The collapse in oil prices and the changes they have brought to the global crude markets have been the focus of many industry observers for the past year, but there have been nearly as many changes related to the drop in natural gas prices around the world.

In just two short years, the LNG market has seen a turnaround with lower profit margins and a reversal in the supply-demand ratio even as demand grows. Though countries continue to grow their demand for LNG, supplies are overwhelming the market, which is leading to big changes.

According to a recent PwC report, titled “Navigating the transformation of the gas market,” a glut of production on the market is requiring changes for all parties—buyers, sellers, traders and governments—involved in the market to adjust their operating models.

“Starting in 2014, this profitable, optimistic sector suddenly turned into a market in which companies are struggling to survive—and buyers, sellers and traders must adopt creative strategies to navigate the uncertainty,” according to PwC.

These adjustments will result in lower prices, more short-term trades and demands for contractual flexibility.

“The right strategic response will vary from one player to another, and there is a great deal of risk and uncertainty. But any company in this industry can succeed by carving out a focused value proposition and developing the capabilities to deliver it,” the report said.

The firm said that the issue isn’t so much volatility, which is a normal part of the market, as it is structural changes to the market that could result in lower prices going forward. Indeed, increased shale production in the U.S. may see the end of traditional oil-linked LNG contracts.

“Suppliers and buyers routinely sign long-term contracts for pipeline gas and LNG indexed to Brent crude closings. Until recently, this has generated impressive profit margins for producers," the report said.

In 2014, a healthy average global LNG price of about $14 per million Btu (MMBtu) was supported from oil hovering around $100 per barrel. But when oil prices began their steady decline, global LNG prices fell in concert—to an average of $10 per MMBtu in 2015 and below $7 in 2016.

"Not only did that drop practically eliminate any significant regional arbitrage potential, it also made profitability more elusive,” the report said.

According to PwC, the average global price for gas has fallen below the average breakeven point of $7.20 for LNG exporters.

Despite the increased global demand for LNG resulting from carbon emission reductions, prices have not followed suit because of the link with crude. However, even if oil and gas prices are delinked in future LNG contracts, lower crude prices may still have a negative psychological impact on gas prices.

The largest impact on the LNG is the oversupply situation that is causing sellers to find alternative markets for their production while sharing more risk with traders attempting to exploit arbitrage opportunities. In addition, some sellers with lower costs may cut their prices in order to protect market share.

“No company, in any part of the gas value chain, will be insulated from these disruptions. To prepare for these changes, companies must carefully consider their strategies and capabilities,” the report said.

PwC issued the following advice to participants:

  • Buyers should be more aggressive and utilize their new leverage to revise contracts and renegotiate contracts by linking them to spot markets;
  • Sellers should remain disciplined by delaying projects that haven’t had an FID (final investment decision) made yet and also seeking to reduce costs where they can; and
  • Traders should be opportunistic by picking up some of the deals that sellers will shy away from while squeezing small margins out of these transactions and securing long-term access to assets.

Additionally, the firm advised that other stakeholders, such as midstream companies and governments, will need to adjust to the changing landscape as well. Governments must balance their policies regarding domestic market regulations, the environment and national security of supply in regards to natural gas, while midstream operators must be aware of contracts and supply and demand dynamics.

“Given the pivotal role gas will play in the transition to a low-carbon world, combined with the tide of commoditization that is sweeping the sector, [participants] must prepare for change,” PwC advised.

Frank Nieto can be reached at fnieto@hartenergy.com.