海角大神

Should Japan invest in European Shale Gas?

I think so and here鈥檚 why:

Natural gas pricing is a complex subject tied to seemingly unconnected multiple variables that simply don鈥檛 lend themselves to a simple narrative.聽 That doesn鈥檛 stop most people trying to create one. If they want a simple life, these people should get out of the big money and go open a laundromat or something. Natural gas pricing is a high impact multi-billion dollar issue. This may explain why those who go for the natural gas is just another fossil fuel narrative just can鈥檛 get gas pricing either. Their Peak Gas narrative is essentially we鈥檙e all using a lot of a declining resource and we鈥檙e doomed, or if we stop we鈥檙e doomed anyway or we can get out of it spending a trillion euros to go green. In which case we鈥檙e doomed and broke. As an aside, peakers are often as unaware of, and uncomfortable with, the success of energy efficiency on the demand side as they are with shale on the supply side, denying the good news reality of each.聽

A key issue in Europe remains that some continue to refuse to accept that the shale revolution will have consequences in European markets.

Under this scenario, European shale gas won鈥檛 evolve for a variety of reasons and the comfortable world of rising gas prices that underpins European energy policy in other areas will remain intact. 聽

More and more conventional experts are joining me in pointing out that without so much as a molecule of shale gas, European markets have already been affected by North American developments. One of those experts is Jonathan Stern of Oxford Energy Institute, who while he didn鈥檛 write the book on gas pricing,he didedit it聽and everyone who purports to be an energy expert needs to read it.

Jonathan has 40 years of experience, knows a lot about Russian gas and was not one of the first out of the starting gate on shale to be polite, and remains a doubter over European shale. He wrote to the聽FT the other day calling out聽their usual reverential approach to whatever Ofgem says, on this occassion on international gas prices.

Again, Jonathan is not a natural optimist who throws caution to the wind, so his opinion that it鈥檚 complicated would be a massive sell signal from anyone else. I point this out to set the scene for this from the FT, who remain far better聽informed on global gas聽than at home:

Let's look at some trends we鈥檝e been seeing in Japan recently:

Japan鈥檚 import costs for LNG have risen by several tens of billions of dollars and trillions of yen since March 11 2011.

Despite Japan being stuck for many years in a recession that forces many people to live at the standard of living of say, Switzerland, even Japan is seeing energy costs providing a systemic shock that cannot continue. In that respect they are no different than Europe, but at least Japan is confronting the issue. This is especially true since the election of Prime Minister Shinzo Abe last December, although the trend towards聽refusing to countenance the old ways聽started last September.

Less than two months after taking office Abe was in Washington seeking to hurry up US LNG exports to Japan. But even more importantly he is putting his money where his mouth is:

Meanwhile, LNG is a key political issue and the key driver to reducing them is by removing the link to oil indexed prices. Going back to Europe, oil linked prices, so beloved due to their simplicity by simple people such as Ofgem, journalists and Gazprom, have been disrupted by LNG pricing reflecting the Atlantic Basin inflection point of US shale.聽

There are a number of reasons why Japanese prices have not been similarly effected. Japan imports more LNG than anyone else into a market with minimal domestic production. In a constrained world, Japan had no choice, and was even happy, to pay oil linked prices for security of supply. In the new world where oil is so high yet supplies of LNG are increasing post 2015, inevitably new realities are dawning.

A report released yesterday by the International Energy Agency offers a full discussion of Asian price development. For those, reading this during the dry cycle who still seek the聽Reader鈥檚 Digest explanation,

Accordingly, Asia must develop a competitive gas market, which is only in it鈥檚 most early days.聽 It鈥檚 complicated by LNG prices soaring in the short term. Until new export capacity develops both from export terminals and shipping, the next couple of years don鈥檛 look promising. This winter we鈥檝e even seen Japan spot LNG cargoes go above $20, quite someway north of oil linked prices. This is due in the short term to a drought in Brazil leading to them paying any price and Japanese and Korean buyers having to trump the suddenly booming Brazilians, an example of multiple variables yet again. 聽

Sooner or later it will rain in the rain forest again, and LNG from Angola, the US and later on, Canada and East Africa and the East Med, will provide liquidity that will make supply far less problematic as soon as two years from now and certainly by 2020.

That will mean the inevitable development of some sort of Asian, and thus global gas market. It鈥檚 going to happen, but what will it look like? 聽

In a gross over simplification for those who require one, I think the dual role of Brent and WTI in the oil market provides precedents as to how a global gas market could operate. The two oil blends provide price signals for many smaller individual markets and even when they vary as much as they do today, they don鈥檛 operate entirely independently. Effectively all oil is the same price. Even when it isn鈥檛.

Similarly, Asian Hub Prices could be a synthesis of Henry Hub and European Prices. (The UK NBP is thought by many to be imminently replaced by a larger European price index).

However, back to the here and now, and we already have seen some spot cargoes to Japan indexed to at least some elements of UK NBP. We don鈥檛 necessarily need to wait until a formal market exists - in some ways it already does

Back to the original topic, and Japan must ask what they wish to achieve and the answer is simple: They want access to world prices. So far they seem to think聽Henry Hub聽will provide them and are willing to spend聽$10 billion聽to do so:

The way this would work is the Japanese Government gives loan guarantees to insure the massive sums needed for shale development in fields, pipelines and LNG plants. 聽

But thinking outside the bento box here, a similar outcome could be achieved by simpler means. Means that are no riskier than the LNG market but a lot cheaper and probably quicker, and involve investing in European shale gas. If, or as I like to say when, European shale is successful, Japan will reap two major advantages:

• In the local European market, increased gas supply would put further downward pressure on NBP/TTF prices, and thus any Japanese LNG contracts linked to them.
• Increased supply would mean world LNG prices reflecting reduced European demand. In effect, the only major LNG market remaining would be Japan. Does that sound far-fetched? Only as far-fetched as US LNG exports sounded four years ago.

The above scenario will happen anyway. But perhaps Japan and European shale explorers could act in concert to make it happen sooner. Sooner in fact than investing in outback Australia or Canada and building pipelines and terminals, which have their own risks.

I鈥檝e spoken to Japanese investors before and they were happy to invest billions at 聽low interest rates for sure things, but hesitant to risk tens of millions on what are considered high risk long term exploration projects. 聽

Until now, we haven鈥檛 had sure things in Europe, but we鈥檙e getting closer every day. Even a month ago, we wouldn鈥檛 have seen聽headlines like this聽example:

France (and everyone else) is waiting to see what UK shale gas turns out like. Let鈥檚 not forget the possibility of a Polish surprise or two. We could envisage a future, not so far fetched, where some or even all the negatives about European shale get turned around. That鈥檚 an outcome that I have no doubt will happen. The question is when.The answer: you鈥檇 be surprised.

People who go looking for problems often find them. Those obsessed with risk, stay home or sit in the laundromat. But those who see challenges and rise to meet them will certainly be sometimes disappointed.聽 Sometimes however, they will be rewarded.

If Japanese companies could get even a portion of the guarantee program, investments in European shale would entail far less risk, and would achieve the outcome the Japanese government seeks, i.e pushing the reset button on LNG pricing, at a lower price. Sometimes its best not to think about the journey and to concentrate on the destination.