Natural Gas Pricing: future perspectives and competitiveness with coal

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1 Natural Gas Pricing: future perspectives and competitiveness with coal Professor Jonathan Stern Chairman and Senior Research Fellow, OIES JOGMEC Seminar, Tokyo, March 2016

2 Natural Gas Pricing: changes in price level and price formation NORTH AMERICA: price level changes with established hubs EUROPE: price level changes hubs becoming established ASIAN LNG: price level changes JCC in the process of change to what?? Failure to distinguish between price level and price formation increases commercial risks $/mmbtu Jan-07 The Gas and LNG price cycle Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 SOURCE: Platts, EIA, Argus, OIES Average Japan LNG Price Jan-10 Jul-10 Jan-11 Asian LNG Spot Jul-11 Jan-12 Brent Henry Hub Jul-12 NBP Jan-13 Jul-13 Europe Oil Indexed Contract estimate: Before concessions After concessions (estimate)

3 $/mmbtu Jan-13 Europe Oil Indexed Contract Pre 2009 formula Jul-13 The Price Cycle With 15% Reduction German Border Price Jan-14 Brent Jul-14 SOURCES: Platts, EIA, Argus, CME, OIES NBP Asian LNG Spot Jan-15 Average Japan LNG Price Henry Hub Jul-15 Jan-16 Jul-16 European Wholesale Gas Pricing (%) Natural Gas Research Programme OPE = oil-indexed pricing; GOG = gas on gas/hub-based pricing Source: IGU Wholesale Gas Price Survey 2015, June 2015,Figure 4.8, p.27.

4 European Gas Hubs and Market Centres There are many locations which call themselves `hubs but only North West, Central Europe and Italy are significant trading locations 7 European Wholesale Gas Pricing 2014 (%) Source: IGU Wholesale Gas Price Survey 2015, June 2015, pp Region and approx % total European demand OPE GOG RCS (BIM) RSP North West Europe 50% Central Europe 10% (2) 15* Medit nean Europe 30% 64 30** (6) South East Europe 10% *Hungary and Poland **mainly in Italy NW Europe: Belgium, Denmark, France, Germany, Ireland, Netherlands, UK Central Europe: Austria, Czech Rep, Hungary, Poland, Slovakia, Switzerland Mediterranean Europe: Greece, Italy, Portugal, Spain, Turkey SE Europe: Bosnia, Bulgaria, Croatia, FYROM, Romania, Serbia, Slovenia

5 European Hub Price Correlation Source: Petrovich/OIES based on Tankard data PSV-CEGH PSV-PEGN PSV-ZEE PSV-GSL H H H 20132H 20141H 20142H PSV-NCG PEGS-ZEE PEGS-TTF PSV-TTF CEGH-PEGN PEGS-PEGN PEGS-NCG PEGS-GSL NBP-TTF 100% 90% 80% 70% 60% 50% 40% 30% 20% CEGH-ZEE CEGH-GSL CEGH-NCG NBP-GSL NBP-NCG NBP-PEGN PEGN-GSL PEGN-ZEE CEGH-TTF NBP-ZEE ZEE-TTF ZEE-GSL ZEE-NCG TTF-GSL TTF-NCG GSL-NCG PEGN-TTF PEGN-NCG Price correlation between NWE hubs is excellent Russian Gas Prices Compared with NBP and Oil l-linked Contracts Source: Henderson/OIES 10

6 Ukraine Purchase Prices from European Hubs Compared with Russian Price Offer: October February 2016 Purchase of 2 Bcm of Russian gas Source: Platts 11 ASIA: PROGRESS TOWARDS A MARKET PRICE 12

7 Key Question: do Asian companies and govt s want to replace JCC with a market price? When oil prices were at $100/bbl this was a priority because of the `Asian premium At $30-40/bbl is this any longer important? Have governments recognised the destructive impact of competition on companies? If Asian countries really want to move to market pricing and competitive markets, this is the time because of market surplus Unprecedented Expansion of LNG Supply Natural Gas Research Programme 2014 LNG output = 246 mt PLUS 143 mtpa capacity equates to ~ 131 mt additional production PLUS eventual restart of Angola and Yemen ~ 12 mt additional production TOTAL SUPPLY= 388 MT by 2018/19 (or by more than 50% compared with 2014) Source: Ledesma/OIES Abundant supply at low prices likely for some years perfect market conditions for competition 14

8 Natural Gas Research Programme Price formation mechanisms which could replace JCC Henry Hub or European (NBP/TTF) hub prices Asian spot price Index (eg JKM, RIM, Argus, JOE): too few cargos (at least currently) on which to base long term contracts Prices at an Asian hub or hubs `Hybrid pricing a mixture of all of these + JCC/oil+electricity+ Which of these mechanisms best reflects gas supply/demand conditions in Asian countries? 15 US LNG export contract based on Henry Hub prices plus costs Looked `cheap when oil was at $100/bbl But at oil prices below $50/bbl very difficult for offtakers to recover full cost = Henry Hub* shipping If Henry Hub rises above $2.50/Mmbtu then exports even at short run marginal cost under threat at oil prices around $30/bbl Henry Hub reflects fundamentals of the US market Basing Asian prices on Henry Hub was never logical; it was a consequence of focussing on price level not price formation

9 BCMA BCMA Spot LNG prices can be a starting point: volumes are limited but growing Global Asia 'Spot Traded' LNG Short Term Contracts Medium & Long Term Volumes Toal LNG Supply 'Spot Traded' LNG Short Term Contracts Medium & Long Term Volumes Toal LNG Supply In 2014, Spot LNG Cargoes Represented 24% of Global LNG Volumes In 2014, Spot LNG Cargoes Represented 24% of Asian LNG Volumes As spot volumes grow the short term market will become deeper and more liquid and could form the basis of. Source: Rogers/OIES based on GIIGNL A Future Asian LNG Hub: Singapore, Shanghai or Tokyo?

