Gas put under the price test

Feb 28, 2017 5:48 pm

Interview with Sergey Komlev, Head of the Contract Structuring and Pricing Directorate of Gazprom Export

The recent agreements that have restored a little confidence to the global oil markets have, only briefly, distracted attention from the sudden development of another peak energy resource: natural gas. The expansion of the global LNG networks, the interest shown with regard to this resource even from countries traditionally almost exclusively focused on crude oil production, such as Saudi Arabia, whose “bridge resource” feature on the path of transition towards renewables has made natural gas the key player in the global energy scenario. This is also the opinion of Sergey Komlev, Head of the Contract Structuring and Pricing Directorate of Gazprom Export, who, in this interview, provides us with further elements to assess how the gas market must amend certain dynamics, particularly related to prices, to support the global “competition”.

What is the current role that natural gas is playing in the world energy balance?

Natural gas plays a critical role in the world energy balance. In 2015, according to BP report, 3.1bn toe worth of natural gas was consumed globally compared to 3.8 bn toe of coal and 4.3 bn toe of oil. In terms of international trade, 0.9 bn toe of natural gas were exported in 2015 making it a second tradeable energy commodity after oil/oil products (3,0 bn toe).

Why traditional price models will lead to market failure?

In my book, I explain how traditional price models that are now being applied to natural gas will lead to market failure and what alternatives there are to traditional price models. Pricing based on gas-on-gas competition generates below-optimal prices due to the market failures characteristic of natural gas as a unique commodity. These market failures cannot be sorted out simply by readjustment of supply and demand in the due course of events. In the case of North America, the required readjustment is in the physical gas supply; while in Europe, the required readjustment is in “paper” gas supplies in the futures market.

Do you suggest any remedy for them?

The book describes in detail not only the origin of these market failures, but also the remedy for them. That remedy is oil-indexation of natural gas prices, meaning the application of the value replacement principle based on inter-fuel competition. The use of oil-indexation in the natural gas industry has enabled the gas industry the opportunity to develop and prosper for more than 40 years. I defend the legacy and future utility of oil-indexation from the current assault by abstract application of allegedly free market principles. In my view oil-indexed pricing for natural gas is not something “pre-historic” as mainstream view postulates but actually a natural, truly market, and up-to-date instrument for curing market failure.

What are the possible negative consequences of the low current natural gas prices?

The book examines the negative consequences of the absurdly low current natural gas prices. Inappropriately low gas prices curb options for the globalization of the gas market build around worldwide LNG flows. When gas prices drop below the costs of liquefaction, LNG sales cover only the short-run marginal costs. Although LNG flows may continue this way for a long time to the benefit of end-users, the upset in the balance of interests between buyer and seller is perilous to the gas industry as a whole. Below-optimal prices undermine the ability of the industry to attract external financing and, as a result, puts at risk the next long-term investment cycle. On a short-term basis, below-optimal prices may become a threat to energy security: despite cold weather in Europe and depleted stocks LNG arrival into Northwest Europe are still unlikely, as price signals do not support it.

What is the main conclusion of this book?

The main conclusion of this book is that the use of gas-on-gas pricing prevents the required market rebalancing in natural gas pricing and is leading to major setbacks in both the forward and current markets. Liberal model of price globalization therefore should be applied with caution in order to avoid irreparable damage to the industry of pivotal importance for our civilization.

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