LONDON—Special to The Globe and Mail
Published Thursday, Feb. 04, 2016 4:00PM EST
Last updated Thursday, Feb. 04, 2016 7:18PM EST
Someone at OPEC misunderstood the message from Moscow last month when rumours circulated that Russia might fall in line with cartel policy. The oil price surged briefly in the hope that Russian oil producers would reduce output in collaboration with Saudi Aramco, but the whisperers were looking at the wrong commodity and the wrong policy.
Instead of oil, think of natural gas, where Russia finds itself in a similar quandary as Saudi Arabia: The largest and, traditionally, the lowest-cost producer is under threat from the new boys on the block. Gazprom, the Russian state utility and biggest supplier to the European Union, is readying itself for a showdown with liquefied natural gas exporters, including anticipated shipments of LNG from the United States. The Financial Times reports that Gazprom executives are preparing the company for a price war to protect their market share in Europe. Just as Saudi Arabia took off the gloves last year to defend its oil market share and drive more expensive (American) producers out of the market, Russia plans to adopt the same strategy against the threat from U.S. LNG.
For natural gas investors, the story has a dreadful ring of truth about it. Separately, Argus Media reports that Gazprom’s deputy chief executive, Alexander Medvedev, confirmed that the Russian company intends to maintain its 30-per-cent share of the European market, even in the face of increasing LNG imports. A defiant Gazprom and the recent surge in LNG capacity with more than 18 million tonnes a year coming on stream before June can mean only one thing – falling gas prices. Most of that extra gas is coming from Australia, where the LNG glut has since 2014 halved the cost of gas for delivery to Japan, China and South Korea.
The availability of cheap LNG is now depressing gas prices in the Atlantic Basin, where the LNG price is now assessed at $6 (U.S.) per million British thermal units compared with $10 in 2014. Meanwhile, U.S. energy companies are planning to use LNG as an escape valve to deflate America’s growing natural gas bubble. Cheniere Energy is preparing to export a test cargo from its new liquefaction plant in Louisiana in late February or March.
Even in the teeth of winter blizzards and an expanding power generation market, the U.S. wholesale natural gas price has fallen by a third since last summer to $2 per million Btu. The American gas bubble has cost Canadian gas producers dearly. The huge output of the Marcellus shale formation in Pennsylvania has resulted in Canadian gas exporters losing more than half of their market in the U.S. Northeast during the past year. One might have hoped that LNG exports from the U.S. Gulf would reduce the pressure on the U.S. bubble but that will depend on whether frozen gas in ships can compete with Gazprom’s pipelines and the determination of the Kremlin to price the Yankee gas out of Europe.
LNG is significantly more expensive to produce and transport. The rapidly falling output of Britain’s dwindling North Sea gas fields leaves a door open to LNG importers if American exporters can compete; the EU market looks attractive with gas prices above $5 per million Btu, but Gazprom’s delivery cost to Germany is about $3.5 per million Btu compared with a break-even cost for shipping LNG from the U.S. Gulf to a European port priced at $4.3.
For Canadian gas producers, the outlook in the neighbouring market may depend as much on Russia’s willingness to sustain losses as it does on U.S. domestic gas demand. Gazprom has already absorbed big price cuts as its main customers have taken advantage of arbitration clauses to force through reductions in the cost of long-term contracts. Meanwhile, the European Commission is demanding changes in the way Gazprom does business, including its ability to control capacity in new pipeline investments. The collapse in energy prices has come at a bad time for Gazprom, forcing the monopoly utility to accept market pricing and competition. It may be that Gazprom, like Saudi Aramco, has concluded that in a world of cheap energy, only the lowest-cost producers will survive.
It’s almost a scorched-earth policy, but Russia has done that before and, in the end, defeated the invaders.
Carl Mortished is a Canadian financial journalist based in London