10 Establishing a liquid hub takes time and commitment 10 + years? OTC Brokered Trading Balancing Rules & Standardised Trading Contracts Price Discovery and Disclosure Bi-Lateral Trades Third Party Access to Pipelines/Regas Terminals Indices derived for LT Contracts Liquid Forward Curve Develops Futures Exchange Non Physical Players enter Based on Experience in US, UK and Continental Europe: This could take 10 years in Asia. It requires the commitment of government, suppliers and system operators. An over-supplied market with strong competition accelerates the process. A Singapore Hub? POTENTIAL DISADVANTAGES: A market of 6mt although with plans to expand significantly may not be large enough to set prices for Asia. (LNG Imports in mtpa). Location may be too far from the major Asian LNG markets to provide a compelling price reference; but close enough to SE Asian countries ADVANTAGES: First mover current location of 24 companies operating in the Asian LNG space Sufficiently neutral politically that others may accept it as an index A virtual hub for SE Asia? Unlikely to develop enough depth and liquidity to be a reference for the big Asian LNG markets 9

11 Shanghai: a hub or a citygate price? ADVANTAGES: The location where domestic and international (LNG and pipeline) gas supplies come together in Asia s biggest (and most rapidly expanding) gas market Result of a price reform with a compelling market logic (but lacks market flexibility) TPA in principle to pipelines and LNG terminals DISADVANTAGES: Lack of transparency of supply and demand ie not genuinely market-driven Overly dominated by three Chinese state-owned companies (and hence the Chinese government) Shanghai is currently a city gate benchmark rather than a hub price, but it could evolve over time A Japanese Hub: what are the options and requirements? Physical hub would be easier to start Virtual hub possible where pipeline connectivity exists Both will need: TPA to regas terminals and pipelines UIOLI/secondary capacity market for regas Map source: The Asian Quest for LNG in a Globalising Market, IEA, 2014, 9

12 Japanese Gas Liberalisation Programme Natural Gas Research Programme Natural Gas Research Programme 2014: METI announces intention to create a futures market and starts monthly publication of JOE (spot) price 2015: gas liberalisation legislation passed (after electricity) 2017: liberalisation of retail market; third party access to LNG terminals comes into force 2022: full separation of transportation from supply comes into force How quickly can competition evolve? Japan: changes may occur quickly once legislation and market surplus take hold METI seeking to encourage new players into the market especially post electricity liberalisation If spot prices remain below contract prices in the period then pressure on utilities will grow (especially when terminals are opened) Contract length is shortening to around 5 years Hybrid (oil/hh/spot) pricing dominates short tem contracts but still no consensus on long term contract prices for new projects `Hybrid pricing shows continued confusion between price formation and price level 23 9

13 Asian markets do not need to adopt the same price mechanism SINGAPORE: an LNG trading location which develops a regional price for South East Asia CHINA: a Shanghai citygate benchmark price reflecting domestic/international gas prices, and prices of competing fuels (fuel oil and LPG) JAPAN: a hybrid/spot JCC/JKM/HH/NBP price developed by competition which could evolve into a hub These prices will have a relationship with each other and in time will create a messy transition to a converged Asian composite price; meanwhile expansion of spot pricing will put continued pressure on JCC-based long term contracts, especially if oil prices increase CAN GAS COMPETE WITH COAL IF SO WHERE AND HOW? 26

14 Gas Versus Coal* Prices in India Natural Gas Research Programme * coal price series is an average of several different grades and regional prices of coal and may be misleading Source: Sen/OIES Gas cannot compete with coal China coal, gas and LPG prices for industry Natural Gas Research Programme Source: Chen/OIES Gas cannot compete on price with coal or LPG, but may be necessary to improve air quality

15 Impact of the EUETS (CO2 price) + national carbon price floor in the UK on the competitiveness of coal vs gas in power generation Xxx Can any new coal stations be built in Europe? OXFORD INSTITUTE FOR ENERGY STUDIES - Natural Gas Research Programme OXFORD INSTITUTE FOR ENERGY STUDIES - Natural Gas Research Programme Gas/Coal switching boundaries in the UK power market Source: French government Natural Gas Research Programme Source: Timera Energy Gas-fired generation will win over coal stations (with 36% efficiency) at expected prices 30

16 Natural Gas Research Programme SUMMARY AND CONCLUSIONS Natural gas price levels have experienced severe turbulence but the more important issue is price formation Market prices at hubs are established in North America and most of Europe but Asian LNG prices are still largely JCC-based but this has diminishing market logic so Asian hubs may evolve over the next decade and this could be accelerated by over-supply of LNG up to 2020 Gas cannot compete on price with coal anywhere unless: there is a significant carbon price, or regulation to restrict new coal plant for air quality reasons 31 Natural Gas Research Programme THANK YOU jonathan.stern@oxfordenergy.org