Downward revisions of gas price assumptions

While oil markets have grabbed all the headlines in recent weeks, there is something afoot in the natural gas markets that’s telling. Several analysts and rating agencies have revised their short to medium term gas price forecasts downwards over the past six weeks.

Earlier this month, Fitch Ratings revised its base case for Henry Hub down to US$3/mcf from $4/mcf in 2015, while not losing sight of a long-term value of $4.50/mcf. The agency’s stress case for credit ratings purposes this year has been revised to $2.75/mcf from $3.25/mcf, and the long run price to $3.25/mcf from $3.50/mcf.

There is nothing to sensationalise here, we’re not slipping down to April 2012 levels and sub-$2 prices. Yet, there is little to be broadly upbeat about over the medium term for US producers given the current abundance of gas. Alex Griffiths, Managing Director at Fitch Ratings, says the agency has merely reacted to rebounding inventories as noted by the EIA and other sources.

“A warmer US winter, and continued strong growth in domestic shale gas supply, including ongoing efficiency gains in drilling are having a bearing. The drop in forward oil prices is also likely to have a dampening effect on US gas demand over the medium term, as lower oil prices suggest lower profits and reduced economic feasibility for at least some US based LNG projects still at the planning stages,” he adds.

In fact, natural gas abundance could stunt the growth of new nuclear build in the eyes of many contacts. At present, nuclear power share of the overall US market is just shy of 20%. Cheap gas means the level is likely to be severely tested over the coming years. Only two new nuclear plants are currently under construction, with the first not expected to come online before 2018 at the earliest.

Gas producers, unlike their oil counterparts, can at least take some solace now in exporting their proceeds of shale to Europe and Asia as Sabine Pass LNG export terminal kicks into gear in 2017. However, Fitch says while the European gas price is in a much better place than the US, it too is going through testing times.

Fitch uses UK’s National Balancing Point (NBP) gas price as proxy, which it has also revised down to $6/mcf in 2015 from $8/mcf to reflect downward movements in the market price since last year. Overall, the NBP has fallen nearly 20% since a year ago to around $7.50/mcf.

“We believe that due to seasonal factors and the downward impact of oil-linked gas contracts elsewhere in the market, which typically readjust price with a six or nine-month lag, it is appropriate to reflect a weaker market as our base assumption for the rest of the year. From 2016, the base case price deck for NBP sees a gradual improvement back to $8 in the long run,” Griffiths adds.

So should US producers continue to look elsewhere in order to get more bang for their invested bucks? Exporting to Europe and Asia seems to be the answer. Invariably though, as pointed out by opponents of US gas exports, this would lead to a rise in domestic gas prices.

US gas will continue to trade at some discount to European prices and at a considerable discount to Asian prices. As the Oilholic noted last year in a Forbes column, the Henry Hub is not relocating to Wales or Singapore any time soon! Even in a depressed gas market, disparities will persist.

That the European market is the most depressed of all shouldn’t be in any doubt. On February 3, Russia’s Gazprom, still Europe’s leading provider of natural gas (Ukraine-related sanctions or not), said it would reduce gas imports from Turkmenistan and Uzbekistan, which it passes on to end clients, by 60% and 75% respectively, to compensate for weak demand.

Not only does it have heavy implications for both those countries, but Moody’s unsurprisingly views it as a credit negative for Intergas Central Asia (ICA, Baa3 positive), Kazakhstan's gas transmission company operating one of main Central Asian pipelines.

The agency says Gazprom’s move has the potential to trigger a 40% dip in ICA’s profits on an annualised basis. “Such revenue deterioration would weaken the credit metrics of ICA, which generates more than 50% of its revenue from the transportation of Asian gas under contract for Gazprom. It would also reduce the company's ability to generate cash, as well as its resilience to foreign currency risk associated with its predominantly US dollar-denominated debt,” it adds.

In summation, these are serious if not precarious times for the gas markets, and it’s not the just US players who ought to be worried.

On a closing note, here is the Oilholic’s recent chat for Forbes with US Department of Energy CIO Donald Adcock. Additionally, here is one’s take on how oil traders, trading houses and of course hedge funds are looking to play contango. As usual they’ll be winners, losers, sinners and pretty happy shippers.

That’s all for the moment folks! The Oilholic is off to gather fresh intel from Mexico City and Houston. Until next time, keep reading, keep it ‘crude’!

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© Gaurav Sharma 2015. Photo: Offshore rig, USA  © Shell

End of Q1 2013 trade @ CBOT & hot air on shale

As trading came to a close for Q1 2013 at the Chicago Board of Trade (CBOT) on Thursday afternoon, the Oilholic saw crude oil futures rise during the last session of the first quarter aided undoubtedly by a weaker dollar supporting the prices. However, yours truly also saw something particularly telling – fidgeting with the nearest available data terminal would tell you that Brent crude futures slipped nearly 1 percent over Q1 2013. This extended a near-1 percent dip seen in Q4 2012. Overall, Brent averaged just around the US$112 per barrel level for much of 2012 and the Brent-WTI premium narrowed to its lowest level in eight months on March 28. That said, it must be acknowledged that US$112 is still the highest ever average annual price for the benchmark as far as the Oilholic can remember.

