The price of gas under long-term contracts has been at a premium to hub-priced gas in recent times – but the plummeting oil prices have turned things on its head. “For China, at an oil price of $35/bbl, contracted LNG arrives at a cost lower than domestic wholesale price benchmarks,” said Wood Mackenzie senior manager Miaoru Huang.
“While there is strong incentive for NOCs to retain the benefits to compensate for years of import losses, the import cost reduction will be partially passed through to downstream and will allow the government to push through its policy of lowering gas prices to end users,” she explained, adding; “This will help coronavirus-affected businesses to resume operations but stimulating new coal-to-gas switching will require further policy support even under a low oil price environment.”
Gas squeezed out in India
But in other markets, gas demand will come under pressure from oil as a competing fuel. Notably in India, analysts suggest “a lower oil price could slow the shift from oil to gas in the industrial sector,” as both long and spot LNG prices will compete with fuels like heating oil, LPG and naphtha.
European gas demand and flows will face little impact from even a sustained oil price collapse. Oil-indexed Russian pipeline contracts now account for less than 25% of Gazprom’s portfolio and, regardless, the current market share strategy is unlikely to change.
Algerian pipeline contracts into Spain remain fully oil-indexed and have been sitting at take-or-pay levels. “If oil prices remain low, Spanish buyers would take more Algerian piped volumes,” Ms Huang said. This would not become a possibility until October 2020 due to the lag on the contract - “but in 2021 it would reduce the space for LNG into Spain by 2 billion cubic metres, placing even more pressure on the oversupplied LNG market.”
U.S. gas production plunges
The biggest downside risk from the oil price crash to gas supply is associated with gas production – largely from unconventionals in the United States. “However, it’s not an instantaneous effect,” analysts said, “as prices are still generally above variable wellhead operating costs.”
As oil drilling slows, so does associated gas production growth, particularly in the Permian. Wood Mackenzie’s Genscape estimates that by the end of the year, U.S. gas production would be 0.9 billion cubic feet per day (cfd) lower than pre-crash estimates. This could be exacerbated to a fall of 3.1 billion cfd through 2021, with more flexibility in drilling reductions.
LNG projects face delays
Most liquefaction projects in the U.S. are supplied from non-associated gas so there’s little direct impact. ““The greater risk to supply is pre-FID investments,” said WoodMac research director Giles Farrer.
Record LNG supply investments last year and plunging LNG spot prices this year were already testing the appetite of LNG project developers to sanction new LNG projects in 2020. But the drop in oil price will make these decisions more complicated.
“Lower oil prices will have several consequences for the sector. These include restricted capital investment budgets, reduced appetite for financing LNG projects with exposure to oil prices. US LNG projects selling on a Henry Hub-plus basis will also be perceived as less competitive than oil-indexed LNG,” he explained. “As a result, there will be fewer LNG projects taking FID in 2020 and 2021. Projects in Mozambique, Mauritania/Senegal and Australasia will come under pressure. This is likely to translate into lower global supply between 2024 and 2027.
In contrast, Qatar - with low fiscal breakevens and an ambition to grow LNG market share long term - is expected to continue to push forwards with its North Field expansion plans.