Flame in Focus, Issue #1

In Focus

Featuring:

European Gas Security: Should we be worried about supply, demand or flow changes?

Can LNG ride to the rescue of Europe?

Opec is dead: The oil war could crown America as the global swing producer

Security of Supply

Where will Europe's supply come from in

2015

?

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CONTENTS INSIGHT In Focus

In this edition...

Welcome

Victoria Chatterton, Flame Conference Director Insight

European Gas Security: Should we be worried about supply, demand or flow changes?

Jonathan Stern, Chairman, Natural Gas Research Programme & Senior Research Fellow, OIES

Can LNG ride to the rescue of Europe?

Thierry Bros, Senior Analyst European Gas & LNG Markets, Societe Generale

Fresh Perspectives

Opec is dead: The oil war could crown America as the global swing producer John Hulsman, Geopolitical Expert & Life Member, US Council On Foreign Relations

Industry Opinions

Ask the experts: European security of supply What do you think? A visual look at the industry

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WELCOME INSIGHT In Focus

Welcome to our first edition of 'Flame in Focus'

Featuring natural gas community news, articles and industry research powered by Flame's expert speaker faculty.

The concept Flame may just be once a year but wouldn’t it be great if you could hear what our speakers have to say on the industry issues as they evolve all year round? With that aim we'd like to introduce 'Flame in Focus', the digital magazine powered by industry contributions to keep you informed all year round.

The Febuary theme: Security of Supply For our first edition we have zeroed in on security of supply which is top of the industry’s agenda due to the current geopolitical, economic and environmental challenges we face. We are so glad that Jonathan Stern, Thierry Bros, Wolfgang Peters, Cordi O’Hara and John Hulsman have agreed to share their views on this vital topic!

When can you expect 'Flame in Focus'?

A new edition of ‘Flame In Focus’ will be published every two months. Make sure to keep an eye out for our February edition which will look at the future role of gas in the energy sector.

In the meantime, we'd love for you to join in the discussion on the Security of Supply - feel free to reach out to us online via LinkedIn or Twitter, or join us in Amsterdam in April.

Victoria Chatterton Flame Conference Director Issue

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INSIGHT In Focus

European Gas Security: Should we be worried about supply, demand or flow changes?

While all the discussion of European gas security in the press is about Russian gas and the ongoing Ukraine crisis, those involved in gas markets have other things on their minds. While one should not be over-confident it seems likely that we shall get through the winter without a major interruption of Russian gas through Ukraine.

While all the discussion of European gas security in the press is about Russian gas and the ongoing Ukraine crisis, those involved in gas markets have other things on their minds. While one should not be over-confident it seems likely that we shall get through the winter without a major interruption of Russian gas through Ukraine. However, preliminary data for 2014 show that European gas demand fell 13% compared with the previous year, continuing a decline which started in 2009 and has reduced demand to the levels of the 1990s. Many national markets have experienced double digit reductions with nearly new and highly efficient gas-fired power stations being mothballed, and some older stations permanently decommissioned. Most projections suggest that overall European demand will not recover to 2010 levels until the mid to late 2020s. Given that the traditional approach to European gas security was to assume that demand would increase, but supply would fall, the question now is whether we should be more worried about security of supply or security of demand?

Jonathan Stern

Chairman, Natural Gas Research Programme & Senior Research Fellow, OIES Jonathan Stern will be hosting a morning session titled 'Security of Supply & the Fall out from the Winter', dedicated to determining how Europe is mobilising.

For more information on this session visit www.icbi-flame.com.

