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Unsettling outlook for gas

By Charles Ellinas

This was the message in a report from the UK’s Chatham House policy institute, entitled ‘The Impact of the COP21 Climate Change Negotiations on the Oil and Gas Industries’.

It describes a far more unsettling outlook for global gas than recent energy outlooks from the International Energy Agency (IEA), BP, ExxonMobil and others might suggest.

The report argues, given that the gap between the current round of intended nationally determined contributions (INDCs) for the reduction of greenhouse gas emissions (GHG) and the overall target to cap global warming at no more than 2°C above pre-industrial levels, further stringent measures are likely to be imposed on fossil fuels in future.

The implications of this on the outlook for natural gas are unpredictable and unsettling.

The report examines INDCs from China, EU, India, Iran, Japan, Saudi Arabia and US. It argues that in developed countries where electricity demand is not growing, there will be neither room nor profitability for investors in gas-fired power without exiting coal.

In developing markets where access to power is critical, the report says that gas producers will have to compete against cheap coal at almost half the price.

It speaks of a mismatch between gas as a cleaner, transitional fuel and the likely future where major investments in LNG and long-distance gas pipelines are difficult to justify at a time of political and economic flux.

The INDC pledges made during the run-up to COP21 in 2015 must be fulfilled by 2020. The review process and firming up of INDC pledges for the period 2020-2030 starts at 2018 for completion by 2020.

This applies also to Cyprus – this time it will have to agree to real targets to match those of Europe.

For Europe, this means at least 40% cuts in GHG emissions from 1990 levels, 27% share for renewable energy and at least 27% improvement in energy efficiency. A tall order for Cyprus; unachievable without liberalising the renewables sector and stopping the use of heavy fuel oil.

INDCs committed to at COP21 do not place global emissions on a path likely to meet the agreed climate target. The report says it is inevitable that the review in 2018–2020 will aim at tougher policies.

A further review round will take place in 2020 for the period 2030-2040. There will also be five-year review cycles to establish that countries are sticking to their pledges and to submit progressively more ambitious contributions. The result of these is that the impact on the oil & gas sector will intensify.

Thus, the challenge for the gas industry has started in the run-up to 2020. But after 2020, the challenge of restructuring the power sector, particularly in Europe and Asia, will have an even greater impact on the prospects for gas.

There will be serious issues concerning structure, regulation and policy stability that impact investment in generation and the infrastructure needed to expand the use of gas at the expense of coal.

Major oil and gas companies have yet to demonstrate strategies for the uncertain medium-term future for gas.

Impact on the gas sector
The policies emerging from COP21 are unpredictable and unsettling for natural gas. Gas is used in most countries mostly for power generation and, as a result, prospects for gas depend on policy intentions for the power markets.

Many countries and gas-producing companies would envisage a greater use of natural gas in power generation, replacing coal. But aggressive policies to use renewables make this uncertain, with gas taking on a different role, possibly ending up as a residual fuel, filling the gap.

There are developed countries where electricity demand is not growing and within which the promotion of renewables, without a managed exit from coal, does not create room for gas.

In developing countries, where demand for power is growing, it is difficult to persuade governments that gas has a place at the expense of much-cheaper coal.

As a result, the markets available for new gas supplies become uncertain, making gas investment decision-making, whether in production or consumption, a challenge.

This uncertainty, combined with a low-price environment, leads to unwillingness from investors to support major new projects, including LNG, and infrastructure and the supply behind it. The risk of ending up with stranded assets increases.

Credible policies are also needed to send a strong signal to those producing and consuming carbon-based fuels so that their investment plans can be amended to reflect the shape of a lower-carbon economy.

In the gas sector, the challenge is to try and negotiate a role for gas in the generation systems of developed countries and to gain a share of generation growth in developing markets sufficient to justify the infrastructure investments that gas needs. Investment requires policy clarity and stability and assured returns.

Ultimately, companies need to consider that the expected golden age of gas as the cleaner, transitional fuel is not likely to materialise as hoped. There are strong signs of this already in Europe.

However, generalisation of such arguments has its limits. In the US, the talk is indeed about the golden age of natural gas.

US carbon emissions from power plants have fallen to 25-year lows.  No other country is reducing its emissions faster. Wholesale electricity prices have fallen 40% over the past five years due to increasing use of shale natural gas, displacing coal.

Shale gas is also helping the US to integrate more wind and solar power onto the grid. China has also made developing its own shale gas resources a priority.

COP21 and the future
There are uncertainties about how COP21 will develop and be implemented in practice. The broad nature and diversity of INDCs made so far is such that it is challenging to monitor and review them.

However, change driven by the need to limit GHG emissions is inevitable and, combined with a future of plenty in terms of energy supplies and peaking primary energy consumption globally, the pressure on fossil fuels will only grow.

Better integration between environmental and energy policies will be important. But climate change mitigation needs to be reconciled with economic growth objectives. And the oil and gas industry needs to embrace change and direct its policies and investments accordingly.

These findings are supported by the World Energy Investment report by the IEA. It states that global gas demand growth remained subdued in 2015, as well as in 2016, as a result of a slowdown in electricity demand and the expansion of renewables.

Gas-fired power generation has a problem competing with coal, due to higher gas costs in comparison to low coal prices, with investment in gas projects declining by nearly 40% in 2015.

Structural change in the way energy is produced and consumed is increasing uncertainty and affects gas demand patterns, leading to low prices in the longer term.

Dr Charles Ellinas is a non-resident Senior Fellow, Eurasian Energy Futures Initiative, Atlantic Council

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