Even though Russia will continue to provide the majority of natural gas to Europe, and holds a dominant position over the continent’s pipeline infrastructure, the surging volume and diversity of LNG supply will force Gazprom to keep prices low and supply steady—providing a huge boon for European energy security.
Russia has the means and determination to hold onto its market in Europe, but in doing so, will be forced to give up much of its leverage over pricing and the way contracts are written.
The U.S. has shipped a half dozen LNG cargoes since Cheniere Energy’s Sabine Pass export facility began operations in February, and the first shipment of American LNG to Europe arrived in Portugal at the end of April—a shot across the bow for Russia, which depends on the European market to purchase its gas. The threat to Russia’s most prized market does not just come from the United States. LNG export capacity is expanding in Australia, and soft demand in Asia means extra cargoes can be rerouted to Europe.
Russia won’t cede the market easily, however. At a time when LNG supplies are ballooning around the globe, Russia is increasing natural gas exports to Europe in an effort to hold onto market share. “It’s the start of the price war between U.S. LNG and pipeline gas,” Thierry Bros, an analyst at Société Générale, said in an interview with The Wall Street Journal.
Russia has the means and determination to hold onto its market in Europe, but in doing so, will be forced to give up much of its leverage over pricing and the way contracts are written. Meanwhile, U.S. LNG exporters will send some cargoes to Europe, but could find it difficult to truly establish a foothold. Nevertheless, the mere presence of competition for the European market and the growing abundance in global natural gas markets will not only put downward pressure on European natural gas prices for years to come, but will boost energy security on the continent and provide Europe with a critical alternative to Russian supply.
American policymakers seek to bolster LNG ties
The U.S. Congress is pushing to expedite American LNG exports, with proponents using Europe’s energy security as a core justification. Rep. Jim Bridenstine (R-OK) slipped an amendment into the 2017 National Defense Authorization Act, a must-pass bill that funds the Defense Department and is currently working its way through Congress. The amendment would put a 30-day limit on DOE to approve LNG export terminals. Separately, the Senate passed an energy package that would also seek to accelerate DOE permitting. The Energy Policy Modernization Act, or S.2012, would require a decision from DOE on LNG export projects within 45 days of the completion of an environmental assessment. The bill received approval from the Senate but still needs to be reconciled with a similar House version before it can be sent to the President’s desk.
By 2020, global LNG export capacity could expand by 40 percent, with large gains coming from Australia and the United States. Rising export capacity is occurring at the same time that demand in Asia has slowed.
Countries in Central and Eastern Europe are cheering on the bipartisan campaign for liberalizing American gas exports. On April 28, proponents of U.S. LNG exports held several events in Washington DC to press their case. LNG Allies, an industry group, hosted an event on Capitol Hill, featuring several prominent speakers: U.S. Reps. Joe Barton (R-TX), Kevin Cramer (R-ND) and Henry Cuellar (D-TX), as well as the Czech Ambassador to the United States Petr Gandalovic, and top economic and energy security officials from Hungary, Poland and Slovakia. Not too far away, The Atlantic Council hosted a half-day event on European energy security and the role that U.S. LNG can play, with several of the same speakers.
At The Atlantic Council, Robin Dunnigan, Deputy Assistant Secretary of State for Energy Diplomacy at the U.S. State Department, said that the U.S. will be a “reliable, market-based supplier to global markets,” which she said would bolster EU energy security in the years to come. She described the first shipment of U.S. LNG from Cheniere Energy’s Sabine Pass facility as a “foreign policy achievement.”
U.S. LNG faces down market
However, thanks to oversaturation of the global LNG market, more permit approvals and the blessing of the U.S. government do not necessarily mean that gas flows from the Gulf of Mexico to Europe will increase substantially. It is an inauspicious time for new LNG export terminals to enter the marketplace.
Just as we have seen in the crude oil markets, the prices for LNG cargoes around the world have crashed over the past two years. Oil-linked pricing formulas have helped drive down LNG prices. Spot cargoes for delivery in East Asia have declined to $4.24 per million Btu (MMBtu) for May delivery, down 42.5 percent from 2015 levels. Prices now stand at less than one quarter of the levels seen in early 2014.
