Since late 2008, the UK spot gas price has been significantly lower than oil-indexed contract prices. Although a large proportion of gas flowing to the UK is supplied under long-term contracts, significant volumes also are traded on the spot market. The delinkage between contract and spot gas prices has been prompted by oil price movements providing support to the former, while the latter has been weakened by oversupply and sluggish demand. The UK’s oversupply position has been compounded by deliveries of LNG, with Europe, in general, offering more attractive returns to suppliers than other Atlantic basin markets.
Shifting market dynamics
Historically, UK gas demand has been met primarily by indigenous production, with piped imports from Norway and The Netherlands filling the supply-demand gap. One of the shifts in the supply mix over the last five years has been the increase in LNG imports, particularly from Qatar.
LNG is anticipated to supply 15% of UK demand in 2010, and this figure is expected to grow as UK gas production further declines. Regasification capacity has been substantially increased – doubling in 2009 – in anticipation of this growth, and it now equates to around 40% of demand. The projected growth in LNG supply will be sourced from various countries – including Nigeria – which, so far, have not played a significant role in the UK supply mix.
Because of the country’s increased LNG import dependence, UK supply now is heavily influenced by the global gas market and, therefore, by spot prices at other trading hubs, in particular, the Henry Hub in the US.
International supplier strategy
In the wake of lower spot gas pricing, there has been some production restraint from key international suppliers. Production capacity at LNG projects in Qatar has decreased as producers carry out prolonged maintenance on LNG trains. Production from the Troll gas field in Norway also has decreased as a result of lower gas demand. Although this has had some near-term impact on spot prices, continued restraint by producers is expected to cause the UK spot gas price to return to oil-indexed levels by 2015.
Current UK production
Despite the relatively low gas price, little existing short-term UK production is sub-economic under Wood Mackenzie’s current gas price forecast – 30 MMcf/d of UK dry gas production. The short-run economics of most fields currently in production remain robust, even if gas prices fall well below the forecast – 60 MMcf/d of existing production becomes sub-economic at US $5/Mcf. Therefore, in the near future, hardly any UK gas production is likely to be shut in simply because it is unprofitable.
In fact, although gas production was lower than expected during 2009, the majority of the decrease was due to field underperformance, project delays, and maintenance issues, and not as a direct result of low gas prices.
Future UK production
Low and uncertain gas prices increase risk for projects that have not yet been sanctioned. By 2014, developments designated as “probable” by Wood Mackenzie are expected to produce 1.2 Bcf/d – almost one-fourth of domestic production. All but one of the projects provides more than 15% return to the companies at the forecast gas price of $6.24/Mcf in 2010. However, downside risks to gas price remain in the current oversupplied market, and pressure on costs remain. In fact, approximately one-third of the recoverable reserves associated with the probable projects require a gas price of greater than $5/Mcf for the projects to achieve 15% return.
Cost impact
Normally, a drop in price would bring a drop in industry costs as activity slows. However, costs have come down only marginally from highs in 2008 as they remain supported by the relatively high oil price. The disconnect between costs and realized price has put added pressure on gas developments. It also means, should the spot gas price remain delinked from the oil price, any future increase in the oil price could put further pressure on gas field development costs without an equivalent rise in production revenues.
Operators that do not require near-term revenue and believe spot gas prices will rise may choose to delay production and development projects to maximize the value of their gas.
Deferred production could increase reliance on the global gas market. Should operators choose to delay projects or production to maximize the value of their gas, UK indigenous gas supply could decline more rapidly. Should this occur, the country could become even more reliant on gas imports and, therefore, more susceptible to supply and price fluctuations in the global gas market.
Recommended Reading
Quantum Capital’s View on AI: Lots of Benefits, Pain Points
2024-05-16 - The energy industry is lagging in the race to implement AI, but Sebastian Gass, CTO of Quantum Capital Group, offered a few solutions during Hart Energy’s 2024 SUPER DUG Conference & Expo.
Aramco Credits Adaptability, Collaboration for Driving Innovation
2024-05-15 - Aramco’s implementation of different approaches has led to the creation and commercialization of newer products, said Max Deffenbaugh, principal scientist for Aramco, at the 2024 Offshore Technology Conference in Houston.
OTC: E&Ps Improving Operational Safety with Digitization
2024-05-13 - Artificial intelligence and the digitization of the oilfield have allowed for several improvements in keeping operators out of harm’s way, panelists said during the 2024 Offshore Technology Conference.
Exclusive: Cost-effective Benefits of Extracting from Mature Assets
2024-05-13 - Baker Hughes' well abandonment leader Bart Joppe details the importance of extracting resources from mature assets and the company's approach to managing a well, in this Hart Energy Exclusive interview.
TGS Starts Up Multiclient Wind, Metaocean North Sea Campaign
2024-05-07 - TGS is utilizing two laser imaging and ranging buoys to receive detailed wind measurements and metaocean data, with the goal of supporting decision-making in wind lease rounds in the German Bright.