Issue #1 March 2015

In Focus

Where will Europe'ssupply come from in

2015?

Security of Supply

Featuring:

European Gas Security: Should we beworried about supply, demand or flowchanges?

Can LNG ride to the rescueof Europe?

Opec is dead: Theoil war could crownAmerica as theglobal swingproducer

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INSIGHTCONTENTS

Issue #1 March 2015

In this edition...

Welcome

Insight

Victoria Chatterton, Flame Conference Director

European Gas Security: Should we be worried about supply,demand or flow changes?Jonathan Stern, Chairman, Natural Gas Research Programme & Senior ResearchFellow, OIES

Can LNG ride to the rescue of Europe?Thierry Bros, Senior Analyst European Gas & LNG Markets, Societe Generale

Fresh PerspectivesOpec is dead: The oil war could crown America as the globalswing producerJohn Hulsman, Geopolitical Expert & Life Member, US Council On Foreign Relations

Industry OpinionsAsk the experts: European security of supply

What do you think? A visual look at the industry

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INSIGHTWELCOME

Flame may just be once a year but wouldn’t it be great if you could hear what our speakershave to say on the industry issues as they evolve all year round? With that aim we'd like tointroduce 'Flame in Focus', the digital magazine powered by industry contributions to keep youinformed all year round.

Issue #1 March 2015

Welcome to our first editionof 'Flame in Focus'

Featuring natural gas community news, articlesand industry research powered by Flame's expertspeaker faculty.

A new edition of ‘Flame In Focus’ will be published every two months. Make sure to keep aneye out for our February edition which will look at the future role of gas in the energy sector.

In the meantime, we'd love for you to join in the discussion on the Security of Supply - feelfree to reach out to us online via LinkedIn or Twitter, or join us in Amsterdam in April.

Victoria ChattertonFlame Conference Director

The concept

The Febuary theme: Security of SupplyFor our first edition we have zeroed in on security of supply which is top of the industry’sagenda due to the current geopolitical, economic and environmental challenges we face. Weare so glad that Jonathan Stern, Thierry Bros, Wolfgang Peters, Cordi O’Hara and JohnHulsman have agreed to share their views on this vital topic!

When can you expect 'Flame in Focus'?

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European Gas Security: Should we be worried about supply,demand or flow changes?While all the discussion of European gas security in thepress is about Russian gas and the ongoing Ukrainecrisis, those involved in gas markets have other thingson their minds. While one should not be over-confidentit seems likely that we shall get through the winterwithout a major interruption of Russian gas throughUkraine.

INSIGHTINSIGHT

While all the discussion of European gas security in the press isabout Russian gas and the ongoing Ukraine crisis, thoseinvolved in gas markets have other things on their minds. Whileone should not be over-confident it seems likely that we shall getthrough the winter without a major interruption of Russian gasthrough Ukraine. However, preliminary data for 2014 show thatEuropean gas demand fell 13% compared with the previousyear, continuing a decline which started in 2009 and has reduceddemand to the levels of the 1990s. Many national markets haveexperienced double digit reductions with nearly new and highlyefficient gas-fired power stations being mothballed, and someolder stations permanently decommissioned. Most projectionssuggest that overall European demand will not recover to 2010levels until the mid to late 2020s. Given that the traditionalapproach to European gas security was to assume that demandwould increase, but supply would fall, the question now iswhether we should be more worried about security of supply orsecurity of demand?

Possibly we should be worried about both. Analysis of the supplyside suggests that conventional gas production from the UK,

Jonathan Stern

Issue #1 March 2015

Chairman, Natural GasResearch Programme& Senior ResearchFellow, OIES

Jonathan Stern will be hosting amorning session titled 'Security ofSupply & the Fall out from theWinter', dedicated to determininghow Europe is mobilising.

For more information on this sessionvisit www.icbi-flame.com.

