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$90 barrel prompts new look at gas link to oil
Thu Nov 1, 2007 7:41am EDT
By Simon Webb - Analysis

DOHA (Reuters) - Record oil at more than $90 a barrel has rekindled the debate about a long-established practice of pricing natural gas off oil, but breaking the link is difficult because of the lack of easy alternatives.

Natural gas is much more abundant than oil and is still relatively cheap, but because most gas is sold through long-term gas contracts priced off oil products, a vigorous rally on the oil markets has had an impact on gas.

Some argue gas is still undervalued. Others say gas price rises will erode demand and make power generators turn to the cheaper, but dirtier substitute -- coal.

"It is possible to destroy the future of the business by being too tied to an oil index," Michael Corke, senior vice president at energy consultancy Purvin & Gertz, told a gas conference this week in Qatar.

"The power sector will not be well served by an oil index. It is mainly coal, not oil, that is the competition."

Power generation was expected to provide between two thirds and three quarters of future gas demand growth, he said.

To meet that growth, countries such as Qatar have spent tens of billions of dollars developing liquefied natural gas (LNG).

If demand falls short of expectations, that could damage the hugely expensive LNG industry, Corke said.

By contrast with pipeline gas, LNG is cooled to liquid form so it can be shipped on specially-designed tankers to whoever will pay the highest price.

Its increasing popularity is regarded as a major step towards making gas a global commodity, which should help it to break away from oil, said Jean-Pierre Mateille, general manager for gas and power trading at French energy giant Total.

"You cannot build an industry based on the wrong set of pricing," Mateille told reporters at the conference.

"For years, using oil has worked. But the underlying assumption is that oil is an infinitely liquid commodity. If oil spikes to $100, you may have to contest the assumption. Why should you price what is not a tight commodity on the basis of a very tight one?"

LITTLE CHOICE

One of the principal problems with breaking the link was that there were no easy alternatives, Corke said.

For now, pricing is complex. In Asia, gas is priced against oil. In Europe there is a mix, and in Britain and the United States, gas is priced in its own right.

Differences between old and new long-term supply agreements and spot market prices further complicate the picture.

Pricing is one of the key matters that energy ministers from the producer group the Gas Exporting Countries Forum agreed to study when they met earlier this year. Ministers have said the study was a move towards turning the previously toothless body into a group with the clout of the Organization of the Petroleum Exporting Countries.

Coal has traditionally set a floor for natural gas prices, and so in places where it provides competition, a coal index might be appropriate, Corke said. But for the future, coal's potential as a competitor could be limited by environmental concerns.

More important than creating a new global benchmark or index was ensuring pricing was flexible so that gas could compete with other fuels, Corke said.

For some, the debate is academic as even where gas is sold in relation to gas rather than oil, it still follows oil trends.

"Whether it is sold on a gas-to-gas basis or on an oil index basis, oil is still driving up the price. There is no real alternative," said Mostefa Ouki, manager of oil and gas at consultancy Nexant.

Qatar has gas supply contracts into the United States, Europe and Asia based on gas-to-gas pricing and oil indexing.

It was concerned regulators would force changes in pricing to long-term contracts, said Faisal al Suwaidi, the chief executive of Qatar gas producer Qatargas. That could affect revenues for the projects that were producing the gas, he said.

"Different buyers feel comfortable with different pricing," he said. "We're very familiar with working with different indexes. What we don't want to do is to change the nature of the game during the life of a project."

Qatar is home to the world's largest field of pure gas and is the world's largest LNG producer. It aims to boost capacity to 77 million tonnes per year in 2010 from around 31 million tonnes in 2007.



© Reuters 2006.