The end of gas prices as we know them
Friday, January 10, 2014
Many have heard about fears that exports of natural gas in the U.S. could lead to comparatively higher domestic gas prices, potentially hampering the growth of the U.S. economy. Antiexport proponents are mostly energy-intensive groups like the chemical and metal industries.
On the contrary, a study done for the U.S. Department of Energy by the economic consultancy NERA in 2013 suggests that natural gas exports would actually benefit the U.S. economy, despite rising natural gas prices.
As of November 2013, the U.S. Department of Energy approved five LNG* export permits. The latest is an expansion of the Freeport facility in Quintana Island, Texas. The first is Sabine Pass terminal and expected to begin export operations as of 2015 or 2016.
A question, however, that has caught my attention is why exactly domestic gas prices in the U.S. are expected rise if the U.S. starts to export natural gas in the form of LNG?
A simple answer is that due to increasing trade in LNG, natural gas becomes a tradable commodity (like oil) and therefore regional gas prices will soon be a feature of the past. This is especially true for the U.S., which has been isolated from the global gas market ever since its shale gas revolution.
For a more in depth answer, however, I have to make a short excursion through the world of natural gas prices, whose main character is that import prices are strikingly different from region to region, particularly since 2006 (see the graph below).
Basically, there are different types of wholesale prices. Some are linked to oil prices through indexation. This is, for instance, the case in Asia where natural gas imports currently cost about five times more than in the U.S., given the record oil prices since 2008.
Other wholesale prices are partially determined by natural gas spot prices, which experts also term "gas-on-gas competition" and which means that these prices are determined at trading hubs like the Henry Hub in Louisiana. Again other prices are regulated or determined by geopolitical factors — having a look at the Russia-Ukraine gas disputes tells a good story about that
According to the International Energy Agency (IEA), oil-indexed natural gas prices currently affect one-fifth of global natural gas demand while one-third of demand is met by spot-market prices. However, this will change increasingly with the trade of spot-price-based LNG which currently makes up about 9 percent of global natural gas demand and which is expected double until 2030, according to a report by Ernst and Young.
Other important factors that will play into the changing price mix are the increasing competition of sellers (including the U.S., Australia and East Africa) and the sure end of oil-indexed prices in the foreseeable future.
For the U.S., this means natural gas prices are currently low because they are determined by the current global and regional supply-and-demand dynamics, which are in favor of the U.S. With the production of unconventional gas in the U.S., global gas demand dropped significantly — particularly between 2008 and 2010 at a time of ample LNG supplies (mostly from Qatar, which is still the biggest LNG producer worldwide). This has led to low spot prices in the U.S. and Europe compared to natural gas prices in Asia ever since.
Yet, since 2010 demand for natural gas has picked up again, with demand being expected to rise by 1.6 percent per year till 2035, according to the IEA. If the U.S. starts to export LNG now, its previously protected spot market will be influenced by the rising global demand and higher natural gas prices in other parts of the world.
While the impacts of these new supply-and-demand dynamics on prices can be chaotic, the overall expectation by analysts (i.e. from Ernst and Young) is that prices will converge — oil-indexed prices in Asia will be deregulated and drop, while U.S. prices will rise steadily.
*For those who are not familiar with the term, LNG stands for liquefied natural gas and is basically what the name says: natural gas that has been liquefied for transport, often by ship and sometimes by truck. Liquefying gas is not an easy task because you need to cool natural gas to about minus-162 degrees C (equal to minus-260 Fahrenheit), which is altogether another story.
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