The Oxford Energy Forum

A QUARTERLY JOURNAL FOR DEBATING ENERGY ISSUES AND POLICIES CONTENTS Issue 89 August 2012 Natural Gas Demand and Supply The world’s growing demand for energy and a desire to diversify sources Thierry Bros .................... 3 of energy has driven demand for natural gas. This issue ofForum looks Laura El-Katiri .................. 5 closely at recent regional demand and supply developments: the greater Howard V Rogers ............. 6 David Ledesma ................ 9 flexibility of natural gas trade following the rapid growth in LNG Simon Pirani .................. 12 trade over the past 20 years, allowing the emergence of major consumer Keun-Wook Paik ............. 15 markets in East- and South-East Asia; the development of hubs for Anil Jain ......................... 17 spot trade in North America and Europe, allowing for a rethink of the Danila Bochkarev ........... 19 traditional price link of contracted gas to oil or other energy prices in Jon Marks ..................... 21 this part of the world; and recent technology breakthroughs in the area Hakim Darbouche ..........23 of unconventional gas, which may yet redefine the import and export Walid Khadduri ...............26 market, most immediately the USA. We start with an account of Europe’s Countries’ Forum. In her view, recent ongoing transition from a traditional responses to the forum have been market with oil-linked long-term vastly over-exaggerated, for the con- contracts to one with shorter contract tinued predominance of oil-linked, lengths with a much greater role long-term contracts limits exporters’ for hub-based pricing. Thierry Bros ability to impose quotas and to reduce argues that the rationale for the use production, and the lack of liquid spot of oil indexation in Europe has disap- markets in most regions looks likely peared, making a greater share of to prevent any change in prevailing gas-to-gas links in contract formulas contracting practices. This is because more sensible. The biggest remaining ‘the reality is that gas markets, and the challenge in his view consists in the pricing of gas, until today function European gas market’s continued very differently from oil markets, and dependence on its main long-term gas for a variety of good reasons.’ supply partners. For this reason, Bros Howard Rogers turns to North suggests Europe needs its own shale America, where the spectacular gas revolution similar to that in North breakthrough in US shale gas pro- America to ramp up production and duction during the late 2000s has supply options. fundamentally turned around the Given the concentration of gas sup- region’s natural gas balance outlook. pliers to traditional import markets Rogers nevertheless cautions expecta- such as Europe, Laura El-Katiri tions about US gas exports, pointing reflects on the viability of what some towards declining Henry Hub spot market observers see as a potential gas- prices and the big question of the cartel in making, the Gas Exporting commercial viability of much of the PagE 2 | OXFORD ENERGY FORUM | AUGUST 2012 US shale gas industry in the coming decade. In Rog- out to become a producer, and possibly even exporter ers’ view, only sustained, sufficient Henry Hub price following East Africa’s recent, significant discover- levels, and a positive long-term response by industry ies of commercial quantities of natural gas. Hakim will maintain the present US outlook. Darbouche suggests that the Middle East and North Africa’s natural gas potential on the other hand Australia looks set to overtake Qatar as the largest remains under-exploited ‘owing to a combination of supplier of LNG before 2020 and David Ledesma low domestic gas prices, unattractive fiscal terms, and believes that it can be expected to maintain this heavily-bureaucratised sector management.’ In view position beyond the next decade. The key challenge of the region’s own rapid demand growth, he sees the for Australia’s LNG potential, he argues, is that ‘over MENA likely to evolve as a growing demand and the past five years, the cost-base of LNG projects has import market, rather than a major supply centre of increased, reflecting rising contractor and raw mate- natural gas. Walid Khadduri looks at the most recent rial costs. As a result, the Australian projects that are offshore discoveries in the East Mediterranean, Israel, currently under construction are the most expensive Cyprus, and the wider Levant basin. Rather than LNG projects in the world.’ development potential, in his view it will be politics Russia, the world’s largest gas producer and key that are likely to determine the region’s outlook as a supplier of Europe’s market, is expected to maintain future natural gas producer – and exporter – to the this role. Simon Pirani argues that nevertheless ‘the regional market and possibly Europe. way that Russia produces and markets natural gas will change substantially over the next decade.’ This is due to changing market conditions both at home Contributors to this issue and in its main export market, including the geo- graphical shift in production away from former key DANILA BOCHKAREV is an EastWest Institute productive centres towards more frontier projects; Energy Fellow. a change in the industry’s corporate make-up; new THIERRY BROS is Senior European Gas and LNG market conditions for the sale and marketing of gas Analyst at Société Générale. under the planned domestic market liberalisation framework; and a further decline in Russia’s share of HAKIM DARBOUCHE is Research Fellow at the Oxford Institute for Energy Studies. the European market coupled to its increasing inter- est in Asian markets. LAURA EL-KATIRI is Junior Research Fellow at the Oxford Institute for Energy Studies. Turning towards main regional demand centres, ANIL JAIN is Energy Advisor to the Planning Com- Keun-Wook Paik analyses China’s options as a mission of the Government of India and a Senior natural gas consumer, and emphasises the country’s Visiting Research Fellow at the Oxford Institute for growing need for imports – most importantly via Energy Studies. LNG. Anil Jain looks at the Indian domestic market for natural gas, which is yet to evolve to match the WALID KHADDURI is Consultant at the Middle East Economic Survey (MEES). country’s significance as a demand centre on the global oil market. Looking more closely at regional DAVID LEDESMA is Senior Research Fellow at the trade options, Danila Bochkarev argues the case for Oxford Institute for Energy Studies. the Trans-Afghan Corridor to supply both India and JON MARKS is chairman of Cross-border Information Pakistan with much needed natural gas. The project, Ltd (CbI), editorial director of CbI’s African Energy first proposed in the 2000s, would involve not only and an associate fellow at Chatham House. a new regionally significant role for Afghanistan as a KEUN-WOOK PAIK is Senior Research Fellow at the transit country, but would contribute to the creation Oxford Institute for Energy Studies. of a new cross-regional sub-market between Central SIMON PIRANI is Senior Research Fellow at the Asia and the Indian Sub-Continent. Oxford Institute for Energy Studies. Africa and the Middle East present a varied picture. HOWARDS V ROGERS is Director of Natural Gas Jon Marks argues that Sub-Saharan Africa, so far Research at the Oxford Institute for Energy Studies. mainly viewed as a sub-regional net importer, may set AUGUST 2012 | OXFORD ENERGY FORUM | PagE 3 European Gas Supply: On the Verge of Being Mostly Spot-Indexed THIERRY BROS believes that Europe needs a shale gas revolution to achieve a fully functioning European gas market According to our estimates, in 2011, 58 In March 2012, ENI and Gazprom to spot indexation. percent of the gas sold in Europe was reached an agreement on gas supply Thanks to these recent deals, it is under an oil-linked formula (Figure contracts. ENI/Gazprom revised prices estimated that European gas supply could 1). Since the 2008 crisis, this ratio has and flexibility but didn’t disclose details be 55 percent oil-indexed and 45 percent remained unchanged at 58 percent: on on the agreement reached. We estimate spot-indexed in 2012 (Figure 2). the one hand successful renegotiations that they agreed a total c.13 percent dis- 26 bcm of contracted gas from Gas- of long-term contracts introduced some count (taking into account renegotiations Terra are also up for renegotiation. Little spot indexation but on the other, due since 2009) but have maintained a full information is available on the negotia- to demand destruction, buyers had to oil-indexed formula. With this discount, tions. But if we assume those volumes reduce their spot purchases and there Gazprom gas is now more competitive move from 75 percent oil-indexation to was an increase in oil-linked Qatar LNG than Statoil gas, which faces further 100 percent spot indexation, then the split volumes in Continental Europe during renegotiations in 2012 (estimated). could even be 51 percent oil-indexed/49 this period. But contract renegotiations In March 2012, E.ON and Statoil percent spot-indexed. and arbitration cases could reduce oil agreed a ‘structural’ solution on long-term The closer we get to 50 percent, the indexation to less than 50 percent of the gas prices. This is a long-term fix that more unstable the system is going to be. total by 2014. We believe this could be a allows E.ON not to find itself in the So oil indexation is facing major chal- tipping point. loss-making position of paying higher lenges. The old system where oil-linked In February 2012, GDF SUEZ prices for its gas purchases than that long-term contracts were signed to ensure confirmed that almost all its long-term obtained on resale. As neither of the both security of demand and security of gas contracts had been reviewed to companies gave details of the terms of the supply and hub spot trading provided ad- increase market price indexation to above deal, if we assume that (i) Statoil/E.ON ditional volumes, is facing a step change.

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