IT'S ALL IN THE TIMING – AND THE TIMING IS ALL OFF

Sarah Miller, New York - Apr 5, 2022

The energy transition is overlapping with an intense, highly emotional drive in the West to slash Russian oil and gas purchases. The two things point to the same end: less fossil fuel use and more renewables. But the timing is off — somewhat with oil, yet dramatically when it comes to natural gas. Unless allowances are made for enormous mismatches in when, and also where, replacements for Russian fuels can become available, the EU and its cheerleaders in Washington may plunge the world into economic chaos. With oil, the situation is probably manageable — unless the US decides to use financial sanctions to severely limit Russian export volumes to Asia. For gas, a serious attempt to line up the LNG needed to meet the European Commission target of replacing two-thirds of Russian supply this year would wreak havoc on global LNG markets, even if it fails. LNG market mayhem could stretch for decades into the future if buyers sign up for long-term supply that won’t arrive until it is no longer wanted.  

With oil, the immediate problem is supply chain disruption. What with China locking down some of its largest cities to fight Covid-19, US demand overstated by a massive 2 million barrels per day in January and possibly beyond, and 1 million b/d in sales from the US Strategic Petroleum Reserve pending, global supply will probably be adequate to cover demand in 2022. It may take a while to get the crude to places where refiners can still buy it, and a few months longer to get regional product markets back in balance. But the problem appears containable.

That’s assuming the US doesn’t push financial sanctions to the point of severely constraining all Russian oil shipments, as was done with Iran — assuming that’s even possible. All bets are off should Washington carry through on vague threats that hint at secondary sanctions on China if it ramps up its trade with Russia. So far, no similar threats have been delivered to India, at least not publicly, even though it has been grabbing discounted Russian supply in reportedly large volumes.

Gas Complexities

With gas, the timing gaps are larger and more complex. European officials appear to understand this to a degree, and most are rejecting calls for an immediate Russian gas import cutoff. Even so, the goals being pushed by the European Commission for this calendar year are problematic.

The 10 Point Plan the International Energy Agency (IEA) came out with in mid-March as a guide to reducing European reliance on Russian gas calls for a cut in imports of roughly one-third by end-2022. That’s ambitious enough. It suggests increases of 10 billion cubic meters in pipeline gas shipments into the EU, mainly from Norway and Azerbaijan, and of 20 Bcm (14.8 million tons) in Europe’s LNG imports this year. This would allow for a total cut of 30 Bcm in Russian gas purchases without big disruption.

The Commission promptly came out with its own plan, which ups the goal to a two-thirds cut in imports from Russia this year, with LNG purchases targeted to rise by 2.5 times, to 50 Bcm (37 million tons). The IEA’s 10 Point Plan concedes that the EU could “theoretically increase near-term LNG imports by some 60 Bcm,” but “this would mean exceptionally tight LNG markets and very high prices.” Hence its target of a boost of only 20 Bcm in EU LNG purchases. Energy Intelligence suggests the European Commission's proposed goal of buying 50 Bcm more LNG in 2022 simply can’t be met.

Much of the discussion about all this ignores infrastructure limitations and the years required to build new liquefaction plants at the exporting end and regas terminals and pipes at the receiving end. Yes, the US can produce more natural gas in a matter of months, but except for one facility now being ramped up, it wouldn’t have capacity to export that gas until sometime around mid-decade. The export capacity it already has is fully utilized. Washington can expedite licensing of new LNG export facilities, but they still won’t be available until late this decade. New LNG capacity generally takes even longer to build in other countries.

In any case, Europe doesn’t have much spare receiving capacity. Some LNG could come in via the UK and run through existing pipes to the continent, but the empty half of Spanish and Portuguese terminals — which is included in most EU receiving capacity totals — is useless unless or until a big pipeline is built to France, a line that certainly won’t be operating by end-2022. Neither will the terminals Germany is hoping to install.

Tight Markets

Nonetheless, both the IEA and Energy Intelligence calculate that “in theory,” the EU could bring in the 50 Bcm in LNG the commission is targeting this year. But what might the “very tight market” the IEA expects as a result look like? Global LNG markets are already crazy. Spot prices as assessed in both Europe and Asia are currently at a multiple of roughly five times year-ago levels — and that’s a sharp retreat from a spike early in March to more than twice current rates.

What’s more, recent prices reflect relatively low “shoulder-season” demand for LNG, which like all gas demand, tends to be higher in winter. That means spot LNG markets will start to tighten by late summer, when heavy EU buying could send spot assessments into the stratosphere.

India and other relatively low-income countries have already reduced LNG imports and seem destined to slash them further still. That means more LNG for Europe, and in the midterm, it may lead India to turbocharge an already high-powered campaign to boost solar installations. But in the meantime, losing gas to Europe means India will burn more coal, adding to carbon emissions, deadly urban pollution — and coal prices. They and others may also burn more oil, further revving up prices for crude and the mid-distillates that are burned in small generators. And that’s before considering the impact on fertilizer and food prices.

China’s situation is similar, except that it can afford to bid up the price further to retain LNG, if it wants to. With its highly managed economy and surplus solar manufacturing capacity, China could also ramp up solar installation quickly. However, experience suggests it might have problems getting transmission capacity in place rapidly enough to make greater solar additions usable as soon as next winter. Mismatches in timing can afflict renewable energy, too.

Then Loose Markets

Meanwhile, there’s talk of buyers being willing to sign 20-year or longer contracts for not-yet-existing LNG supply. How genuine buyer interest really is in such contracts remains to be seen. When push comes to shove, how many utilities will want to sign up to buy gas they may not even need when it becomes available five or more years down the line, much less for two decades beyond that, i.e. until sometime between 2040 and 2050? Most Western countries are targeting 80%-100% renewable power well before 2040.

And in the middle of a transition, who can seriously claim to have bankable insight for 25 years into the likely level of oil prices, against which long-term contracts outside the US would presumably be pegged? Sellers and their bankers still seem to like the idea of oil-indexed long-term LNG contracts, but one wonders. The history of the LNG industry is filled with challenges to long-term pricing provisions when circumstances change. How likely is it that circumstances in gas and oil markets will not materially change within the next 25 years?

That’s just pricing. What happens if too much new LNG capacity is built and buyers don’t exist for all of it at any price, because of regulations or competition from cheap solar? It could easily happen. No one knows at this stage. The LNG business has often been highly profitable for sellers over the long-term. But it’s a steep front-end-cost business, and in the long-term, the business could all be dead.

Sarah Miller is a former editor of Petroleum Intelligence Weekly, World Gas Intelligence and Energy Compass.

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