Price of Natural Gas

     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.