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Norway, Netherlands and other Continental European countries will decline by more than 100Bcm/year (or 40%) by 2030. While the media is full of stories about European shale gas, thereis very little prospect of significant production over the next decade. Much more promising arethe prospects for biogas and biomethane, despite the current need for significant subsidy. Asfar as imports are concerned, Russia is the only major expansion source for pipeline gas. Thesituation in North Africa is not promising: Egypt is becoming a gas importer, Libya is sufferingfrom ongoing political instability, and the Algerian production and export outlook seems unlikelyto improve in the wake of another elatively unsuccessful licensing round last year. All haverapidly increasing domestic demand fuelled by subsidised prices which are proving difficult toreform. The much-discussed Southern Corridor will yield 10 Bcm/year of gas by the end of thisdecade, with the possibility of increasing that figure in the 2020s.

INSIGHT

Issue #1 March 2015

The major prospects on the supply side rest with LNG. European import terminals have beenrunning at less than 30% capacity for much of the post-Fukushima period, but as Asiandemand weakens and new supplies from Australia and the US come on stream over the nextyear, cargoes are already showing signs of returning to Europe. This is good news for the nextfew years but the 2011-14 period demonstrated how quickly Europe can lose LNG when Asianeeds it.

What might all of this add up to? The minimum seems to be significant changes in flows asUkraine attempts to attract non-Russian gas, while Gazprom seeks to reorient more than 60Bcm of its exports to Europe away from Ukraine and across the Black Sea through a new`Turkish Stream’ pipeline system. At the same time markets will be adapting to increasedvolumes of LNG, increased interconnection of grids and the introduction of a completely newEU gas transportation regime, as the network codes are rolled out over the next few years.Whether security will be threatened depends how that threat is defined and for which groups ofstakeholders. But these are challenging and rapidly changing times!

While the media is full of stories about Europeanshale gas, there is very little prospect ofsignificant production over the next decade.

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Can LNG ride to the rescue of Europe?

As Russian spare capacity (to produce and shipgas) is massive, Europe can balance its reduceddemand with or without LNG supply. In short,Europe is the swing receiver of LNG supply andbalances its demand thanks to Russia.

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In 2011-2014, with poor LNG supply growth, Europe saw lessand less LNG as it was needed in Japan to mitigate theFukushima disaster - 6.9% of worldwide supply was needed toreplace part of Japan’s missing nuclear power-generatedelectricity – and in China due to strong demand growth.

Thierry Bros

Issue #1 March 2015

Senior AnalystEuropean Gas & LNGMarkets, SocieteGenerale

Thierry Bros will be participating inthe 'Security of Supply and the Fallout from Winter' session takingplace at Flame 2015. For moreinformation visit www.icbi-flame.com

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2015e: no LNG reload in Europe should weigh on prices

INSIGHT

Spot LNG prices are depressed due to falling oil prices and low demand in Asia. This leads usto assume there will be no LNG reload in 2015e.

As the amount of gross imports in the past two years was exactly the same, we can assume thisis the minimum non-flexible level and that the only flexibility in the system was the ability ofcompanies to re-load LNG from Europe when Asian spot prices were much higher than thecontracted prices for this LNG supply with Europe as a destination clause. This means netimports in Europe in 2015e will be the same as the gross import levels witnessed in 2013 and2014 as the system now has no flexibility price-wise to re-export LNG. This extra LNG couldslightly reduce Gazprom’s market share in 2015e vs 2014e.

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Issue #1 March 2015

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2020e: US LNG an expensive bet or a rational hedge?

INSIGHT

As we have repeatedly pointed out, Russia and Norway have market power in Europe. With morethan 50% market share for gas in Europe, Russia and Norway have theoretically even morepower on European gas markets than OPEC has on oil markets. The latter provides 32% of theglobal oil supply (not to mention the fact that it has given up its market management role). Webelieve that both Russia and Norway have a vested interest in keeping gas prices in Europebetween a floor that we estimate at 5$/MBtu and a ceiling that is either the cost of new gas(estimated at 9.5 $/MBtu for pipe gas from the Caspian Sea) or HH+6 $/MBtu for US LNG.

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Our model of 50 mtpa of US LNG exports in 2020e translates into 69 bcm of LNG reachingEurope. We believe this is the maximum Gazprom (in a business as usual situation) will allowto berth in Europe.

Extra US LNG (above our 50 mtpa forecast) at a time when the long-term decline in gasdemand in Europe is set to resume could trigger a price war as we suspect Gazprom is notwilling to reduce its volume below the 2012 minimum level.

