Our Energy Economist, Dominic Whittome continues the exploration in the second installment of our Energy Highlights Report for 2023. Uncover the risks associated with the petrodollar, analyze the trends shaping gas prices, and scrutinize Russia's significant role in the global gas market.
Potential petrodollar risk to long-term oil, gas and LNG contracts
The chances of any ‘shock devaluation’ of the US dollar might look slim just now. But the risk is real and being taken increasingly seriously in oil as well as gas trading circles and we could be seeing early evidence of this, the risk anyway, in government bond markets which are falling across western economies this week. There has been disquiet over all government debts, not just in the USA, which is evidently testing the patience of sovereign lenders and private foreign buyers of western government bonds. How soon – if at all – a ‘day of reckoning’ for the petrodollar comes is a difficult question to answer. However, the headline US federal debt figure of $33 trillion belies the worst-case scenario or the background picture. For example, the latest Congressional Budget Office reports see the debt rising further, potentially rising to $44 trillion by the end of 2029.
The consensus of dealers in Forex markets do half-expect a new ‘dollar event’ at some future point. Many see it farfetched to expect a debt of such size to be bought under control, let alone repaid, without some form of dollar revaluation: be it a straight devaluation, a new digital currency (possibly under the auspices of the International Monetary Fund – based on gold and/or the Special Drawing Right (or SDR – the IMF’s existing inter-bank currency); or the ‘soft default’ option (allowing inflation to continue and restarting QE, although the bond market will not stand for that, if the past week is any pointer) or some other monetary chicanery for that matter.
National major oil and gas producers will not accept alternative payment in any newly devalued dollar-based currency, whatever form it takes. So there may well be a future impact on contract pricing at some point. On the producers’ side, one should not underestimate the wish for an alternative to the petrodollar once a sufficiently liquid alternative becomes available. The principal candidate here a future gold-backed BRICS currency, which Russia, Saudi Arabia, Iran and other key energy players met to discuss in August.
Changes afoot – potentially within the next five or ten years – could affect the status of existing long-term oil, natural gas and LNG contracts. Not just in respect of the base price, set at the negotiation stage but mid-term as well. For example, a dollar revaluation will impact contracts under ‘price re-opener’ clauses, triggered at scheduled mid contract dates as well as through such contracts’ continuous price escalation to oil, petroleum products and other energy commodities. Equally, one would see direct impacts on the $/MMBTU price on both spot and long-term contracted LNG.
Changes in the way oil and gas are traded look firmly off the table just for now. In fact the outcome of the August BRICS meeting will verify this. The new BRICs currency is destined to happen gradually. Rather than being fixed according to the dollar-value it will be fixed by the weight of gold itself. This should preserve the status quo in respect of export contracts which no exporting producer will want to undermine, or not at these prices. However, ‘destined’ the BRICs currency certainly is and long-term contract negotiators will need to be prepared for it, come the day it may finally happen. Conceivably it will increase the risk-premium in longer-dated contracts. Or, conversely, dissuade buyers or sellers from trading long-term altogether. One other reason perhaps why the BRICs didn’t want to rush into a pure gold-backed currency two months ago, even if monetary economists had been expecting more than the blue-print the meeting finally produced to date.
Gas prices continue flat-lining, for the time being
Contrasting with the rally in crude, the wholesale gas market has been remarkably stable, barely deviating 10% from its circa 120 p/th moving average established since early February. The forward curve is still in backwardation (long-dated volumes trading at a discount to prompt deliveries). This is a generally ‘normal’ shape for a commodities forward curve. It suggests that, in the main, gas traders generally see prices staying stable, or possibly dipping slightly in the months ahead.
However, there are no hard & fast rules and this view is not shared by all; there is no way ‘to read a forward price curve’ especially one that is this illiquid. The long-dated prices as posted may not be reliable, quite possibly prone to disappearing before you can hit more than one of them on the screen. The short of it:
the current wholesale gas market (and base-load power is worse) may well be instilling a false sense of security at the moment.
There is no doubt that prompt and medium-term prices have softened, much as the curve may have at least ‘anticipated’ earlier on in the year. In recent months wholesale gas prices have continued to soften. Completely replenished (in early time) across Europe and persistent, unusually mild weather for this time of year are two key factors for this.
And whilst the gas supply system across the UK and Continent also coped perfectly well last winter, favourable conditions could change and in light of a new backdrop of increasing rather than falling oil prices; the potential for a sharply recovering South East Asian LNG market, which was weak and was offering Europe some slack this time last year; a significant curtailment of Russian gas supplies (see below); and the potential yet for this winter to turn very cold, a converse of the searing summer temperatures in most of southern Europe this year.
France leapfrogs Germany to become Russia's largest gas customer
Russia has continued to export gas to Europe, a significant quotient transported to EU countries through Ukraine itself. This month alone Ukraine is still accepting Russia’s money to transport an expected volume of 39.5 mcm (million cubic metres). Down on last month’s 41 mcm but only due to European utilities currently having nowhere to store it amid lower-than-expected demand.
In addition to the Ukrtransgaz volumes, Russia has been augmenting its gas supply to Europe through new LNG trains. Final shipments of LNG have increased by more than 40% since the invasion, half of which roughly were purchased by EU utilities between January and July this year alone with Engie (formerly Gaz de France) and Total Energies cited key traders involved. As well as Russia, France has signed LNG deals with the United Arab Emirates, a BRICs country which is accepting or demanding payment in Yuan, the Yuan being exchangeable for physical gold in Shanghai. It is not so unfathomable therefore to expect to see a closer correlation between gas prices and the general commodities’ complex, bullion being one.
Continue your journey through the energy landscape by delving into the first and third parts of this insightful series.
Dominic Whittome is an economist with 25 years of commercial experience in oil & gas exploration, power generation, business development and supply & trading. Dominic has served as an analyst, contract negotiator and Head of Trading with four energy majors (Statoil, Mobil, ENI and EDF). As a consultant, Dominic has also advised government clients (including the UK Treasury, Met Office and Consumer Focus) and private entities on a range of energy origination, strategy and trading issues.
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