As you can
see in the chart above, there is a significant divergence in the price of
natural gas across US, Europe and Japan.
This divergence is the evidence of limited integration of the natural
gas markets. Natural gas markets are much less integrated than oil markets
because of the cost and logistical hurdles in trading gas across borders.
Transportation of natural gas requires either pipeline networks or
liquefaction infrastructure and equipment at the source, and then
re-gasification infrastructure at the destination. The costs and the time involved in building
the infrastructure have created global market dislocations causing price
divergence across regions. The prices here have dropped in the recent
times due to the ongoing oil shale boom, whereas the recent Fukushima disaster in
Japan has seen the prices shoot through the roof there as natural gas plants
have been roped into meet energy shortages arising from inoperative nuclear
plants. Had there been full integration
of the gas market, there would have been uninhibited trade of the supplies
resulting in some convergence in the prices across regions, contrary to what we
are seeing today. Apart from integration
hurdles, the regions have divergent pricing mechanisms too. In the US, the prices of gas are determined
in the spot markets, but in Asia the prices are indexed to the crude-oil
prices. In Europe, the prices are
determined by a combination of spot prices and indexation. The different pricing mechanisms have added
to the divergence resulting in segmented markets
The recent shale boom in the US
has made it the largest natural gas producer in the world. Surging supply and weak demand, has caused
prices in the US to fall sharply without having any bearing on other markets,
where the prices are relatively at elevated levels partially due to reasons
ascribed earlier. Prior to the boom, US were
a net importer of gas and therefore have tremendous import regasification capabilities. With the boom, the unused regasification
facilities have become redundant, and cannot be converted to liquefaction
facilities because liquefaction capacity required is different from
regasification capacity. Apart from
infrastructure hurdles, there are regulatory hurdles (for detailed discussion read here) too. Firms in the US are required to obtain authorization
to export natural gas (except to Canada and Mexico). In the medium term, the regulatory hurdles are
expected to be removed, triggering the building up and reconversion of
liquefied natural gas infrastructure for export purposes. The US House of Representatives have passed a
bill HR.6 – Domestic Prosperity and Global Freedom Act – in June of this year
removing the regulatory hurdles that prevent export of natural gas to non-FTA
countries and directing the Department of Energy to streamline the process to
issue decisions on applications to export natural gas. The new make-up of the Republican-majority
Senate should help HR. 6 pass through the elder house without any hassles and
should be on the President’s desk to sign sometime next year
The Fukushima
Daiichi nuclear disaster in March 2011 induced a sharp increase in natural gas
usage. Before the disaster, one-quarter
of Japan’s energy was generated by means of nuclear plants. Following the disaster, the Japanese
government shut down production at all nuclear reactors in the country and to
make up for the resulting loss of electricity generation, Japanese power
companies increased the use of fossil-fuel power stations and appended natural
gas turbines to existing plants. As a
result, Japan’s liquefied natural gas imports have increased dramatically by
about 40% since the disaster. This sharp
increase in demand from Japan has caused higher prices in Asia, and
particularly in Japan. Japan is thus now
the world’s largest importer of liquefied natural, and in 2013 imported 119
billion cubic meters, about more than one-third of the world total. Increased natural gas demand from Japan has
helped offset the reduced imports from the US, and countries like Australia,
Brunei, Indonesia, Malaysia and Qatar have seen their liquefied natural gas
exports to Japan rise rapidly.
In the medium
term, prices in Japan are expected to decline when the nuclear reactors resume
power generation. The European gas
prices are bound to edge lower as the European countries move away from
indexation to crude-oil. The
geopolitical tensions between Russia and Ukraine do not pose any risk to the
prices in continental Europe as was evidenced in the recent times, when as
recently as January 2009 the Russian energy giant Gazprom cut off all supply to
Europe via Ukraine. Since January 2009,
Europe’s dependence on natural gas transiting through Ukraine has decreased
from 80 percent to roughly 50 percent with the opening of Nord Stream. In the medium term prices in US are bound to
increase with rapidly rising exports, but markedly lower that in Europe and
Asia.