The rise of unconventional oil and natural gas in the United States continues to shift the dynamics of global energy markets, according to the latest Statistical Review of World Energy from BP. In 2012 the US saw the world’s highest production growth of oil and gas – and the impacts were felt far and wide. Japan, left without almost all its nuclear capacity, would have had an even greater struggle coping if the US had become a major LNG importer, as it was once expected to do. The European Union found itself switching from gas to coal in power generation, as cheap coal “exiled” by even cheaper gas in the US exposed a failure of EU energy and climate policy. The US, for its part, saw carbon emissions plummet, despite a virtual absence of federal climate policy. The overall trends, in what BP’s chief economist Christof Rühl calls the “Year of the Swan”, may have looked unremarkable – but below the surface 2012 was an extraordinary year.
In the summer of 2008, I was asked by the editor of a well-known petroleum journal to write an analysis of LNG imports into the United States. The conventional wisdom at the time was that gas production in the US was in inexorable decline. Companies were therefore spending billions of dollars on building LNG import infrastructure.
As I researched it became clear that something strange was going on. Indigenous US gas production was not falling but had begun growing strongly. The US was entering a new era of gas production growth.
My article began: “Until a couple of years ago, the main claim to fame of Haynesville – a town in the US state of Louisiana, four miles south of the border with Arkansas – was the success of one of its school American Football teams. The Golden Tornados have won the state championship 12 times – not bad for a town of fewer than 3,000, served by 15 churches, three police patrol cars, two banks and one weekly newspaper.
“But – since it was discovered that the town might be sitting on the country’s largest onshore natural gas field – Haynesville has become the object of what local media reports are calling an ‘investment frenzy’.”
“Shale gale”: A little over a year later, at the World Gas Conference in Buenos Aires, I listened as the great and good of the energy world discussed the profound implications of the North American unconventional gas revolution, of which the Haynesville Shale had become a part. I vividly remember Daniel Yergin – chairman of IHS-CERA and Pulitzer Prize-winning author – telling journalists that it would be years before the full implications of the “shale gale” would become clear.
How right he was. Five years on, we continue to see the implications unfold, in often surprising ways, as the latest edition of BP’s Statistical Review of World Energy – launched earlier this month in London – makes clear.
Unexpected consequences: One of the first impacts of the shale gale was to make lots of expensive US LNG import infrastructure largely redundant. As it became clear that the US was not going to become a major LNG importer, gas liquefaction projects around the world – notably in Qatar – that had been targeting the US market were forced to think again. One consequence was that more LNG was available than had been expected for markets in Europe and Asia, and indeed for emerging markets in South America and the Middle East.
In Europe it contributed to a shift in gas contract pricing. As relatively cheap LNG found its way into traded markets, big buyers with oil-indexed long-term take-or-pay contracts found themselves saddled with gas they were having to sell at a loss. They in turn began putting pressure on their big suppliers, such as Russia and Norway, to make concessions. These tensions also unleashed a wave of arbitration proceedings.
US LNG export stampede: Meanwhile, gas prices in North America were under pressure as unconventional gas production defied the sceptics and grew rapidly – so rapidly that by 2010 some owners of the largely redundant LNG import infrastructure were hatching plans to convert regasification terminals into export facilities.
Only one such project – Cheniere’s Sabine Pass – is under construction, but another – Freeport LNG – recently received the required export licence, and another 15 projects are waiting. In 2011 two crucial developments took place:
ENERGY PRICES – The last decade has seen an unprecedented rise in energy prices. In inflation adjusted terms, average annual Brent oil prices were 230% higher than for the same period ten years ago. For coal the increase was 140% and for coal 90%. Moreover, the spread across fossil fuels has also widened, between fuels and between regions. The charts include data from ICIS Heren Energy, Energy Intelligence Group, McCloskey and Platts. (Charts courtesy of BP)
The story of 2012: It is at around this point that BP’s chief economist, Christof Rühl – who led the team that produced the statistical review and analysis of 2012 energy data – takes up the story.
