Gas goes global

Unlike the highly liquid global oil market, natural gas has always been traded regionally. Asia, Europe and North America represent three different gas markets with their own unique dynamics.

Regional gas markets

Asia is very reliant on LNG (liquefied natural gas) imports. Natural gas demand significantly outstrips low levels of domestic production. Prices spiked after the Fukushima Daiichi disaster in 2011 when Japan began importing record volumes of gas for electricity generation to replace the output of nuclear power plants that were shut down.

North American gas production has always been strong, but exploded over the past few years. Hydraulic fracturing (or fracking) activity and the discovery of significant shale gas reserves halved North American gas prices between 2010-11. Prices remain at historic lows today. Henry Hub in Louisiana, where North American gas is physically delivered as well as virtually traded, is the world’s most liquid spot and futures market for natural gas. North America’s well-developed pipeline infrastructure also minimises transportation costs and promotes access to the market. And a high degree of competition lowers the barriers to entry.

Europe’s numerous trading hubs are still developing and are yet to match Henry Hub’s liquidity. Until recently the majority of European wholesale gas buyers maintained long-term contracts with mega-suppliers – namely Russia’s Gazprom and Norway’s Statoil. According to the Oxford Energy Institute, 2015 was the first year that more than fifty-percent of gas trades in Europe took place on the spot market. Demand has yet to return to pre-2008 levels and is still soft across the continent, but prices remain consistently higher than in the US.

Gas producers rely on pipeline infrastructure to connect supply with demand centres. This is why North America’s shale gas revolution and the subsequent decline in natural gas prices have not affected European prices – no pipeline crosses the Atlantic. But, LNG can easily be shipped between the continents. Why then are the world’s two biggest gas markets still disconnected?

Intercontinental LNG trade

LNG (liquefied natural gas) is made by cooling natural gas to -162ºC. This transformation to liquid shrinks the volume of the gas 600 times, making it safe and easy to ship. LNG is colourless, odourless and non-toxic. Nevertheless, the added cost of liquefaction, sea transportation in specialised vessels and regasification at the destination has so far limited global arbitrage opportunities.

Yet, a barrage of new LNG investment over the past few years has lead some to speculate that natural gas markets are globalising. The International Energy Agency claims that global liquefaction capacity will increase by forty-five percent between 2015 and 2021, with most of this growth coming from the United States and Australia. If this glut makes enough cheap LNG available then North American and European gas prices might slowly converge.

In February, the Cheniere Energy LNG terminal at Sabine Pass between Texas and Louisiana was the first to begin exporting. In anticipation of a LNG supply glut Eastern European countries, including Poland and Lithuania, have been building regasification terminals. Lithuania is testing floating regasification technology – offshore plants connected by pipeline to the shore. Spain, being part of a peninsula, is isolated from the European continent’s pipeline network. Historically, this has made it an important destination for LNG cargoes. In fact, the economic downturn since 2008 created an opportunity for Spanish buyers to reload LNG cargoes and sell them in Asia where prices are higher. This churn enhances liquidity. Otherwise, LNG is injected into the network all over Europe. There are important regasification terminals in the Mediterranean: Italy, Greece and France, as well as north-western Europe: the UK, the Netherlands and on France’s west coast.

US LNG producers are increasingly flexible too – offering variable volume contracts or FOB (free-on-board) cargoes. Variable volume contracts permit buyers to increase or decrease the amount of gas they take depending on their needs. They may purchase extra volumes to take advantage of high spot prices – reselling the LNG cargo or trading gas locally. Or they may reduce their volume off-take when local demand is low. FOB means a buyer has not yet been found nor locked into delivery. An LNG cargo leaves the liquefaction terminal and can be bought and resold “on board”. The cargo may eventually be dumped in a spot market at a loss if a buyer can’t be found, but LNG suppliers’ willingness to send out FOB cargoes shows liquidity to be improving.

Not yet a single market

European countries are keen to reduce their dependence on Russian gas for political reasons. However, uncertainty remains as to whether US LNG can compete with Gazprom on price.  Analysts at the Oxford Energy Institute estimate Gazprom’s cost of delivering gas to Germany to be 3.5 USD per mmbtu (million British thermal unit). Whereas the break-even price for the cheapest US LNG supplies is around 4.3 USD per mmbtu – even with Henry Hub still trading at historic lows. Gazprom, Europe’s largest gas supplier, has significant spare production capacity and some of the lowest cost production in the world. Given these conditions, LNG traders are unlikely to win a price war on the continent.

