North America – the lowest prices, for now
Part 4 of 4
The Arab oil embargo had profound immediate effect on oil prices in North America. But not on natural gas prices.
That's because the natural gas industry – from prices to pipelines – was heavily regulated at the time. Through the mid-1970s, this regulation kept gas prices, supply and demand little changed. Deregulation began in the late 1970s and was essentially done by the early 1990s, giving rise to the North American gas industry we see today.
In general, North American gas is a classic commodity that can freely move throughout the United States and Canada on an extensive pipeline network.
Unlike other parts of the world, North America has many gas fields and many producers.
Gas is priced against other gas supplies available in North America, and an active futures market keeps the pricing transparent while letting traders manage price risk by locking in the price they'll pay in coming months.
As was mentioned, the energy punch of a thousand cubic feet of natural gas is about one-sixth the punch of a barrel of oil. As recently as 2005, U.S. oil and gas prices fit this one-to-six ratio. But since then both oil prices and shale gas production have soared. U.S. natural gas at present is priced about one-30th of oil prices.
The oil-price link in North America becomes more evident in times of scarcity, however.
The United States had a "gas shock" during the winter of 2000-2001. Domestic gas supplies fell short of demand. "Buyers quickly bid up gas prices, until dual-fired power generation users found it economical to switch from gas to residual fuel oil," said the Energy Charter Secretariat report. "Thus an indirect linkage between gas prices and oil prices was re-established."
The price link lingered until early 2006, when gas surpluses reappeared and gas prices started moving away from oil.
Imported gas, even LNG, is priced against other U.S. supplies, not against prices in overseas markets. The United States relies mostly on Canadian pipeline-gas imports to ensure adequate supply. Both Canadian and LNG imports have fallen because of higher Lower 48 shale gas production.
Imports peaked at 16.4 percent of U.S. demand in 2005. Last year, the U.S. imported 11 percent of the gas used, according to the EIA. Canadian pipeline gas comprised almost 90 percent of the imports last year.
An ocean of arbitrage opportunities
What caused the current gas world, where buyers pay $16 in Japan, $10 in Europe and $3.60 in the United States for essentially identical molecules of methane?
At its root, supply and demand turmoil is striking the different market structures of Asia, Europe and North America differently.
The forces at play in today's haywire gas pricing include:
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- Rising shale gas production in the United States. This event has rippled through the world. It cut loose some global LNG production that had eyed the U.S. market and sent it to Europe and Asia. In Europe, LNG makers found willing buyers eager to send a message to Gazprom about its pipeline-gas prices. In Asia, Japan has been an avid buyer, needing extra gas to replace lost nuclear power generation.
- High oil prices. This has pained gas buyers everywhere in the world except North America. The link of gas prices to oil prices is strained today, but generally intact because the link is written into long-term contracts. Some gas buyers are getting gas sellers to give them price breaks. Some gas sellers are asking gas buyers to renegotiate the oil price ceiling that limits how high gas can go. Some European contracts are including local gas prices in the pricing formula. Some Asian contracts are tweaking their pricing formulas to soften how much gas prices respond to higher oil prices. It's unclear how much more pushback will come from LNG buyers, particularly as old contracts expire, if oil prices remain high or keep rising.
- The U.K.'s paradox. The United Kingdom's rising gas imports are weakening that nation's resistance to oil-linked gas prices, although Norway, the main exporter to Great Britain, has moved to base its natural gas price there on local gas prices rather than oil.
- The China factor. China is hotly chasing its own domestic gas production, including abundant shale gas reserves. Last year its production grew 14 percent. China also intends to increase its pipeline-gas imports and is investing in LNG projects to secure supply as its appetite for energy grows. In September, China paid 15 percent less for gas from a new Turkmenistan pipeline than it paid for LNG. With lots of options, China is positioning itself to pay less than top-dollar for gas. The low prices it secured a decade ago with its initial LNG buys were not lost on Japanese buyers. How much China will influence Asian gas prices is unclear.
- The Japan factor. Since last March's Fukushima disaster, this country is figuring out what role it wants nuclear power to play in its future. Gas-fired generation will fill part of any cut in nuclear power, as will coal and oil fuels.
- Ample LNG supply. For now, the 19 nations that export LNG can make far more than the market needs. This imbalance has helped boost spot and short-term supplies of LNG. European buyers have benefitted by getting lower prices, but Japan's desperate need for more gas after Fukushima means high spot prices in Asia. The LNG supply-demand imbalance might disappear in a few years as demand grows, then reappear later this decade when new LNG capacity in Australia starts up. Nobody's sure how this imbalance will affect prices.
Why would anyone ship LNG to the United States, as is occurring occasionally? Why isn't every ounce of LNG production sold to Asia, where buyers today pay top prices?
Here are some of the reasons:
- Most LNG is sold under long-term contracts to utilities in specific countries.
- Typically the long-term contracts don't allow deliveries to places not specified in the contract. Sometimes, after delivery, gas will get diverted to a higher-paying market, if the buyer has more supply than needed.
- Some LNG makers have investments in LNG-receiving ports and need gas deliveries at those ports.
- An LNG maker might send a spot shipment to Europe rather than Asia to keep from flooding the Asia market and weakening prices there.
- Most LNG tankers are contracted to sail between specific ports.
- The biggest LNG tankers that might be available to free-lance a shipment are too big for many Asian LNG ports.
Still, the price disparity today is big enough that it's profitable to divert LNG cargos to higher-paying markets if possible.
And this is happening.
In some cases, LNG shipments are getting redirected to Asia to get the best price there.
In some cases, LNG shipments meant for the United States are heading to Europe instead.
In some cases, LNG loads are arriving in the United States to fulfill contract-destination terms then heading back to sea in search of a better market.
Some U.S. and Canadian companies are positioning themselves to export LNG as a price-arbitrage play. If they succeed and export enough volume, most analysts expect U.S. natural gas prices to rise.
No one knows if and when the price disparity will end.
It could end if arbitrage opportunities grow, forcing prices to converge.
It could end if oil prices plunge, or China grows its own gas production quickly, or the U.S. shale plays fizzle, or Europe exploits its own shale gas resources, or the U.S. exports gas as LNG, or Japan re-embraces nuclear power, or world economic doldrums dampen demand.
Or any of a thousand other events could factor in.
Analyst Jim Jensen of Jensen Associates in 2009 had this insight into the gas market that seems to apply today:
"Natural gas is the manic depressive of the fossil fuel sources. We have been through a period of depression. We are now in the manic phase. It's kind of useful to step back and realize that things were not as bad as you thought they were when it was depressive, and they may not be as good as you think they were when it's manic."
- LNG market grows but uncertainties persist
- Global LNG: Rapid growth, overestimated demand, excess capacity