In its quarter ending oil market report, the CME/CBOT said improved sentiment towards Cyprus was seen as a supportive force helping to lift risk taking sentiment in the final few days before Easter. On the other hand, concerns over ample near term supply weighed on nearby calendar spreads, in particular the Brent May contract.

In fact, the May versus June Brent crude oil spread narrowed to its slimmest margin since July 2012. Some traders here indicated that an unwinding of the spread was in part due to an active North Sea loading schedule for April and prospects for further declines in Cushing, Oaklahoma supply.

Away from price issues, news arrived here that ratings agency Moody’s reckons an escalation in the cost of complying with US federal renewable fuel requirements poses a headwind for the American refining and marketing industry over the next two years (and potentially beyond if yours truly read the small print right).

Moody’s said prices were spiking for renewable identification numbers (RIN) which the US Environmental Protection Agency (EPA) uses to track whether fuel refiners, blenders and importers are meeting their renewable-fuel volume obligations.

Senior analyst Saulat Sultan said, "US refining companies either amass RINs through their blending efforts or buy them on the secondary market in order to meet their annual renewable-fuel obligations. It isn't yet clear whether recent price increases reflect a potential shortfall in RIN availability in 2014, or more structural and permanent changes for the refining industry."

The impact of higher RIN prices will depend on a company's ability to meet its RIN requirements internally, as well as the amount of RINs it can carry over to 2014 and gasoline export opportunities, Sultan says. Refiners carried over about 2.6 billion excess RINs to 2013 from 2012, but the EPA expects a lower quantity to be carried over to 2014.

"RIN purchasing costs can be sizable, even while refiners are generally enjoying a period of strong profitability, such as they are now. Integrated refining and marketing companies including Phillips 66, Marathon Petroleum and Northern Tier Energy LLC are likely to be better positioned than sellers that do not blend most of their gasoline, such as Valero Energy, CVR Refining LLC and PBF Energy, or refiners with limited export capabilities, such as HollyFrontier," Sultan added.

Concurrently, increasing ethanol blending, which is used to generate enough RINs to comply with federal regulations, raises potential legal issues for refiners. This is because gasoline demand is flat or declining and exceeding the 10% threshold (the "blend wall") could attract lawsuits from consumers whose vehicle warranties prohibit using fuel with a higher percentage. However, Moody's does not believe that companies will raise the ethanol content without some protection from the federal government. 

Meanwhile, all the hot air about the ‘domestic dangers’ and ‘negative implications’ of the US exporting gas is getting hotter. A group – America’s Energy Advantage – has hit the airwaves, newspapers and wires here claiming that "exporting LNG carries with it the potential threat of damaging jobs and investment in the US manufacturing sector as rising exports will drive up the price of gas to the detriment of domestic industries."

So who are these guys? Well the group is backed by several prominent US industrial brands including Alcoa, Huntsman chemicals and Dow Chemical. Continuing with the subject, even though only one US terminal – Sabine Pass – has been permitted to export the fruits of the shale revolution, chatter in forex circles is already turning to shale oil and gas improving the fortunes of the US Dollar!

For instance, Ashok Shah, investment director at London & Capital, feels this seismic shift could improve growth prospects, reduce inflation and diminish the US current account deficit, with significant ramifications for long-term investors.

"For the past decade we have seen the US Dollar in decline, on a trade weighted basis. I believe the emergence of shale oil as a viable energy source looks set to have a considerable impact on the US dollar, and on the global economy as a whole," Shah said.

"Furthermore, a lower oil price will drive lower global headline inflation benefiting the US in particular - and a lower relative inflation rate will be a positive USD driver, improving the long-term purchasing power of the currency," he added.

The Russians are stirring up too. Last week, Gazprom and CNPC signed a 30-year memorandum to supply 38 billion cubic meters (bcm) to 60 bcm of natural gas from Eastern Siberian fields to China from 2018. The negotiations haven’t concluded yet. A legally binding agreement must be signed by June and final documents by the end of the year, covering pricing and prepayment terms. Let us see the small print before making a call on this one. On a related note, ratings agency Fitch says Gazprom is unlikely to offer any meaningful gas price concessions to another one of its customers – Naftogaz of Ukraine – in the short term owing to high spot prices for natural gas in Europe, currently being driven by the continued cold weather.

