Confronting the Gas Revolution
Doha’s fight for the status quo
Prepare for the Shale gas boom. Today the phrase is plastered across the world’s leading newspapers with much dramatic effect. They are not alone: seasoned energy experts are predicting the triumph of unconventional gas producers over the energy sector’s old guard by the end of this decade. When it comes to gas, we are told, Doha and Moscow are on their way out and DC and Canberra are in.
Most gas in the Middle East is in conventional sandstone rock formations, which are relatively simple to develop. As recently as a decade ago, gas in non-conventional reservoirs—rock formations that made extraction more difficult and costly—could not be developed at a reasonable profit. New technology has not only made the exploitation of unconventional deposits viable, it has often resulted in gas booms in new production centers. This rising unconventional gas production in countries that are not members of the Organization of the Petroleum Exporting Countries (OPEC) has invited hysteria from all sides. Producers and consumers in Western, Asian, and Middle Eastern markets have fueled an endless stream of projections as to what the increase in non-conventionals and new gas investments would mean for the future of the Middle East, OPEC, and their respective economic and political futures. For Qatar, the world’s largest Liquified Natural Gas (LNG) exporter, the risk of reliance on an industry with shrinking profit margins is driving a change in national strategy and economic behavior.
Such drastic action hinges largely on an expectation that a fundamental shift in global trade flows is imminent, with a predicted expanding market share for non-conventionals. Nevertheless, while it may be appropriate for those countries without pipeline access to non-liquefied natural gas—for example, Hungary—to perceive the rise of the unconventional gas supplier as a threat, European and Asian buyers with dependency concerns are not about to see the world’s traditional producers squeezed out of the market. Most analysts agree that today’s largest suppliers are likely to be able to offload volumes of gas over the coming decade. A gas supply glut would encourage higher global demand, particularly in markets that have hesitated in promoting a fuel switch to gas. Yet growth in one-time, market-price spot sales and the impending death of oil-indexed gas, after several major European utilities renegotiated their long-term gas contracts to link prices instead to the significantly cheaper wholesale gas markets, has suppliers concerned over shrinking profit margins.
But Doha’s fears are not over dwindling market share or capacity constraints. Despite the hype, the world should expect to see Qatar’s role as a global gas heavyweight grow beyond 2015, alongside that of Australia. According to the United States’ Energy Information Agency (EIA), the strongest growth in gas production within the Middle East will continue to come out of Qatar for the next two decades, with natural gas production increasing by an estimated 5.4 trillion cubic feet.
As a strategist with Qatar Petroleum put it, “People are putting Australian capacity anywhere between 60 and 160 million tons over the longer term. That’s a lot of uncertainty in a market governments are banking on.” Thus foreign governments are hesitant to reopen negotiations on existing long-term contracts for Qatari gas. Even in the unlikely scenario that all seven of Australia’s LNG projects come online by 2017, Qatar will still remain one of the largest suppliers of LNG, with the lowest production costs in the world until at least 2040. While Australia may overtake the Qatari LNG market in the next four years, growing gas demands in China and India will eventually open new, larger markets for LNG: as Australia aggressively targets the lucrative Asian market, Qatar seems poised to play a pivotal role in limiting European dependence on Russian gas.
Even if Doha can keep its market share concerns at bay, the emirate must still confront the larger concern of pricing. For Asian and European buyers, a competitive LNG import mix that includes unconventional Australian, Canadian, Norwegian, and even American gas induces competition in the market attractive to suppliers, giving them capabilities to swap contracted flows and to demand an end to higher, oil-indexed gas prices. Emerging LNG players share an interest in keeping the oil-indexed premiums. Unlike RasGas or Qatargas, unconventional producers could face bankruptcy if they are forced to deliver tankers at prices below around USD 8 per million British thermal units (Btu). David Knox, CEO of Santos, points out that Australia is “the most expensive offshore exploration and production location in the world today.” In their fight for market share, though, price collusion among major suppliers seems out of the question. Even though it can develop gas much more inexpensively than non-conventional suppliers, this competitive pricing dynamic has Doha worried about keeping its pockets lined with sufficient netback from price index premiums.
The Qatari gas industry may not go belly up anytime soon, but Doha will likely face some serious budgetary challenges. If Qatari gas sales can no longer count on today’s Asian and European market premiums, the country could begin to face major budgetary risks. In light of the recent patterns of public expenditure and electricity consumption, Qatar has been aggressive in trying to lock in longer and larger term contracts with Asian and European customers while, in anticipation of a supply overhang, accepting short-term contracts on new gas sales with Asian buyers such as Kogas.
What Qatari policymakers should be concerned about are the projections for electricity consumption growth, which reach as high as 10 percent Compound Annual Growth Rate (CAGR). To meet the region’s growth projections, installed power generation capacity requirements over the coming decades must expand to nearly twice the level of current installed capacity by 2020. For a country that has depended almost entirely on natural gas for its power needs, budding supply gaps signal a rising need for more aggressive investment strategies. Doha plans to develop its petrochemical and heavy industry sectors and build infrastructure in anticipation of hosting the 2022 FIFA World Cup.
Fears of a future of diminishing returns and domestic strains may explain the rise of the Gulf nation’s furious activity in steel, fertilizers, fuel additives, polysilicon, petrochemicals, and capital markets. It also underwrites Qatar’s hedging strategy in LNG projects abroad and its increasing attention to the expensive Barzan gas development project, set for full completion in 2015. After Barzan, there are no large non-associated gas finds that are in development. Qatar’s revenues from LNG sales are more than double what it earns from its crude oil exports. Qatar must ensure a healthy domestic gas supply-demand scenario so that its valuable LNG exports are not jeopardized in the future by untamed domestic gas consumption.
Another mitigation strategy is to temper domestic gas consumption by replacing gas with fuel alternatives in the power sector. Given the vast opportunity cost of crude oil burn, single-cycle natural gas generation and high solar irradiance in Qatar, solar energy has become a key mechanism for cutting domestic power costs—and thus boosting national profits. At USD 0.30 per kilowatt-hour (kWh), the cost of direct burn of heavy fuel oil far outstrips that of both solar thermal and photovoltaic electricity generation.
In a country like Qatar, where the government is responsible for maintaining a vast public welfare system, industrial diversification is the word of the decade. Cheap labor and feedstock costs will allow Doha to undercut the global competition in the panoply of fuel-intensive industries it appears to be pursuing. As a myriad of protectionist policies emerge in the US, Europe, and possibly Asia, Qatar is increasingly responding to cues for new markets. As low profit margins force growing levels of consolidation across every major industry outside of oil and gas, Qatar’s proximity to European markets and low-cost feedstock place the country in a competitive position as a primary exporter of industrial products. But in spite of the popular chant that a revolution is underway, the Qatari gas industry’s days are not numbered.