Emerging Troika Will Control the Natural Gas Global Market
During the G20 Summit in Germany earlier this month, Russian President Vladimir Putin and Turkish President Recep Tayyip Erdogan agreed to shorten the period of work needed to finish the first phase of Turkish Stream. This was coupled with reports in European media that the European Union (EU) may launch an ambitious project to ban the sale of cars that use gasoline or diesel.
Once these two developments unfold, liquefied natural gas (LNG) markets will see a true revolution, and the EU will be at the top of the new market. The LNG “revolution” can be described as a kind of “magic”: It will place the market under the control of importers, not exporters. According to traditional wisdom, the major exporters of a commodity have control of the market. Now, in a twist in the history of energy markets, importers — who reexport — will be king.
In this relatively early phase, it is clear that Europe is likely to act as a “clearing house” for surplus LNG cargoes, given its excess re-gasification capacity and its ability to use the fuel for a variety of purposes, from motor vehicles to power generation to manufacturing to household heating.
Europe is also the only region that can effectively arbitrage between LNG and pipeline prices, given its connection to Russian and other eastern natural gas reserves via pipelines.
Reexporting LNG and pricing it will be placed squarely in the hands of American, European, and Australian companies. We should not forget that the EU is also best positioned to use market forces to find a price level for natural gas versus its competitors, given it still has substantial coal-fired power in some countries.Additionally, Europe is a leader in renewables, such as wind and solar.
It is, therefore, very important to understand the dynamics of this expected development. In a way, Europe will use its position as the main consumer to shape the LNG market. LNG has traditionally been an opaque and tightly-controlled market, where a small number of exporters signed long-term, oil-linked contracts with an equally small number of buyers, who were more concerned about energy security than price.
Moreover, so far, the major producers included Qatar, Indonesia, and Malaysia, while the top buyers were concentrated in North Asia, namely Japan and South Korea, and also in Europe. For some reason — we believe related to expected rise in consumption — global energy giants such as Chevron, Royal Dutch Shell, ConocoPhillips, and Exxon Mobil decided to pour some $200 billion into developing eight new LNG projects in Australia. The pretext might be that the United States is looking to become a major exporter of LNG, and the giant companies want to preserve their relevance in this emerging LNG market.
Whatever the reason, this major plan, which will transform the global energy market, has already started. Three of the new projects in Australia are groundbreaking ventures: one uses coal seam gas as feedstock, one is the biggest floating LNG project, and the rest are conventional offshore gas-to-onshore liquefaction plants.
These projects will be operational next year. Australia will have around 80 million tons of annual LNG capacity, overtaking Qatar as the top exporter of the fuel. Australia is followed by the United States, with 16 million tons of LNG capacity already operating at the Sabine Pass Facility in the Gulf of Mexico. But a further 60.5 million tons of annual capacity is under construction now in the United States, and will arrive from late 2017 to late 2019, with the bulk scheduled to be commissioned in 2018. The global storage capacity, as stated by industry lobby group the International Gas Union (IGU) in its annual review in April, is 340 million tons by the end of 2016. A further 114 million tons are under construction, as of the start of this year.
It is puzzling to some analysts that all of these developments are taking place while the most respected forecasts see that the world will have an LNG oversupply situation by 2020, notwithstanding increased imports by China and the emergence of new buyers in Asia, such as Pakistan and Singapore.
But it should not be a mystery. It’s this oversupply dynamic that is changing the way global energy giants look at future markets, as it is the reason they decided to move now in building storage facilities as part of a well-studied division of labor between the EU, Australia, and the United States.
This is also why LNG markets are ripe for a historical change. The direct reasons for this development should not be understood as merely the current chaos in pricing LNG. It is also due to buyers who are no longer willing to lock into longterm contracts linked to the price of crude oil, and brokers who are ready for a reexporting-dominated market.
This is why we should expect that the future LNG market will see two central features: 1 – Major re-exporters will tend to prefer longterm contracts signed in times when prices are low. 2 –Waves of consecutive low prices followed by high prices to permit reexporters to buy cheap and sell expensive.