In sum, greater supply and liquidity in the global LNG market offers some opportunities for arbitrage between the continents and provides European gas buyers with options. This does have the potential to disrupt Europe’s monopolies and introduce greater competition into the market.  Yet, LNG and pipeline gas markets are not one and the same. Whilst the price gap persists, gas markets will retain their regional characteristics.


What the frack?

The US shale revolution is a hot topic these days. It’s one reason  America recovered faster than Europe following the 2008 global financial crisis. But what is shale gas and shale oil? And what’s all the controversy about?

Fracking 101

Hydraulic fracturing, abbreviated to “fracking,” technology is not new. It’s been around since at least the 1920s. It simply got cheaper and easier to do in the last ten years. Basically, instead of drilling multiple wells to extract gas or oil from underground rock formations, water or a mix of chemical lubricants is injected into the ground at very high pressure to shatter or “frack” the surrounding rock and increase yield from the well. This can be done several times at different intervals along the well shaft. The gas then travels up the well shaft and is collected at the surface.

Fracking can also be carried out horizontally as sketched in the diagram below. Rather than drilling several vertical wells down into the same shale rock layer, the well turns a corner and follows the hydrocarbon producing rock.


Shale gas is the same organic compound we refer to when we say natural gas – primarily methane. Shale actually refers to the porous rock within which gas is trapped. Generally shale, but sometimes sandstone. It’s like a solid sponge which shatters under the high-pressure injections of water and releases gas.

The most profitable shale “plays” (industry-speak for a geological area containing underground shale gas reserves) are described as “wet” because they also contain crude oil. This liquid hydrocarbon is called shale oil or light, tight oil being trapped in the porous rock and very high quality crude.  [i]

The shale gas revolution

Small and medium-sized producers began fracking in the United States several years ago. Enormous shale plays were discovered in Pennsylvania (Marcellus), Texas (Eagle Ford), and North Dakota, Montana (Bakken). All very profitable whilst international oil prices were high. Since the US gas pipeline network is so well developed it was easy to market the associated natural gas.

The gas market was flooded with diverse new supplies – decreasing gas prices at physical trading hubs substantially. This was a huge boon for industry. Cheaper energy has made US exporters more competitive whilst Europe continues to struggle with higher gas prices and economic recession.

It was heralded as a golden age of gas. This was good news for US greenhouse gas emissions too. Emissions have decreased since gas became more competitive with cheap, but polluting coal in the electricity sector. Additionally, some fuel-switching has occurred with natural gas replacing petrol in a limited number of cases in the transportation sector. This is no small achievement. The US transportation sector is overwhelmingly the greatest source of greenhouse gas emissions in the world.

Could the shale gas revolution happen in Europe?

Two factors allowed US production to take off the way it did. Firstly, in the United States mineral wealth is privately owned. Meaning whatever you dig up and find in the subsoil beneath your property belongs to you. This is why we have the stereotype of a Texan oil baron. A lucky farmer that strikes oil on his ranch keeps one hundred percent of the profits. (Best practice is to hide your find from your neighbours for as long as possible, lest they get digging as well).

In Europe governments retain mineral and mining rights. There is much less incentive for small-time producers to drill for hydrocarbons outside of the United States. Despite your capital investment, the profitability of the project is unpredictable.

Second, the industry was almost completely unregulated when it got started. The wells were already pumping gas and turning a profit before proper regulatory oversight came into play.

Fracking companies have been targeted with accusations of poisoning aquifers. Aquifers are a subsoil layer that must be drilled through to reach shale rock formations below. This is also referred to as groundwater – frequently a natural source of water for rural and urban communities.

There have been cases of the chemicals used during fracking processes leaking into the groundwater in parts of America. Very toxic lubricants were used to make the wells more productive in the early days. Nowadays shale gas producers are willingly reporting the chemicals they are using, (previously considered a commercial secret,) to try and regain the American public’s confidence. And a properly reinforced well should not be leaking into an aquifer for any reason. It’s eventually been made harder for frackers to get the right permits to go ahead with new projects.

Proper geological imaging to ensure wells are drilled far from sensitive fault lines, as small earth tremors have been linked to fracking processes, and regulations regarding water use in drought-prone areas have emerged too.

There are shale basins in Europe, notably in France, Poland and the UK, quite close to dense population centres. If proper regulation oversees the production process chemical leakage and earth tremors are totally avoidable. Nevertheless, the conditions that shaped a shale gas revolution in America are still unlikely materialise in Europe.

[i] This should not be confused with oil shale, which is kerogen. Kerogen rock needs to be heated up to extract crude oil. This is a very different and more expensive industrial process.