Natural gas trading to become more like coal, not oil

Wed Nov 21, 2012 4:18am EST

* Coal, gas have similar supply and demand patterns

* Australia, USA become coal and gas exporters

By Henning Gloystein

LONDON, Nov 21 (Reuters) - New natural gas discoveries and rising demand are changing gas from a cluster of regional markets into a global marketplace, but instead of becoming a second oil market gas is likely to become more like coal.

Because gas and oil were being produced largely by the same exporters and both fuels were often used in the same industries, gas has historically been pegged to the oil market through long-term contracts.

But a rising disconnect between gas and oil suppliers and new bilateral contracts between exporters and their customers based on regional gas exchanges mean that gas, like coal, is more likely to take its cue from specific regional prices rather than global benchmarks, such as oil's Brent crude.

"A new relationship is developing between oil and gas prices," Axa Investment managers said in a research report published this month.

Additionally, the rise of new gas supplies from countries that don't export oil, as well as the emergence of Asia as a major demand hub, have boosted trading of liquefied natural gas (LNG).

This will shift gas trading away from pipelines towards a seaborne commodity set to emerge next to coal as the world's dominant fuel for electricity generation.

"More LNG terminals ... mean liquid fuels can come from anywhere," Axa said.

This would mirror developments previously seen in the coal market, which emerged as a globally traded commodity in the second half of the 20th century as suppliers around the world began serving centres of big demand in America, Europe and Asia.

Global LNG trading is much younger, and as a result of the immature market, LNG prices differ widely by region.

Currently, North America benefits from the lowest gas prices at around $3.5 per million British thermal units (mmBtu), while Asian importers have to pay almost $14 per mmBtu for LNG imports.

Europe, which relies more on pipeline imports from Russia, Norway and North Africa, is priced in between at around $11 per mmBtu.

But analysts say that prices will converge as the market matures.

"Rising LNG supplies are likely to lead to increasing price connectivity between regions and a degree of price convergence," the International Energy Agency (IEA) said in its latest World Energy Outlook to 2035.

This would take the gas market in the direction of coal, where regional prices vary but at much lower differentials than the current LNG market.

Prompt physical deliveries for Australian coal currently cost around $85 per tonne, and South African cargoes are priced around $83 per tonne.

LOW SPOT TRADING VOLUMES

Rising global gas supplies do not necessarily result in more liquidity of the traded commodity.

Despite massive combined annual demand of 6.3 billion tonnes of oil equivalent (3.6 billion tonnes for coal, 2.7 billion tonnes for natural gas), LNG and coal trading are marked by low physical spot volumes.

Oil, by contrast, is one of the world's most traded products although its annual demand for physical cargoes of 4 billion tonnes is not much bigger than that of coal.

The reason for the low liquidity in coal and gas is that these products are usually supplied under bilateral long-term contracts between supplier and customer, leaving only small volumes to be freely traded.

Both established LNG exporters such as Qatar, as well as upcoming suppliers such as the United States and Australia, prefer long-term supply contracts over spot trading.

This too follows the trend in coal, where bilateral long-term contracts dominate the market.

The World Coal Association says that only around 15 percent of global coal consumption is internationally traded.

AUSTRALIA, USA JOIN EXPORTERS

In terms of supply and demand, gas and coal markets are also becoming more similar.

On the demand side, traditional hubs such as North America and Europe are seeing increased competition for the fuel from Asia, especially China and India.

In coal, China is already the world's top importer.

On the supply side, Australia is already a major exporter of coal, and the country is poised to become a top supplier of LNG.

In North America, which is both a large coal consumer and miner, the recent shale gas boom has meant U.S. coal companies have begun to export in order to find new customers.

Its high shale gas reserves mean that U.S. gas producers are also planning to become LNG exporters, adding another supply source to the world gas market.

"We project that North American exports of LNG reach 35 billion cubic metres (bcm) by 2020 and more than 40 bcm by 2035," the IEA says.

In Africa, Mozambique and Tanzania hope that recent offshore gas discoveries will lead to an LNG export bonanza.

With South Africa, the continent already has a major coal exporter. (Editing by Jason Neely)

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