In 2017, natural gas imports to the European Union reached about 360 billion cu m, 10% higher than in 2016, supported by a combination of increasing consumption and falling indigenous production.
Pipeline gas from Russia remained the EU’s top supply, 43% of imports, followed by Norway, 34%, and LNG, 12%.
In determining wholesale market gas prices, the key is the marginal flexible supply where supply and demand intersect. This marginal flexible supply could be either imported LNG or flexible pipeline gas from Russia above take-or-pay levels.
Whether LNG or Russian gas is the price-setting supply in Europe largely depends on Asian hub prices. Increases in Asian gas prices tend to draw LNG away from Europe, leaving Russian pipeline gas to be price-setting, while decreases in Asian gas prices tend to push LNG into Europe, displacing pipeline gas as the marginal supplies.
With vast reserves in Western Siberia, Russian flexible oil-indexed contracts have dominated marginal price setting dynamics at European hubs, but as European LNG import volumes increase with new supply available, these may push oil-indexed pipeline contracts off the margin more often.
LNG imports to the EU increased 16% year-on-year in fourth-quarter 2017 despite high Asian prices attracting cargos. Although the US was only the sixth largest LNG supplier to Europe in 2017, its market share increased markedly to more than 5% from 0.6% a year ago.
According to a report from Charles River Associates, as US LNG export capacity is set to increase over the next few years, US LNG will soon have a substantial market share in Europe and will over time play an increasingly important role in European gas price determination.
With the commissioning of substantial additional projects in the US, “even a relatively modest share of total US export capacity could constitute a significant share of European demand.”
More specifically, by 2030, 50% of the restrained potential export capacity as estimated by the US Energy Information Administration would constitute nearly 20% of the EU’s 2016 overall demand.
US LNG pricing
US LNG pricing is based on marginal, not average, costs. Even though there is a loss, once revenues are sufficient—after allowing for variable costs—to contribute to unavoidable fixed costs, US LNG shippers would be incentivized to make the deal.
“US LNG shippers have committed to long-term liquefaction contracts with take-or-pay obligations covering around 80% of the export terminals’ liquefaction capacity. This means that liquefaction fees are effectively unavoidable costs until this capacity is utilized. Consequently, the spread between European hub prices and Henry Hub could even fall below $2/MMbtu and US LNG shippers would still be incentivized to take US LNG to Europe while capacity utilization of US terminals is below 80%,” Charles River said.
In practice, forward markets currently exhibit a spread of up to $2/MMbtu or more through to 2020, indicating the continuing prospect of US LNG exports to Europe, subject, of course, to the draw of other LNG markets.
A step-up
But when utilization of terminal capacity exceeds take-or-pay levels, marginal US LNG shipments will be priced to recover full costs. This will introduce around a 50% or $2.5/MMbtu increment in required prices, according to Charles River.
As some forecasts, the existing global LNG supply surplus could be eliminated by the mid-2020s. This follows from increasing global gas demand despite the continued addition of new LNG capacity in the US as well as in other parts of the world.
Meantime, in the US, the surging gas production and limited increase in domestic consumption mean additional export-oriented LNG production above existing or currently under construction capacity which, of course, would not reach final investment decision unless full costs were expected to be recovered.
“The structure of the US LNG supply curve means that European LNG prices should be expected to step-up by around $2.5/MMbtu in the mid-2020s as global LNG demand rises to allow LNG terminal capacity to surpass take-or-pay levels, unless other sources of gas to Europe, such as Russian gas, seek to exploit the return to supply-demand balance in the global LNG market and undercut US LNG to increase their own sales,” Charles River said.
