Could Gazprom be about to start a price war in the global gas market? With the prospect of a wave of US liquefied natural gas supplies hitting the market this year, energy investors fear that the Russian state gas heavyweight will adopt the same strategy in the gas market that Saudi Arabia has done in oil.
It may seem like a gas price war is the last thing Russia, already reeling from the impact of low oil prices, needs. But analysts say such a strategy may be economically rational for Gazprom. Low prices in the European gas market mean it could relatively easily push prices to a level at which it would be unprofitable to ship LNG from the US – and so defend its market share in a region that accounts for the bulk of its profits.
“That is the question everyone is asking: are they prepared to push down prices to keep out US LNG?” says a portfolio manager at an energy-focused private equity fund.
Such a move would have significant repercussions for the global energy markets. A fully fledged price war in Europe could have a ripple effect across other regions and commodities, from Australian LNG to Colombian coal, and threaten the viability of the nascent US LNG industry.
“Why would you concede market share to a higher-cost producer?” says James Henderson, Russian oil and gas specialist at the Oxford Institute for Energy Studies. “If I was an investor in US LNG I would be worried.”
The argument in favour of a price war is simple. Just as Saudi Arabia is the main swing producer for the global oil market, thanks to its ability to ramp up production if needed, Gazprom is the main holder of spare gas capacity.
According to Gazprom executives, the company has about 100bn cubic metres of spare production capacity, thanks largely to investments made on over-optimistic assumptions about future demand. That is equivalent to almost a quarter of its production and about 3 per cent of world output.
Just as Saudi Arabia has been unnerved by US shale, Gazprom faces a similar threat to its market share. The flood of cheap gas unleashed by the shale boom has prompted a wave of US LNG projects in recent years. The first cargo of LNG from the “lower 48” contiguous states of the US is due to be shipped in the next two months, and total export capacity under construction is equivalent to two-thirds of Gazprom’s exports to Europe.
Finally, and again like Saudi Arabia in oil, Gazprom is one of the lowest-cost gas producers. According to Mr Henderson, the cost of delivering its gas to Germany is $US3.5 per mmbtu (million British thermal unit), compared with an estimated $US4.3 per mmbtu break-even for US LNG supplies even though US gas prices are trading near 16-year lows. Put all those facts together, and it would make sense for the Russian company to push down prices to keep US LNG out of Europe.
“Now the market is getting excited about it, but the Russians have done their maths and they know they can win if it happens,” says Thierry Bros, European gas analyst at Société Générale.
Such a move has become cheaper to implement because European gas prices have fallen dramatically, with spot UK prices down 50 per cent in two years. Gazprom’s contract prices, largely tied to oil prices, have kept pace with the spot decline and are likely to fall further.
Mr Bros says it would cost Gazprom $US1.3 billion in lost revenues to price US LNG out of the market this year – less than 1 per cent of its historical annual sales.
Gazprom executives have studied the economics and are discussing the price-war approach, according to people familiar with the company’s thinking.
Adopting such an aggressive strategy would be a big shift. Gazprom has long sought to maximise revenue through long-term contracts linked to the oil price, which commit buyers to buy fixed volumes of gas even if spot prices are lower. Committing to price war would require it to become more involved in Europe’s spot gas markets – an idea that has met opposition in the company, although it moved in that direction last year with its first gas auction.
At a meeting with investors in New York this week, Alexander Medvedev, Gazprom deputy chief executive, said low spot prices in Europe had already made US LNG supplies uneconomical.
Analysts say a Gazprom-led price war could have two objectives: first, to price cargoes of US LNG out of the European market in the short term; and second, to discourage investment in LNG projects longer term.
The first goal would require the European spot price to fall below the marginal cost of shipping US gas to Europe – a scenario that Mr Bros says is likely in the second half of this year, but which would be painful to maintain.
More sustainably, Gazprom could adopt a medium-term strategy of managing European prices to prevent new LNG projects being approved if prices rise in the next year or two.
As one government official in Moscow puts it: “They have no choice. They are already in a price war,” – reported http://www.ft.com.