Goldman: The Gas Wars Are Coming And “Russia’s Grip On Europe” Is Slipping

One of the best (or “worst,” depending on your penchant for journalistic veracity) stories about the six-year-old conflict in Syria is that it has almost nothing to do with the sectarian divide and everything to do with a proposed Qatari natural gas pipeline.

I’m not going to get into the details (you can find that conspiracy theory expounded elsewhere), but it amounts to this: what you think you see in Syria is another manifestation of Sunni/Shiite antagonism exacerbated by Washington’s never ending efforts to implement regime change in the Mideast, but what you’re actually seeing is a global conspiracy against Russia ,whose energy interests in Europe would be undermined by a new pipeline that Bashar al-Assad didn’t support.

Make no mistake, there might be some kernels of truth in that story, but the idea that this is more “evil Western conspiracy against Kremlin energy interests” and less “Sunni/Shiite conflict” is silly in the extreme. It’s “big league” silly. Which is fine, because the people pushing that line are “big league” conspiracy theorists. So you know, if the shoe fits and all that.

Well in light of the above, I wanted to highlight a few excerpts out this morning from Goldman who reminds you that “Russia’s grip on the European gas market is facing its toughest test yet from the wave of LNG supply coming on line and heading for Europe,” and as it turns out, that thesis doesn’t rely entirely on a Doha-based conspiracy theory. Or at least not as that theory relies on a pipeline. In fact, the whole point is this:

Gas has been slow to emerge as a globally traded commodity Despite having a lower cost of production and larger reserves and lower ecological impact than other fossil fuels, for a long period the gas market did not expand to become a global commodity market. The key bottleneck was transportation: the only way to deliver gas to the consumer was to build a pipeline. While oil or coal could be loaded on ships and delivered to any destination, to deliver gas, producers needed a pipeline that would connect the field to the consumer. This required a large investment. As a result, and unlike oil and coal, natural gas was historically consumed in regions located close to production centres. This created separate regional markets (a European market, a US market, etc.) which had almost no connection with each other, resulting in regional imbalances.

LNG has enabled bottlenecks to be removed. However, with the emergence of LNG, transportation bottlenecks are no a longer barrier for gas. Gas can now be liquefied and, just like oil, loaded on ships and delivered to any destination. As a result, countries which have more gas than is needed for domestic consumption, such as the US and Australia, can now export their gas, monetizing their gas reserves. This would be impossible without LNG technology. Australia, for instance, would instead need to build pipelines under the ocean to deliver gas to China and other consuming nations.

Regasification capacity has doubled over ten years. Over the course of last 10 years, LNG infrastructure has developed substantially across the globe: Global regasification capacity (the facility which allows the conversion of LNG to natural gas) has doubled between 2005 and 2015, while the LNG fleet’s capacity has tripled over the same period. Following the development of LNG infrastructure, Asia emerged as the largest LNG consumer, reflecting an insufficient supply of pipeline gas volumes to meet its needs.

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Go figure, right?

To be sure, this is a very long note from Goldman. And undoubtedly, one could extract (no energy pun intended) from it what one wanted to in terms of finding evidence to support one’s argument. I’m just going to give you the executive summary below along with a few other selected paragraphs and visuals. But I guess what I would note is that if you do a word search for “Syria” on this 41-page, exhaustive study, you get … nothing.

Via Goldman

Global LNG glut is heading for Europe… Russia’s grip on the European gas market is facing its toughest test yet from the wave of LNG supply coming on line and heading for Europe. Much like OPEC in its battle with US shale for the oil market, we see little choice for Russia but to defend its market share, leading to lower-for-longer prices and wide-ranging repercussions for gas exporters and European gas consumers.

…disrupting Russia’s role as a balancing supplier… Over the years Gazprom has acted as the balancing supplier of gas in Europe, supplying 35% of the market and acting, in effect, as the OPEC of the European gas industry. Prices were set largely by long-term contracts indexed to the price of oil. With LNG supplies building toward a global surplus on GS estimates, we expect the excess to head for Europe, the only region where there is the opportunity to displace supplies of pipeline gas. We believe Gazprom will have to make a choice – either lose volume or keep incremental LNG away by selling below its cash break-evens (GSe).

Gas was historically traded as a point-to-point sale, with terms governed by long-term takeor-pay contracts. Most contracts had a link to the oil price, which was considered an alternative fuel, with market pricing mechanisms. However, rising LNG capacity has made the market a great deal more flexible, with shorter-duration contracts, larger volumes available at spot, and emerging spot indices (e.g. Platts JKM). Over the course of last 10 years, the share of non-long-term LNG trade grew from c.10% to c.30%. With new LNG volumes due to hit the market from Australia and the US, we believe that non-long-term trade volumes will be boosted further. This process is forcing pipeline gas producers to re-negotiate their contracts from oil-indexed to spot gas price-based to ensure they remain competitive.

