LNG, pipeline gas, carbon pricing dynamics and EU’s energy mix: can US LNG compete with coal in the EU power sector?
DN: The current edition of BP Statistical Review highlights the evolving character of the LNG market, which becomes increasingly more integrated and global with the shifting pattern of trade flows and a sharp narrowing in price differentials on the regional level. Could one conclude that we are witnessing a more and more pronounced trend of LNG price de-coupling from oil prices; and, having in mind both the oil an LNG pricing dynamics, what would be your view on the competitiveness of LNG vis-à-vis pipeline gas in Europe?
Spencer Dale: It is inevitable that over a long period of time we will see a gradual de-coupling of LNG prices from the oil price. The key driver of that would be the growth of US LNG, the pricing of which will be hub-based; and this will encourage the de-coupling trend. In the case of Russian gas exports – although they are based on oil-indexed contracts - we have seen a whole series of rebates and discounts, whereby the size of these rebates and discounts was a function of the gap between the oil-indexed contracts and hub prices. Hence hub-based pricing is already taken on increasingly, even in the cases when the gas volumes are formally oil-indexed. In other words, the actual gas price already has an element of hub-based pricing in it, so we have seen that there is an on-going trend of moving towards hub-based indexation in gas. How quickly this trend will evolve - that is an issue. I still see many contracts written today - which would be there for the next 20 years, having the oil-index component, so the de-coupling process is going to be slow. There are some parts in Asia, where oil and gas still compete directly, so there is going to be some resistance to this trend.
In terms of that competitiveness issue in Europe, in the next 4-5 years there is going to be a glut in LNG supplies looking for a home and Europe is a natural market of last resort (as it is a large market, well-positioned in terms of the major centres of supplies and it has large regasification facilities). We also know that for some of the US LNG volumes that start increasing in 2018-2019, the liquefaction cost sunk, so the willingness to supply these volumes would depend purely on whether one could cover operating costs. I speak to many US LNG exporters, they are telling me that they would be able to land US LNG in Europe at that period at 4 $ per mmbtu.
The costs of extraction and transportation of Russian gas is of course lower than this figure, so Russian gas will be able to compete with the US LNG. The question is whether gas would be able to compete with coal in the EU power sector. The 4 $ per mmbtu price of US LNG seems to be right on the edge. If EU was successful in raising its minimum carbon price, it would be increasing likely – if that were to happen – that some of this US LNG exports get shut in and stay within the US market, so I think that’s where the pitch point is when it comes to the period when you are dealing with sunk costs. It is US LNG competing with coal, while pipeline gas has competitive advantage over both of those. Hence, it looks like Russian gas will remain competitive.