Shifting Sands under Qatari Gas

View of Qatar Petroleum (QP), a state-owned corporation established in 1974 and responsible for all phases of the oil and gas industry in Qatar on December 29, 2010 in Umm Said, Qatar. (Nadine Rupp/Getty Images) View of Qatar Petroleum (QP), a state-owned corporation established in 1974 and responsible for all phases of the oil and gas industry in Qatar on December 29, 2010 in Umm Said, Qatar. (Nadine Rupp/Getty Images)

View of Qatar Petroleum (QP), a state-owned corporation established in 1974 and responsible for all phases of the oil and gas industry in Qatar on December 29, 2010 in Umm Said, Qatar. (Nadine Rupp/Getty Images)

Among the array of financial suits European utilities have brought against major gas exporters in the courts, the pricing dispute between German utility RWE and Russian export giant Gazprom that ended last month stands out among its peers. As a result of that arbitration decision, we have for the first time a ruling that disputes the legality of oil indexation, essentially the practice of linking gas prices to oil prices, in long-term gas pricing formulas. Despite the wave of commentary prompted by RWE’s victory, few have noted the impeccable timing of the event. The July ruling coincided with a seemingly tangential change: new appointments to the most senior positions in the Qatari government in light of the recent ascension of the new Emir, Tamim bin Hamad bin Khalifa Al Thani.

Oil indexation in long-term gas contracts has been a source of contention between European utilities and members of the Gas Exporting Countries Forum (GECF) for years. Russia’s response to the RWE ruling—one of dramatized apathy and a degree of scorn—came as little surprise, given that for years its export strategy has centered in large part around securing the European market.

On the European side, the arbitration ruling is expected to serve as a milestone in regional efforts to price imports through gas-to-gas competition. But with pipeline gas concentrated in Gazprom’s hands and low-cost marginal liquefied natural gas (LNG) flows facing a host of cost and delivery constraints, Europe’s bargaining power has rested on the willingness of Qatar and Algeria to provide wedge cargoes to northwest and southwest Europe respectively. With Qatar’s most adept political machinist stepping down from his post, forcing a complete reversal in its national gas sales strategy, Qatar will soon find itself offloading one-off spot cargoes that were originally intended for term delivery under longstanding multi-year contracts. To Russia’s dismay and Europe’s advantage, these Qatari cargoes will likely head to Europe.

Europe takes on big gas

Although Gazprom has borne the brunt of European utilities’ commercial woes so far, Europe’s price shake-up has also targeted gas majors Qatar and Algeria. Algerian gas supplier Sonatrach won nearly USD 2 billion in compensation in a suit brought against Spanish gas importer Gas Natural, but a court ruling earlier this year will force price revisions in a long-term contract Sonatrach signed with Italy’s Edison. A similar ruling was handed down in a suit Edison brought against Qatari LNG company RasGas, which now also faces arbitration over contract renegotiation disputes with Spanish company Endesa and Belgium’s Distrigas.

The RWE case was a financial blow to Gazprom, which must now reimburse the utility for retroactive losses totaling USD 500 million. However, these cases are becoming increasingly routine. Less than a year earlier, Czech subsidiary RWE Transgas defeated Gazprom in arbitration over payments for unused gas stipulated by their long-term contract’s take-or-pay clause, which required the Czech company to either take a set amount of gas from Gazprom or pay a penalty. And out-of-court settlements have forced Gazprom to accept price revisions in long-term contracts with Poland’s PGNiG and with Germany’s E.ON.

The behavior of European utilities suggests a bearish future for gas pricing benchmarks at major hubs—at least in the short term. With growing physical and (by consequence) financial liquidity of the UK National Balancing Point, the virtual hub at which UK gas is bought and sold and which has significant influence over gas prices, companies and institutions in Europe are gathering regional momentum for a vital shift in gas pricing mechanisms. Despite the infrastructural and regulatory challenges that have prevented diversification of supply from the beginning, gas-to-gas competitive pricing already comprises a rising share of trade flows into Europe. Russia and Norway were forced to yield to pressures for long-term contract adjustments that include a gas-to-gas indexation component. Consequently, the oil-indexed share of Europe’s total gas purchases fell nearly 30 percent between 2005 and 2010.

Qatar’s European Retreat

As an increasing number of trades in Europe move towards hub-based pricing as an alternative to oil indexation, speculation varies over how suppliers will respond to the undercurrents of change in the European market. After all, leverage still lies supply-side. Now more than ever, the price-setting power of Europe’s GECF partners depends profoundly on the price response from Qatar. Given the high degree of price uncertainty surrounding Europe’s future, many observers have noted that Qatar and Russia share a price incentive to cooperate. In 2009, Russian gas industry leader Alexander Medvedev launched a failed campaign to create a gas “troika” between Russia, Iran and Qatar. As Russia’s attempts to cozy up with its biggest competitors have faded over the past four years, the specter of rising global competition from Australia, Canada, the United States and Africa looms large. More recently, Russia has sought cooperative links to Qatar in an effort to protect its hold over important European buyers in exchange for increased Qatari access to Asian LNG markets through limited location swaps.

And until very recently, Qatar seemed to be acquiescent enough. The Qatari strategy of international engagement, evident in the diversified portfolios of LNG suppliers Qatargas and Ras Laffan LNG, placed national attention on securing Asian markets through long-term agreements. As early as 2010, Qatari officials have pushed to reduce spot sales, one-off sales for a fixed price and delivered on a fixed day, in favor of long-term contracts pegged to oil markets. Within the past year, Qatar has inked contracts with major utilities in Japan, China, South Korea, Thailand and Malaysia. With negotiations with China underway for some seven million tons of LNG annually, Qatari officials reaffirmed interests in shoring up Asian offtake before new LNG producers are able to bring supplies to global markets. In December 2012, Qatar National Bank declared that Qatari spot sales would be reduced by over 40 percent by 2014.

QNB gave notice of a major retreat from the European spot sales, citing Qatar’s “price incentive for spot-market deliveries to be exported to the Asia Pacific, in addition to the rising number of long-term [contracts].”

Qatar’s European Revival

With netbacks for Qatari suppliers as much as USD 7 per million British thermal units (mmBtu) higher to Asian markets than UK–Belgium trades, it is little wonder Qatari exporters are looking to lock in market share in northeast markets. Yet the recent Cabinet reshuffle in Qatar has dragged out the strategic lead on international engagement and, with him, the political backing required in order for Qatar to turn away from European spot traders.

Last month, a senior Qatari official declared: "Our entire strategy of international engagement is gone."

Short a pan-European overhaul of bundled gas market structures, Qatar need not worry too heavily about cash flows. The events this summer indicate that oil indexation eventually will evolve to gas-on-gas pricing in Europe, and EU–Russian pipeline politics continue to dominate the discussion over oil-indexed contracts and the potential evolution of global gas-on-gas pricing. In the meantime, Qatar is still selling to Europe at well above USD 4/mmBtu over the cost of production and delivery to market.

Kate Kremling, a research assistant at the Center for Energy Studies, contributed to this piece.

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