Issue #1 March 2015

Europe is and will continue to be the “dumping” place for excess LNG as China has contractedenough gas until 2023e. So if the LNG supply growth becomes excessive, LNG supplies inEurope will return to levels not seen since Fukushima.

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And as Gazprom has both market power and the lower supply cost, it can engage in a price warthat will push US LNG out of Europe and will lead to US trains having to stop production. But tostop US LNG cargoes from berthing in Europe, the European price will have to be around HH +$2/MBtu as liquefaction (c.$3/MBtu), regas (c.$0.5/MBtu) and part of the shipping costs (c.$0.5out of a total of $1.5/MBtu) are sunk costs. After mothballed regas in the 2010s, we could seemothballed LNG trains in the US in the 2020s.

So far, 45 mtpa are under construction and too much LNG supply could entail a price war withGazprom that could reduce European prices to a level where US liquefaction plants could bemothballed. Too much US LNG could be an expensive bet…

But if Gazprom doesn’t renew the transit contract via Ukraine that expires on 31 December2019, Europe could face a shortage of c.40 bcm/y of Russian gas This is because the gas(even if produced in Russia) won’t be able to either transit via Ukraine (44 bcm of Russian gastransited Ukraine for Europe in 2014 or be transported via the Opal pipeline where Gazpromhas failed to get an exemption from the European Commission to fully used its nameplatecapacity. This means that Europe either gets delivery of those volumes at the Turkish border(an option suggested by Gazprom, which wants to build the Turkish Stream instead of the nowscrapped South Stream – we believe this will not be acceptable to European institutions andcompanies) or it tries to provide additional LNG supply as extra pipe gas is unlikely. (Shale gasin Europe – if any – could only partially mitigate for the decline of domestic conventionalproduction. Meanwhile, Norway doesn’t want to increase its production capacity and Azeri gas is unlikely as we continue to believe that Shah Deniz 2 gas is not going to reach Europe in 2020e). In this case, too much US LNG could be a rational hedge…

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Opec is dead: The oil war could crownAmerica as the global swing producerThis piece first appeared on City AM

INSIGHTFRESH PERSPECTIVES

Properly defined, an efficient cartel possesses three basicproperties: the ironclad discipline of its membership; acommanding market position; and formidable barriers tointerlopers entering the closed market. By every one of theseanalytical benchmarks, Opec – the most famous and fearedcartel in the world – shows itself to be in its death throes. If this isso, beyond the compelling headlines of the current oil war lies atruly game-changing moment for the global economy.

The November 2014 meeting – when the cartel could not agreeto cut production in response to tumbling world prices – signalsjust how fractious Opec has become. Both inefficient Iran andVenezuela, acutely suffering from an oil price that has halvedover the last six months, were desperate for the cartel to do whatit has so often done in the past: support global price stability forits membership. But Saudi Arabia has made it quite clear that itsinterests fundamentally diverge from those of Opec’s morehard-pressed members. Little interested in price stabilisation, theSaudis care primarily about protecting market share. Thisfundamental disagreement simply can no longer be papered over.

John Hulsman

Issue #1 March 2015

I well remember suffering through my collegemacroeconomic class, steeling myself to stayawake through the consumption of gallons ofcoffee. However, one of the rare things thatpiqued my interest was the theory of cartels.

John will be giving a guestgeopolitical address at Flame andthen will be hosting a specialWashington-inspired simulation.This simulation, Washington-StyleScenario Game on Security ofSupply in Europe, will be open to30 Flame attendees to join, and isdedicated to looking at thepossible challenges and outcomesto security of supply.

For more information about John’spresentation and his simulation,visit www.icbi-flame.com.

Geopolitical Expert &Life Member, USCouncil On ForeignRelations

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INSIGHTFRESH PERSPECTIVES

Without the Saudis (who account for more than 16 per cent of the world’s proven oil reservesthat are the easiest and cheapest to extract), Opec is a paper tiger. All along – and incontradiction to tardy conventional wisdom – I’ve believed Saudi oil minister Ali al-Naimi, whohas clearly stated that the Saudis want Opec to continue pumping 30m barrels per day (bpd)come hell or high water. Recently, al-Naimi stirred the pot further, insouciantly claiming that thekingdom was perfectly content to let prices fall to $20 a barrel, as the Saudi’s production costsrun to only a meagre $5 a barrel. One can hear the whimperings in Tehran, Moscow, andCaracas from here.