Possibly we should be worried about both. Analysis of the supply side suggests that conventional gas production from the UK, Issue

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INSIGHT In Focus

Norway, Netherlands and other Continental European countries will decline by more than 100 Bcm/year (or 40%) by 2030. While the media is full of stories about European shale gas, there is very little prospect of significant production over the next decade. Much more promising are the prospects for biogas and biomethane, despite the current need for significant subsidy. As far as imports are concerned, Russia is the only major expansion source for pipeline gas. The situation in North Africa is not promising: Egypt is becoming a gas importer, Libya is suffering from ongoing political instability, and the Algerian production and export outlook seems unlikely to improve in the wake of another elatively unsuccessful licensing round last year. All have rapidly increasing domestic demand fuelled by subsidised prices which are proving difficult to reform. The much-discussed Southern Corridor will yield 10 Bcm/year of gas by the end of this decade, with the possibility of increasing that figure in the 2020s.

While the media is full of stories about European shale gas, there is very little prospect of significant production over the next decade.

The major prospects on the supply side rest with LNG. European import terminals have been running at less than 30% capacity for much of the post-Fukushima period, but as Asian demand weakens and new supplies from Australia and the US come on stream over the next year, cargoes are already showing signs of returning to Europe. This is good news for the next few years but the 2011-14 period demonstrated how quickly Europe can lose LNG when Asia needs it.

What might all of this add up to? The minimum seems to be significant changes in flows as Ukraine attempts to attract non-Russian gas, while Gazprom seeks to reorient more than 60 Bcm of its exports to Europe away from Ukraine and across the Black Sea through a new `Turkish Stream’ pipeline system. At the same time markets will be adapting to increased volumes of LNG, increased interconnection of grids and the introduction of a completely new EU gas transportation regime, as the network codes are rolled out over the next few years.

Whether security will be threatened depends how that threat is defined and for which groups of stakeholders. But these are challenging and rapidly changing times!

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INSIGHT In Focus

Can LNG ride to the rescue of Europe?

As Russian spare capacity (to produce and ship gas) is massive, Europe can balance its reduced demand with or without LNG supply. In short, Europe is the swing receiver of LNG supply and balances its demand thanks to Russia.

In 2011-2014, with poor LNG supply growth, Europe saw less and less LNG as it was needed in Japan to mitigate the Fukushima disaster - 6.9% of worldwide supply was needed to replace part of Japan’s missing nuclear power-generated electricity – and in China due to strong demand growth.

Thierry Bros

Senior Analyst European Gas & LNG Markets, Societe Generale Thierry Bros will be participating in the 'Security of Supply and the Fall out from Winter' session taking place at Flame 2015. For more information visit www.icbi-flame.com

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INSIGHT In Focus

2015e: no LNG reload in Europe should weigh on prices Spot LNG prices are depressed due to falling oil prices and low demand in Asia. This leads us to assume there will be no LNG reload in 2015e.

As the amount of gross imports in the past two years was exactly the same, we can assume this is the minimum non-flexible level and that the only flexibility in the system was the ability of companies to re-load LNG from Europe when Asian spot prices were much higher than the contracted prices for this LNG supply with Europe as a destination clause. This means net imports in Europe in 2015e will be the same as the gross import levels witnessed in 2013 and 2014 as the system now has no flexibility price-wise to re-export LNG. This extra LNG could slightly reduce Gazprom’s market share in 2015e vs 2014e.

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INSIGHT In Focus

2020e: US LNG an expensive bet or a rational hedge?

As we have repeatedly pointed out, Russia and Norway have market power in Europe. With more than 50% market share for gas in Europe, Russia and Norway have theoretically even more power on European gas markets than OPEC has on oil markets. The latter provides 32% of the global oil supply (not to mention the fact that it has given up its market management role). We believe that both Russia and Norway have a vested interest in keeping gas prices in Europe between a floor that we estimate at 5$/MBtu and a ceiling that is either the cost of new gas (estimated at 9.5 $/MBtu for pipe gas from the Caspian Sea) or HH+6 $/MBtu for US LNG.

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INSIGHT In Focus

Europe is and will continue to be the “dumping� place for excess LNG as China has contracted enough gas until 2023e. So if the LNG supply growth becomes excessive, LNG supplies in Europe will return to levels not seen since Fukushima.

