Commodity Analysis

Supply glut to keep natural gas prices low

Anand Kalyanaraman | Updated on June 02, 2019 Published on June 02, 2019

Presents India with a good window of opportunity

A dichotomy is playing out in natural gas — with global prices falling and local prices rising. From about $9.3/mmbtu (metric million British thermal unit) a year ago to $4.7 now, the price of the Japan/Korea Marker (JKM) — a key benchmark for liquefied natural gas (LNG) imported by Asian countries — has crashed nearly 50 per cent.

This is due to a supply glut in the global LNG market that has seen many international gas benchmarks touch multi-year lows. Meanwhile, counter-intuitively, the price of natural gas produced in India has been rising steadily.

In the latest half-yearly revision for the April-September 2019 period, the domestic gas price increased nearly 10 per cent sequentially to $3.69/mmbtu. The increase in local prices is due to the peculiar pricing formula for domestic natural gas.

It is the weighted average price of four global benchmarks (the US-based Henry Hub, Canada-based Alberta gas, the UK-based NBP and Russian gas) in the previous year, and kicks in with a quarter’s lag. So, the price from April 1 to September 30, 2019, is based on the average of the four benchmark prices from January to December 2018.

Global gas prices, while on the decline for the past many months, were rising for a good part of the last year. So, the domestic gas price now has been hiked, as per the formula. In short, global and local prices are not in sync.

Price divergence

This divergence in price patterns has meant consumers of local gas have seen their bills go up while users of imported spot gas could have seen their bills moderate. For instance, in April, city gas distributors Indraprastha Gas and Mahanagar Gas increased the price of compressed natural gas (CNG) and piped natural gas (PNG). This was the latest in a series of hikes seen over the past year or so. City gas distributors get priority allocation of domestic gas for supply of CNG used in vehicles and PNG used in households.

Thanks to the formula-based pricing, domestic gas in India has historically been cheaper than imported gas; it is still so, despite the price hikes. But the gap between the prices of imported spot gas and local gas has narrowed sharply due to their divergent price patterns over the past many months — it is now just about $1/mmbtu compared with nearly $5/mmbtu a year ago. This gap could widen somewhat after the next round of gas price revision — when the local price could move down in line with the decline in global benchmarks.

Despite the price hikes over the past year or so, CNG for vehicles and PNG for households remain price-competitive compared with alternatives such as petrol, diesel and LPG. So, consumption demand should remain steady and grow. Meanwhile, cheaper imported spot gas could translate into higher consumption by user industries including tiles, power, fertilisers and refineries, if prices stay low and gas importers pass on benefits to customers.

Over-supply to continue

Over the past couple of years, many new large LNG projects have come on stream globally, adding significantly to global LNG supplies. This includes some major projects in Australia, the US and Russia. While global LNG demand was also healthy due to increased off-take from Asian countries, especially China, it was outpaced by global supply. The supply glut that ensued is likely to continue over the next few years. More LNG projects are expected to come on stream, including in Mozambique, Canada, Qatar and Russia.

On the other hand, the demand outlook seems cloudy due to uncertainties arising from the ongoing trade wars; new cross-country pipelines such as the Russia-China one (The Power of Siberia); a thrust to increase domestic output by gas-consuming nations; and the focus of some major consumer nations such as South Korea on renewables and nuclear energy. Ergo, the global LNG supply glut may continue and global benchmark prices may stay low. This could eventually translate into lower domestic gas prices in India, even if with a lag.

This low-price scenario presents India and its gas importers with a few opportunities. One, there could be windows to re-negotiate costlier long-term contracts that make up the chunk of India’s gas imports. Two, end-users such as power, fertilisers and refineries that baulk at costly imports might be encouraged to increase off-take, thanks to lower spot prices of imported gas. Three, the narrow gap between imported and domestic gas prices allows a leeway for further pricing reform — doing away with the arbitrary formula-based pricing for the domestic gas being produced, and moving towards a true market-linked, arms-length pricing.

When oil price can be market-linked, there is little reason why gas price shouldn’t be. This will encourage domestic gas production. Coupled with acceleration of building gas infrastructure across the country, higher domestic gas output will help India move towards its vision of increasing the share of natural gas in its primary energy mix — from about 6 per cent currently to 15 per cent by 2030.

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