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Sustaining power - new gas supplies

Clay Technology magazine
17 Apr 2009
Liquified natural gas carrier Northwest Shearwater. Image courtesy of BP

UK gas prices have been volatile but the substantial drop in oil prices and new supplies to the UK have brought prices down again. Vanessa Strowger, Partner Responsible for Market Analysis and Products at Eclipse Energy Group, London, reports

The UK gas market has experienced a dramatic rise and fall in prices over the past year. The Q1-09 forward contract, covering gas for delivery between January and March, traded as high as 110 pence per therm (p/th) in July 2008 and was still above 60p/th when the contract expired at the end of December.

However, the average out-turn price for gas bought ‘on the day’, rather than purchased as a forward contract, for this quarter was just 47p/th and, during March, the average price fell even further to 32p/th. Forward prices have also dropped, although not to the same extent, the Q1-10 contract peaked at 115/pth last summer but is now 56p/th.

So what has driven this step-change in pricing, and can the significantly lower levels be sustained for a prolonged period? The UK supply has increased as demand has fallen. According to Eclipse modelling, which predicted the lower prices, this situation should continue for the next few years, but the country may face another supply crunch before the middle of the next decade.

Boosted supply

There are a number of factors on the supply side, not least a slowing rate of decline from the UK’s North Sea fields, where sustained high prices encouraged producers to invest in prolonging field life and boosting recovery rates. But the two most relevant drivers of higher supply are Norwegian imports and liquefied natural gas (LNG), where gas is cooled into liquid form and transported in tankers from countries such as Algeria, Egypt and Trinidad, which are too distant to have pipeline links with some customer nations.

Norway’s Ormen Lange field, which came on stream in late 2007, is building up to production rates close to its design maximum of 70 million cubic metres a day (mcm/d). To put this into context, this one field at plateau will be able to provide about 15-20% of the gas required to meet UK demand on a typical winter day. The field produced an average of 56mcm/d in January 2009, according to the Norwegian Petroleum Directorate, and contributed an extra 28mcm/d to Norway’s gas output. It has a dedicated pipeline arriving at Easington on England’s east coast. The UK is the major beneficiary of this extra supply, with volumes coming through the three import pipelines from Norway, on average, 22mcm/d higher than last winter.

At the beginning of this winter, the UK only had two relatively small LNG import facilities, at the Isle of Grain and Teesside. Utilisation rates at the former terminal had been low for some time, as higher priced markets in the Far East, India and Spain soaked up the vast majority of global cargoes, leaving few for the UK market, while the latter had never received a commercial delivery.

However, last October saw a major upgrade at the Isle of Grain, boosting capacity by well over 100% and increasing the number of capacity holders – firms with permission to bring in ships loaded with LNG – from two to four. Another terminal, at South Hook in Wales, received its first commissioning cargo in March this year, while a second facility in the same location is due on stream later in 2009.

So far in 2009, the UK has received, on average, 12mcm/d of LNG, compared to just two million cubic metres a day in the same period last year. But increased capacity is only part of the story. The impact of the global financial crisis has dramatically decreased gas demand in other countries, such as Japan, South Korea, India and Spain, that competed with the UK for LNG cargoes. Also, LNG imports into these countries are often priced relative to oil, so a lower crude oil market means that the price paid to meet the remaining demand has also reduced, increasing the attractiveness of the UK market.

A third factor is that investment in the facilities capable of turning gas into liquid takes a number of years, and projects that began during the commodity price boom are only arriving now, just as demand contracts, creating a global excess of supply. New liquefaction capacity has appeared in Australia this year and further boosts are expected over the next few months in Indonesia, Qatar, Russia and Yemen.

Industrial issues

Loss of industrial gas demand is also an issue closer to home. The European Commission’s statistics collection, Eurostat, suggests that German industrial production was down 19% year-on-year in January 2009, while for the EU-27 as a whole, the decline was 16%.

The UK is linked to mainland Europe by two pipelines with Belgium and the Netherlands, as well as through the offshore Norwegian network, which can send gas either to the UK or mainland Europe. With European demand weak (and there is clear evidence that French industrial gas demand, for example, is significantly lower than last year) there is less scope for the UK to re-export any oversupply into to mainland Europe.

This lack of European demand ensures that UK prices can decouple from the
oil-linked prices paid under long-term contracts, which remain higher than traded prices due to a time-lag on lower crude filtering into these gas supply deals. Also, Norway’s major firms have production targets to meet in order to satisfy the demands of equity analysts, so they may divert volumes unwanted by continental customers into the UK’s traded market, rather than turn down production at their fields.

The UK’s domestic demand has taken its own hit due to the financial crisis. The requirement of the largest industrial gas users, with direct connections to the national high pressure grid, is down by around 20% year-on-year. And local distribution zone demand has been lower-than-average this winter, despite the fact that the country has seen substantially colder-than-average temperatures, which would normally be expected to boost the need for heating. When the weather has been warmer, the gulf between actual and expected demand has been huge, suggesting that the cold winter has masked the extent of the issue.

Therefore, the UK gas market is caught in a cycle of falling demand and increasing supply, in part because it is the beneficiary of gas left without a home due to falling continental and global demand for the fuel, and in part because investments in the boom time are only just arriving after the commodity bubble burst. The lower prices may persist for the next few years as demand recovers and the impact of further field production declines take effect. However, the price spike earlier this decade was driven by sustained low prices, discouraging infrastructure investment only until the UK was short of supply. A similar pattern by the middle of the next decade should not be ruled out.

Further information: Eclipse Energy Group