As LNG volumes rise, the competition in the markets where both pipeline gas and LNG are available is increasing, driving growth in spot gas trading. In Europe, we have witnessed the rise of spot hubs and spot gas trading. The share of spot trading volumes as a percentage of total consumption is increasing gradually, and reached c.33% in 2015, vs. only c.3% in 2005. We estimate that over c.60% of European gas needs are currently contracted under spot pricing vs. only c.5% in 2005.

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A clear example of how the gas market is evolving, and how pricing is increasingly spotbased, is provided by Europe’s two largest gas suppliers, Statoil and Gazprom. Since 2008, Statoil (which supplies c.25% of Europe’s gas needs) has moved almost all of its gas contracts to spot pricing, from oil-indexed previously. In the case of Gazprom (which supplies c.35% of Europe’s gas needs), the majority of its contracts with European consumers were historically signed on a long-term supply basis, with take-or-pay terms and pricing linked to the oil price with a 6-9 month lag. In recent years, however, Gazprom has started to introduce a spot component in most of its contracts, and the spot component has been gradually increasing. This suggests that the gas market is becoming more commoditized. On our estimates, c.40% of Gazprom’s sales in Europe is now spot priced.

With the rise of LNG capacity around the world, the key question investors are asking is, will all this LNG be needed? Our answer is “no”. While we expect a large portion of this incremental LNG supply to be absorbed by rising demand in Asia, South America and other parts of the world (where LNG is the only source of gas imports), we expect demand growth in these regions to fall short of the incremental LNG supply increase.

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We expect this surplus LNG to be directed to Europe, the only region which can attract consumers by competing with pipeline gas and which also has vast spare LNG regasification capacity, equivalent to >20% of European gas consumption. How pipeline gas producers (specifically in Russia) react to rising LNG supply will determine the future of gas pricing in Europe.

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…but don’t underestimate the Russian response We believe investors are underestimating Russia’s willingness and ability to defend its market share. On our estimates it has significant spare capacity to sell more gas to Europe and Russia’s operating cash breakevens at the delivery point in Europe is just US$1.50/mcf ex taxes vs. c.US$4-4.50/mcf for marginal US and Australian LNG projects. The result is likely to be lower-for-longer gas prices and increased demand, particularly in accelerated switching of power plants from coal to gas (C2G), which would make sense with gas prices below c.$4/mcf.

How will low-cost pipeline gas producers with vast reserves and large pipeline capacity running into consumption centers respond to the rising influence of LNG? We believe that we are likely to see a similar response from low-cost producers to that seen in the oil market to the rise of shale production. OPEC, which has been limiting its production for a long period of time, decided to take on the shale producers in 2014, ramping up its output in a bid to force shale producers to reduce their investment and output. This eventually occurred in 2016.

In the gas industry, key pipeline gas producers have been limiting their sales volumes for many years to achieve better pricing. Russia is producing less than its capacity allows and is the de facto marginal supplier to Europe. The emergence and expansion of LNG will, in our view, force low-cost gas producers to choose between maintaining volumes (at a lower price to deter LNG) or maintaining high pricing (but with reduced sales volumes, allowing LNG to take market share). In the case of the latter, low-cost producers are exposed to the risk of further LNG capacity ramp ups/additions. Therefore, we believe it is most likely that low-cost producers will defend their market share.

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Russia, despite already having the largest excess gas pipeline export capacity, continues expanding capacity (North Stream 2 and Turkish Stream). These pipelines will expand Russia’s gas export to Europe capacity by >30%. According to Gazprom, these pipelines are expected to come on stream by 2019-20. An additional 8 bcm are attributable to the GALSI pipeline (from Algeria into Europe). The remaining c.31 bcm will be added by the TAPTANAP pipelines, which will bring additional gas volumes from Azerbaijan and central Asia to Europe (including Turkey). Hence, as well as Russia, Algeria, Libya and Azerbaijan will have sufficient pipeline transportation capacity to increase their exports to the European gas market, once their infrastructure projects are completed (subject to production capacity availability).

Why wouldn’t Russia sell more gas to China instead of selling to Europe? The main reason is there is no pipeline connecting Russian gas fields to China and there won’t be any for the foreseeable future.

Note that Iran is mentioned:

With regards to potential Iranian gas exports ramp-up post lifting of international sanctions last year, we believe that in the mid-term it will be almost impossible for Iran to ramp up gas supplies to Europe. The main reason is limited export pipeline capacity: currently there is only one pipeline which connects Iran with Europe (Turkey) with a total capacity of 10 bcm, which is now fully utilized. The construction of additional pipeline capacity will require substantial investments and time to complete. Production capacity is also limited currently, in our view: historically, Iran consumed almost all of the gas it produced; hence, material increase in gas volumes available for export is possible only post the launch of new gas fields. However, we did not see any FIDs for greenfield gas projects in Iran currently, which implies that so far vast Iranian gas reserves remain largely untapped. Russia, however, has plenty of spare production capacity, in our view.

And here’s a look at Qatari LNG project ramp:

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In the end though, the news isn’t all bad for those of a “Russophilic” persuasion.

Because even though Goldman says “Sell Gazprom”, they nevertheless expect that Russia will be able to keep LNG out of the market and remain the price setter:

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