There is a huge difference in the price of natural gas around the world. The price in Japan is three times higher than what you will find in the US. Prices in the EU are tied to oil and double of what you will find in the US. The natural gas supply gains are very localized and unlikely to change in the near-term.
The development of shale gas has been a key driver for the decline in the US prices relative to the rest of the world; however, contract pricing for natural gas around the world has a big impact on overall demand. The pricing of natural gas is more complex than just saying the US is drilling more relative to the rest of the world. The pricing design mechanism for a commodity will have a large impact on the ultimate price of exchange.
The development of shale gas has been a key driver for the decline in the US prices relative to the rest of the world; however, contract pricing for natural gas around the world has a big impact on overall demand. The pricing of natural gas is more complex than just saying the US is drilling more relative to the rest of the world. The pricing design mechanism for a commodity will have a large impact on the ultimate price of exchange.
Market design matters with determining ultimate demand and supply within a market. If there is a an active spot market, there will be significant more price volatility. If there is a long-term contract market, prices will be less volatile and will adjust slowly to changes in supply. If the contract ties the prices to other energy sources, there will be a an average price per BTU of energy. If supply is determined by long-term contract, spot supply will not be able to come to the market and lower costs.
While many often talk about competitive markets, in reality the desire for a competitive market may not be that strong. The energy company that invests in natural gas development would like to know with certainty that their investment will pay and would like to lock-in long-term prices. This makes project financing easy. Similarly, the demanders of energy would also like to lock-in prices to determine their energy input costs. Both parties would like longer-term pricing but with flexibility if there is a change in supply or demand. Contracting is not just on the price side. The suppliers would like to ensure that they can sell a fixed quantity and demanders would like to have certainty in quantity as well as price. Hence, there developed the take or pay contracts in the US. The key to contract markets will be the number of comepetitve players and the opportunity for new entrants in a market. if there are more players or entrants, there will be a greater demand for a spot market.
These long-term pricing designs work well when there is little surprise in the market. If there are shocks, a spot market can serve as a safety valve for the market. In the US, given coal contracts are starting to roll-off, there ill be increased demand for gas. Switching will continue. Pricing in natural gas is on the rise because contracting behavior is changing market structure.
While many often talk about competitive markets, in reality the desire for a competitive market may not be that strong. The energy company that invests in natural gas development would like to know with certainty that their investment will pay and would like to lock-in long-term prices. This makes project financing easy. Similarly, the demanders of energy would also like to lock-in prices to determine their energy input costs. Both parties would like longer-term pricing but with flexibility if there is a change in supply or demand. Contracting is not just on the price side. The suppliers would like to ensure that they can sell a fixed quantity and demanders would like to have certainty in quantity as well as price. Hence, there developed the take or pay contracts in the US. The key to contract markets will be the number of comepetitve players and the opportunity for new entrants in a market. if there are more players or entrants, there will be a greater demand for a spot market.
These long-term pricing designs work well when there is little surprise in the market. If there are shocks, a spot market can serve as a safety valve for the market. In the US, given coal contracts are starting to roll-off, there ill be increased demand for gas. Switching will continue. Pricing in natural gas is on the rise because contracting behavior is changing market structure.
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