

Gas demand projections in Europe already factor in a significant switch to gas in the power generation sector from other fossil fuels like coal. This switch is driven by the increasing cost associated with CO2 emissions. In contrast, U.S. gas consumption growth projections generally do not take into account the costs of greenhouse gas emissions as a key driver. According to the IEA, Europe’s gas consumption will increase with 2.9% per year until 2015 while growth forecasts for the U.S. run at roughly half that number, i.e. 1.5% per year. However, the U.S. energy market may have to deal sooner rather than later with stricter regulations for CO2 emissions when a new administration takes office in early 2009. The U.S. might then be faced with an increasing gas-to-power demand in the mid-term, as alternative low-carbon generation sources such as clean coal and nuclear energy cannot be developed in time to fill emerging electricity supply gaps in many states. As domestic gas production will unlikely be able to meet a rise in demand, the U.S. market will have to compete more strongly for international gas (i.e. LNG) supplies. The study of Booz & Company shows that the increased demand for gas imports into the US may result in the re-directing of LNG from the Caribbean, North-Africa and the Middle East in particular. This supply would normally be destined for Europe, shaking up the fragile gas balance in Europe. “CO2 regulation is becoming more global, and therefore, creating a more global gas market with implications on volume flows and price levels”, says Thomas Schlaak, Principal and gas expert at Booz & Company and co-author of the study.

Investments in European LNG Import Infrastructure Challenged

In our analysed scenario, the upward swing in demand for gas in the United States until 2015 will be substantial: up to 84 bcm of natural gas which compares to 12% of OECD Europe demand. Mostly this must be supplied through LNG imports. These additional imports compete with European imports. Booz & Company analyses show that a significant proportion of US additional demand will likely be met by volumes otherwise targeted for Europe. This may challenge the economic viability of several of the more than 30 European re-gasification expansion and new-build projects which are planned up to a capacity of about 130 bcm by 2015.

Europe Needs to Keep all Supplies Open, including Additional Pipe Gas from Russia

A changing gas balance would increase Europe’s dependence on other markets in two ways. First, Europe would need additional gas imports through pipelines, most likely from already established suppliers, including Russia, Algeria and Norway, and new supply routes such as Nabucco and piped Nigerian gas. While this analysis supports the strategic rationale for the EU to support the development of alternative pipelines such as Nabucco from Central Asia/Middle East, the outcome contrasts efforts from by EU to become less dependent on Russia.

Secondly, the increased gas demand and larger connectivity between the Americas and the European gas markets will impact gas prices across the Atlantic basin. We expect upward price pressure and possibly larger price volatility in particular on short-term markets and energy exchanges.  

Opportunities for Gas Exporters

For the world’s major gas producers, a more integrated global gas market with substantial demand uncertainty in the U.S. and Europe might in fact offer attractive mid-term growth opportunities. Off course it also presents the challenge of an ever more complex market place calling for carefully crafted commercialization plans and strategies. The increasing market place complexity may indeed result in major suppliers to accelerate initiatives to pursue an OPEC like equivalent “GASPEC”.

Europe’s Gas Importers and Governments Need to Develop a “Plan B”

European gas importers and governments should more explicitly consider the globalizing nature and interdependency of their regional gas markets. They should develop alternatives if insufficient LNG can be attracted to satisfy and diversify gas supplies. A prerequisite for any action is a thorough understanding of the U.S. energy market, and here in particular the impact of CO2 regulation on power plant new build activity. With an established view on the size and timing of the described “imported” supply squeeze, European players need to re-adjust their view on the region’s supply-demand-balance. In this context, George Sarraf, a principal in Booz & Company said: “Multiple potential avenues can be explored such as (1) seeking investments in upstream assets like LNG liquefaction plants and export terminals in Africa and the Middle East, (2) strengthening existing supply partnerships, including with Russia, through joint projects and perhaps increasing demand dependency for those suppliers, (3) carefully enabling sufficient LNG imports through long-term commitments, (4) stimulating an Atlantic rim market to trade gas between the regions and for gas players developing a footprint across the Atlantic basin”.