Long-term gas contracts under pressure as market conditions transform commercial landscape

LONDON, 16 DECEMBER 2009 – European gas companies need to move quickly to adapt to the revolution currently under way in the industry. Especially urgent is the need to address the intense pressure that is building to review the terms of long-term, oil-indexed take-or-pay contracts, one of the very foundations of the industry. That is the central conclusion of a survey of 300 executives and policy-makers conducted by Gas Strategies at the recent European Autumn Gas Conference (EAGC) in Bilbao, Spain.

A report detailing and analysing their responses to fundamental questions about the state and direction of the European gas industry – in the context of the broader energy industry – is published today. Entitled Europe’s gas industry needs transformation to adapt to energy revolution the report identifies four trends that together are transforming the commercial landscape:

* A severe recession-induced fall in demand for natural gas has coincided with new waves of supply, notably from new liquefied natural gas (LNG) projects and the boom in unconventional gas production in the United States, to create what some are calling an “acute gas glut”.

* This glut has in turn led to weakening gas prices in traded markets as compared to gas prices indexed to oil under long term contracts which have remained firm with oil prices at $70-80/barrel.  Some traders believe that the divergence between traded and oil indexed gas prices could persist into 2012/13.

* This oil/gas price divergence is creating unprecedented pressure to review the price and volume terms of long-term take-or-pay contracts, many of which are looking expensive because they are indexed to oil prices. Some European utilities are having to sell large amounts of high-priced long-term gas into low-priced traded markets, and losses on individual contracts can run into hundreds of millions of Euros.

* Low prices, abundant supply and climate change imperatives are a potent mix of drivers for a new “dash for gas” when gas demand returns to its long-term growth trajectory. This could lead to much higher demand for gas than was previously being anticipated, from around 2012/13. However, this raises questions about the adequacy of infrastructure investment and the future role of regulation.

“In such demanding times, the players in the industry will need to consider carefully how they manage their assets, contractual positions and operations,” says James Ball, President Director of Gas Strategies.

“Positions will need to be either exploited or defended through M & A activity and consolidation, price review, asset management, operational excellence and contractual changes such as in price, take-or-pay levels or other flexibility clauses. It is unlikely that value maximisation can be achieved from the status quo.”

The EAGC survey involved putting 18 fundamental questions about the state and direction of the industry to the delegates and speakers attending the conference and asking them to vote electronically (and anonymously) from a range of options. As today’s report illustrates, the results were often surprising.

When asked “Oil-indexed long-term gas contracts are increasingly exposed to unprecedented take-or-pay pressures in Europe. Where are we heading?” the view of a majority of the delegates at the EAGC was that re-negotiation of some kind is likely (see Q9 on page 14 of the report). Moreover, close to two-thirds of them felt that resolution through arbitration should be avoided due to the complexity of the issues at stake (see Q10, p15).

The jury is still out on whether the oil/gas price divergence will persist or be short-lived, however only 15% of those polled opted for “the divergence of oil and gas prices will be a short-term phenomenon . . .”

Much will depend on how quickly gas demand recovers after the dramatic falls we have seen over the past year, as the world’s economies were gripped by the worst recession since the Second World War. Estimates vary, but it seems that gas demand in Europe in 2009 will be between 6% and 10% lower than in 2008. Even Spain, which has become accustomed to double-digit gas growth, is likely to see a double-digit demand fall in 2009.

The views in Bilbao on demand were mixed, with a third of delegates voting that “demand destruction should not be under-estimated; even after economic recovery, demand growth will be lower than forecast”. That compares with 27% who felt that “demand has been suppressed rather than destroyed; it will bounce back when economic growth returns” (see Q1, p7).

“Such large discrepancy in views on the future of demand – whether demand reduction is systemic or short-term – brings into question the decision fundamentals of a large part of the industry,” said James Ball. “Companies can choose to simply react to events or they can plan for a fundamentally different world. Reliable strategy and operating decisions depend upon it.”

Expectations in the industry that climate change imperatives will lead to much greater use of gas, while low-zero carbon sources such as renewables, nuclear and clean coal get up to speed, raise questions about the adequacy of infrastructure investment and the role of regulation.  Likewise, delays to nuclear and renewable programmes will favour the fastest and cheapest alternative, gas-fired power.

An overwhelming majority of delegates felt that energy regulation in Europe leaves much to be desired. What is desired now is an emphasis on incentivising new investment, rather than sweating the existing assets. When asked whether European regulation is “fit-for-purpose?” only 18% of delegates felt that it was (see Q15, p19).

“Last year we commented that economic gloom was tending to overshadow the traditional regulatory concerns,” says James Ball. “This year, we saw how people really related to the storm that burst upon the energy world.  We are also seeing signs of the divergent paths companies will take into the changed landscape that is emerging.”

For more information, contact Leo Grange, Marketing and Communications Manager on +44 (0)20 7332 9976.

NOTES FOR EDITORS

1 – About Gas Strategies

Gas Strategies is a specialist professional services organisation providing commercial energy advisory services globally.

We operate in all sectors of the supply chain: upstream, midstream and markets, and cover the full LNG Value Chain and gas-to-power.

Our clients benefit from a strong business model in which our integrated service lines combine to bring powerful solutions, meeting their specific needs through Consulting, Training, and Information Services.

 

2 – About the EAGC survey

One of the unique features of the annual European Autumn Gas Conference (EAGC) – Europe’s longest-running natural gas conference – is the opportunity to poll delegates during the event. It is a rare chance to ask a significant cross-section of the industry’s key executives for their sentiment on how the industry is developing and what the future might hold.

Each year, over the course of the conference, delegates are asked a series of carefully framed, multi-choice questions, the answers to which are given using an electronic voting system. The results provide a valuable insight into the preoccupations of the people at the sharp end of European gas.

Gas Strategies, which sponsors these voting sessions, has been involved in both the framing of the questions, and subsequently producing a concise view of what emerged. The results from this year’s event – the 24th EAGC, held in Bilbao in northern Spain in late November – build on those that emerged from Lake Como in 2008, Düsseldorf in 2007, Cannes in 2006 and London in 2005.