The critical natural gas transit country, Ukraine, reached a supply agreement in the last week of September with the EU’s largest fuel supply partner: Russia.
One could argue that this agreement could actually have come too late. Natural gas supply to Europe heading into winter 2015 seems more secure than ever before, a sharp contrast to the icy winters of 2006 and 2009, in which Russia cut off natural gas supply to Eastern Europe over a conflict with the Ukraine. The following factors have turned the European natural gas market from a ‘’beggars can’t be choosers” into a true “buyers’ market’’.
1. Declining European demand
In spite of the current surge in natural gas imports from Russia, Norway and Qatar (described in point 4 below), the IEA foresees a decline in European demand for natural gas because of a decline in ’thermal generation growth,’ increased energy efficiency and the shift to renewables. Natural gas demand could, however, be partially rescued by a colder than expected winter or the accelerated shutdown of coal-fired electricity plants. The below chart demonstrates the fall in natural gas demand across the EU.
(Click to enlarge)
2. Better connected networks
After the 2006 and 2009 natural gas supply disruptions, the European Union decided to decrease its natural gas import dependence from Russia (ironically enough, natural gas imports from Russia are surging at the time of writing. More on that below) by improving its natural gas infrastructure. Ever since, over €50 billion (≈U.S$55.8) was invested in 107 gas projects with one important goal: sharing energy resources. This sharing of energy resources can potentially limit the direct demand for natural gas on the short-term and therefore prevent a quick hike in natural gas prices.
3. First natural gas imports from U.S.
Another reason why natural gas prices in Europe are bound to remain subdued is the planned supply of U.S LNG to Europe. In an article on Oilprice.com on July 29, it was revealed that Houston-based Cheniere Energy is looking to supply European customers as of December 2015. Cheniere also plans to deploy a floating regasification terminal off the Croatian coast in order to supply Central and Eastern European countries. Even though Cheniere has admitted that its goal is not to ‘squeeze out’ the Russians, it is clear that the company aims for Russian market share in Eastern Europe.
4. Full storage
A massive production decline in Europe’s largest natural gas field in Groningen, located in the north of the Netherlands could not stop European natural gas prices from sinking further. Natural gas imports from Russia, Norway and Qatar provided too much counterweight to lower Dutch output. On October 2, Russia’s Gazprom reported a 23 percent year-on-year increase on exports to Europe of which most went to Germany (a 19 percent increase to 11.2 bcm) and Italy (a 6 percent increase to 7 bcm), and also Norway and Qatar have contributed to filling European storage sites. Currently, Europe is filling its natural gas stockpiles at the fastest rate since 2009. Full natural gas storage sites will slow the potential rebound of natural gas prices, as it will put a dampener on demand in the near future.
(Click to enlarge)
5. Low valuation of Ruble and low taxes
Russia’s oil and gas producers have proven to be resilient and have shown firm production numbers throughout the current oil price slump. Two of the most important reasons for this are the low valued ruble and the low taxes that Russian oil and gas producers are currently paying to Moscow.
After a period of relative stability, the Ruble has again lost value against the U.S dollar, increasing profit margins for Russian oil and gas producers, enabling them to keep production up, thus increasing pressure on natural gas prices.
6. Oil indexed Russian natural gas prices
One of the main reasons for the natural gas stockpiling we are currently seeing (see point #4) is the low natural gas price European importers pay for Russian natural gas. The oil price slump has dragged natural gas prices down with it.
Pegging the price of natural gas to oil is nothing new. Already back in the 1960’s and 1970’s, European natural gas exporters linked the price of their natural gas oil prices in order to secure long-term infrastructure investments. However, with the so-called ‘spot gas trading hubs’ developed in the 1990’s in The Netherlands, Germany and the U.K, the European Union is now accusing Russian natural gas exporters of breaching competition laws by selling their natural gas to oil indexed prices, giving them an unfair edge over European produced natural gas.
Cheap Russian oil-indexed natural gas bears an inherent risk for gas price dynamics. If Brent prices are to stay low (Goldman Sachs low), a rise in natural gas prices will be unlikely.
Consequences for natural gas prices
The shrinking European demand for natural gas and the firm supply from Russia, Norway, Qatar and now even the U.S will keep European natural gas prices low.
While European Union natural gas import prices equaled USD$11,60 per MMBtu on 31 Jul 2013, and USD$9.27 per MMBtu just over a year ago, EU natural gas import prices came down to $6.95 per MMBtu last August.
At this point in time, it seems that only a demand surge or a sudden spike in oil prices can drive natural gas prices up above USD$10 per MMBtu again.
The below bonus chart gives an overview of the expected trajectory for natural gas prices.
(Click Image To Enlarge)
By Tom Kool of Oilprice.com
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