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Read our forum questions below:
July 4, 2014 Why is it that gas prices are so different to oil? Do the prices not track each other?
Thanks for this question Mike. If we didn’t know better we’d think that this question has come from one of the Russian Gas Companies. The reason we say this is because for the last 10 years or so, the Russian gas suppliers have been desperately trying to keep the link between oil and gas prices alive, whereas in reality there is now little correlation between the two products.
Historically this was not the case and gas was priced alongside oil because in general, gas was a by-product of oil exploration (gas reserves typically sitting above crude oil reservoirs). At that time and because gas demand was (relatively) modest, linking oil and gas prices was very common and probably logical, ie, gas was simply a bi-product of oil.
However as gas production technology developed, increasing numbers of gas reserves were located where no crude oil was extracted or even present. In addition (and possibly indirectly related), demand for gas started to explode (boom, boom…and a further boom, boom!). Initially the linking of gas and oil prices continued because much of the gas usage was simply replacing oil for the same purposes. Examples would be heavy industry (glass manufacturing, steel making) and electricity generation (power stations), where power from gas was simply replacing power from oil for the manufacturing process. In fact in these cases, the buyers were actively keen to maintain the link between oil and gas, so that there was consistency in pricing and a benchmark to compare the new supply costs with the old.
Since that point though (around the late 1980’s / early 1990’s) the divergence of oil and gas has accelerated in almost every way: exploration, supply-chain, pricing, uses. The result is that today there really should be no correlation between oil and gas prices as they are fundamentally two separate markets. The likes of Gazprom have of course fought to maintain the link, but this has nothing to do with operational correlations but is purely because the oil price is so high – even if you end up selling gas at a discount to oil (which the Russians have recently done with their mega Chinese gas deal), this still isn’t a bad price if oil is sitting at $110 per barrel.
You only have to look outside the Russian sphere of influence to see clear differences in gas prices. For example in the USA, gas is currently trading at the $3-4 per mBTU (Millions of British Thermal Units – the gas equivalent of $ per barrel), whereas in Europe and the Far East (Russian influence), the price of gas is in the order of $15-20 / mBTU! Calculating equivalent mBTU gas prices with $ per tonne oil prices is notoriously difficult, but if we consider that the European / Far Eastern gas price sits at the top end of oil pricing (ie, $110 per barrel), this would mean that the current US gas price is equivalent to $25 per barrel! Now in reality WTI (the US crude benchmark) is trading at about $95-100 per barrel which only goes to show that where gas prices are open to market influences (rather than supply manipulation), they follow a completely different path to oil.
If only the yanks would start exporting the stuff…
This question came in from Mike in Swansea (July 2014).
April 3, 2014 You paint a pretty gloomy picture for the Nabucco pipeline in your last Oil Market Report and yet still say it is Europe’s best hope for gas security. How so?
The March Oil Market Report certainly generated a fair bit of interest…
Nabucco certainly faces massive challenges, but still does hold a couple of “aces in the pack”. The first one is obviously the increasing EU determination to get the thing done. Yes of course we can all joke about EU bureaucracy, but where there is a political will, things do happen in the end – even in Brussels! So whilst it’s true that Nabucco has been severely hampered by a lack of political will over the last 5 years, we believe that events in Ukraine will bring an increasing focus to this project and we should expect accelerated activity on the Nabucco pipeline, as a result.
The second ace is Turkey and its booming economy – the fastest growing economy in the European area and expected to be the 3rd largest electricity and gas market in Europe by 2020. The country is planning to spend 100bn lira (£50bn) on energy projects over the next 10 years and the Nabucco line is expected to be the main supplier to many of these projects. So you can also expect a re-opening of EU accession negotiations with Turkey on the back of these developments, as Turkey is almost certainly going to become the key to Nabucco’s success.
We received this email from Helena in London
March 28, 2014 I am very interested in your latest article on our country. You seem to know a lot. We have nice summer house in Oblast-Siberia. I would like to invite you. We always interested in protecting people like you. Do not tell anyone of arrangements in case they worry. You may be some time.
That’s a kind offer Vladmir, but we will give it a miss. I will not look as good as you without my shirt.
This latest question/invitation relating to the March Oil Market Report came from Vladimir in Moscow.
March 17, 2014 I enjoyed January’s Oil Market Report on price predictions for 2014, but felt they only touched on the really big issues. Are there smaller, more technical issues that might affect prices this year?
Respect Jackie! You are certainly keen, although you should perhaps get out a bit more…
To answer your question, we see two factors that could shape oil prices in 2014 – both unlikely to grab too many headlines but both significant;
Firstly, the strength of the $ has always had a big impact on oil prices. Put simply, as the $ weakens against other currencies, it means that those currencies can afford to buy more things that are priced in $. For tourists, this might mean they can enjoy a cheaper holiday in the USA or fly to New York and stock up with cheap goods. But in commercial terms, this means that buyers of oil can buy a lot more oil for the same amount of money. Take the UK and today’s oil prices at $100 per barrel. With current exchange rates (circa $1.65 per £), a UK buyer could buy 1 barrel of oil for £61, but if the $ was to weaken versus the £ (say for example, we went up to an exchange rate of $1.90 per pound – roughly where it was in 2007), then that £61 would now buy circa 1.2 barrels of oil.
