Utilities Unbundled issue 13

A volatile mix

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New exports of liquefied natural gas (LNG) from the US could cause a major shakeup in world gas markets. What are the implications for generators and utilities?

Natural gas and power markets are set to become more interdependent than ever before.

In the long term, natural gas is expected to play an increasingly important role in the world’s energy future, particularly LNG. But right now, the future for gas-fired generation looks bleak – unless you are operating in the US.

Natural gas priced out in Europe

In Europe, generation from natural gas is losing out to output from coal-fired thermal plants and renewable sources. In the face of lower industrial demand for power, the price of carbon in the EU Emissions Trading Scheme is providing only limited support for lower carbon generation.

“It’s a very challenging situation for our stations at the moment. Every day we have to decide: can we create value from operating these plants?” says Stefan Dohler, Vattenfall’s Head of Asset Optimisation and Trading.

US turns to gas

Meanwhile, continued low natural gas prices in the US, driven by shale gas, are encouraging coal-to-gas switching in the power sector on a large scale. Natural gas pricing in North America has become totally disconnected from the other regions of the world, with Henry Hub prices now at US$3/mmBtu, significantly lower than in Europe or Asia (see the below image).

Over the past year, this pricing disparity has encouraged North American natural gas producers to consider exporting LNG overseas. The potential impact on natural gas prices has attracted more and more interest.

Global natural gas prices (monthly averages)

EY analysis of data from Natural Gas Week and Thomson Reuters

Source: EY analysis of data from Natural Gas Week and Thomson Reuters

The number of proposed liquefaction projects for LNG export from North America totals almost 250 million tonnes per annum (mtpa) across the US, Canada and Mexico1 - the equivalent of the world’s entire current global liquefaction capacity.

While no one truly expects all this to be built, LNG exports from North America should help the market to level out large price differences between North America, Europe and Asia.

We have the genuine prospect of a single global natural gas market eventually emerging, with price differentials more or less reflecting transport costs.

Asian importers seek gas at hub prices

The market for natural gas is tight in Asia, with demand from China, India and several new natural gas importers such as Thailand, Indonesia and Malaysia rising, or likely in the medium term.

Many Asian buyers, such as Japan’s TEPCO2, want to break from oil-indexed contracts and buy natural gas at hub prices instead.

Chinese demand for LNG is reported to have increased by 31% in 20113 and will be a huge factor in shaping the world’s future LNG markets.

Uncertainties affect future of US LNG exports

Large scale exports from North America face three key uncertainties:

  • Regulatory approval in the US: Only one of the proposed LNG liquefaction projects has received full approval.
  • Price: Natural gas prices in the US are widely expected to rise, which is likely to make supplying Europe unprofitable.
  • Competition: Most notable is Australia, where much of the world’s new LNG liquefaction capacity currently under construction is located.

Still, the signs look promising for North American exporters targeting Asia. Even if the Henry Hub price were to rise to US$6/mmBtu, exports to Asia should still be viable – so long as the JCC oil price, off which competing Australian exports would typically be priced, remains above US$90/bbl, according to Citigroup’s analysis of export project economics.4

Where does this leave Europe’s utilities?

In the short term, operating conditions look challenging. European utilities are heading toward lower load factors, lower margins and more pricing volatility as renewables output increases. When prices spike, operational flexibility and the ability to take advantage of those spikes will be critical.

In the medium-term, European gas hub pricing will increasingly reflect the dynamics of global LNG trade. Howard Rogers, Natural Gas Programme Director at the Oxford Institute for Energy Studies, says: “If you are a utility in Europe, you will have to think about the regions of the world that are connected in terms of sharing LNG supply. It’s going to be a big learning curve for some utilities to go up in a relatively short space of time.”

The LNG business is fundamentally more complex than pipeline supply. Maximizing the portfolio value from LNG means utilities have to respond to factors such as:

  • Multiple sources of gas production, liquefaction and regasification capacity
  • Shipping constraints
  • Contract flexibility to enable sales at multiple locations
  • Marketing capability to a range of end-users
  • All the above within customized contract structures

Natural gas and power markets are set to become more interdependent than ever before.

For more information, contact Duncan Coneybeare.

  • 1 ”LNG Landscape – More US exports likely, but Asian LNG prices to remain robust,“ Citi Research, 18 September 2012.
  • 2 ”Tepco in talks to buy LNG from North America,“ IHS World Markets Energy, 18 September 2012.
  • 3 ”Strong market for now, but uncertainties lie ahead,” Petroleum Review, July 2012.
  • 4 “‘LNG Landscape – More US exports likely, but Asian LNG prices to remain robust,” Citi Research, 18 September 2012.

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