As Rühl pointed out in his analysis of energy trends: “On the face of it energy developments in 2012 look unsurprising.” (our article on global energy trends in 2012, gives a run down on these trends as reported by BP’s statistics.) However, the global numbers mask some extraordinary shifts – between countries and regions, and between fuels – which had big impacts on the dynamics of regional gas markets.
“Two trends have dominated the evolution of natural gas markets over the past few years,” said Rühl, “the rapid growth of shale gas in the US, and the expansion of global LNG. Gas production continued to grow in 2012, if at a slower pace. But LNG trade declined, for the first time in our data. These developments, together with the impact of Japan’s post-Fukushima adjustment, shaped gas markets in 2012.”
The largest volume gain in gas consumption was in the US, while LNG imports to Asia continued rising. Europe and the former Soviet Union registered the largest regional declines.
“Regional gas prices moved in lock-step with these regional patterns,” said Rühl. “Spreads widened, with US gas prices recording their lowest annual average since 1999, Japanese import prices reaching a new average annual record, and spot prices in the UK edging up as the global competition for LNG tightened the market in Europe.”
GLOBAL NATURAL GAS BALANCE – Global gas consumption rose by 2.2% (82 Bcm) in 2012, faster than 2011 but below the ten year average (2.7%). The US saw the world’s largest volume gain in consumption (31.6 Bcm, 4.1%) – an increase by itself bigger than that of any global region. gas prices moved in lockstep with this pattern. Price spreads widened, with US prices recording their lowest annual average since 1999, Japanese import prices reaching a new average annual record and UK spot prices edging up as the global competition for LNG tightened the market in Europe. The charts include data from ICIS Heren Energy and Energy Intelligence Group. (Charts courtesy of BP)
US gas production continued to rise, up 4.7% in 2012, but this was significantly below the record expansion of 2011. “The slowdown,” said Rühl, “was driven by the re-orientation of US drilling away from gas and towards higher-priced oil.”
Prices at Henry Hub declined from late 2011, bottoming out in April 2012, at $1.83/MMBtu. So many dry shale gas plays became uneconomic. The overall rig count fell by 46%. However, this shift was partly offset by the rapid growth of associated and liquids-rich gas.
“Switching from dry to wet and associated gas production, encouraged by high oil prices, helped to contain the impact,” said Rühl. Non-associated shale gas production grew by 84 Bcm in 2011, compared with 10 Bcm last year, while associated gas output grew by 12 Bcm. Declining supply growth has continued into 2013.
Switching from coal to gas: Gas over-supply in the US in 2011 and 2012 meant that there was a shift in electricity generation from coal to gas, as gas prices fell far enough for gas to compete with coal in baseload power generation. An additional 44 Bcm of gas went into the US power sector in 2012, boosting gas-fired generation by 21% – “the largest increment of any fuel in US power generation for at least 40 years,” said Rühl. Coal-fired generation fell by 12% to its lowest level since 1987.
US COAL TO GAS SWITCHING – An additional 44 Bcm of gas went into the US power sector last year, boosting gas-fired power generation by 21% (217 TWh) – the largest increment of any fuel in US power generation for at least 40 years, and leading to an all-time high for gas-fired power generation (1295 TWh). Coal-fired power generation (-12%) fell to its lowest level since 1987, and US coal consumption declined by almost 12% in 2012, in volume terms the largest decline worldwide. The charts include data from Energy Information Administration and Platts. (Charts courtesy of BP)
Since 2007, gas-fired generation has expanded by an average of 6.5%/year while coal-fired generation declined by more than 5%/year. “So far in 2013,” said Rühl, “we have seen some loss of gas share in power as gas prices recover from their lows.”