In a few words, we are now seeing the early signs of a comprehensive plan to totally control the LNG global market before it develops to its full potential.
Is it fair that importers control the market? “Fair” is a word hardly understood in the language of markets. The real question should be: Why Western countries and not Asian countries? Are Asian countries not the principal buyers?
In 2016, 278.9 million tons of LNG moved by ship globally, according to vessel tracking and port data, which is a 7.6 percent hike from the 259.2 million shipped the prior year. Of this total, 41.7 million tons went to Europe, while 156.5 million went to North Asia, which includes Japan, South Korea ,and China, and 33.2 million was shipped to the rest of Asia. In 2013, total LNG trade stood at 243.9 million tons, with 38.5 million going to Europe, 151.5 million to North Asia, and 17.7 million to the rest of Asia.
The data show that Europe and North Asia grew slowly in the past four years, while emerging Asia surged on the back of rising imports by India and newer buyers, such as Singapore and Pakistan, and even by traditional exporters like Malaysia. However, Asia does not have the edge that the troika has:the increase of U.S. production. This production allows a high degree of control over the market once the curve of supply-demand reaches its critical balancing point.
But why Australia?
Australia succeeded in demonstrating that to gain a seat among exporting countries, you do not necessarily need to be a producer. The Australians stretched this new lesson one step further as they were aiming not to be a member among the exporters, but the main and principal exporter. If we look at the breakdown by exporting country we will see that Australia has gone from shipping 23.7 million tons in 2013 to 46.1 million in 2016. Of Australian shipments in 2016, 39.6 million tons went to North Asia, up from 21.4 million in 2013.
On the other hand, Qatar shipped 34.7 million tons to North Asia in 2016, down from 40.5 million in 2013. It seems clear that Australia is supplanting Qatar as the main supplier to North Asian markets, a trend that’s likely to continue as the Pacific nation brings another 40 million tons of LNG capacity online by 2018.
Qatar has had success in boosting its shipments to the rest of Asia and to Europe, but it will also face pressure in those markets as Australia has gone from shipping 65,900 tons, or just one cargo, to the rest of Asia in 2013 to supplying 3.1 million tons in 2016.It is also likely that its producers, especially those on the northwest coast, will be trying to gain a bigger foothold in markets like India and Sri Lanka.
We are clearly witnessing an important chapter in the history of global energy. It is also clear that there is a division of labor between major Western powers: EU to consume, the United States to expand its production capacity, and the Australians to build storage facilities. Producers like Qatar, Russia, or Iran are only spectators who sell at the price pre-determined by the major Western companies.
For the troika to implement its strategy, it needs to keep prices of LNG low until all new storages are filled. Then, we might see either an increase in demand — reaching the forecasted level — or a crisis that prevents a percentage of the supplies from flowing to the global market. This will be the second half of the cycle that we described above. The first half, which we are currently going through and which may continue until 2020, requires supplies in the market to stay high in order to keep prices low for now. Only upon moving to the second half of the cycle will we see prices considerably flying high.
Therefore, the Turkish Stream will not be a game changer in pricing LNG. It will come to an already tightly controlled market ruled by others.
Anwar Al Taqi – Esam Aziz
U.S. Shale and the Role of Washington in
“Operation Global LNG”
We have discussed, in this issue’s editorial, the emerging would-be dominant troika in the future LNG global market: the EU, Australia, and the United States. Here, we will focus on how this will also shape future production of LNG in the United States.
OPEC controlled oil markets for decades, despite the fact that its total production was roughly one third of the world’s output. This was possible because of the organization’s discipline, and because the world was walking a tight rope between supply and demand. But the lesson shows us that if a producer controls a portion of the supply, it can, if it uses its share smartly, manipulate the whole marketplace.
As we saw in the editorial, the current case is not only that of a producer (the United States) that steadily increases its production, but also the case of two consumers that have huge storage facilities and are situated as natural springboards to large markets in East Asia.
