Report: Surplus on world gas markets may reach 15%

International demand for gas will drop for the first time in history

NOCs may struggle to find new export markets for their gas.
NOCs may struggle to find new export markets for their gas.

The economic downturn has the potential to profoundly change global gas markets. Deeply negative forecasts for industrial output in developed countries will reduce world-wide demand for natural gas in 2009 and 2010 - the first time in history; while potentially setting back the market for up to 10 years, according to Booz & Company’s report - ‘An Unprecedented Market. How the recession is changing global gas markets’. Combined with new gas export developments already underway the report found, the market will be in a position of oversupply of between 5 and 15% this year and the next.

Global gas markets will be set back by up to 10 years
Since the development of international gas markets in the 1960s, gas has been a highly sought after fuel, with sales volumes rising at an average rate of four per cent annually between 1965 and 2007. Before the recession hit last year, analysts predicted world gas demand to steadily grow two per cent per annum on average for the foreseeable future - almost double the growth for oil.

Because demand for gas closely correlates with the development of industrial output in developed countries, the economic downturn and resulting decline in output has prompted a decline in natural gas demand. This reduction is led by energy-intensive industries. According to analysts, automobile manufacturing is likely to fall by 25 per cent in 2009, output in the chemical industry - the basis for many natural gas value chains - will drop at a similar pace, while output in the steel industry is declining by 30 per cent in Europe and North America. “This unprecedented worldwide drop in demand for natural gas may well set back global natural gas markets in terms of growth and profitability, by as much as 10 years,” commented George Sarraf, a Principal at Booz & Co.

Surplus to continue well into next decade
The implications for suppliers and buyers could be considerable. Due to the new demand uncertainty and reduced access to project financing, a substantial number of new gas infrastructure development projects have been cancelled or delayed until demand growth returns. Liquefaction projects in Russia and Bolivia have been shelved, while projects in Iran, Nigeria, Australia, Egypt and Trinidad and Tobago are on hold pending a final investment decision. However, based on the pre-recession growth outlook, a number of gas export infrastructure projects were approved and are currently under construction, such as additional liquefaction plants, export pipelines and increased gas production from unconventional sources in North-America. “Taking these developments together, we expect the worldwide natural gas supply-demand balance to be in surplus of five to 15% this year and to continue well into the next decade - something not seen before in this market,” Sarraf said.

Incentive for large exporters to cooperate
To reduce the market risks of oversupply - such as pressure on prices and even changes in pricing structures such as decoupling from oil prices - the leading gas exporting countries such as Russia, Norway, Algeria and Qatar have a strong incentive to cooperate in managing their markets. “In addition to reduced demand, profitability will be at risk if buyers seek to renegotiate contracts. Thus the large NOCs (National Oil and Gas companies) such as Gazprom in Russia, Statoil in Norway, Sonatrach in Algeria and QP in Qatar, should assess the implications of reducing production, and align their project portfolios with the new market realities,” Sarraf explained. Additionally, they should take advantage now from cost reductions in the market for contractors, rigs and materials. Other options to consider are geographical swaps with other players, to optimize logistical costs and capabilities expansion, by taking over specialized companies and benefiting from lower company valuations.

Buyers might partner to access new sources and take advantage of lower pricing
For gas importers and buyers, opportunities may arise to renegotiate prices and other contract conditions, as well as opportunities to exploit increased supply on spot markets. Nevertheless, they should be cautious not to damage their long term relationships with NOCs as they will need these alliances in the long term. Buyers should also review their gas supply portfolios, and consider the merits of partnering with other importers to secure new sources of gas, share risk and take advantage of the current lower asset valuations, for instance by entering upstream operations.

Value of Liquefied Natural Gas (LNG) projects will shift from volume to access
“The main risk for infrastructure companies is reduced project profitability and reduced access to project financing. Customers looking for capacity on new LNG-infrastructure or pipeline assets may delay decisions in the current uncertain environment, placing risks on timing and financing for infrastructure projects,” commented Sarraf. In addition, business models may change as the value in LNG regasification may shift from “volume-plays”, where companies seek to contract-out all capacity long term, to “access-plays”, where players hold capacity available in multiple locations to be able to take advantage of potential geographical arbitrage opportunities. At the same time, infrastructure companies should take advantage of falling prices for materials, labor and construction services, to push down project costs.

Middle East producers are still pressing ahead with gas expansion plans
There is no doubt that Middle East gas producers are feeling the effect of the global economic crisis. Demand destruction in Asian markets, which are the traditional recipients of GCC gas, are challenging export schemes. Nevertheless, many regional NOCs such as those in Iran, Egypt, Qatar and the UAE are still confident and are pressing ahead with their ambitious plans to increase gas output. Unlike developed countries, Middle Eastern markets are still hungry for gas, with demand expected to increase by at least 6 per cent per annum in the medium-term. “The major driver for this growth is electricity production, which is continuing to grow at a high rate, in part due to relatively low and subsidized electricity tariffs,” Sarraf said. While NOCs might be struggling to find new export markets for their gas or face challenges over pricing - domestic gas needs are significant. This situation is likely to keep projects on track for domestic supply, and also serve the region’s needs.

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