The arrival of a New Gas Price Model in Europe

Day by day it becomes latent in main European gas markets, a greater participation of Liquefied Natural Gas (LNG) supply to the system. Europe has been and remains a clearly importing gas region. Historically, gas inputs were made through pipelines, through long-term contracts, mostly indexed to oil, which cover part of the funding of the necessary infrastructure to ensure connection. In Europe, these contracts are usually with neighboring countries, especially Russia (27%). On the other hand, Europe also has its own small gas reserves that allow direct supply to northern Europe, such as those from Norway (21%) and to a lesser extent, from Netherlands and the United Kingdom.

However, this year 2015 we are seeing as Europe is becoming an attractive market for the entry of LNG, mainly from countries like Qatar and Nigeria, although currently they only represents 5% and 1% of total gas inputs, respectively. What are the reasons that are driving this change of model? What is the impact on gas prices?

LNG global demand has historically been concentrated in Asia, especially in Japan, reaching 73% of global demand in 2014. Followed by Europe with 15%, Latin America 9%, Middle East (2%) and US (1%).

Asian market has undergone a major change in recent years and is still the main driver of a new global energy scenario. LNG imports in Japan soared in 2011 after the tsunami and Fukushima disaster, which caused the closure of all nuclear plants in the country. As a result, Japan had to make a quick transition to other models of power generation, like gas burning, becoming the largest importer of LNG. The dramatic increase in demand caused a sharp rise in LNG prices in Asia.

Recently, since mid-2014, weakening demand in Japan, Korea and China, by the slowdown in their economies, and the increasing offer from Australia thanks to new investments in liquefaction plants, have pushed prices to lows, very close to European markets values. This is coupled to the fall in oil prices since late 2014 and the gradual revival of nuclear generation in Japan. Since last August, three reactors have been launched again.

The following chart shows the evolution of spot gas prices in key global markets. During 2015, LNG spot prices in Asia (orange) have converged closer to gas hub values in UK, the NBP (in blue). Should be noted that the other major European hubs (such as TTF in Holland, Zeebrugge in Belgium, NCG in Germany or PEG Nord in France) maintain a price level and trend correlation with NBP.

Meanwhile, gas price in the main hub of the United States (Henry Hub) continues its downward trend, supported by the oversupply in the country caused by new extraction technologies (shale gas) that have led to a reduction in production costs. Indeed, US is presented for 2016 as a potential exporting country of gas via LNG to Europe and South America.

Such convergence in prices between Asia and Europe is encouraging imports of LNG to European markets. LNG price in Europe is becoming competitive with gas from pipeline. How far? So far this year, imports of LNG in Europe have increased by 26% compared with the same period last year. In particular, Spain has positioned itself as the main importer of LNG. Thanks to its regasification infrastructure, Spain has become a major port of gas entries to Europe, which often acts as a bridge to forwarding gas to northern Europe.

The fall in Asian LNG prices is leading an increase in gas supply in Europe. However, it should be noted that the promotion of renewable energy and lower gas consumption due to efficiency measures slow down a significant increase in total gas demand in Europe. Therefore, Asia is expected to continue to maintain an important role in LNG market.

How far may lower spot LNG prices?

With the sharp decline in LNG prices and increased costs of carbon,  generation plants based on gas burning are increasing their competitiveness against coal or other fossil fuels. The market is in a price level that fosters a switch from coal to natural gas, with equal variable costs in electricity generation.

During the first quarter of 2015 the entry of LNG cargoes in UK has been significantly higher than last year. UK acts as a sink in the European market, absorbing glut. This is pushing NBP prices downward. However, switching price from coal to gas is provoking a response in demand, leading to a floor in gas prices and preventing further decline.

Therefore, Asian LNG spot prices have a floor, marked by NBP spot market and Britain’s transport costs. This is still the current limit to a greater fall in prices of LNG.

The entrance of LNG in Europe is exacerbating the drop in gas prices in major European markets and also in Spain, beyond the impact from oil prices fall. For Europe, LNG represents a key alternative in the struggle to limit import dependence on Russia and Algeria. For Spain, it represents a great opportunity to capitalize country regasification infrastructure and reach trade agreements with other countries, diversifying the gas supply and reducing our dependence on North Africa.

Susana Gómez | Energy Consultant