19 August 2022

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YEAR OF GOLD FUEL

Incredibly high demand for natural gas in Europe affects the liquefied natural gas market

Author:

15.01.2022

Last year was a year of unpredictable growth in the oil and gas markets. Recovery of demand from the low levels as a result of the Covid spread in 2020 exceeded all expectations, while supply constraints fuelled prices. As a result, Brent crude gained around 64% on average over the year, the best growth rate since the early 2000s.

It has literally been a golden year for the gas industry. Natural gas prices in Europe rose almost fivefold and even exceeded $2,000 per thousand cubic meters at the peak in December, which is about 8 times more than at the beginning of 2021.

Back in 2011, when the International Energy Agency (IEA) proclaimed the "golden age of natural gas" when the gas price in Europe was around $300-350 per thousand cubic metres, it made us smile. At the time, no one seriously thought that the price of gas could equal the price of gold. Gas, which everyone had long regarded as any other type of utility resource like water or electricity, became a luxury commodity...

 

Change of course

In 2021, the day-ahead contract price at Europe's largest gas hub, TTF, hit the all-time low several times. A record price of $2,200 per thousand cubic metres was recorded for the last time on December 21. However, there was a decline in the following days. On December 31, quotations fell below $800 for the first time since November 10. This took place amid the warming weather in Europe, LNG supplies from the US, and the reopening of wind farms.

Despite the short-term drop, prices are still high, with quotations at just above $1,000 per thousand cubic metres. The pressure on prices comes from both weather conditions and Russia's refusal to increase supplies to Europe. The latter can be explained simply by Russia continuing the policy of tightening the screws. In fact, Russia fulfils its obligations under long-term contracts, but is not obliged to cover current market needs without new long-term contracts.

Furthermore, uncertainty about the launch of Nord Stream 2, which is supposed to be the main supplier of the Russian gas to Europe, also affects the prices.

Market is reacting to this by increasing prices, but at the same time it is also attracting other operators for whom deliveries become more profitable, in particular importers of liquefied natural gas (LNG). Gas supplies from the LNG terminals to the European grid more than doubled in January 2022 compared to January 2021.

Over the past year, market participants have watched a price duel between Europe (TTF hub index in the Netherlands) and Asia (Platts JKM Asian spot index). The year ended in a pyrrhic victory for Europe: on December 21, 2021 all the ills of the energy sector came together, when the cold weather and doldrums in France put several nuclear power generation units to a halt. As a result, trading that day saw gas prices soar to unprecedented heights. The price was so attractive that American tankers travelling to Asia switched direction to Europe immediately. In late December, three LNG tankers bound for Asia from the US turned around halfway through and diverted to Europe.

However, the change of direction of gas carriers can also be explained by China having increased coal supplies to the domestic market to resolve the crisis in the country, which eventually caused prices in Asia fall. Accordingly, the European market has become more attractive than the Asian one. However, Europe should not get encouraged to rely solely on the American LNG. There is no guarantee that prices in Asia will not go up again and ships will not turn towards China and other Asian markets.

Wei Xiong, Senior Analyst at Rystad Energy, believes that the diversion of the LNG tankers from Asia is a temporary measure and cannot replace stable pipeline supplies.

In addition, since October 2021, seven major deals have already been concluded between the US exporters and Chinese customers, with some of them spanning several decades. In January-September 2021, the US was the second largest supplier of gas to China, behind only Australia.

 

Battle of the titans

Unbelievably high demand for gas in Europe led to the American LNG exports reaching record levels in December. According to Refinitiv and the US Energy Information Administration, about half of the liquefied natural gas shipped to the US in December was shipped to Europe—up from 37% in early 2021.

The US is currently the world's third largest supplier of LNG after Qatar and Australia. However, in the near future, the Americans are expected to significantly strengthen their position on the global gas market. According to Ivan Timonin, a consultant with VYGON Consulting, the US may overtake the world's largest LNG exporters as early as this year and become the first in terms of supplies. However, the main challenge for the US will be to hold on to this position.

S&P Global Platts predicts that in 2022 it will adopt a decision on investing in 3-5 new LNG export projects from North America. But to do so, companies need to enter into new long-term supply contracts, which can be a challenge.

In addition, the US companies willing to raise funding for LNG projects must not only make agreements in advance to supply fuel from future facilities, but also consider the environmental agenda. France's Engie, for example, pulled out of a joint project with NextDecade last year amid concerns about fracking gas production. The uncertain outlook for natural gas as a transition fuel (‘greener’ than oil and coal, but with a larger carbon footprint than in solar and wind power) is also pushing potential buyers towards short-term contracts, where it is harder to secure financial backing from banks.

Meanwhile, Qatar clearly has no intention to lag behind the rest of the global LNG suppliers. According to S&P Global Platts analyst Ross Vaino, Qatar's LNG production costs are the lowest in the world and the country can even wage a price war against the US in an attempt to keep its market share. The expansion of production operations in the North field are expected to increase Qatar's LNG capacity from 77m tonnes to 126m tonnes annually by 2027.

Overall, Qatar Energy's outlook for global LNG demand is more optimistic than many analysts expect. The company expects demand to continue to grow strongly through 2050, and is building its investment programme accordingly.

Meanwhile, the Independent has revealed that the UK relays on Qatar to secure its gas supply. "Amid the limited domestic gas storage capacity (in Q4 2021, R+), the UK has agreed on an informal deal with Qatar to ensure security of supply and is preparing to conclude a full strategic partnership in 2022, the Independent reported. This measure should help reduce Britain's dependence on supplies from Norway and the US.

Natural gas accounts for about 40% of the UK's power generation and is used to heat most homes. It is expected to remain the main source of fuel, despite the country's goal of zero emissions by 2050.

 

Price pessimism

Despite a variety of pipeline projects, the global LNG demand is set to grow. According to current expectations, global consumption will reach around 442 million tonnes by 2025, according to VYGON Consulting. That is an increase of almost 70 million tonnes compared to 2021.

Global LNG demand has been growing annually since 2012, increasing by 40% in the last five years alone.

Natural gas prices are not expected to fall as the winter is still on and problems with insufficient levels of European underground storage remain. Given the unresolved issues of additional Russian gas supplies to Europe and the delayed launch of the Nord Stream 2, the focus will be on alternative resources. These include increasing supplies of LNG or limiting sales of natural gas and electricity to other regions. For example, last October, Serbian President Alexander Vucic warned of a possible suspension of electricity exports to "keep people warm in their homes". If the situation develops adversely, a cold winter will force industrial companies, especially in the metal processing and chemical industries, to shut down. This may reduce demand to a certain extent and affect the price, but it will still not have the desired effect.

Kaushal Ramesh, Senior Analyst at Rystad Energy in Norway, does not see what circumstances could contribute to lower gas prices in the short term.

"The balance of supply and demand is such that the price is quite high. I think it will also remain at high throughout 2022," believes Russian Deputy Prime Minister Alexander Novak.

According to Mr. Novak, with the level of gas imports to Europe at 250-300bn cubic meters annually, "it is necessary to understand where it will come from and rely, first and foremost, on long-term contracts. Russia has always supported long-term contracts in its policy and relations," Mr. Novak said.

"According to our estimates, the gas market will be a seller's market in 2022," said Maria Belova, Research Director at VYGON Consulting.

In general, market participants believe that in Europe and the Asia-Pacific region spot prices for gas below $1,000 per thousand cubic meters should not be expected before 2H2022. And the commissioning of Nord Stream 2 could push quotations even lower.


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