The depressed marketplace for LNG shows little sign of relenting. LNG markets are already well-supplied, and more export terminals are under construction. By 2020, global LNG export capacity could expand by 40 percent, with large gains coming from Australia and the United States. Rising export capacity is occurring at the same time that demand in Asia has slowed. Japan is making a slow return to nuclear power and China has also seem LNG demand come to a halt. ”You can say the sky has fallen in on LNG in Asia,” Gordon Kwan, head of oil and gas research at Nomura, told The Wall Street Journal.
Weak demand in Asia frees up more cargos that could potentially head to Europe, putting even more pressure on prices. Natural gas prices in the UK have declined 37 percent over the past year, for example. After factoring liquefaction and transportation, U.S. LNG will have a tough time competing in Europe if prices stay low.
Russia maintains strong advantage over U.S. LNG
Russia is already responding to the prospect of more American LNG, lowering prices and increasing gas exports to Europe in order to hold onto its market share. Although it maintains a structural advantage, it will have to fight to maintain its position.
In the first quarter of 2016, Russian natural gas exports to Europe surged more than 50 percent from the same quarter a year earlier, according to Platts. In March, gas flows from Russia to Western Europe hit 10.245 billion cubic meters, up 30 percent year-on-year and close to record highs. Additionally, Gazprom’s pricing structure links natural gas to oil.
“They are trying to defend market shares because they see—like everybody else—that failure to do so is going to allow more LNG—not just U.S. LNG but any LNG—to displace their pipeline supplies,” the chairman of the gas research program at the Oxford Institute for Energy Studies, Jonathan Stern, told Bloomberg. “European utilities are winning because this is the surplus cycle and prices look like they will go even lower as we approach the summer.”
“They are trying to defend market shares because they see—like everybody else—that failure to do so is going to allow more LNG—not just U.S. LNG but any LNG—to displace their pipeline supplies.”
Price wise, Russia is willing to take it on the chin in order to prevent surging supply from the U.S. from moving in, a strategy reminiscent of Saudi Arabia’s actions in the oil market. “In the near-term, in the next two years, there is not going to be a whole lot of U.S. LNG available to compete with Russian gas. The Russians are exporting about 130 bcm to Europe last year, and the amount of LNG coming out of the U.S. will be a fairly small fraction of that,” Bud Coote, Resident Senior Fellow at The Atlantic Council, said at an event hosted by the think tank in Washington DC on April 28.
The Nord Stream 2 expansion will deepen Russia’s ability to export gas volumes to Europe, which some argue presents a looming long-term threat to the viability of U.S. LNG to make a real impact.
Sizable benefits for Europe even if U.S. LNG is small
In addition to pricing, the lack of infrastructure is making it difficult for U.S. LNG to find its way to the areas of the continent where dependence on Russian gas is highest. The first shipment of U.S. LNG was sent to Portugal, not Eastern Europe.
Moreover, about 30 percent of Europe’s regasification capacity is located in Spain, but Spain and France lack adequate pipeline interconnections, creating a large bottleneck in terms of transmitting that gas on to the rest of Europe. The Iberian Peninsula is too far from Eastern Europe to realistically compete with Russian gas on a large scale. Expanding pipeline interconnections to allow for much greater transmission of natural gas around the continent is identified as one of the top priorities for the EU Commission in a recent strategy report.
“It would cost Gazprom a lot of money for a large volume of gas to keep out a relatively small amount of U.S. LNG.”
But where there are entry points for U.S. LNG in Central and Eastern Europe—Lithuania and Poland—real tangible benefits have become visible. The presence of a floating regasification vessel off the coast of Lithuania helped that country negotiate better gas prices with Russia in 2014. Poland received its first LNG shipment from Qatar at an inaugurated import terminal in late 2015, and hopes to use that as leverage in gas pricing negotiations with Russia. The shipments have been small thus far, but new access points for global LNG are already starting to change the game. Gazprom is increasingly shifting towards shorter-term contracts, with lower and more flexible pricing terms.
“In Europe, you don’t get the lowest price for Russian pipeline gas unless you have access to alternatives,” Coote said.
Accordingly, U.S. LNG shipments will struggle to compete with Gazprom in many countries, and shipments are likelty to remain limited. But that doesn’t mean that even a relatively small amount of LNG—combined with the growing global supply overhang in LNG export capacity—will force Gazprom to keep prices low indefinitely to keep international LNG out.
As Coote put it, “it would cost Gazprom a lot of money for a large volume of gas to keep out a relatively small amount of U.S. LNG.”