It was reported that during the last G20 summit in Germany, U.S. President Donald Trump encouraged Eastern European leaders who are worried about their dependence on Russian energy to take advantage of newly available supplies of U.S. natural gas. Trump’s argument was based on a simple fact: In recent years, Moscow has cut off gas shipments during pricing disputes with neighboring countries in winter months, prompting a drive in the region to find more secure sources of energy. One White House official said that the United States has recently began shipping liquefied gas to Poland for the first time, and Trump told allies in Poland that he wants to make it as easy as possible for U.S. companies to ship more gas to Central and Eastern Europe.
And if we carefully look at the details of the “Three Seas” summit — so named because several of its members border the Adriatic, Baltic, and Black Seas — we can see that the Three Seas project aims to expand regional energy infrastructure, including liquefied natural gas (LNG) import terminals and gas pipelines. Members of the initiative include Poland, Austria, Hungary, and Russia’s neighbors Latvia and Estonia.
U.S. producers are in a position to start aggressively marketing gas exports to Europe because of its “fracking revolution,” which has made supplies of gas plentiful and cheap. After decades of consuming nearly all of the energy it produced, the United States is now expected to become the world’s third-largest exporter of gas by 2020. Trump last week proclaimed that a “golden era” in U.S. energy production will enable the country to develop a policy of “energy dominance” through exports to Europe and Asia. But his ambitions in the European market run headlong into Russia, which relies heavily on oil and gas exports there to fuel its economy and generate government revenues.
Naturally, Russia is monitoring the American moves into Eastern European markets with particular worry. Moscow is concerned about any attempt by the United States to cut into its export markets in Eastern Europe, where it has dominated for decades. While Trump has talked about improving relations with Russia, some Republican lawmakers in Congress would like to see him take a hard line against Russia on energy because of Moscow’s aggression in Ukraine and alleged interference in the U.S. presidential elections.U.S. moves undermine the strategies of Russian President Vladimir Putin and other strongmen who are trying to use energy supplies as an element of strategic offense. In many ways,U.S. gas exports are the most threatening American policy affecting Russia.
As we said in our editorial, this is not the only trouble Russia will face. The rising troika — the EU, Australia, and the United States — in the LNG global market will most certainly reduce the role played by Russia in energy geopolitics. It will also guarantee U.S. producers the ability to manipulate prices in order to obtain a stable increase in their production and a continuous flow of investments into their operations. Coupled with the steadily reducing production of gas in fracking fields, the US saw far enough to start from now providing the proper conditions to control the market.
Some analysts are dubious of U.S. ambitions to supply the European market, however, as a glut of gas in world markets has been depressing prices and making it difficult for liquefied natural gas to turn a profit. Russia has the advantage of lower costs in Europe because of its close proximity and pipeline connections. But analysts say concerns about security may ultimately overcome that advantage.
However, the issue of costs could be tackled through two avenues: technology and price manipulation. If the global troika controls the market to a degree where it can cause waves of high and low prices, the troika may be able to buy when prices are low, store purchases, then sell when prices are high. It is a basic market technique.
The only problem the Americans are facing now is Germany’s resistance to American LNG. Germany and other European countries are involved in building a new pipeline to pump Russian gas to Germany through the Baltic Sea. Germany’s foreign minister last month questioned whether U.S. ambitions to export gas weren’t behind the U.S. Senate’s move to include a provision in its Russian sanctions bill that would penalize European firms involved with that pipeline, known as Nord Stream 2. The U.S. State Department has maintained that Nord Stream 2 is undesirable because it would make Europe more vulnerable and dependent on Russia.
It helps the United States that Rex Tillerson, an energy executive, is the Secretary of State. This promises US LNG producers with a golden future indeed.
The question now is: What will the Russians do?To be sure, Russia will never sit back and observe. Perhaps, Russia-Iran-Turkey ties deserve analytical attention.
Will Other Oil Majors Follow Total to Iran?
