Note: This piece was first posted on Forbes on April 1.
In a less spectacular fashion than oil, international natural gas prices have fallen. The explanation goes far beyond low demand related to the COVID-19 pandemic or demand in general. It relies on a much larger and more complicated array of factors that include supply and demand and oil pricing. Disentangling those various considerations can be helpful when trying to assess future developments in natural gas trade.
Now and Then
In the past, international trade in natural gas was based on mostly pipeline transportation from a limited number of regional, often dominant, suppliers. LNG was expensive and would be shipped only to areas where pipelines were difficult or impossible to build. Given a lack of competitiveness, pricing gas has been a challenge. Thus, even though it is no real alternative to gas, oil and its price has become a reference point (oil-indexing).
This changed in recent years. Thanks to technological advances and lower costs of extraction (unconventional gas and hydrofracturing) and liquefaction, international oil and natural gas pricing has experienced significant decoupling. Natural gas is in the process of transforming to a more global commodity.
We see an increasing portion of trade not indexed to oil but to competitive pricing set by natural gas hubs such as TTF (Title Transfer Facility), NBP (National Balancing), JKM (Japan-Korea Marker), or HH (Henry Hub). In addition, traditional long-term (three or four decades even) contracts are often replaced by short or medium-term contracts or by spot purchases. A steadily increasing number of suppliers draws on different types of gas resources (from traditional ones to unconventional shale or coalbed methane) which adds complexity to cost and price formation.
Demand and Supply
Prices of natural gas have been extremely low for a while now due to a trend of slowing global demand that was additionally exacerbated by a warm winter. The COVID-19 pandemic additionally impacted demand, starting with China and now moving through Europe and North America. Low industrial activity has been the major driver while residential demand (much lower than industrial) can probably be sustained (or even slightly increased) wherever households are supplied with gas-powered generation and gas heating.
Meanwhile, the world has been experiencing an abundance of natural gas for some time now with new supplies and suppliers entering the market. This includes U.S. LNG companies such as Cheniere, Freeport LNG, or Dominion Energy. New pipeline routes have opened, including Power of Siberia from Russia to China or Nord Stream 1 from Russia to Germany. Russian LNG production is growing too as Novatek expands its Arctic operations. And Australia has been ramping up its LNG production with the recently commissioned floating LNG units (FLNG). Qatar—the world’s largest LNG producer—is not falling behind either as it plans to develop new supplies in its North Field and expand its production by 64 percent by 2027. In addition, new significant LNG projects are scheduled in Canada, Mozambique, or Nigeria, to name just a few.
Absent a reduction in supply (which could happen, see below on associated gas), lower global demand means lower prices in the competitive hub pricing and, as such, we see an immediate impact on spot prices. For example, future LNG prices as recorded in the Platts Japan-Korea Marker (JKM) are almost $1/MMBtu lower for March 2024 than they were just a month ago.
That being said, if the COVID-19 economic slowdown edges off, we can envision demand recovering and even increasing—with the support of low prices. The latter would be related to a higher rate of coal to gas switching in power generation (including in China) and, as some argue, a more significant turn toward hydrogen generation where gas is used as feedstock.
Oil Prices: Oil-Indexing
Where contract prices are indexed to crude (mostly in Asia and Europe) we also should see natural gas prices fall. However, the fall will experience a lag (per contract formula—up to 12 months). It will also be based on prices of crude oil and not on supply and demand conditions for natural gas. Given the precipitous fall in prices the world is experiencing today, there is a good chance that prices under oil-indexed contracts will be even lower than spot and hub-indexed prices. It makes one wonder whether buyers will try to go back to oil-indexed contracts, which would be opposite of the current trend toward market driven hub-based pricing.
Oil Prices: Associated Gas and Condensate
In cases where gas is produced together with oil or condensate, oil prices are likely to impact the production of both.
For example, in the case of some U.S. gas production in the Permian, if oil production is profitable then gas production follows (particularly if/when flaring or venting is prohibited/discouraged). This leads to a paradox, where under high oil prices U.S. gas production can grow even when natural gas prices keep falling (even more so if new pipelines are added to resolve the existing pipeline bottlenecks). This means that the local price of gas in some of the fields in the Permian can on occasion be negative, i.e. it costs more to extract and transport the gas than it can be sold for.
But falling crude prices have already resulted in U.S. oil producers big and small slashing their capital expenditures and cutting back on drilling. Interestingly, in this case by lowering gas supply, lower oil prices could actually push U.S. prices of gas up. That being said this mostly relates to local pricing (at the well), since pricing at HH is very liquid and needs a significant signal to be materially influenced by any specific local field conditions.
Internationally, we see a somewhat similar situation in Qatar. There the cost of producing natural gas is offset by both the value of gas and condensate that is produced at the same time.
What About LNG and Future Market Developments?
Where or when other options are available—domestic production or pipeline imports—LNG is generally a pricier alternative. As such, the onset and persistence of the COVID-19 pandemic means an even more challenging environment. For some, this will be more challenging than it is for others. As mentioned above, Qatar production is based on different fundamentals, but Australian production, for example, will be challenged by low prices in Asia and Europe.
Also, greater flexibility of some contracts will make it easier for some customers to cancel their shipments. This is often the case of U.S. LNG producers. But while it is relatively easy for shale producers to close a stripper well or cease drilling and leave some wells unfinished, it is much more difficult to mothball LNG trains given the high capital cost invested in those trains and their relatively low operating cost. Thus, we may see more maintenance being performed on existing terminals as well as more floating LNG storage. As for LNG investment, it could definitely experience delays and, in extreme cases cancellations. This includes regasification projects in Asia, as well as LNG investment in Australia and the U.S.
That being said, the investment is made for the future and not current conditions. As such, it is valuable to step back and look at the large, long-term picture. As per a 2015 DOE report by researchers at Oxford Economics and the Baker Institute: there has been a prior expectation of rather soft demand until at least the mid-2020s. While the demand will be admittedly much softer than expected due to COVID-19, the effect will be rather short-term and as such should not change the report’s expectations about demand growth and a much tighter global gas market starting in the mid-to-late 2020s.
The current situation may, however, impact recent trend toward more liquid and competitive gas markets if, for example 1) buyers turn back to oil indexing as oil prices continue to fall and 2) as highly flexible, market-based suppliers are discourages and LNG projects cancelled or delayed.