The Fuse

Global Natural Gas Markets to Remain Oversupplied Through the Rest of the Decade

by Nick Cunningham | June 10, 2016

In 2011, the International Energy Agency posed the following question in a special report: “Are we entering a golden age of gas?”

Natural gas markets have not lived up to the expectations in the intervening years since the IEA originally speculated about a potential golden age for gas.

There was a confluence of factors at that time for why natural gas demand was set to take off. Gas is flexible, allowing it to be used for manufacturing, industrial processes, power generation, and even as a transportation fuel. It is mostly cleaner than the fossil fuels it tends to replace, whether coal or crude oil. Natural gas is also found in greater abundance and in more locations than oil, making it accessible to developed and developing countries alike.

The timing for boom in natural gas consumption also appeared ripe at the beginning of the decade. Natural gas prices were falling, particularly in the U.S. because of the shale revolution, and the rapidly expanding global liquefaction capacity would allow the natural gas trade to continue to blossom

But natural gas markets have not lived up to the expectations in the intervening years since the IEA originally speculated about a potential golden age for gas. The golden age appears to be on hold, perhaps until the 2020s at the earliest. “Developments are pointing to a period of oversupply,” IEA executive director Fatih Birol said in the just released Medium-Term Gas Market Report. “The next five years will witness a reshaping of global gas trade.”

Surging supply

Demand for natural gas was expected to explode this decade. With aggressive projections for gas demand in mind, developers gave the greenlight to a wave of LNG export terminals. Between 2011 and 2014, an average of 35 billion cubic meters (bcm) of annual LNG export capacity received final investment decisions each year, according to the IEA. These are large additions planned for a market that only produced 333.5 bcm of LNG in 2015. All of those terminals, most of which are concentrated in the U.S. and Australia, will expand global liquefaction and export capacity by 45 percent between 2015 and 2021.

But LNG prices have crashed to just $4.70 per million Btu (MMBtu) for delivery to Asia in July 2016, down roughly 75 percent from a high of just over $19/MMBtu a little over two years ago. As a result of falling prices, only 25 bcm of new LNG projects received final investment decisions in 2015.

For projects further behind, which have not secured customers at yesterday’s prices under long-term contracts, the market no longer looks welcoming. Projects in the pre-FID phase have been deferred. With the second quarter of 2016 nearly in the books, no new LNG export terminals have been sanctioned anywhere in the world so far this year.

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Slow demand

A very large volume of LNG export capacity is under construction, but prices have collapsed well before most of those terminals have come online.

A very large volume of LNG export capacity is under construction, but prices have collapsed well before most of those terminals have come online. Much of that has to do with falling crude oil prices, which heavily determine the price of LNG. But spot LNG cargoes have fallen even further below the prices found in oil-linked contracts, indicating that crude oil is not entirely to blame. LNG markets are already depressed as demand for gas has cooled substantially.

Global gas demand has grown by just 1 percent per year since 2012, less than half of the 2.2 percent ten-year average, according to the IEA.

Looking across the globe, there are few reasons to feel optimistic if you are a gas exporter. Japan and Korea, which account for roughly half of the total global LNG import volume, have little scope for growth. Despite being the largest LNG consumers, their markets are mature. The return of some of Japan’s nuclear power plants plus the buildup of renewable energy capacity could even cause LNG imports to decline. In 2015, the top five LNG importers in Asia saw collective imports fall by 3.6 percent year-on-year.

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The U.S. may also see weaker gas demand than expected, owing to an extension of federal tax credits that subsidize solar and wind. The EIA projects that the U.S. will add 26 gigawatts of new utility-scale electricity generation in 2016, and 62 percent of that will come from solar and wind. Natural gas will capture just 30 percent of the new capacity additions. Natural gas has done quite a bit to push out coal-fired generation, but the coal-to-gas switching potential is mostly exhausted, the IEA says. The installation of new gas-fired power plants could stagnate as a result. That leaves more gas left over for export.

Some of that could head to Europe, where competition will become more intense as LNG supplies arrive in a saturated market. Flat demand, cheap coal, and renewables could keep a lid on gas prices. New pipelines stretching from the Caspian Sea and beneath the Baltic Sea will bring in more gas. These new supplies, plus a handful of LNG cargoes from the U.S. that have already started to arrive on the continent, will force Gazprom, one of Europe’s most important gas suppliers, to cut prices and introduce contract flexibility. Europe could offer one of the most interesting theaters for competition in the gas landscape, but it won’t be a cure for an oversupplied LNG market.

It all comes down to China

The hopes for rescuing depressed gas markets are thus pinned on China. But China is a big factor for why global gas markets have fallen on hard times over the past two years. China has seen its economy cool, and gas still has stiff competition from cheap coal and renewable energy. Between 2009 and 2014, China’s natural gas demand surged 15 percent on average each year. However, demand abruptly came nearly to a halt in 2015, growing by just 4 percent.

That slowdown could be temporary. The economy hit a rough patch. Moreover, regulated natural gas prices mean that the Chinese economy has not seen large savings from falling market prices experienced elsewhere. Gas is still about three times more expensive than coal. The bullish case for China’s gas demand is still strong – environmental regulation should continue to tighten, forcing more coal plants to shut down. Furthermore, gas will regain competitiveness as oil prices rise.

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But predicting how China’s demand will change amid its ongoing economic transition away from heavy industry is incredibly difficult. How this plays out in China is one the most important drivers for global gas markets and also one of the largest unknowns. If China’s gas demand does not pick up from 2015 levels, the IEA cautions, the global gas glut will persist “well into the 2020s.”

The IEA says that China has probably contracted out more LNG supply than it can handle – it has locked in 55 bcm for delivery in 2020, roughly twice its 2015 levels. Chinese companies have already started reselling cargoes on the spot market to unload the excess, a practice that could intensify if China’s economy can’t soak up all the LNG that it promised to purchase.

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China won’t be the only place where reselling cargoes becomes more common. Oversupply will accelerate a transformation in how the market is structured. More liquidity will erode the practice of long-term contracts and push the market towards short-term and spot market trading. That will be a boon to consumers, coming at the expense of exporters.

No Golden Age this decade

The IEA does “not foresee oversupply in traded gas markets improving meaningfully before the end of the decade.”

The global surplus in oil production is finally starting to ease, aided by the very large disruptions in Canada, Nigeria, Libya, as well as declining production in the U.S. and elsewhere. The oil markets could balance as soon as the third quarter of this year.

But the gas markets are a different story. The collapse of spot LNG prices is heavily influenced by the plunge in crude oil, and could start to climb as oil regains its footing. However, LNG spot prices are trading much lower than even the oil-linked LNG contracts, illustrating the very weak fundamentals unique to LNG markets (i.e., oversupply and weak demand). The substantial excess of liquefaction capacity set to come online will take years to absorb. Weaker-than-expected demand means balancing might not occur until the 2020s.

The supply overhang will force LNG export terminals to continue to operate below capacity. In fact, on a global basis, although the utilization rates for LNG export infrastructure rebounds toward the end of the decade, they probably won’t return to the high levels seen in 2011 and 2012. Ultimately, the IEA does “not foresee oversupply in traded gas markets improving meaningfully before the end of the decade.”

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