The Missing Piece in Turkey's Gas Hub Ambitions

The Missing Piece in Turkey's Gas Hub Ambitions

1. European Natural Gas Markets

The international natural gas market has significantly changed since it first emerged several decades ago as an important part of the European energy economy. European international gas trade began with the construction of gas transmission pipelines that were financially secured with long term contracts. These typically linked the contracted gas price to oil prices and included destination clauses that prevented the resale of gas. However, during the 1970’s the British Gas Corporation developed reforms partly in response to Britain’s own North Sea resources moving to a “cost plus” pricing structure. As European gas demand was rapidly increasing after 1970, Russian, Algerian, Libyan, pipeline supplies were added to Europe’s own resources. LNG supplies then expanded significantly after 1990. In 1996 Britain established the National Balancing Point which provided an opportunity to have more innovative natural gas contracts. Nonetheless, Continental Europe remained dependent on conventional contracts with Russia, the Netherlands and Norway indexed to oil prices. The rationale for such linkage was quickly disappearing as oil-to-gas switching became less of a factor in the power market as oil-fired power generation began to quickly disappear except in Italy and Spain. Later such switching became less significant in heating sector as well.

By 2008, it became apparent that the LNG supplies that had been intended to supply a large gas-thirsty U.S. market must be sold elsewhere. Much of this flowed to Asian, Middle East and Latin American markets but 30 BCM/yr. arrived in Europe since 2010. The pressure of rapidly rising and volatile oil prices from 2002 to 2008, the following price collapse and recovery and sharp increase after 2011 placed considerable stress on oil price-linked gas customers and drove a Europe wide gas market reform. The decline of oil-linked contracts has been very significant in North West Europe, less so in Central Europe while they are common in South East Europe and Mediterranean Europe. Despite the continuation of oil-price linked contracts, gas-on-gas competition has caused Gazprom to make pricing concessions to avoid losing market share. Nonetheless, European hub prices and oil prices remain highly correlated bringing into question whether natural gas and oil prices have actually become de-linked.

With the growth on LNG trade in the 1980s, there could have been an opportunity to move toward more flexible contract terms considering the flexibility of LNG transport to serve any destination with a liquefaction facility. However, supplier countries, particularly Qatar, were successful in maintaining a negotiating advantage and replicated the type of contracts that were more suitable for financing pipelines. Long term, oil-linked, destination clause contracts remained the norm for LNG trade. While a spot market for LNG would have been technically feasible, destination clauses ensured that it would not be significant and similar to what had happened with pipeline contracts gas customers needed to rely on long-term LNG contracts to achieve security of supply.

This picture began to change with the emergence of U.S. LNG supply. Because of the relatively unique circumstances that caused the emergence of U.S. LNG exports, the requirements of U.S. LNG exporters were quite different than export projects that involved LNG and natural gas supply infrastructure. In the U.S., large volumes of spot natural gas could be purchased by U.S. LNG exporters with little impact on U.S. gas prices since U.S. LNG exports constitute a small percentage of a large and price-elastic U.S. supply. U.S. LNG exporters offered contracts that did require “take-or-pay” for the gas. The contracts only needed to secure a return on liquefaction investments. In addition, destination clauses did not offer the advantages to U.S. LNG exporters that previous LNG exporters aimed to achieve with them. Consequently, they were dispensed with making U.S. LNG contracts more attractive. As U.S. gas prices had become among the lowest in the world, the prospects for U.S. LNG exporters gained considerable attention. U.S. LNG contract terms began to impact the world LNG market far more than the volumes of these first contracts might otherwise have implied. While the growth of U.S. LNG exports stalled due to the collapse of world LNG prices now, with the emerging second wave, the U.S. is expected, along with Qatar and Australia, to have roughly equal shares of approximately 80% of the world’s LNG trade. Regardless of the influence one wants to attribute to the introduction of the liberal U.S. LNG contract terms, the world LNG market has evolved significantly since 2010. The percentage of spot LNG traded has increased from less than 10% (2010) to close to 30% (2018). Also LNG contracts are now typically available for short periods of time (e.g., 5 years).