Age of cheap natural gas must prompt creative thinking – IEA’s Birol

Energy stakeholders will have to think creatively to meet a number of challenges arising from the easier availability of natural gas, Fatih Birol, chief economist at the International Energy Agency, told ICIS in an exclusive interview.

While the fuel’s abundance will likely lead to the erosion of oil indexation in long-term gas contracts and its replacement with new formulas, it may also hit coal and renewable electricity generation. But even in an age of cheap gas, there is a strong need for green energy, Birol says.

Price effect

Increased availability of gas, and in particular of LNG, may lead to the replacement of traditional oil-indexed contracts for gas contracts with a hub-based pricing system and help to bridge the current gap between North American, European and Asian prices, said Birol.

The greater availability of gas, especially in the wake of growing shale gas exploration and production across the world, will not only help to create a more competitive and liquid market, but also challenge stakeholders to rethink current pricing structures, he said.

It will also have a strong moderating effect on the price of gas, narrowing current spreads between the US, where prices are about $2.50/MMBtu, Europe, where it trades at an average $8.00/MMBtu, and $18.00/MMBtu in Asia.

“In the medium term we are going to see major transformations in the gas-pricing system,” Birol said. “There will need to be creative [pricing] formulas. I hope to see more and more hub pricing in many regions of the world, which should be a reflection of greater liquidity and availability of gas.”

Tighter regulation

Birol conceded that following the 2008 economic crisis, governments and international institutions, such as the International Organisation of Securities Commission (IOSCO), were seeking tighter regulations of financial and commodity markets, which could affect the entire energy supply chain.

“I think when I look at the evolution of oil prices – which are far too high and volatile – that this volatility is due to several factors, but I would not put speculation as the top reason, either for volatility or for high oil prices,” Birol said.

“The main reason is market fundamentals – supply and demand. Carefully designed regulatory measures are more than welcome in order to bring more transparency [to] the market, but one should also be careful not to bring unintended consequences to the market.”

Birol explained that the introduction of a more flexible pricing mechanism for gas can only happen if there is greater transparency in an opaque environment. He said the IEA was supportive of transposing into the gas sector the aims of the Joint Organisations Data Initiative (JODI), which aims to increase transparency in the oil market.

“Gas transparency is high on the agenda. It has been mentioned at the G8 Camp David summit recently. Together with our counterparties we [the IEA] are very much supporting such an initiative,” he said.

Squeezing coal

In its special report, Golden Rules for a Golden Age of Gas, which was released at the end of May, the IEA predicts that the production of unconventional gas, primarily shale gas, is set to more than triple to 1.6 trillion cubic metres by 2035.

As a result the shale gas revolution, which started in the US and is expected to be replicated as far afield as east Africa, China and Australia, could lead to natural gas replacing coal as a secondary fuel, Birol said.

“In the US shale gas availability exceeded market expectations so strongly that it substituted coal in a big way and a lot of coal became available for exports. That coal brought coal prices in Europe to a historical low.

“What I expect, if the US and China continue shale gas exploration and production, is to see coal as the most likely victim,” Birol said.

Vulnerable renewables

He said that renewable forms of generation were also vulnerable to the shale gas revolution, but insisted that, with support from governments, production from clean sources of energy ought to continue.

He said that even in an era of low gas prices, there is a case for renewables generation, arguing that the gas sector itself may support renewable forms of generation.

“I hope renewables will not be affected,” Birol said. “If governments continue their support, gas could in many cases support renewable generation. But my message to governments today is that if they take energy security and climate change seriously, they should continue to support renewable projects. There is a need to support renewable projects despite the lower gas prices.”

Overcoming uncertainty

While optimistic about the future for the gas market, Birol was also keen to emphasise that gas production, and in particular that of unconventional sources such as shale, coal bed methane and tight gas, may come up against a series of challenges ranging from political uncertainty in the US, risk in the Middle East and Africa, cost escalation in Australia, as well as environmental scrutiny.

He reiterated the IEA’s call to the natural gas industry to abide by seven “golden rules” – a set of principles ranging from full transparency to engaging with local communities – that would allow policy makers, regulators and operators to address environmental and social impacts resulting from the exploration and production of unconventional sources of gas.

The IEA estimates that applying the seven golden rules could increase the financial cost of developing a typical shale gas well by 7%.

“Roadblocks can be removed if governments and the gas industry were to increase shale gas production in line with the right rules and regulations and [by] getting a social licence from local communities.

“We may suggest seven local rules for companies. If they are followed, we may see more gas from the US, China, Canada and Australia coming on line.” AS