If Opec clearly lacks discipline, its position in the global market isn’t what it used to be; itsmarket share has declined from around 50 per cent in the 1980s to merely one-third today. Oilprices falling out of the sky reflect a supply shock as much as anything else, with non-Opecmembers Russia and the US flooding the market over the past few years, while the cartelmerely treads water.

Issue #1 March 2015

Saudi Arabia has made it quite clear that itsinterests fundamentally diverge from those ofOpec’s more hard-pressed members

The US shale revolution alone has placed an additional 3m bpd onto global markets over thelast three years; shale has become the grand disruptor. Russia has followed suit, with Moscowpumping a post-Soviet record of 10.58m bpd in 2014. So the third property of cartels – thatthere are high barriers for outsiders to market entry – also fails the laugh test in regards to Opec.

A series of startling changes follow on from Opec’s demise. First, all of these intractable realitiesmean that, in the short term of the next six months, the oil price is set to continue downwards.There is a floor to the oil war, however – Saudi geopolitical sensitivities. On the one hand, theywant nothing so much as to drive a stake through the heart of the US shale revolution; on theother, they certainly do not want an open economic confrontation with Washington, whichremains the ultimate guarantor of Riyadh’s security in a very rough neighbourhood. As such, theAmerican shale industry can suffer, but not too much.

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INSIGHTFRESH PERSPECTIVES

Second, while the Saudis are certainly on course to win the short-term oil battle against theAmericans, they could well lose the war. Riyadh can extract and make money at a far lowerglobal price than the shale industry; this, coupled with the kingdom’s massive foreignreserves of $900bn, mean that they are well-placed to begin to drive some US producerstemporarily out of the market in the second half of this year.

But by knobbling Opec, Riyadh is unwittingly anointing a new global swing producer – its shalerivals. For the shale industry can far more quickly ramp up and dial back drilling operations inresponse to price movements than the conventional oil industry. In other words, American shalehas the scale and a better capacity to nimbly add and subtract barrels from the global total thananyone else in the post-Opec era. If this proves true, the most startling long-term realityemanating from the present oil war is that America, of all places, may find itself the new globalswing producer over time.

And that does nothing less than change the world.

Issue #1 March 2015

JOIN THE CONVERSATION

What do you think about the security of supply?Connect with us on Twitter (@FlameConference) and take part in the discussion

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INSIGHTINDUSTRY OPINIONS

Issue #1 March 2015

Ask the ExpertsWhat’s the most promisingdevelopment for European securityof supply and why?

Dr Wolfgang PetersHead of Supplies, Caspian Central Asia & Russia, RWE Supply &Trading

In my book, the most promising development for European security ofsupply is the advent of liquid traded gas wholesale markets. What’smore, the respective national hubs are pricewise strongly correlated. Why is that positive? Because, in a functioning European tradedwholesale market, security of supply becomes a function of price ratherthan being a matter of physical dependency. To be more blunt (and a bitsimplistic to make the point): If Russian supplies drop, the price will riseand attract e.g. LNG (for which Europe avails of plenty of – presentlyunderutilized – regas capacity).

Cordi O'HaraDirector, UK Market Operation, National Grid

Increasing levels of supply diversity as Europe continues its route tomarket harmonisation and the global market becomes more liquid

present the biggest opportunities for ensuring security of supply forEurope."

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INSIGHTINDUSTRY OPINIONS

Issue #1 March 2015

What do you think?At the past two Flame conferences we asked for your opinion onSecurity of Supply. Here are the results of what you predicted for2015. Do you think we're still heading in the right direction?

Join us at Flame 2015

Want to take part in the conversation about Security of Supply?

Connect with us online

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Editor: Lucy EldredEditorial credits: Victoria Chatterton, Jonathan Stern, Thierry Bros, JohnHulsman, Wolfgang Peters & Cordi O'Hara.

Credits