Our model of 50 mtpa of US LNG exports in 2020e translates into 69 bcm of LNG reaching Europe. We believe this is the maximum Gazprom (in a business as usual situation) will allow to berth in Europe.

Extra US LNG (above our 50 mtpa forecast) at a time when the long-term decline in gas demand in Europe is set to resume could trigger a price war as we suspect Gazprom is not willing to reduce its volume below the 2012 minimum level.

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INSIGHT In Focus

And as Gazprom has both market power and the lower supply cost, it can engage in a price war that will push US LNG out of Europe and will lead to US trains having to stop production. But to stop US LNG cargoes from berthing in Europe, the European price will have to be around HH + $2/MBtu as liquefaction (c.$3/MBtu), regas (c.$0.5/MBtu) and part of the shipping costs (c.$0.5 out of a total of $1.5/MBtu) are sunk costs. After mothballed regas in the 2010s, we could see mothballed LNG trains in the US in the 2020s.

So far, 45 mtpa are under construction and too much LNG supply could entail a price war with Gazprom that could reduce European prices to a level where US liquefaction plants could be mothballed. Too much US LNG could be an expensive bet…

But if Gazprom doesn’t renew the transit contract via Ukraine that expires on 31 December 2019, Europe could face a shortage of c.40 bcm/y of Russian gas This is because the gas (even if produced in Russia) won’t be able to either transit via Ukraine (44 bcm of Russian gas transited Ukraine for Europe in 2014 or be transported via the Opal pipeline where Gazprom has failed to get an exemption from the European Commission to fully used its nameplate capacity. This means that Europe either gets delivery of those volumes at the Turkish border (an option suggested by Gazprom, which wants to build the Turkish Stream instead of the now scrapped South Stream – we believe this will not be acceptable to European institutions and companies) or it tries to provide additional LNG supply as extra pipe gas is unlikely. (Shale gas in Europe – if any – could only partially mitigate for the decline of domestic conventional production. Meanwhile, Norway doesn’t want to increase its production capacity and Azeri gas is unlikely as we continue to believe that Shah Deniz 2 gas is not going to reach Europe in 2020e). In this case, too much US LNG could be a rational hedge…

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In Focus

FRESH INSIGHT PERSPECTIVES

Opec is dead: The oil war could crown America as the global swing producer

This piece first appeared on City AM

I well remember suffering through my college macroeconomic class, steeling myself to stay awake through the consumption of gallons of coffee. However, one of the rare things that piqued my interest was the theory of cartels.

Properly defined, an efficient cartel possesses three basic properties: the ironclad discipline of its membership; a commanding market position; and formidable barriers to interlopers entering the closed market. By every one of these analytical benchmarks, Opec – the most famous and feared cartel in the world – shows itself to be in its death throes. If this is so, beyond the compelling headlines of the current oil war lies a truly game-changing moment for the global economy.

The November 2014 meeting – when the cartel could not agree to cut production in response to tumbling world prices – signals just how fractious Opec has become. Both inefficient Iran and Venezuela, acutely suffering from an oil price that has halved over the last six months, were desperate for the cartel to do what it has so often done in the past: support global price stability for its membership. But Saudi Arabia has made it quite clear that its interests fundamentally diverge from those of Opec’s more hard-pressed members. Little interested in price stabilisation, the Saudis care primarily about protecting market share. This fundamental disagreement simply can no longer be papered over.

John Hulsman

Geopolitical Expert & Life Member, US Council On Foreign Relations John will be giving a guest geopolitical address at Flame and then will be hosting a special Washington-inspired simulation.

This simulation, Washington-Style Scenario Game on Security of Supply in Europe, will be open to 30 Flame attendees to join, and is dedicated to looking at the possible challenges and outcomes to security of supply.

For more information about John’s presentation and his simulation, visit www.icbi-flame.com.

