A Short Term Outlook For Gas Prices: Russia Calls The Shots (Again)

Gas prices have held up well, in part on the prolonged cold spell. However, in absence of weather support, by the summer prices will have to be lower in order to take the rise in LNG and Russian gas (161BCM) expected.

It is widely recognized that there’s a big build in LNG supply coming (extra 8bcf/d from the summer, ie three-quarters of UK consumption)) and that Gazprom is planning to increase its sales to Europe (by about 2bcf/d over the year = 20% of UK demand).

So likely that European gas storage will be filled relatively early. Unfortunately, storage levels are still relatively high (equal to almost 3bcf/d of extra supply if returned to normal levels over 3 months). Nevertheless, should storage still close to current levels rather than drop to 25-30% fullness, that would add 9bcf/d to demand over the next 3 months.

Economic recovery may lift demand, and Spain has started 2009 with January consumption up 4.2%. However, the industrial production is still more than 10% below 2008 levels.

The big mover for LNG would be a recovery in Japan, which looks encouraging even when industrial production is still 20% below 2008. South Korea and Taiwan are picking up but together these two countries are only half of Japan’s LNG demand.

Last year, in Europe, Gazprom’s gas buyers sharply reduced volumes early in the year. These are huge numbers – about 14-15bcf/d (ie almost the entire consumption of the UK and Germany combined). This was a”no-brainer” for the gas buyers. Their contracted price is based on oil prices with a 6-9 month lag. So deferring gas take until later in the year meant the gas would be cheaper.

Going forward, it looks likely that gas prices now are close to the lowest level for the year. Hence, the buyers are likely to want to take the gas now (saving about $2-2.5/mmbtu).

As a result of coal’s decline, gas at higher prices would no longer be the preferred fuel for generating power in the UK (where most of the swing occurs between coal and gas).

• Coal has come down as concern surfaced about the extent of policy tightening in China. The Australian coal price has been hit hardest, but clearly this has been the driver for South Africa (and European) coal over much of the past year.

• Marginal generation costs in the UK now favour coal dispatch.

So, gas prices will have to drop (or coal prices have to rise) in order to stimulate enough demand to take the Russian gas. Coal market fundamentals look positive once the trend of Chinese coal import data post-tightening is evident in 1 month time. So near-term, the market balance is more likely to be brought back into balance by falling gas prices enhancing power station competitiveness (along with Europe maintaining high storage levels over the summer), but more expensive coal and lower Russian gas might balance the equation.

So the x factor to bring gas markets to balance is Russia. Unless Gazprom allows a smaller off take, there could be as much as 10bcf/d trying to find a home in the UK/European power sector over the coming 3-6 months. That’s too much for UK/Europe to absorb; so up to 5bcf/d could end up headed for the US. I struggle to believe Russia will work on volume alone given they have a 6% decline in the base. If they allow a lower off-take, US pricing won’t get dragged down in this environment.

The current forward curve has Henry Hub some $0.5/mmbtu above UK’s NBP, so there is not much scope for UK prices to drop without impacting LNG flows and depressing US prices.

In summary, the picture is not that oversupplied if Gazprom volumes (161BCM) include storage and some level of flexibility. Chinese coal buying might keep gas prices more competitive than coal for power generation, and we are seeing LNG projects delayed (Shtockman, Australia) or sending lower volumes to Europe (Yemen). Looks like the picture of oversupply that the market discounts is too extreme. Not that my view will imply gas price appreciation, but the massive downside predicted by some looks less evident to me.

About Daniel Lacalle

Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.

One thought on “A Short Term Outlook For Gas Prices: Russia Calls The Shots (Again)

  1. congrats! keep up the good work/this is a great presentation

    just linked this article on my facebook account. it’s a very interesting article for all.

    Gas Salamander

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.