[NGW Magazine] Editorial: Oil Prices on the Rebound

This article is featured in NGW Magazine Volume 2, Issue 20

By NGW

The fighting between the Kurdish peshmerga and Iraqi forces in the oil-rich region of Kirkuk – the Kurdish Regional Government wants to include it in sovereign territory, independent of Baghdad – was one of the factors that helped push Brent crude prices above $58/barrel in late October: a short-term high.

Later that week, oilfield services giant Schlumberger pointed to the “visible tightening of the supply and demand balance and the current geopolitical tensions in many of the world’s key oil producing regions,” making the point that “a geopolitical risk premium may again become a significant factor.” Announcing its Q3 results October 20, it said the days of the oversupply discount are numbered – just when the majors, after much bloodletting and belt-tightening, have got used to working in a $50/barrel environment.

Fellow engineering firm Baker Hughes GE made a related, if opposite point the same day, saying the LNG market “continues to be over-supplied in the near term with gas prices pressured in most markets,” but said, despite that, the long-term value proposition for LNG remains positive. 

This is ambiguous: what is a positive long-term value proposition for LNG sellers – and their contractors – might not be so good for buyers. The word ‘partnership’ is apt in today's competitive gas business: the more time the two sides spend locked in disputes over prices, the more the buyer will consider other energy types. The seller on the other hand is unlikely to have other options apart from continuing to make LNG. The seller needs the buyer more: and as Tellurian is finding out, offering equity stakes upstream might be easier to arrange than possibly unbankable short-term offtake agreements. Now, all kinds of pricing options have suddenly become worthy of the seller's consideration.

Producers of LNG have been quick to recognise the competitive environment becoming much harsher and the consequent need to keep prices down as far as possible. Tellurian is incorporating upstream gas in the US into its business model, which it says it can then liquefy for sale free on board US Gulf Coast at $3/mn Btu in today’s market. That is going a bit further than Cheniere, which charges its customers the agreed Henry Hub price, although its own procurement cost might be lower, and then charges another $3/mn Btu or so for liquefaction on top.

Even more aggressive is the regime that will apply to Novatek’s Arctic LNG terminal, if it takes the final investment decision. Not satisfied with the cost savings that a gravity-based system will bring, it is going to build its own modular plants at its own plant in Russia, where it can keep a close watch on the cost of labour and materials, nearly all of which will have to be sourced or made in Russia. It also has some of the cheapest feedstock in the world under the Yamal and Gydan peninsulas, and it is unlikely to be hit by any political risk. The stability of the regime in Moscow and the strength of the president’s personal ties with Novatek are beyond question.

Finding ways to develop markets for LNG will mean eating into the oil products business: diesel in the power generation sector and marine fuel oil in the shipping sector are both vulnerable to this relative newcomer, on cost as well as health grounds. Some major LNG producers have very little oil production so they won’t suffer from this; and the majors too are moving more of their production portfolio into gas, knowing that oil will still be needed in key areas such as plastics and – for the time being – air travel.

So far the small inroads gas has made do not fully reflect the benefits of gas. This has the potential to change though after 2020 when the new bunkering regulations come in, lowering the cap on sulphur still further and improving the economics for cheap gas compared with relatively high oil.

Technology will also help LNG find a market as economies of scale are not always the solution: small, modular production trains can cut the midstream costs. Downstream, there are obvious markets for LNG scattered across the world’s oceans, where it can stimulate economic growth if it is hooked up to despatchable power generation plant. New means of delivering LNG, whether by ISO container tank or floating hoses, mean building less infrastructure.

Continuing stronger oil prices will stimulate investment upstream and so benefit consumers later on, but the equation that higher oil prices mean higher gas prices is now nothing like as simple as it was. There are now so many moving parts. Higher oil and gas prices make other fuels more attractive, for example, especially when the cost of these fuels is not set by the market, but artificially, through government taxes.

This is one of the ways that the new Dutch government has proposed to make the country greener than its neighbours: a higher tax on gas and a lower tax on electricity ought to mean more homes heated by other fuels and less by gas – thus the government turns its back on the commodity that has contributed so much to the state coffers over the decades, but now sees as a major liability and barrier to progress.

But in the absence of a meaningful carbon price that could make carbon capture and storage an economic proposition, gas will never benefit from its cleanness relative to coal in Europe. The two are lumped together, against all logic, as ‘fossil fuels’ and therefore bad.

NGW