US LNG exports force Russia’s hand on energy strategy

The end of February saw the first exports of liquefied natural gas from the U.S. mainland when major shale gas company Cheniere Energy’s first LNG cargo left the Sabine Pass terminal in Texas. While the gas was initially bound for Brazil, rumors are circulating that it will be resold to Europe.

There are expectations that the beginning of U.S. exports may trigger flexible trading in the LNG market, which in most cases is subject to strict resale restrictions.

With U.S. exports carrying no such restrictions, significant structural change is expected in what has until now been a suppliers’ market, paving the way for a tug of war between old and new players. Europe, one of the likely main battlegrounds, is now seeing a concerned Russia try to shore up some of its key interests.

As Cheniere has concluded long-term supply contracts with LNG buyers such as the U.K.’s BG Group, which has been taken over by Royal Dutch Shell, many of its exports are expected to end up in Europe.

In addition to the lack of resale restrictions, contracts for U.S. LNG exports base prices on natural gas futures prices in New York trading, as opposed to conventional contracts which use crude oil and petroleum products as pricing indexes.

This means that traders will likely engage in arbitrage trading to capitalize on regional price gaps. LNG markets in Europe, Asia and other regions, which have different price systems due to the costs of transportation, may even converge into one market.

As one of the world’s leading producers, Russia will be affected more than any other country.

Having captured more than 30% of the European natural gas market, the region has been something of a goldmine for Russian state-run gas company Gazprom. If it makes inroads into the European market, U.S. LNG could deal a significant blow to Russia’s national revenue and could even affect the country’s clout on the international stage, with so much of Moscow’s diplomacy leveraged on energy exports.

As a number of European countries, such as Lithuania and Hungary, seek to reduce their reliance on Russia for energy, Moscow has resorted to a number of different measures in an effort to protect its European market share.

On Feb. 24, just as U.S. LNG exports were getting underway, Gazprom CEO Alexei Miller visited Rome to sign a memorandum of understanding with major Italian and Greek energy companies for the construction of an undersea gas pipeline across the Black Sea.

The deal highlights Russia’s need to secure a route to Europe after increased tensions have put the brakes on a plan for a similar pipeline through Turkey. Moscow will also push ahead with the expansion of the Nord Stream pipeline which runs from Russia to Germany via the Baltic Sea.

In an altogether different tactic, Russia will seek to keep U.S. LNG in check through price negotiations. In a departure from the country’s adherence to long-term contracts, Moscow announced that it would sell natural gas via auction in September 2015.

The announcement signaled a move away from contracts linked to petroleum product prices and acceptance of prices determined by supply and demand. To pay greater heed to buyers, Gazprom now plans to increase auction-based sales of natural gas.

Barometer prices of natural gas in Europe hover around $4 per million British thermal units. U.S. prices stand at around $2, but are calculated to be $6 to $7 on delivery to Europe once liquidation and transport costs are taken into account.

“U.S. LNG is less price-competitive but is expected to arouse demand from consumer countries seeking to diversify suppliers and pricing formats,” said Takayuki Nogami, chief economist at Japan Oil, Gas and Metals National Corp.

Leading U.S. investment banking firm Goldman Sachs forecasts that U.S. LNG exports will reach 25.5 million tons in 2019, capturing the third largest share of the global market.

With the glut dragging on, gas producing nations are certain to intensify competition for market share. Qatar and other oil producers in the Middle East are increasing LNG exports to Europe. Iran, the country with the world’s largest reserves, has set an eye toward global exports.

In the same way that the emergence of shale oil has forced Saudi Arabia to abandon its role of coordinating supply and demand in the crude oil market, U.S. LNG has put Russia under growing pressure to reconsider its energy strategy.

Source: Nikkei