By Ivan Marten | –
Today’s low oil prices have already had a significant impact on much of the global energy landscape—including the U.S. natural-gas market. How will the U.S. market react if oil prices remain low for an extended period?
Let’s start with demand. The U.S. Energy Information Administration (EIA) projected that domestic demand for natural gas would reach 770 billion cubic meters in 2020, up significantly from 690 billion cubic meters in 2014. This projection, however, was issued in early 2014—before oil prices began their descent—and assumed demand growth across all major segments. Given that oil prices have been roughly halved since mid-2014, however, some of those assumptions—specifically for exports and transportation—must be revisited.
Look first at exports. The EIA projected that U.S. exports of liquefied natural gas would exceed 70 billion cubic meters in 2020, propelled by the price competitiveness of U.S. supplies in the global arena. But the fall in oil prices undermines that assumption. For U.S. liquefied natural gas to appeal to buyers in Asia and Europe, differentials between U.S. gas-hub prices and prices in Asia (which are indexed to the price of oil) and Europe must be sufficiently wide. But these differentials have narrowed considerably as oil prices have fallen. Given this, and the cost of transporting liquefied natural gas overseas, the economics of the U.S. exporting liquefied natural gas become increasingly less compelling, likely leading to delays in, or cancellation of, some export-related development projects. In light of the above, we now expect U.S. natural-gas exports in 2020 to be in the range of 40 to 50 billion cubic meters.
Projections for demand from transportation must be similarly ratcheted down. The EIA estimated that demand would reach approximately 2 billion cubic meters in 2020, with high price differentials between natural gas and oil products, most critically diesel fuel, leading to increased substitution of the former for the latter. But with persistent low oil prices, that seems far less likely.
Now consider supply. Sustained low oil prices will lead to a smaller supply of natural gas in the U.S. market, since oil and gas companies are likely to scale back development. There are several reasons for this. One is that these companies’ current upstream investments were established when oil was priced at $100 per barrel. With oil prices at current levels, the costs of many of these projects are now high compared with their expected revenues, and it will take the industry some time to adapt its cost structures to the new environment. Until that happens, investment activity will be curtailed. This will be exacerbated by the fact that, with cash flows from their currently operating oil fields shrinking, oil and gas companies have less cash to invest. This will force them to be increasingly selective in the investments they do make, and projects with relatively high break-even prices, which would include some gas-development projects in the current environment, could be delayed or cancelled.
Considering these dynamics in aggregate, it seems clear that a prolonged period of low oil prices would lead to a smaller U.S. natural-gas market. It would also limit the U.S.’s role as an exporter of liquefied natural gas, slow the development of natural gas’s role in the transportation sector, and reduce the price competitiveness of U.S.-produced natural gas on the global market.
Iván Martén is a senior partner at the Boston Consulting Group, and the global leader of its energy practice.