Total and the National Iranian Oil Company (NIOC) have signed a contract for the development and production of phase 11 of South Pars (SP11), the world’s largest gas field. The move is Iran’s first-ever Iranian petroleum contract and seals its first upstream contract with foreign firms in 10 years. The contract has a 20-year duration, extendable by another five years. Total is the operator of the project with a 50.1 percent interest alongside the Chinese state-owned oil and gas company CNPC (30 percent), and Petropars (19.9 percent), a wholly owned subsidiary of NIOC.
The French giant is expected to install 20,000-ton compressor platforms, the biggest platforms ever installed in the Gulf. Hopes are high in Iran that the Iranian Petroleum Contract will enhance local companies’ capabilities. As was the case with previous buy-back contracts, contractors will not have any right to the gas and will be paid by the sale of condensate. Gas from Phase 11 is earmarked for the domestic market. Iran has the world’s third largest gas market, bigger than China, with close to 200 billion cubic meters (bcm) consumed in a year. This number does not include gas re-injected into oil fields, which currently requires about 50 bcm per annum. However, increased gas production opens new opportunities for piped exports and LNG. Iran started test exports to Iraq two weeks ago and,by 2019, could send up to 20 bcm to its neighbor.
Iranian officials anticipate the deal will see gas production increase to nearly 600 million cubic meters from the current 540 million cubic meters. The development at phase 11 of the South Pars field will see 20 wells and two wellhead platforms built and connected to existing facilities by two underwater pipelines, Total officials said. A second phase will involve the construction of offshore compression facilities. Total spokespeople said the project will have a capacity of two billion cubic feet of natural gas a day, or 400,000 barrels of oil equivalent per day, including condensate.
The South Pars Phase 11 deal will, Iran hopes, prompt other international oil companies to re-enter the country’s upstream sector. Reopening the Iranian upstream to foreign investors could very well become one of President Hassan Rouhani’s main economic achievements. With 21 trillion cubic feet (tcf) of gas in place, it is estimated that Phase 11 could recover more than 10 tcf of sweetened gas and 450 million barrels per day of condensate. The project will require investment estimated at $5 billion and will have a production capacity of two billion cubic feet per day or 400,000 barrels of oil equivalent per day, including condensate. The produced gas will supply the Iranian domestic market starting in 2021.
But will more international firms go to Iran on the tail of Total?
India, one of Iran’s most steadfast trading partners, announced that a consortium of domestic businesses would offer up to $11 billion to develop another of Iran’s natural gas fields, Farzad-B field, and create the infrastructure to export the fuel, Bloomberg reported, citing Narendra Kumar Verma, managing director of the overseas investment unit of India’s largest explorer, Oil & Natural Gas Corp.
Iran is the second-largest supplier of crude oil to India, and, as a result, India is one of the largest foreign investors in Iran’s oil and gas industry. However, fraught diplomatic relations between Iran and other states have made it a difficult relationship to uphold. Under U.S. sanctions, which were reinforced last month, India has been unable to trade with Iran using the dollar — the world’s premier reserve currency — and was forced to defer payments or revert to payments in rupees and, more recently, euros.
While companies including Royal Dutch Shell and Italy’s Eni have signed provisional agreements with Iran, the path ahead to recovering Iran’s energy sector looks far from smooth. Other developments are not so positive, like Azadegan, another Iranian oil field project which has suffered continued delays amid uncertainties over Iran’s trading future. The tender for the Azadegan oil field was supposed to be imminent but was then pushed back by three or four months to give foreign companies more time for analysis. This suggests that the major firms that Tehran really wants to attract are largely not ready to commit to Iranian deals. Currently, Iran’s oil production has been flat and each fresh delay to the return of foreign investors pushes back the timeline for further growth in output.
Why We Do Not Share the Optimism of Some
Experts on Oil Prices
Even the International Energy Agency (IEA) cannot predict the course of oil prices over a single year. IEA Deputy Executive Director Paul Simons said recently that the expected trajectory of prices is indeed a tough call. “In the second half of 2017, we will see some movement towards rebalancing in the market. And then in early 2018… I think there is quite a bit of uncertainty out there,” he explained.
