Impact of the oil price: How long will this new pricing world continue?

Geoffroy Hureau's picture
Geoffroy Hureau, Secretary General, Cedigaz
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According to the latest IGU survey, almost half of natural gas imports are still priced using oil-indexation. For the other half, price is mainly the result of supply and demand on the gas market (“gas-on-gas” pricing). The global influence of oil in the pricing of natural gas has significantly declined since 2009, but this was mainly a European phenomenon due to a wave of contract reopening sparked by liberalisation in the backdrop of deteriorating market fundamentals. In 2015, only 30% of European consumption was still priced on oil, down from 78% in 2005. By contrast, oil-indexation is still largely dominant in Asia-Pacific, where it represents close to 60% of gas consumption and 83% of the pricing of imported gas. In short, when analysing gas prices’ evolution, one has to consider the dynamics of two different markets: that of oil and that of gas. Diverging fundamentals in those two markets create spreads between gas-on-gas and oil-linked prices. In turn, those spreads can be a catalyst for the evolution of pricing mechanisms as has happened in Europe in recent years.

Weaknesses in the global gas market precipitated the fall of spot gas prices at the beginning of 2014. This was followed six months later by the decline of oil prices. Both markets are now characterised by a global supply glut that has led to a dual price convergence: that of regional gas prices and that of oil-indexed and spot prices. How long this new pricing world will continue mainly depends on the supply dynamics in the oil market and on the demand dynamics in the gas market.

In the oil market, OPEC’s November 2014 decision to stop attempting to control prices and fight for market share resulted in new market dynamics whereby supply/demand balance depends on non-OPEC producers reacting to low prices by shutting down high-cost production. Initially forecast to occur by the second half of 2015, rebalancing of the market and gradual price recovery are now expected by the end of this year, although it could be precipitated by unexpected events, such as the current wildfires in Canada or geopolitical events.

In the gas market, where a 50% surge in LNG supply is expected from now to 2020, and with downgraded perspectives on Asian gas demand and little hope of a market recovery in Europe, the main question is that of the evolution of global demand. Current forecasts call for the gas glut to last until after 2020. The pressure on spot prices is even likely to increase in the meantime with the coming on line of the Australian and US export projects.

For Europe, the lag time between oil price and gas price recovery will lead to a growing divergence between spot and long-term prices, which are still influenced by oil, especially in Southern and Eastern Europe, and in the Baltics. This will put increasing pressure on the remaining pockets of oil indexation in the continent.

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