Sticking with the Russian front, Rosneft, which recently completed the acquisition of TNK-BP, has negotiated an increase in its oil shipments to China from the current 15mtpa to as much as 31mtpa in exchange for a pre-payment, and has agreed on a number of joint projects in exploration, refining and chemicals production with CNPC and Sinopec.

This is it for this post; it is time to bid goodbye to Chicago and Lake Michigan’s shoreline and hop 436 miles across the Great Lakes to say hello to Lake Ontario’s shoreline and Toronto. The Oilholic leaves you with a view of the waterfront and the city’s iconic buildings; the Willis Tower (once Sears Tower is on the left of the frame above).

It’s been a memorable adventure to Illinois, not least getting to visit  CBOT – the world’s oldest options and futures exchange. Leaving is always hard, but to quote Robert Frost – “I have promises to keep, and miles before I go to sleep.” That’s all from the Windy City folks! Keep reading, keep it ‘crude’!

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To email: gaurav.sharma@oilholicssynonymous.com

© Gaurav Sharma 2013. Photo 1: Exterior of the Chicago Board of Trade. Photo 2: Chicago's Skyline and Lake Michigan, Illinois, USA © Gaurav Sharma.

US LNG exports to the UK: The ‘Stateside’ Story

The Oilholic finds himself in Chicago IL, meeting old friends and making new ones! A story much discussed this week in the Windy City is US firm Cheniere Energy’s deal to export LNG to UK’s Centrica. More on why it is such a headline grabber later, but first the headline figures related to the deal.

The agreement, inked by Centrica and Cheniere on March 25, sees the latter provide 20-years' worth of LNG shipments starting from September 2018, which according to the former is enough to fuel 1.8 million British homes.

Centrica said it would purchase about 1.75 million metric tonnes per annum of annual LNG volumes for export from the Sabine Pass Project in Louisiana. (see Cheniere Energy’s graphic on the left, click image to enlarge). The contract covers an initial 20-year period, with an option for a 10-year extension.

Centrica, which owns utility British Gas, has fished overseas in recent years as the North Sea’s output plummets. For instance, around the 20th World Petroleum Congress in 2011, it inked deals with Norway’s Statoil and Qatar Petroleum. US companies have also flirted with the export market. So the nature of the deal is not new for either party; the timing and significance of it is.

According to City analysts and their peers here in Chicago, the announcement is a ground breaking move owing to two factors – (1) it’s the first ever long-term LNG supply deal for the Brits and (2) a market breakthrough for a US gas exporter in Europe.

Additionally, it blows away the insistence by the Russians and Qataris to link longer term supply contracts to the crude oil price (hello?? keep dreaming) instead of contracts priced relative to gas market movements. As for gas market prices, here is the math – excluding the recent (temporary) spike, gas prices in the UK are on average 3 to 3.5 times higher than the current price in the US. So we’re talking in the range of US$9.75 to $10.25 per million British thermal units (mmBtu). The Americans want to sell the stuff, the Brits want to buy – it’s a no brainer.

Except – as a contact in Chicago correctly points out – things are never straightforward in this crude world. Sounding eerily similar to what Chatham House fellow Prof. Paul Stevens told the Oilholic earlier this month, he says, “Have you forgotten the politics of ‘cheap’ US gas exports landing up on foreign shores? Even if it’s to our old friends the Brits?”

The US shale revolution has been price positive for American consumers – the exchequer is happy, the political classes are happy and so is the public which sees their country edging towards “energy independence.” (A big achievement in the current geopolitical climate and despite the quakes in Oklahoma).

The only people who are not all that happy, apart from the environmentalists, are the pioneers who persevered and kick-started this US shale gas revolution which was three decades in the making. To quote one who is now happily retired in Skokie, IL, “We no longer get more bang for our bucks anymore when it comes to domestic contracts.”

Another valid argument, from some in the trading community here in Chicago, is that as soon as US gas exports gain traction, bulk of which would head to Asia and not mother England, domestic prices will start climbing. So the Centrica-Cheniere deal, while widely cheered in the UK, has got little more than a perfunctory, albeit positive, acknowledgement from the political classes stateside.

In contrast, across the pond, none other than the UK Prime Minister David Cameron himself took to the airwaves declaring, “Future gas supplies from the US will help diversify our energy mix and provide British consumers with a new long term, secure and affordable source of fuel.”

The Prime Minister is quite right – the UK would rather buy from a ‘friendly’ country. Problem is, the friendly country might cool off on the idea of gas exports, were US domestic prices to pick-up in tandem with a rise in export volumes.

That’s all for the moment from Chicago folks! More from here over the next few days; keep reading, keep it ‘crude’!

To follow The Oilholic on Twitter click here.

To email: gaurav.sharma@oilholicssynonymous.com

© Gaurav Sharma 2013. Photo: Sabine Pass Project, USA © Cheniere Energy Inc.