Moreover, forecasts, however modest, are being revised almost on a monthly basis. Recently, Goldman Sachs slashed its three-month price expectations forcrude oil by 15 percent to $47.50 a barrel from $55, as production gains in Libya and Nigeria are jeopardizing OPEC’s efforts to reduce global inventories and may force the cartel to cut even deeper to prop up oil prices. Unexpected rebounds in those countries, which were exempted from OPEC’s November deal to curb production, could offset inventory declines expected in the third quarter of the year, Goldman Sachs officials say.
In fact, the return of Nigeria and Libya resulted in an increase in OPEC total output, despite the renewal of the cuts deal. Therefore, while some experts were talking about a self-sustained price rally due to increasing demand in Western countries, we concluded that this surge was temporary, caused by vacation season, that the decrease of inventories was not serious, (e.g. U.S. crude inventories remain more than 100 million barrels above the five-year average), and that oil in New York and London posted a monthly loss in June after tumbling into a bear market on concerns that rising global supply will counter curbs from OPEC.
To simplify the picture, we should say that the two factors stopping OPEC from improving the level of prices are 1-Increasing levels of supplies and 2- very competitively priced U.S. shale oils. This also shows how difficult it is for the organization to control global price trends.
As explained repeatedly, U.S. shale producers keep making their costs cheaper, while Nigeria and Libya — two OPEC countries exempted from the cuts — keep producing more. When it looks like there is progress toward rebalancing, these two factors continue to foil the effort and block any sustainable rebalancing.
However, there are still experts who believe oil prices will improve. What do they say, and what makes them reach that conclusion?
One of those experts explains his view as follows: “My main view is based on [a forecast] that supply growth will lag behind demand growth in the third quarter and that we should see large inventory declines. Historically, we have seen a negative correlation between inventory dynamics and price dynamics.”
The expert, based in Europe, believes that when inventories go down, prices usually go up. Overproduction in the oil market has led to persistently high inventories in recent years, keeping a lid on prices, which haven’t topped the $60 level in two years. This argument explains the foundation of why OPEC and a group of non-organization members have agreed to cut production by 1.8 million barrels a day until the end of the first quarter of 2018. The group is committed to bringing global oil inventories to the five-year average, with the Saudi Arabian and Russian oil ministers pledging to do “whatever it takes” to balance the market.
However, experts in this camp believe that U.S. production will cease to increase at the relatively high rate we see now. However, U.S. oil output has been rising since the OPEC-led production cuts helped lift prices, leaving room for and incentivizing another producer. The U.S. Energy Information Administration in May increased its 2017 U.S. output forecast to an average of 9.31 million barrels per day. Last June, the EIA raised its 2018 production forecast once more.
The key number here is the U.S. rig count. Recently, and after 24 consecutive weeks of increasing rig counts, we have seen a small decline for a week or two. Is it a trend? We do not know yet. But we know that rig counts increase if production costs decrease. In other words, shale is just another investment territory. If an investor knows that whatever will be produced by his money will cost much less than the average market price of the commodity, he will rush to this lucrative territory. So, it boils down to detecting the impact of continuous technological renovation in the field of shale extraction. And through human history, we know that technological improvements is a one-way road — it always goes higher.
Even if there is a lull in reducing production cost, it would be short term. The only way that U.S. shale output would decline is if the U.S. government initiated tax policies that increase the financial cost of operating in this field. So far, we see the U.S. government doing exactly the opposite.
We also hear the argument that inventory levels are declining and that this decline will help improve global prices.
Of course, there is a relation between inventory levels and prices. But we claim that this relation is slowly changing now and becoming more and more a psychological matter, as inventories are meant to be a buffer mitigating the impact of any supply shock. But why would the United States feel worried about supply shocks if it produces its own oil and even exports it?
For any country that has enough domestic production of oil, the point of keeping a high level of reserves will be ridiculous. Therefore, those who keep their eyes focused on the level of reserves in the United States, as the largest global consumer, should understand that while they are gazing at the levels of the reserves, the whole logic of the reserve equation may be changing.
We will keep saying that the global oil market has fundamentally changed. Therefore, it requires a new approach that all OPEC members should now be working hard to devise.