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News : Global Economy Last Updated: Mar 3, 2011 - 7:22 AM

Global gas glut unhinges natural gas and crude oil prices
By Finfacts Team
Mar 2, 2011 - 3:47 AM

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Source: Deutsche Bank Research

A global gas glut has unhinged the natural gas and crude oil price and according to Deutsche Bank Research, new US gas deposits are calling into question nearly all medium and long-term scenarios which still seemed plausible a few years ago.

As a result of the huge deposits, new strategies for the use of excess supply are currently being discussed in the US and if gas exports were possible, this would be another great challenge for all de facto price links to the oil price that are still in place in Europe, and possibly even the final nail in the coffin.

DBR says price trends over the past ten years have played out against a background of gradual transition from a world gas market broadly in equilibrium in terms of volume to a global gas glut. In the early years of the previous decade, the virtually balanced market situation steered market participants' expectations in approximately the same direction.

Up to the middle of 2008 it was thought that global growth in demand for energy necessitated a marked step-up in the supply of gas. Steep increases in the prices of fossil energies since the beginning of the decade made building up and expanding the necessary gas infrastructure profitable. Consequently, financing for these capital-intensive projects was not usually a problem. Moreover, at least up to the middle of the decade many market

Economist, Dr. Josef Auer, says that until a few years ago, prices for oil and gas used to move in sync due to the oft-cited oil price link. However, over the last few months, things have changed. This is obvious even from a short glance at commodities prices. In true textbook fashion, most commodities prices strongly reflected the last global recession at an early stage. But there have been surprising new developments during the current global economic upturn.

Industrial metals, for instance, priced in the start of a new cycle very early and are now trading substantially above their average levels of the last five years. The situation looks similar for agricultural commodities and precious metals. In contrast, prices for energy inputs are moving in remarkably different directions. Dr Auer says: "True enough, crude oil broke the $100 threshold again in early February 2011. Natural gas, however, is no longer following its traditional pattern. A case in point is the spot price of US natural gas, which is still considerably below its longer-term average. The reason for this special development is the new gas glut in the US which is the result of new technologies."

The new commercial gas sources in the US are calling into question almost all medium and long-term scenarios which still looked plausible only a few years ago. Thanks to its new ample supply of gas, the US will cease to be a sales market for liquefied natural gas (LNG) from third countries such as Qatar. At present, the share of unconventional natural gas in total US gas output already amounts to 50%, up from a mere 30% in 2000.

Dr Auer says new and interesting unconventional gas deposits have recently been discovered not only in North America but also in other regions of the world, inducing producers in the US to consider new sales channels. So far, shale gas from the US has only been used in North America. More recently, though, new business models have been developed  based on the idea that the US could in future benefit more strongly from these large-scale deposits. To reap these benefits, the gas would have to be transported to places that are likely to develop unsaturated demand and/or where prices are relatively favourable. As a result of the gas glut prices are expected to remain relatively flat in the US.

How can such a strategy be implemented? The economist says to be able to export gas, the US would need to build the relevant infrastructure on its coastlines. Currently there are no liquefaction and loading facilities. Nor are the political and legal preconditions in place yet. Such models and strategies are reportedly being discussed or already evaluated at present by the US government and gas producers. If gas exports were possible this would be another great challenge for all de facto price links to the oil price that are still in place in Europe. US gas exports may prove to be the final nail in the coffin of the oil price link.

In the past, the link between gas and oil prices was a useful instrument for introducing gas to the mass market. In the modern world of zero-energy and energy-plus houses, this link no longer provides any added value. Thanks to the trends towards energy-efficient newbuilds and renovations, increasingly less energy will be needed for heating. Of course, this will be a gradual process but in the gas market, too, small changes in volume can trigger large effects on prices.

Dr Auer says that the energy concept devised by the German government does not attach particular significance to natural gas - - at least not explicitly. Not only the heating market but also the electricity sector will likely see shrinking gas shares in future. The boom in renewable energies will mean that on many a windy summer’s day at lunch time, no positive price will be achieved for electricity. This will reduce operating times of gas plants and their profitability, while the cost of EU emissions trading will represent a further burden. So a link to the coal price is no solution either.

Conclusion: The economist says the link between oil and gas prices will make no sense in future. Establishing market prices according to supply and demand is also possible in the case of gas. This will adequately price in current and future scarcities surrounding natural gas. The illusion that the oil price link will persist may cause expensive mistakes, either in the form of large-scale investment - - typical of the gas sector - - such as the development of new deposits or the construction of pipelines spanning thousands of kilometres.

Oil will become considerably more expensive over the coming decades. As regards gas, the current glut made possible by the huge deposits suggests there will be no such growth. It is therefore definitely possible that current pipeline projects such as Nabucco (linking Austria, Hungary, Romania, Bulgaria and Turkey) or South Stream (linking Russia and Europe) will prove less urgent in future and will thus be devalued by the market.

See also: Gas glut reaches Europe: Major impact on prices, security and market structure (pdf)

Cushing, Oklahoma is the US delivery point for all Nymex crude futures. CNBC's Scott Cohn has the story of the little town with the great big oil supply:

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