Test drilling site in Poland, where shale gas reserves are thought to be among the largest in Europe (photo: Kacper Pempel/Reuters/Newscom)
OIL AND GAS MARKETS
In the following interview, Jose Gijón (Senior Economist in the IMF’s Middle East and Central Asia Department) and Reinout De Bock (Economist in the IMF’s Monetary and Capital Markets Department) discuss “Will Natural Gas Prices Decouple from Oil Prices across the Pond?” which examines these developments and their possible implications for gas exporters.
IMF Survey online: How has the global gas market evolved in recent years?
Gijón: One major development is that the United States is now completely self sufficient in natural gas. Over the past two decades, U.S. production of unconventional gas—in other words, gas that is more difficult to extract, such as tight gas, coal bed methane, and shale gas—has quadrupled. Thanks to advances in the extraction methods (such as hydraulic fracturing technology and horizontal drilling), U.S. gas producers are now tapping the country’s large reservoirs of unconventional gas.
Globally, a number of factors have also changed how natural gas is traded. The growing liquefied natural gas trade, market liberalization in several countries, and falling transportation costs have lowered barriers between the traditionally segmented markets of Asia, Europe, and North America. And new emerging producers, such as Qatar, have increased global supply and eroded the market share of traditional gas producers.
IMF Survey online: Your research shows that there is now a looser link between oil and gas prices in the United States. What’s the reason for this?
De Bock: Natural gas prices have traditionally been linked to oil prices since natural gas was usually sold via long-term negotiated contracts at prices indexed to the price of oil. In recent years, the shale gas revolution has led to a “decoupling” of oil and natural gas prices—in other words, gas prices no longer rise and fall with oil prices. In the United States, we have seen that this decoupling has been extreme. This has happened because the increase in supply, lower prices, and the deregulation of markets have encouraged the development of a significant “spot market” for gas (that is, a market in which gas is bought and sold for cash and delivered immediately). This spot market has exerted pressure on the traditional oil-indexed market.
IMF Survey online: Is this decoupling also happening in Europe?
De Bock: No, our research shows that gas prices remain linked to oil prices in Europe, although the link has weakened. This is one key difference between the European and the U.S. gas markets. Another difference is that unconventional gas production has not yet taken off in Europe to the same extent it has in the United States.
IMF Survey online: How have all these changes affected the gas export trade of major suppliers?
Gijón: The 2009 financial crisis depressed demand for gas in Europe. For some exporters of natural gas to Europe, this has meant a decline in the volume of exports.
Take Algeria, for example. One of Europe’s key gas suppliers, Algeria sells gas via pipeline to Spain and Italy, its largest purchasers. These pipelines ensure very stable export destinations, with long-term contracts indexed to oil prices and guaranteed minimum purchases. By contrast, Algeria’s non-pipeline exports to Belgium and the United States—which represented 10 percent of the country’s exports in 2005—have stopped in recent years.
While Algeria’s contracts with Italy and Spain ensure stable export markets, the viability of these markets is highly dependent on the economic performance of these buyers. The global financial crisis and the collapse of demand for industrial gas in Europe sharply reduced Algeria’s exports. It appears that these key buyers, locked into their indexed contracts, responded to the decreased demand by purchasing only the minimum volume required by their long-term, oil-price-indexed gas supply contracts.
Thus, while Algeria’s gas prices increased from the lows of early 2009, the volume of gas sold at these indexed prices decreased. So these long-term contracts have the effect of making Algeria’s gas prices less attractive as oil prices increase.
If gas prices become decoupled from oil prices in Europe, as we’ve already seen happen in North America, traditional gas suppliers such as Algeria could face pressure to sell at prices that reflect a whole slew of factors—the total supply, the new gas deregulation laws, environmental concerns, and the cost of other energy sources—rather than just the evolution of spot oil prices. And this will make it more difficult for gas exporters to forecast revenues from natural gas, since these factors will affect the price in different ways. It will become necessary to take different scenarios for prices and quantities more explicitly into account, including for macroeconomic and financial projections.
IMF Survey online: What is your advice to policymakers in countries like Algeria?
De Bock: Well, the large-scale production of unconventional gas in Europe is probably not imminent. This is partly because of the controversy over the possible environmental effects from the technologies used to extract it. However, the recent European legislation to liberalize the gas market—as well as further political unrest in the Middle East and North Africa—could boost efforts to develop a European shale gas industry or a spot market for natural gas.
Countries like Algeria—where natural gas comprises about 49 percent of the exports and oil accounts for another 49 percent—will be economically vulnerable to prolonged periods of low hydrocarbon prices and demand. We believe it is dangerous for countries to rely on a limited basket of exports. So countries that do should strive to diversify by developing a broader industrial and export base, particularly by investing earnings from oil and gas in sectors that will generate tradable income.
