Jack
Farchy
With the prospect of a wave of US liquefied natural
gas (LNG) supplies starting to hit the market later this year,
energy investors fear the Russian state gas giant may adopt the same strategy
in the gas market that Saudi Arabia has done in oil.
It may seem like a gas price war is the last thing
that Russia, reeling from the impact of low oil prices, needs.
But analysts say that such a strategy may be
economically rational for Gazprom: already low prices in the European gas
market mean it could relatively easily push prices to a level at which it would
be unprofitable to ship LNG from the US — and in doing so defend its market
share in a region that accounts for the bulk of its profits.
Such a move would have significant repercussions for
the global energy markets: a fully-fledged price war in the European gas market
could have a ripple effect across other regions and commodities — from
Australian LNG to Colombian coal — as well as threatening the viability of the
nascent US LNG industry.
“Why would you concede market share to a higher cost
producer?” says James Henderson, Russian oil and gas specialist at the Oxford
Institute for Energy Studies (OIES). “If I was an investor in US LNG I would be
worried.”
The argument in favour of a price war is simple.
Just as Saudi Arabia is the main swing producer for
the global oil market thanks to its ability to ramp up production if needed,
Gazprom is the main holder of spare capacity in the global gas market.
According to Gazprom executives, the company has about
100bn cu m of spare production capacity — thanks largely to investments made on
over-optimistic assumptions about future gas demand — equivalent to almost a
quarter of its production and about 3 per cent of world output.
And just as Saudi Arabia has been unnerved by the
prospect of US shale oil producers eroding its market share, Gazprom faces a
similar prospect in the gas market. The flood of cheap gas unleashed by the US shale boom has prompted
a wave of US LNG projects in recent years. The first cargo of LNG from the
“lower 48” contiguous states of the US is due to be shipped in the next two
months, and the total export capacity under construction is
equivalent to two-thirds of Gazprom’s exports to Europe.
Finally, like Saudi Arabia in oil, Gazprom is one of
the lowest-cost gas producers. According to calculations by Mr Henderson at
OIES, the cost to Gazprom of delivering its gas to Germany is $3.5 per mmbtu
(million British thermal unit) — compared with an estimated $4.3 per mmbtu
break-even for US LNG supplies despite US gas prices trading near 16-year lows.
Put all those facts together, and it would seem to
make sense for the Russian company to push down prices to keep US LNG out of
the market.
“Now the market is getting excited about it; but also
the Russians have done their maths and they know they can win if it happens,”
says Thierry Bros, European gas analyst at Société Générale in Paris.
Such a move would be cheaper to implement now because
European gas prices have already fallen dramatically — spot UK gas prices are
down 50 per cent in the past two years. Gazprom’s contract prices, which are
largely tied to oil prices, have kept pace with the spot gas market decline and
are likely to fall further in the next six to nine months.
Mr Bros estimates it would cost Gazprom $1.3bn in lost
revenues to price US LNG out of the market this year — less than 1 per cent of
its historical annual sales.
Gazprom executives have studied the economics of the
price war approach and are discussing the issue, according to people familiar
with the company’s thinking.
At a meeting with investors in New York this week, Alexander
Medvedev, Gazprom’s deputy chief executive, argued that low spot prices in
Europe had already made US LNG supplies uneconomical. “Despite the prevailing
view on the market that North American LNG can change the current pricing model
in Europe, in reality this is not the case at all,” he said.
Analysts say a Gazprom-led price war could have two
distinct objectives: first, to price cargoes of US LNG out of the European
market in the short term; and second, to disincentivise new investments in LNG
projects in the longer term.
The first goal would require the European spot price
to fall below the marginal cost of shipping US gas to Europe — a scenario that
Mr Bros now believes is likely in the second half of this year, but which
analysts say would be painful for Gazprom to maintain for a long time.
More sustainably, Gazprom could adopt a medium-term
strategy of managing European prices to prevent new LNG projects being
approved. While few projects are likely to be considered in the short term
given low oil and gas prices on both sides of the Atlantic, it may become a
consideration should prices rise in the next year or two.
As one government official in Moscow puts it: “They
have no choice. They are already in a price war.”
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