Impact of LNG constraints: A big factor in the interplay between regional gas markets in 2012 was the unusual decline in LNG trade. Explaining the fall, Rühl said: "The prime suspects would be the lumpy nature of capacity growth in LNG and under-utilisation of existing capacity. Indeed in contrast to the large additions, mostly from Qatar, that characterised the last decade, only one new project was actually operating by the end of 2012 – the lowest annual capacity increase since 2002.
“Utilisation rates also fell, either because rising domestic demand or falling production crowded out gas, or in the wake of unplanned outages and outright infrastructure damage.” He gave as examples Egypt, where production fell by 24% or 2.1 Bcm, Yemen (-20%, -1.8 Bcm), Indonesia (-15%, -4.2 Bcm) and Algeria (-15%, -2.6 Bcm).
With Asian demand for LNG remaining strong, and Japan facing a growing need to replace nuclear power post-Fukushima, the tightening of the LNG market in 2012 meant that Japan had to pay a record premium – of up to $9.47/MMBtu – over European spot prices to attract supply. European LNG imports were down by 21.8 Bcm, or 24%.
Unexpected competition “The lack of LNG should have been good news for traditional suppliers to the European gas market, such as Russia and Norway,” said Rühl. “Instead, they faced competition from an unexpected quarter – cheap coal. Much of it came from the US, exiled by the shale gas revolution. But coal imports from Russia also grew strongly, by 14%.”
European gas prices continued to rise, as Russia largely maintained its oil-indexed pricing, which meant it lost market share to Norway, which has switched much of its supply to spot-related prices. Russian exports to Europe were down 10%, while supply from Norway was up 12%. Overall, European gas consumption was down 2.3%, while coal was up 3.4%.
“The net effect of Russia’s willingness to sacrifice volume for prices was to keep European gas prices relatively high,” said Rühl, “opening up a large gap between the cost of generating power from gas and from coal, with coal-fired power on average 45% cheaper than gas-fired power. Carbon prices were far too low to redress the balance in favour of gas.”
The result was that carbon emissions in Europe, where climate policy is an obsession, fell by much less than expected, while in the US, where climate policy is virtually absent, carbon emissions plummeted.
The US recorded the largest decline in emissions world-wide in 2012, dropping much faster than in the EU. In 2011 the EU and the US were evenly matched, but in 2012 the US decline accelerated while in the EU the decline halved.
Carbon pricing failure: Rühl reckons it would have taken an EU ETS carbon price of €40-45/tonne to keep gas competitive in baseload power. Actual price averaged just €7.90/tonne in 2012 and so far in 2013 has averaged €4.30/tonne, because of a large build-up of allowances.
“To a large extent this surplus reflects the impact of the recession in Europe,” said Rühl. “Changes in economic fortune were not anticipated when the supply of allowances was fixed. But it also reflects the unintended consequences of related but poorly integrated policy interventions – mandated renewable and energy efficiency targets were also not anticipated when the ETS was designed.
“The support of these with various subsidy mechanisms outside the EU ETS contributes directly to reducing the demand for and hence the price of carbon permits. In this way, one part of climate policy – the carbon price – has fallen victim to the success of another – the renewable and efficiency targets.”
Thus misguided – and expensive – over-enthusiasm for renewables led to a massive energy and climate policy failure in the EU, which currently seems unsure about how to react. There is the real prospect of carbon emissions starting to rise in the EU, despite the billions of euros spent subsidising low- and zero-carbon subsidies. The EU has also failed to respond to major developments in other energy markets – such as America’s shale gale.
Economic impacts: Meanwhile the US is seeing an economic renaissance largely founded on cheap energy, which is causing concerns in Asia, especially in Japan, where the balance of payments has been hard hit by the need to import greater quantities of relatively expensive fossil fuels. Europe has also begun waking up to the competitive threat from the US.
The story is not over. If, as seems likely, the US becomes a major LNG exporter, it will again influence global gas market dynamics in ways not easy to predict.
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