Fitch: Loosening the price ties that bind

19 May 2016, Week 19 Issue 418

US LNG exports will drive convergence of natural gas prices between the world’s major gas hubs, while further weakening the link between oil and gas prices, a new report from Fitch Ratings has said. The report, published on May 13, noted the lack of destination clauses for most US exports, saying this would drive liquidity in the market. 

“This should decrease the potential for big and long-lasting differences between natural gas hub prices in the future, especially where LNG represents the marginal delivery source,” it said. 

European prices will remain low, and so will put pressure on profits for US supplies, but may be the “least bad destination for suppliers with contracted volumes”. The ratings agency gave the example of Cheniere Energy, where offtakers have agreed to pay 115% of the Henry Hub price plus a liquefaction fee of up to US$3.5 per million British thermal units (US$96.8 per 1,000 cubic metres). 

This fee is essentially a sunk cost, it continued, so supplies to Europe will continue as long as the combined gas, transportation and regasification costs are below European spot prices. Marginal cash costs were estimated by Fitch to be around US$4 per mmBtu (US$110.6 per 1,000 cubic metres) currently, while the UK’s NBP spot prices are around US$4.3 per mmBtu (US$119 per 1,000 cubic metres). 

This move to convergence will put pressure on regional suppliers that have relied on prices linked to oil. Such changes are already emerging in Europe, where Statoil and Gazprom are increasing their use of spot and hybrid contracts. Slowing this shift, though, will be infrastructure limitations and the high transportation price for LNG, as compared with oil. 

Further adding to price convergence pressure has been the rise of swapping volumes in different regions, such as seen recently in reports about GAIL India and its desire to exchange volumes from Cheniere for supplies closer to home. 

While the LNG market is under pressure for now, and with Fitch predicting this would continue in the medium term, the report went on to say this change would help drive demand in the sector. As such, the longer-term prospects for the feedstock have improved as a result of this shift, “as demand will eventually increase and capacity additions will slow, particularly in the US because of its distance from the main demand centres. We do not expect significant new LNG gasification plant construction in the current environment, other than those already sanctioned.”

Fitch’s thesis extends a broad line of reasoning put forward from an array of sources in recent times. Barclays, for instance, in April put out a note on the coming link between US and UK prices. Europe, Barclays said, “serves as the market of last resort and sets the floor for global LNG prices”. 

Volumes into Europe are likely to rise over the next five years, Barclays said, putting pressure on prices. UK and US prices had moved in tandem up until 2010, when shale in North America removed the need for these two centres to attract LNG cargoes. 

Given the flexibility of US supplies, Barclays noted the possibility of supplies shutting in. It cited three potential factors as having an impact on US exports: global LNG demand, Russian gas supplies into Europe and European coal prices. 

Europe appears to be a likely destination for US LNG volumes and as such will curb prices. The extent to which US volumes will be shipped to the Asia-Pacific region, or have an impact through swapped volumes, remains to be determined.