Such “value for money” might incentivise the UK buyer to take the opportunity and buy a whole lot more oil and if you then extend that concept across the whole world, then the impact on prices becomes apparent. In every country, we have the big strategic buyers (state stocking agencies, big plc’s, large transport infrastructures) increasing their purchases of oil because they can afford more through the weakness of the $. Result = oil prices go up!
Secondly, worldwide interest rates could also play a part in deciding oil prices. Over the last 5 years, interest rates across almost all the major economies have been at record-breaking low-levels. This has meant that a lot of financial funds (pension, hedge) have taken their money out of interest bearing schemes (safe but puny returns) and looked to invest them elsewhere. The elsewhere was often commodities with proven track records of returns, ie, oils, metals and agri-minerals and this has created a buying pressure that has undoubtedly pushed prices northwards. Arguably this is the worst type of speculative pressure, as it simply represents walls of money being invested in oil and simply because historically the oil price has risen and a bet is being made that, that trend will continue.
So central banks now have a very interesting role to play with regard interest rates and indirectly, oil prices. Keep interest rates low and the funds will continue to look at alternatives such as oil – thus keeping oil prices buoyant. Start increasing interest rates on the other hand (for example to encourage prudent savers, to combat inflation or to avoid property bubbles) and funds may come back to the safety of central banks, who can now offer more attractive returns. If and when this happens, you could see a great deal of money leaving the (oil) market and that should push prices downwards.
We had this question at the beginning of February 2014 from an anonymous sender – so we will call him / her Jackie Diesel…
December 19, 2013 Is LPG the same as normal mains gas? And is “normal” gas the same as LNG? Please help – there are too many names….!
No shame in being confused Margaret. Only today, I went to buy my wife some face-cream from our local Department Store….Never again.
First things first, LPG stands for Liquid Petroleum Gas and is not the same as “normal” mains gas. It is heavier than air and therefore sinks to the ground, whereas mains gas is lighter than air and rises upwards under normal atmospheric conditions (and therefore presents a much greater risk in terms of gas leaks). LPG is composed primarily of propane and butane, while natural gas is composed of the lighter methane and ethane. LPG has a higher calorific value than natural gas, which means it gives off more energy (heat) but also tends to mean that LPG is more expensive.
There is also a lot less LPG around. This is because LPG is derived from refining oil (hence Liquid Petroleum Gas), whereby the lightest and most flammable components of crude oil rise to the top of the Distillation Tower when heated (just imagine filling a massive kettle with crude oil and then boiling it). LPG is the first crude oil component to evaporate off, whilst petrol and kerosene (jet fuel) will also rise to the top of the mixture (but will not evaporate). At the same, heavier grades of fuel such as diesel and fuel oil will sink to bottom of the mixture.
On the other hand, Natural Gas is gas that is extracted directly from underground rock formations. Like crude oil, it is formed when layers of buried plants and animals have been crushed by extreme geological pressures over thousands of years. Often, natural gas sits on top of coal deposits and sometimes can also sit on top of existing oil reservoirs. Before it can be used as a fuel, natural gas must be purified and once this is done, it is typically pumped into the gas main (hence “mains” gas).
Transporting mains gas is extremely cost effective (once the pipelines have been constructed), which is why Western European Countries invested in huge gas networks in the 60’s and 70’s. However, the beauty of LPG is that it can be used where no mains gas networks exist – so in the UK it tends to be a central heating fuel in rural areas and in the developing world, it is used as a heating fuel for both hot water and cooking. LPG is also a much more diverse and useful product than natural gas, in that its uses range from camping gas stoves to aerosol propellants (where it has replaced o-zone depleting CFC’s) and of course in cars as Autogas.
Finally, answering your question on LNG; this is the same as natural gas, but it is gas that has been cooled and liquefied for transportation purposes (hence Liquefied Natural Gas). So whereas, natural gas extracted in the North Sea is simply pumped into a pipeline under the sea and then transported by that pipeline into the UK’s gas grid, natural gas in (say) Qatar is extracted and then liquefied, before being pumped onto a ship and sent to an import facility in (eg) the UK, where it is pumped into the mains gas grid.
As central heating systems across the UK started to go into overtime, we had this question from Margaret in Sutton.
October 14, 2013 The news commentators and politicians keep on referring to the California black-outs as a reason that fixed prices are not workable. What was the situation there and when was it?
Another good question, although we would say the link between Ed Milliband’s energy proposals and the California black-outs has been over-played. The California energy crisis took place in 2000 – 2001 and was caused by questionable / fraudulent activity on the part of Enron, who were selling electricity to the Californian utility companies. However, the latter had not hedged their exposure, so that when Enron pushed prices up by a factor of 10 (by physically restricting the market), the utility companies could not pass these increases on to the consumer. The reason they could not pass the costs on – and here is the link with Milliband’s proposals – is that the utility companies were limited by the Californian State as to what prices they could charge. The result was that costs for the utility companies rocketed and with no ability to charge consumers for the higher prices, they simply stopped supplying electricity – leading to wide scale black-outs and power failures.
However, if the electricity companies had hedged in the first place, the rise in costs from Enron would have mattered less (or not at all) because then the hedge would have paid out on any cost increases. So in theory this situation should not occur in the UK, as long as companies hedge correctly. But then again – on the basis that the Government could not force the utility companies to hedge – the risk of this happening in the UK might be remote, but would still be a possibility.