Shale gas may have deep impact on European prices

The era of long-term gas import contracts dominating the European natural gas market is slowly drawing to an end

A new type of peddler has appeared: the natural gas salesman. You will have to decide whether to open the door or send out the guard dog when he comes knocking.

The boom of independent salesmen has not been caused by gas market liberalization required by EU guidelines, but by an ordinary economic crisis. Large gas importers are bound by “take-or-pay” clauses in their long-term contracts.

But factors aside from economic recovery will also play a role in gas prices in the long run. One such factor is that the US has changed its position from being a gas importer to being an exporter due to shale gas extraction.

In practice, a take-or-pay clause means that when there is a significant drop in gas takeoff below the contractual limit, the importer will pay the supplier the same amount as if it were taking off all the contractually agreed gas. 

During the crisis, consumption in Europe decreased to such an extent that importers began to be worried about the possible application of this clause by, above all, the Russian exporter Gazprom. That is why they have stood up to the threat by taking off more gas than their customers actually needed. Subsequently, they got rid of the surpluses at exchanges and “hubs.”

One-third starting prices

Logically, the prices of such “makeshift” gas were significantly lower than the prices the importers paid under long-term import contracts. This situation was the starting point for the numerous independent dealers who were able to offer gas to potential customers at lower prices. Initially, gas prices on spot markets were one-third of the prices fixed in long-term import contracts.

It seemed then that the European gas industry had run aground. The superfluous gas that large importers got rid of through spot trades and exchanges returned to the market at lower prices and further reduced sales of their own gas.

As a result of the subsiding economic crisis, gas consumption in Europe began to grow. The quantity of available excess gas slowly started to diminish. The result was a doubling of the price, yet the price of spot gas is still approximately two-thirds of the long-term contractual import prices.

But what does this mean for prices in the future? Let’s examine the possible scenarios. Such an analysis is important not only for large European gas importers but also, and primarily, consumers who have to decide whether to obtain gas from traditional suppliers or alternative dealers offering cheaper rates.

Perhaps the most important factor is the estimated rate of the gradual growth of gas consumption in Europe owing to the economic recovery. If the turnaround is sufficiently rapid, it will also mean increased gas consumption. As a result, the volume of natural gas available on spot markets will decrease. This will undoubtedly mean a significant reduction in the difference between spot prices and the price level of long-term import contracts.

Slim future prospects

Such a development, however, would lead to a high mortality rate of independent dealers who based their business plans on purchasing available gas from spot markets. People should bear this in mind when considering a change in gas suppliers. The current willingness of some of these dealers to conclude long-term contracts with consumers at a fixed price can in some cases be highly risky.

Some small-scale traders who rely exclusively on spot gas may go out of business over the next two or three years. Dealers who have concluded contracts directly with gas producers are exceptions.

The major blow to this simple line of reasoning has been delivered by the US gas companies through the process of shale gas extraction. When the amount of shale gas turned the US into an exporter, the global gas industry was turned upside down.

The US coastal terminals for receiving liquefied natural gas (LNG) abruptly turned into ghost towns and the Russians suspended a semi-finished project involving the acquisition of the Shtokman deposit, from which they planned to supply LNG to the US.

On the other hand, construction of liquefying gas stations is continuing in Qatar, as well as, for example, Africa. New tankers to transport LNG to vaporization terminals are also under construction. This is all happening while the supposed consumer of gas from new investments was primarily the US.

Countries with large energy demand, such China and India, lack the terminals for gas reception or infrastructure for its transportation.

It appears that only Europe is technically prepared to absorb part of these capacities. The network of terminals for liquefied gas reception has been constantly expanding; during the next two years, their capacity is expected to increase by 70 billion cubic meters (BCM) of gas a year. For comparison, this represents eight times the Czech Republic’s total annual consumption.

This trend is set to continue, and contracts on LNG imports are not usually bound by long-term agreements; gas is frequently sold directly from tankers. Consequently, the situation may occur in which the current spot markets, fed by superfluous gas from long-term contracts, will be replaced by ad hoc LNG imports.

When it comes to long-term contracts on “pipeline” gas supplies, mainly concluded with Russia, Algeria and Norway, this may represent a fatal threat. Fixed prices and take-or-pay clauses exhibit certain stability but minimum flexibility. Unless a sort of cartel agreement of the OPEC-type among gas producers originates (and efforts to establish something similar have been observed for a significant time, especially in Russian initiatives), then Europe’s interest in gas covered by long-term contracts may further diminish.

Bad and even worse news

The news is bad enough for traditional gas companies in the EU. It is even worse for the producers supplying their gas to Europe on the basis of long-term contracts. If so far the gas price has been mainly determined by contracts, in the near future we cannot rule out that these prices will have to be continuously adapted to conditions determined by liquefied gas prices.

Gas producers’ profits may continue to fall significantly. The greatest problems will most probably be encountered by Russia’s Gazprom, whose economic results have already been negatively affected by the global economic crisis.

The conclusion that we can draw is that it is advisable to set the dogs on those gas dealers who exclusively make use of purchases on spot markets.

When it comes to the future, it definitely pays off to monitor the profiles, and primarily, the “source” portfolio, of dealers offering gas. However difficult it will be for the long-established and traditional business companies, the era of domination of long-term gas import contracts on the European natural gas market is slowly coming to an end. Should the spot market become even more saturated by LNG supplies, gas consumers can look forward to some good news.