Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

"This is truly the age of plenty."

Contrary to your first instinct, that isn't necessarily a good outcome for everyone. Say, for example, your business consists of producing a commodity like natural gas, and plentiful supply is keeping the price of it down.

Spencer Dale, who spoke those words on Wednesday, happens to be the chief economist of one such company, BP. He was presenting the company's annual statistical review of global energy trends, with the crash in fossil-fuel prices on abundant supply a key theme.

On the same day, the International Energy Agency released its own tome of numbers, this one specifically on the outlook for natural gas. Even though U.S. gas prices have rallied hard in recent weeks, the IEA's essential message from its 126 pages is: Don't call it a comeback.

Ignition
The benchmark U.S. natural gas price has jumped in recent weeks
Source: Bloomberg

Even without Wednesday's data dumps, the narrow nature of the recent rally in gas prices is evident if you look at the forward curves from today and a month ago. While warm weather -- stoking demand for air conditioning and the gas needed to fuel electricity to power it -- has helped raise 2016 futures by about 8 percent, on average, prices for 2017 are up by less than 3 percent, Bloomberg data show.

The Day After Tomorrow
The rally in natural gas futures is concentrated at the front end of the curve. Prices remain subdued through the rest of the decade
Source: Bloomberg
Note: Bars represent change in average futures prices compared with one month ago.

Gas prices, like those of oil, are weighed down by excess supply. This isn't just an effect of the U.S. shale boom. Big liquefied natural gas projects in Australia and elsewhere, agreed to when prices were much higher, have hit at exactly the wrong moment.

Yet gas has one important difference with oil that has potentially far-reaching implications: The IEA doesn't expect global gas supply and demand to come back into balance through the rest of the decade. In contrast, the oil market is projected to rebalance next year.

This matters because, as I wrote here, Big Oil has increasingly become Big Gas. This is best exemplified by Royal Dutch Shell's takeover of BG Group. But for the big five as a whole, gas production has risen in the past 15 years while their oil output has gone down. This presents a challenge, because gas is a much tougher product to store and transport, meaning it requires more of an emphasis on marketing, trading and customer-relationship skills than oil traditionally has demanded.

Which is why this chart, made with data from BP's statistical review, may actually offer some comfort to the majors:

Plenty Cheap
For most of the past 20 years, gas prices have traded at a discount to crude oil prices in OECD regions
Source: BP
Note: Japan data are for LNG import prices. U.S. and U.K. data are for benchmark wholesale prices.

The most striking aspect of this chart is on the right-hand side. On an energy-equivalent basis, gas remains substantially cheaper than oil in both the U.S. and the U.K. -- despite the price of crude collapsing by half since 2013. Japan is back at a premium for now. But the resumption of nuclear power there, along with Japan's usual demographic and economic caveats, mean that likely won't last.

With oil markets set to balance more quickly than gas, the latter's relative competitiveness should widen further (even though a return to triple-digit oil remains very unlikely). Supply is largely set through the next several years, so that puts the onus on Big Oil to get creative with pushing gas on the demand side. Its cheaper nature offers an opportunity on that score.

One big weakness gas has, though, is that coal -- with which it competes as fuel for the critical power-generation sector -- is also dirt cheap. That provides some incentive for Big Oil to actually get behind efforts to put a price on carbon, which adds more to the cost of coal than gas. Some European majors, including BP, made moves in this direction ahead of December's global climate talks in Paris.

On the other hand, carbon pricing would also boost the economics of renewables, the smallest but fastest-growing source of energy in the world, which also competes for the electricity sector. Total, for one, has made big investments here even if, like gas, renewables likely can't generate the outsize returns on capital that oil can.

Perhaps that is the bigger point, though. With oil rallies potentially capped by the twin effects of OPEC's de-facto demise and shale output, banking on another big cycle upwards in prices to generate the cash needed to cover dividends isn't advisable. Rather than the historical approach of "drill it and they will come," oil majors must devote more efforts to understanding exactly what kind of product "they" want.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net