x Abu Dhabi, UAETuesday 25 July 2017

Gas glut offers insight

Low prices are bad news for producers these days but the natural gas market provides some lessons for Gulf countries in their efforts to maintain prosperity.

Americans heating their homes with natural gas might expect to pay about Dh2,500 for the year.
Americans heating their homes with natural gas might expect to pay about Dh2,500 for the year.

Low prices are bad news for producers these days but the natural gas market provides some lessons for Gulf countries in their efforts to maintain prosperity. Winter weather is approaching in the northern US. Americans heating their homes with natural gas might expect to pay about Dh2,500 (US$680) for the year. But those who choose to heat with oil will be forced to pay four times as much.

What is going on in the world of gas? Does it have implications for the Middle East? For a few years, the dialogue about gas has resembled that on oil. Commentators thought that worldwide supplies were limited. Almost everyone believed that American gas extraction was in permanent, long-term decline and that the country would become increasingly dependent on imports. Alarmist books were published with titles such as High Noon for Natural Gas.

Europeans, meanwhile, became acutely aware of their dependence on Russian gas when supplies through Ukraine were cut off in a pricing dispute with political overtones. Asian importers of liquefied natural gas (LNG) bid record prices for supplies. The Gas Exporting Countries Forum was conceived by some members as emulating OPEC and pronouncements from Iran and Venezuela touted their new-found market power.

Now gas prices have plunged by 60 per cent. LNG ships headed for the US are turning round and setting course for China. A mysterious pipeline explosion has freed Russia from the obligation of buying gas from Turkmenistan for which there were no markets. What has changed? Essentially, three things. First, supply. As I argued even at the time of record gas prices last year, gas is a very abundant resource. This has been most strikingly demonstrated in North America. Technological breakthroughs in extracting gas from shale rocks have led to a resurgence in output. This type of "unconventional gas" first took off in the Barnett Shale formation in the state of Texas early this decade, and required high prices to get started.

But now it is clear that the Barnett is no fluke: at least seven other major formations are under development across the country, from the states of Louisiana to Pennsylvania to North Dakota, and half of all US gas is now unconventional. Since these gas-bearing shales appear ubiquitous in the US, there is no reason why they should not exist elsewhere; the boom is spreading to Canada and companies have started taking a serious look at Europe.

At the same time, a wave of new LNG plants arrived, above all in Qatar. Some of this output was targeted for the US market, but now finds no takers. Long-delayed Australian LNG projects are moving ahead. Some run on gas extracted from coal, a potentially huge resource. It is becoming increasingly clear that not only is there plenty of gas around the world, but that unlike oil there are few political or environmental barriers to extracting it. Good investment conditions and technological breakthroughs have gone hand in hand.

Second, the financial crisis. A strong global economy could probably have absorbed the tidal wave of new supply. But this year, an irresistible force has met a very movable object. Demand, already weakened by high prices, was hammered by factory closures and a slump in electricity demand. World gas use has fallen for the first time in 50 years and European consumption may not return to last year's levels for another decade.

Third, and most important, we have realised that not all energy is created equal. Historically, gas prices in continental Europe have always been benchmarked against oil. Now, with sluggish demand, plentiful supply, the break-up of monopolies and the emergence of liquid trading hubs, the once sacrosanct oil link is breaking down. LNG exporters such as Qatar are fighting to retain oil-based pricing for their key Far East markets.

Oil is a premium source of energy because of its role in transport. Electric or gas-powered cars are a tiny fraction of those on the roads. Gas and oil are barely competitors any more. The key markets for gas are power generation, industrial processes like petrochemicals and domestic uses such as heating - applications where oil is far too expensive. Instead, gas faces real competition from a mix of coal, nuclear and renewable energy sources. Gas demand is therefore price-sensitive in a way that oil is not.

This transformation is good news for gas buyers in the US, Europe and Asia. It is also good news, at least in the short term, for the environment. Cheap gas will displace dirty coal and reduce pollution. Perhaps it might be possible to deflect China and India from their coal-intensive development. In the longer term, gas resources are large enough to cause disastrous climate change on their own, unless we can trap their carbon dioxide emissions, as Abu Dhabi's Masdar is proposing.

The glut is bad news, though, for some gas-rich countries who thought their era of dominance had arrived. Qatar will not suffer too badly, as its LNG plants are up and running and their production costs are exceptionally low. Russia is in a worse position, facing low prices for one of its main exports. Perhaps the biggest losers are countries such as Iran, Venezuela and Bolivia, which failed to capitalise on their vast gas resources while buyers were keen.

There are some key lessons for the Middle East in all of this. First, customers for resources always have other alternatives. Given some time and ingenuity, no energy source is indispensable. Second, diversification is essential to shield economies from volatile energy earnings. Targeting a range of markets and export methods for gas is a wise policy. Third, Middle East countries also have huge unconventional gas potential to add to their conventional reserves. That may be some comfort to regional states struggling to meet exploding demand. But this potential will not be found and unlocked without supportive investment policies, reward for ingenuity and market-based gas prices.

Robin Mills is an energy economist based in Dubai and the author of The Myth of the Oil Crisis