It has been some time since I've had a chance to answer a few questions from the many you've sent in. Let's not waste any time and get right to them.
Tom H. writes:
When the euro collapses (only willpower is holding it up, logic died months ago!), oil usage will drop off a cliff. It may be balanced by new users in the other growing economies, but their markets overseas will be minimal.
A: Well, Tom I am not as pessimistic as you are on the euro front. There will be several years here of weakness and instability, but the real key is whether the political will remains to support the continental currency.
The European Central Bank has now fashioned the bond structure; it remains for the governments to structure the fiscal policies to support the ECB. That will take some time, but it will happen.
What we are likely to see in the interim is a euro trading in a rather narrow range of $1.20 to $1.35. That will actually provide a floor to oil pricing. Demand is another matter. Here, the Western European picture remains restrained.
However, the broader global picture is not. That market is not "minimal;" it is actually expanding rather quickly. The non-North American, non-European sector is driving the oil market and will not be slowing anytime soon.
McKinsey & Company issued a report this week warning that the expansion is now expected to accelerate, with the worldwide supply surplus in danger of disappearing by 2016.
That will certainly send prices higher.
Okay, who's up next?
Enthusisceptic sends along this question:
What about North American natural gas and exporting it from 2014 on?
Vehicles in many countries are powered by natural gas because gasoline is too expensive. The search for shale gas resources in Poland and other parts of Europe has disappointed.
Can this mean that gas from North America can become viable sooner?
A: The prospects for exporting liquefied natural gas (LNG) are one of the primary movers in further development of shale basins in North America. Even Russian giant Gazprom (no fan of shale gas) has acknowledged that the U.S. will probably comprise at least 9% of the global LNG market supply by 2020, from zero currently.
Shale gas resources in Poland are still expected to be a factor, despite early drilling disappointments. And the U.S. Geological Survey's report indicated significant reserves worldwide. Now that does not mean they are profitable or extractable with current technology and infrastructure, but this is not the "flash in the pan" initially projected by detractors.
The advantage for the U.S. in all of this is two-fold. First, we are rapidly developing both the resource base and the production/transport infrastructure to exploit this new market. And, with the completion of the widening and deepening of the Panama Canal completing in 2014, it will be profitable to export LNG from the Gulf coast to Asia as well as Europe.
Second, primarily vehicles are not necessarily driving this move. The transition of fuel options from gasoline to LNG and compressed natural gas (CNG) will add to the demand, but it is the use of natural gas in electricity generation internationally that has been adding to the LNG market and will do so in the decades ahead.
In all of this, American and Canadian LNG exports will benefit first because North America is further along than others are. Yes, the Russians are exporting from Sakhalin, North Africa is already in the trade, and mega projects like Gorgon in Australia will be coming on line. But the projected rise in demand is dwarfing supply.
Another factor to keep in mind is how the rising LNG trade will alter local markets globally. Gas pricing is now dependent upon pipeline volume and direction. That makes pricing points out of locations where the most pipelines intersect. Henry Hub in the U.S. and Baumgarten in Austria are ready examples.
However, LNG will provide a genuine opportunity to set up a number of spot markets worldwide where the pricing of imports will effectively undercut longer-term, take-or-pay, oil-pegged transport contracts. The effect here will be to provide a more flexible market pricing mechanism, thereby improving a number of economic development opportunities.
And that leads me to the final question for today.
Eric T. writes:
Should the global economy stabilize… how will Russia's indexing gas to oil play out in the expensive regulated natural gas market?
Gazprom is not sitting on their hands, but building out twice as fast their enormous pipelines….
A: You're right, Eric.
Gazprom is not sitting on their hands (although they do occasionally sit on the hands of others). Russian authorities have recognized for some time that their traditional way of exporting natural gas to Europe is under pressure. They had expected to export large volumes to North America by mid-decade, but that is now not going to happen because of the shale gas revolution.
The traditional way of pricing Russian gas exports has three components. First, these are long-term fixed contracts, usually for 20 years or more. Second, they include take-or-pay provisions. This means that an end-user would contract for a specific volume of deliveries and most actually take a specific amount of the contracted amount monthly (say 70%) or pay as if they had.
Finally, the cost of the gas is calculated quarterly according to a formula based on the price of crude oil and a basket of oil products. As the price of oil rises, so does the price of the contracted gas.
On the other hand, local spot markets would provide gas readily available for immediate delivery, usually undercutting the price commanded by the long-term contracts. The existence of LNG consignments entering the European market via the new Rotterdam Gate terminal has already obliged Gazprom to alter contract pricing.
So why is Russia building huge (and expensive) pipelines anyway? All parties involved acknowledge that the forward demand for the importing of natural gas into Europe will probably require all trading options currently on the table – LNG, Nord Stream and South Stream (the Russian projects), new pipeline systems for the Shah Deniz and other Caspian/Iraqi production, as well as renewed production from North Africa. The availability of domestic shale gas may delay that somewhat, but that is looking like a longer-impact proposition.
Gazprom will need to revise its pricing structure in view of the new competition realities, but Russia is also positioning itself to participate as a provider in the expanding LNG traffic. There is also the push east to China, where new Russian pipelines for traditional deliveries and LNG from both Sakhalin and proposed facilities in the Russian Far East will figure in satisfying a rapidly expanding Asia-Pacific regional market.
Remember, I really appreciate the emails and questions. Be sure to leave a question or comment in the section below, and we'll take the best ones in the weeks ahead.
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About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.