Our book on Natural Gas was in the final stages of production just as the scale of the COVID-19 pandemic was becoming clear. We were able to include a short postscript presenting our initial thoughts on its impact on natural gas markets. Now, a couple of months further into the pandemic, and with some economies in Asia and across the OECD cautiously moving into the recovery phase, we have a bit more data to work with. Here, we must ask ourselves whether or not the fundamentals as we considered them when writing our book have changed.
Revolution 1: shale gas
A slowdown in the world’s largest shale gas laboratory, the United States, has materialized. The US Department of Energy now anticipates domestic natural gas production to decrease by about 2 percent in 2020 compared to the year before. It is hard to conceive a return to post-pandemic levels of economic activity while ‘social distancing’ remains a requirement. The slowdown may be more significant if a second wave of infections materializes in the second half of the year. Demand for natural gas has declined, though initially not as dramatically as for oil products that rely more heavily on various forms of transportation, something that many citizens have not been enjoying of late.
Ironically, the dramatic slowdown in tight oil production, and with it the decline in associated gas production, may serve as a cushion for dry gas producers in the country. In fact, some analysts have suggested that natural gas prices may receive a boost going into the heating season, resulting in Henry Hub prices that may be above levels that the US has experienced in recent years. However, in the short term we must take notice of the fact that as LNG exports from the US are constrained due to low prices in Asia and Europe, at least in Q2 and Q3, this has a downward effect on domestic natural gas prices.
Shale gas in other parts of the world may receive a boost as countries attempt to incentive domestic production, to support domestic employment, and as the potential for trade disruption lingers. The government of the UK has stated that the debate on fracking is over and they are now focused on expanding cleaner sources of energy. By contrast, China is increasing its determination to increase domestic gas production, including shale gas.
Revolution 2: The coming of age of LNG
As we noted in our book, supply had outpaced demand prior to the start of the pandemic, prices were low, and sellers of liquefied natural gas knew they were in for a tough couple of months. Such cycles are nothing new for LNG project developers and (to an extent) are included in project planning. With historically low spot prices for natural gas—and low oil prices, to which most contracted LNG continues to be linked to—the current market is a buyer’s paradise.
In the first months of the pandemic most cargos, including from the United States, still found their way to market, in part because demand for natural gas was not hit as hard as oil, but also because contractual arrangements prohibit buyers from walking away from purchases without advance notice. It is also worth keeping in mind that the majority of LNG worldwide is contracted under take-or-pay arrangements, providing limited flexibility for buyers to reduce volumes even if demand is down. Consequently, gas storage facilities are now unseasonably full. Going into the summer when the emphasis is historically on filling winter storage, cargoes are now being cancelled by several European buyers, who are opting to pay the tolling fee for liquefaction to some of their US counterparts, rather than taking their cargo of LNG, illustrating the state of the market. As various countries in East Asia slowly open up, countries like China see an opportunity to purchase natural gas, including on the spot market, and some US cargos have found their way to China, something that happened only sporadically of late due the trade war between the two superpowers.
Looking to the longer-term, many project developers had been working hard in recent years to bring new liquefaction capacity to market, and some of these projects are now struggling to reach the finish line. Various U.S. based projects have postponed their final investment decision, as finding new buyers willing to sign long-term contracts to support their projects has become more complicated. Projects that are already underway have reported delays as constructions crews are reduced in light of concerns about the pandemic. Other projects, such as those in Russia and Qatar for instance, appear to be inching forward, anticipating continued demand growth, and supply shortages in a couple of years’ time. Qatar Petroleum, which benefits from very low production costs, has continued to make headlines, not only with its planned liquefaction capacity expansion, but also with various vertical integration announcements, locking in long-term demand for its LNG. The net consequence of the current situation may be a more-balanced market later in the 2020s as some of the currently planned projects are delayed or even cancelled. As ever, the industry portends a tight market and higher prices, but that depends on what happens to demand going forward, with key countries in Asia being the most important consumers to watch.
Revolution 3: Decarbonizing natural gas
Calls to improve the environmental footprint of oil and natural gas continue, not just by the environmental community, but also increasingly by investors and lenders. In the US, Pioneer Natural Resources publicly called on investors to start differentiating between producers that spend money and time improving their environmental footprint, and those that do not. A coalition of oil producers, NGOs and academia launched an initiative called Project Astra, the latest example that efforts are underway to put emerging technologies to use that can better measure, and subsequently help curtail, fugitive emissions of methane (and other pollutants). Though it is probably too early in the crisis to draw definitive conclusions, investor interest in ESG (Environment, Social and Governance) issues appears here to stay, as investors, while acknowledging demand for oil and gas in the foreseeable future, face increasing pressure to differentiate in favour of companies that attempt to ‘do better’ on a wide range of environmental, social and governance metrics. Some noteworthy initial efforts notwithstanding, the financial markets have yet to come up with more standardized ways of reporting these metrics, and safeguarding transparency and third-party verification of the data. It is not inconceivable that the EU taxonomy proposals, which were recently adopted by the European Parliament, can provide such a framework, and will have ripple effects far beyond EU borders.
As we explain in our book, the future role of natural gas varies across the world. In Asia the dramatic falls in urban air pollution due to the ‘lockdowns,’ which are proving short-lived as activity recovers, may actually accelerate the switch from more polluting fuels to natural gas. Elsewhere, in Europe for example, calls for state support to be tied to ‘green recovery’ may accelerate investment in decarbonisation resulting in lower gas demand in the future (though some of the proposed solutions, such as hydrogen as an energy carrier, may require certain amounts of natural gas as a feedstock as well). In sum, the pandemic has the potential to enhance pre-existing opportunities, and challenges, for natural gas producers.
Natural gas, the pandemic and beyond
On a final note, market fundamentals in our view have not materially changed, and are not likely to either. Effectively, world economies have hit a pause button, and that unsurprisingly will also translate in a slowdown in terms of energy demand growth for a number of years as well. During a pandemic, the world is rife with strong opinions about how ‘we’ are going to do everything different this time around. Unfortunately, history tells us that in fact little changes coming out of a major downturn. However, if policy makers can, once the pandemic is under control, shift their attention back to mitigation of and adaptation to climate change, and fighting air pollution, and raise their current ambition levels, this really would be a big win. In such a world, demand for energy will not disappear, and relatively clean fuels would have a substantial role to play in many energy transition pathways. In some jurisdictions green stimulus may help spur investments beyond fossil fuels altogether, though these are so engrained in our daily lives that here too this process will take time. As we have described in our book, if the natural gas industry is to cement its long-term role in the fuel mix in various parts of the world, it needs to create a culture where the environmental bar is continuously raised throughout the supply chain. A third revolution is now needed more than ever.
Natural Gas by Michael J. Bradshaw and Tim Boersma is available now from Polity.