The Gas Conundrum – Profit by Pakistan Today

Pakistan’s latest bid to acquire four shipments of liquefied natural gas (LNG) for the month of July, one each in the first and second weeks, and two last week, has drawn an alarming market response. No offers were received in the first two weeks and only one offer from Qatar Energy Trading was received last week at the highest ever rate of $39.80/mmbtu.

This grim response to the tender is the latest reminder of the extreme volatility in the global energy market at the moment and its potentially disastrous consequences for Pakistan, which is already struggling with high inflation and energy shortages.

The country must take drastic and painful decisions to keep the economy above water. Pakistan has significantly increased its dependence on LNG in recent years, especially for its electricity production.

Burning natural gas produces greenhouse gases, but it also produces far less CO2 and air pollution than most of the hydrocarbons it replaces, including coal. Compared to other fossil fuels, natural gas consumption has increased significantly over the past 10 years, accounting for about a third of the expansion in global energy demand. Studies also show that its use will continue to grow significantly in the coming years, followed by serious divergences.

Additionally, gas is able to meet both seasonal and short-term fluctuations in demand and provide support for the growing use of variable renewables like wind and solar. Because of its storage capacity, its ability to be transported by pipelines or liquefied and shipped by ship, and the ability of gas-fired power plants to turn on and off quickly, gas is essential to facilitate the transition from fossil fuels to renewable energy.

The problem

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Yet the price of LNG has increased by more than 1,000% in the past two years, first due to demand after the epidemic, then due to the Russian invasion of Ukraine.

The Russian-Ukrainian war had a huge impact on global commodity markets. The first source of income for the Russian war machine is its sale of fossil fuels, in particular oil and gas, of which Moscow is one of the main producers. The main buyers of Russian oil and gas are the European economies which are alongside Ukraine. To squeeze Russia’s revenue, Europe is slowly but surely weaning itself off Russian supplies, and at the same time imposing sanctions to prevent other countries from approaching Moscow for their energy needs.

As European countries move away from Russian gas, their dependence on LNG is increasing. Previously, piped gas was shipped from Russia directly to Europe, now these countries are looking to import LNG shipments.

And this has a direct impact on Pakistan.

Pakistan is buying on the spot market but also has several long-term contracts, including two with Qatar – one for six shipments in a month at a 13.37% grade of Brent and the other for two shipments each month at 10.2% Brent.

The price of LNG in long-term contracts is determined by a fixed percentage (slope) of the average oil price over a three-month period. In the spot market, prices are determined on a daily basis and the lowest bidder wins the tender.

With rising oil prices and ever-higher spot rates, Pakistan finds itself in a very precarious position. European customers are prioritized because the higher tariffs suppliers can get from customers in Europe are lucrative enough for companies to divert supplies and even, in some cases, default, as the default penalty can be offset by tariffs higher from EU countries.

This is particularly alarming considering that the demand for energy is inelastic and therefore the supplier has leverage and can get whatever prices they want.

The massive increase in prices can be explained by the basic economic concept of supply and demand. As the United States and Europe shun Russian oil and gas, supply has contracted due to sanctions. If we were to draw a simplified diagram of supply and demand, the supply curve would shift to the left causing prices to rise. The following figure shows the concept when supply contracts and moves towards supply, we can see the increase in price determined by market equilibrium.

What can Pakistan do?

The latest bid received by Pakistan from Qatar at an alarming price can be seen as a precursor to what we can expect later.

Rising international energy prices are straining Pakistan’s coffers, even as the country’s foreign exchange reserves are rapidly shrinking. Even if we are able to finance our expensive LNG, the resulting inflation would have a crippling effect on industries and consumers.

The government’s energy division has apparently also realized that importing increasingly expensive fossil fuels to generate electricity is unsustainable. They highlight the use of renewable energies, coal from the Thar and electricity from Hydel as the answer to our perpetual energy problems. As if it had never happened before.

The government must take a combination of decisive decisions to solve the short and long term problems of the sector. Gas supply will remain tight, at least for the foreseeable future, and being proactive now can help the government avoid shortages over the coming winter when demand peaks.

Thar coal, while not exactly an environmentally friendly option, is perhaps one of the most affordable options available to the government. At present, the contribution of power stations using coal from the Thar is only 1,320 MW, coming from Lucky Electric and Engro power stations.

There are three other projects under construction which will use Thar coal as fuel and bring an additional 1,980 MW to the national grid. Sino Sindh Resources’ 1,320 MW power plant is expected to be commercially operational in August this year, providing much-needed respite to the national grid. The other two projects, with a capacity of 330 MW each, should also become operational during this year.

The government also hopes to convert power plants currently using imported coal to local coal. Although this may prove to be a technical and financial challenge, the option should be explored given the skyrocketing coal rates in the international market as well as the country’s financial situation.

Coal may well be the most practical solution the country has. All stakeholders recognize the environmental implications of using coal as a fuel, but ensuring energy security trumps this concern. This week plans were unveiled by Austria, Germany, Italy and the Netherlands to restart decommissioned coal plants as their gas supplies deteriorate. The action was taken shortly after Moscow cut the flow of natural gas to many European countries.

Pakistan is also expected to follow suit by prioritizing the country’s energy security by relying increasingly on local coal supplies. This requires a long-term commitment from the government and, at the same time, all measures must be taken to minimize the effects of harmful emissions. The global energy situation has been relentless, and it would be safe to assume that this trend will continue.

By the way…

Europe’s attempt to stem the Russian onslaught was not very successful. Russian oil and gas revenues have reached all-time highs due to high commodity prices, and China, the world’s second-largest economy, is now buying more from Russia than before.

Chinese President Xi Jinping recently addressed Western sanctions at the Brazil-Russia-India-China-South Africa (BRICS) Business Forum, saying, “To politicize the global economy and make it its tool or his weapon, and deliberately imposing sanctions… will only end up harming his own interests as well as those of others, and inflicting pain on everyone.

The chain reaction initiated by Russia’s actions in Ukraine is disrupting the entire global economy, which is now a highly integrated ecosystem.

The war increased the already intense pressure on natural gas markets and added uncertainty to the situation. The global energy commodity market is becoming more and more expensive due to the sanctions. Europe has been at the center of market tensions caused by a combination of a below-average underground storage inventory, mainly sites that are partially owned or controlled by Gazprom, a Russian subsidiary, and a significant decline in supply of Russian pipelines.

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