The Giant Squeeze!
This Commodity Is Witnessing An Epic Squeeze!
“Natural Gas is the future. It is here”- Bill Richardson.
Natural Gas is of utmost importance in our day-to-day lives. It is a feedstock in basically every industrial process that mankind has developed. Chemicals, fertilizers, glass, fabrics and plastics are some of the examples that extensively use natural gas.
In fact, you will be amazed to know that mother earth has sustained the colossal population only due to the widespread use of synthetic nitrogen fertilisers, which utilise natural gas as a feedstock.
As a result, it’s unimaginable to think of a life without natural gas on our planet earth.
Lately, natural gas has been the bone of contention between one of the largest producers of gas, Russia and Europe. Russia has successfully managed to weaponise natural gas(in the short term), and Europe’s thirst for natural gas has led to one of the most incredible squeezes for this “critical” commodity in the history of financial markets.
Let us dig deep and understand the natural gas market and what lies ahead!
Brief Overview Of The Natural Gas Market!
A handful of countries dominated the natural gas market before the shale boom transformed the industry. Russia, Iran, Qatar, Australia and Norway were the major producers before the shale gas revolution turned the USA into an energy giant.
Not only did the US become self-sufficient, but it became the largest exporter of natural gas last year, surpassing Russia.
However, there is a stark difference between how Russia and the USA export gas. Let us understand:
There are two ways to export Natural Gas:
- Pipelines: Russia exports the gas from its large gas fields to the EU via pipelines. Together, Nord Stream (NS), Turkstream, Yamal and pipelines that run through Ukraine transported 184.1 bcm of natural gas to the EU in 2021. Pipeline exports are cheap as compared to other modes of transport.
- However, developing pipeline infrastructure requires years and billions of dollars. Nord Stream-2 took ten years to build and cost $11 billion!
Liquefied Natural Gas (LNG): Natural gas export without pipelines is cumbersome.
The gas is first cooled down at sub-zero temperatures and converted to what is known as LNG. The LNG is then exported via special cargoes; the regasification procedure occurs after the LNG is offloaded on specialized LNG terminals.
Countries like the USA and Australia export gas via LNG cargoes to far-off locations in Europe and Asia.
The other important point about the Natural Gas market is that the development of fields ensues by the big energy giants “only” when the long-term contracts to sell the gas are in place.
These long-term contracts detail the volume of purchases and the fixed price the buyer pays over 20–30 years.
Selling the gas in the spot market is tricky as gas prices see highly volatile moves across various geographies. The multiple benchmarks across geographies are:
- USA: Henry Hub
- EU: TTF Gas
- UK: UK Gas
- Asia: Asia LNG (Japan, China and India are significant importers)
Now let us understand how the Natural Gas markets witnessed the “Giant Squeeze” and what lies ahead.
The Giant Squeeze!
Russia continued to increase supplies to Europe even post the Crimea invasion as Nord Stream-1 was opened for operation in phases. In fact, you will be astounded to know that pre-covid Russian gas accounted for almost 45% of European gas imports.
If Gazprom didn’t curtail the gas supply to the EU last year (I covered this in detail in my article: “Winter is Coming”, and Nord Stream-2 (NS2) would have opened this year, then the Russian supply would have met more than half of the total EU gas demand.
The Nord Stream-2 has been the bone of contention between the two continents, as Germany declined to accept gas from the pipeline.
Most European countries have firmly decided to phase out Russian gas entirely by the end of this decade. In addition, countries like Italy will likely phase out Russian gas by 2025.
But what does it means for the rest of the world?
Europe will phase out the Russian gas by replacing it with LNG supplies as Europe doesn’t have any “major” gas fields that will enter production in the next 3–5 years. Norway might increase production, but it will be peanuts compared to Europe’s demand.
Now let us do some number crunching!
We can see that Europe has been able to replace Russian gas by substituting it with LNG imports from primarily the USA.
LNG imports increased from 58.6 bcm to 100.4 bcm, whereas Russian pipeline flows reduced from 88.1 bcm to 45.6 bcm. However, this was before NS1 was operating at reduced capacity.
As NS1 was completely shut off by Russia last month, Europe must import around 200 bcm of gas in 2023.
Importing 200 bcm gas is a significant challenge for EU as the regasification capacity is just 120 bcm/ year. The capacity can be enhanced further via FSRUs (Floating Storage and Regasification Storage), the EU has done a commendable job of leasing and building FSRUs at a war pace. It is expected that 60 bcm/ year of regasification capacity can be added by the EU by 2025.
After all the permutations and combinations, we can conclude that the only way out for the EU is to cut natural gas consumption by at least 15% and look for other sources to meet their energy demand, including coal, oil and nuclear.
Now let us analyze what happens to countries which import LNG as Europe resorts to a mad scramble to meet the supplies.
The other biggest importer of natural gas is Asia. Japan, China and India all import gas from Russia.
The Asian LNG prices saw a parabolic rise as Europe’s squeezed the global LNG supply. Prices rallied 10X from as low as $7 /MMBtu last year to a high of $70/ MMBtu.
Japan which is the biggest importer of LNG so far this year, imports roughly 9% of its LNG needs from Sakhalin project in Russia.
Post the Ukraine war, Shell, which was the minority shareholder, exited the project, whereas Japan’s Mitsui & Co and Mitsubishi are expected to retain the stake as the Sakhalin project is paramount to Japan’s energy security.
However, Japanese utilities fear that Russia might cut supply from Sakhalin and thus are stockpiling LNG supplies to meet the heating demand in winter.
As most of the cargoes head towards Europe, Japan is finding it challenging to find LNG cargoes (the storage was down 13% in September)
As LNG becomes scarce and costlier than fuel oil, the power sector finds it cheaper to run pants on oil.
As a result, Asia economies are boosting fuel oil imports to meet their energy demand.
China is also one of the biggest importers of natural gas. The Power Of SiberiaPipeline opened in 2020, and the gas flows have gradually accelerated this year.
Chinese imports have been lower due to frequent lockdowns and industrial slowdowns. However, if the economy reopens in the forthcoming months, China can further squeeze the LNG market.
Already, China has ordered state-own gas importers to stop LNG sales to foreign buyers so as to ensure that there is no shortage of gas at home in the winter.
The Future!
As natural gas prices have soared in the past months, there has been a dramatic increase in Global LNG greenfield investment approvals. Striking a long-term LNG deal at these prices can be a hugely profitable bet for energy suppliers.
The total LNG supply is predicted to virtually double from around 380 million tonnes per annum (Mtpa) in 2021 to about 636 Mtpa in 2030.
Since LNG projects have an extended turnaround time, therefore it will take a long time for existing projects to start producing gas.
If Russia continues to entirely shut off the supplies to the EU via pipelines (a grave possibility post the NS blow-up), the gas prices may stay elevated for another two-three years unless there is overall demand destruction in double digits.
As per IEA, it would take at least eight years for Russia to ramp up supplies to Asia to 150 bcm (equal to 2021 EU supplies)!
Conclusion!
The giant squeeze that we have witnessed in the natural gas markets might peak this winter, and the situation will begin to improve from next year as the EU readies plan to reduce consumption by 10–15%.
However, as the prices plunge, the demand from Asia will come back with a vengeance as there is no alternative to natural gas in the very short term. Already numerous economies in Asia have spent billions of dollars to build the required infrastructure, like LNG terminals to import gas.
Sustained higher prices of natural gas will keep global inflation elevated as the impact of higher gas will gradually percolate through supply chains via heightened fertilizer prices, and chemical and metal prices (many heavy metal industries have closed in Europe).
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