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Synchronicity for Global Natural Gas Prices As Buyers Get Upper Hand

Natural gas may be difficult to store and move across continents, but global prices have begun to converge, and more projects could be launched in 2019.

The convergence in pricing is linked to two things, said analyst Francisco Blanch of BofA Merrill Lynch Commodity Research. The surge in liquefied natural gas (LNG) exports pressured spot prices, but the decline in global LNG spot and contracted prices also is tied to the collapse in crude oil prices. The collapse in oil prices is linked to the same thing that brought down U.S. gas prices a few years ago: shale and tight oil and gas deposits.

Surplus U.S. gas now is looking for a home overseas, while Australian LNG exports are growing.

“Seasonality in spot Asia LNG prices has been pronounced for a long time, but LNG supply is in the midst of a large growth in output that will likely continue to force liquid gas prices out of the oil band that has dominated LNG pricing for decades,” Blanch said.

Spot LNG pricing traded in an oil price band over a long period for several reasons, including oil-indexed contracts and substitution in the power generation sector around the world.

When the spot market is “severely oversupplied” spot gas prices “drop out of the contract price range if everyone is taking minimum amounts on the long-term contracts, which is exactly what has happened recently,” said Blanch.

Japan, Korea and China, the world’s largest LNG importers, together have contracted more LNG for the next five years than they realistically need, with a lot of the recent surge in LNG exports sold into the spot market.

“LNG spot prices have fallen into a band where seaborne thermal coal acts as a floor and oil prices act as a ceiling,” Blanch said. As was the case in the U.S. gas market, “the drop owes much to a supply surge and the development of a growing spot market for global LNG.”

Gyrations in Asian spot LNG prices have impacted other spot gas markets too, especially in Europe. The UK National Balancing Point (NBP) price, for instance, is connected to German and British coal power generation breakevens, but NBP increasingly is “connected to Asian LNG as Qatari shippers look for the best rates in the Atlantic or the Pacific basins.”

Increased LNG imports into Europe, which have been met by weak demand, have made gas prices “much more dependent on the vagaries of Asian natural gas demand,” said Blanch.

As U.S. LNG makes more inroads over the coming five years, Blanch and his team believe that global prices will become increasingly interconnected.

“This means, in our view, that natural gas prices at the Henry Hub should experience a meaningful upward pressure in 2018. Still, there are other forces at work too. Australia is also planning to quadruple LNG exports between 2016 and 2020, adding more supplies to a heavily oversupplied market.”

Longer term, global gas demand should increase faster than other fossil fuels, such as oil or coal, which should be a positive for U.S. prices, according to BofA Merrill Lynch.

“In our view, the power of global connections will likely bring U.S. natural gas more ‘in-sync’ with global natural gas prices. This shift could translate into higher average prices in the U.S., as practically all natural gas-to-coal breakevens across major regions of the U.S. sit above $3/MMBtu.”

Sanford C. Bernstein Ltd.’s team, led by Neil Beveridge, expects LNG demand to grow about 12% in 2017 year/year (y/y), the strongest uptick since 2011.

“LNG demand is the strongest it has been in five years,” Beveridge said. “China LNG imports are up 50% y/y as the government embarks on several pro-gas policies which could see demand treble by 2030.”

Emerging market LNG demand also is flourishing on “cheap” LNG and advancing technology for floating, storage, regasification units (FSRU) that is opening frontier markets in Pakistan and Jordan.

“Mature markets in Japan and Korea have also started to pick up on improved economic growth and coal-to-gas switching, while Europe has also seen LNG demand recover,” he said. Only Latin America is a weak spot as higher rainfall increases hydroelectric supply.

About 100 million metric tons/year (mmty) of supply from projects now under construction is coming to the market over the next three years, according to Bernstein.

“While we are coming to the end of the Australian buildout, there remains plenty of growth in the U.S. from projects in construction,” analysts said.  New capacity additions are expected to peak in 2019 at 40 MMty.

In Asia, spot LNG prices remain under US$6.00/MMBtu, a $2.00 discount to term.

“Forward markets are implying US$7.00/MMBtu this winter, although new supply additions could put a cap on any seasonal price spike,” said Beveridge. He noted a recent renegotiation of a contract for Australia’s Gorgon project, which “show that buyers have the upper hand in pricing discussions, in what continues to be an over-supplied market.”
The next LNG project cycle is set to begin in 2019, with more final investment decisions (FID) expected.

“With a famine in new project approvals this year (the lowest since 2008), we see a deficit in supply of 30 mmty by 2025. This implies we will need to see several projects reach FID over the coming years, and we expect a new wave of projects to be approved from 2019 onwards.”

It will be buyers -- not sellers -- determining which projects get the green light.

“Given that the lowest cost projects go first, projects in Qatar, Papua New Guinea and the U.S. look well positioned to capture new contracting cycle ahead,” Beveridge said. “But everything depends on what the buyers want, and projects in Mozambique and Canada cannot be ruled out given interests from buyers in further supply diversification.”

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