Global gas prices may remain higher than crude oil benchmarks in the coming years, incentivising fuel substitution, a key tool for the market to rebalance after the removal of Russian gas.
Gas and LNG prices rose above the "oil-parity" level in mid-2021 — meaning that gas is more expensive than oil in energy equivalent terms — and have remained consistently above that level since then (see graph). With one barrel of oil containing about 5.8mn Btu, gas is effectively more expensive than oil when its price in $/mn Btu terms is higher than 17.2pc of crude benchmarks expressed in $/bl.
Gas prices have been higher than oil before but this is the longest period in history of that relation being inverted. Previously, the oil parity level was considered a ceiling for gas and, more specifically LNG prices, based on the assumption that above that level utilities would rather switch to burning fuel oil to generate electricity, weighing on gas demand and prices.
The assumption remains correct, but the extent of its impact on global prices has greatly diminished. That conventional wisdom was formed during years when Japan remained firmly the world's largest LNG importer, but it has recently been overtaken by China, where demand has been driven by industrial activity and residential heating, reducing scope for gas-to-oil switching. And even in Japan, scope for fuel substitution is much less than in the past, with the country's oil-fired generation capacity declining in recent years (see graph).
Nevertheless, the price dynamics observed over the past 18 months have indeed triggered some gas-to-oil switching in power generation — not only in Japan, but also in south Asian markets such as Pakistan and Bangladesh, albeit at a smaller scale. Japanese fuel oil generation rose to 24.3TWh in the 12 months to August 2022 — the most recent figures available — from 15.2TWh a year earlier. Similarly, oil-fired generation in Pakistan rose to 11.8TWh from 7.86TWh over the same period. Assuming this displaced entirely gas-fired generation units with an average efficiency rate of 50pc, it would have resulted in a combined 1.7mn t — or 2.18bn m³ — reduction in gas demand over 12 months in these two countries.
This level of demand reduction accounts for a tiny portion of the amount of Russian gas that has been removed from the global market in recent months. State-owned Gazprom's total gas sales — excluding the Baltic states — were 76.3bn m³ in the first 11 months of 2022, 44.5pc lower than a year earlier, the firm said earlier this month. Russia supplies Europe from fields in western Siberia that are not connected to other export markets such as China, meaning that the vast majority of the supply that does not reach Europe is at present stranded in Russia.
The supply gap left in the European market by a sharp reduction in Russian pipeline flows is being largely filled by an increase in LNG deliveries. But for this to continue in the short to medium term, prices may need to remain high enough to trigger demand reduction in Asia.
Having ceased to act as a ceiling for gas prices, oil parity may have turned into the ultimate support level. After reaching more than 60pc of Brent in late December 2021, the Argus Northeast Asia (ANEA) front half-month price fell to as low as 17.8pc of Brent in the second half of May 2022, when the curtailment of Russian supplies to Europe appeared limited to a handful of companies that had refused to adhere to the rouble payment scheme introduced by the Kremlin. Similarly, the front-month contract at the Dutch TTF fell to as low as 20.4pc of Brent in early June, days before flows through the Nord Stream pipeline began to falter.
And global LNG prices may find other support levels that are even higher than oil parity. Market participants have suggested that LNG becoming competitive with LPG in China may trigger a rebound in industrial gas demand. Domestic LPG prices in China were around $15.52-16.42/mn Btu on 22 December, based on Argus assessments and assuming an energy content of 48.5mn Btu per tonne of LPG. This is approximately half of corresponding domestic LNG prices, but still higher than the oil-parity level of $14.17/mn Btu on the same day.