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In Focus

FRESH INSIGHT PERSPECTIVES

Without the Saudis (who account for more than 16 per cent of the world’s proven oil reserves that are the easiest and cheapest to extract), Opec is a paper tiger. All along – and in contradiction to tardy conventional wisdom – I’ve believed Saudi oil minister Ali al-Naimi, who has clearly stated that the Saudis want Opec to continue pumping 30m barrels per day (bpd) come hell or high water. Recently, al-Naimi stirred the pot further, insouciantly claiming that the kingdom was perfectly content to let prices fall to $20 a barrel, as the Saudi’s production costs run to only a meagre $5 a barrel. One can hear the whimperings in Tehran, Moscow, and Caracas from here.

If Opec clearly lacks discipline, its position in the global market isn’t what it used to be; its market share has declined from around 50 per cent in the 1980s to merely one-third today. Oil prices falling out of the sky reflect a supply shock as much as anything else, with non-Opec members Russia and the US flooding the market over the past few years, while the cartel merely treads water.

Saudi Arabia has made it quite clear that its interests fundamentally diverge from those of Opec’s more hard-pressed members The US shale revolution alone has placed an additional 3m bpd onto global markets over the last three years; shale has become the grand disruptor. Russia has followed suit, with Moscow pumping a post-Soviet record of 10.58m bpd in 2014. So the third property of cartels – that there are high barriers for outsiders to market entry – also fails the laugh test in regards to Opec.

A series of startling changes follow on from Opec’s demise. First, all of these intractable realities mean that, in the short term of the next six months, the oil price is set to continue downwards.

There is a floor to the oil war, however – Saudi geopolitical sensitivities. On the one hand, they want nothing so much as to drive a stake through the heart of the US shale revolution; on the other, they certainly do not want an open economic confrontation with Washington, which remains the ultimate guarantor of Riyadh’s security in a very rough neighbourhood. As such, the American shale industry can suffer, but not too much.

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FRESH INSIGHT PERSPECTIVES

Second, while the Saudis are certainly on course to win the short-term oil battle against the Americans, they could well lose the war. Riyadh can extract and make money at a far lower global price than the shale industry; this, coupled with the kingdom’s massive foreign reserves of $900bn, mean that they are well-placed to begin to drive some US producers temporarily out of the market in the second half of this year.

But by knobbling Opec, Riyadh is unwittingly anointing a new global swing producer – its shale rivals. For the shale industry can far more quickly ramp up and dial back drilling operations in response to price movements than the conventional oil industry. In other words, American shale has the scale and a better capacity to nimbly add and subtract barrels from the global total than anyone else in the post-Opec era. If this proves true, the most startling long-term reality emanating from the present oil war is that America, of all places, may find itself the new global swing producer over time.

And that does nothing less than change the world.

JOIN THE CONVERSATION

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INDUSTRY INSIGHT OPINIONS

In Focus

Ask the Experts

What’s the most promising development for European security of supply and why?

Dr Wolfgang Peters Head of Supplies, Caspian Central Asia & Russia, RWE Supply & Trading In my book, the most promising development for European security of supply is the advent of liquid traded gas wholesale markets. What’s more, the respective national hubs are pricewise strongly correlated.

Why is that positive? Because, in a functioning European traded wholesale market, security of supply becomes a function of price rather than being a matter of physical dependency. To be more blunt (and a bit simplistic to make the point): If Russian supplies drop, the price will rise and attract e.g. LNG (for which Europe avails of plenty of – presently underutilized – regas capacity).

Cordi O'Hara Director, UK Market Operation, National Grid Increasing levels of supply diversity as Europe continues its route to market harmonisation and the global market becomes more liquid present the biggest opportunities for ensuring security of supply for Europe."

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INDUSTRY INSIGHT OPINIONS

What do you think?

At the past two Flame conferences we asked for your opinion on Security of Supply. Here are the results of what you predicted for 2015. Do you think we're still heading in the right direction?

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Credits

Editor: Lucy Eldred Editorial credits: Victoria Chatterton, Jonathan Stern, Thierry Bros, John Hulsman, Wolfgang Peters & Cordi O'Hara.