PVB netbacks hinge on Algeria supply

Published at 19:49 1 Oct 2019 by . Last edited 09:23 2 Oct 2019.

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The Spanish PVB hub will provide a better netback for Atlantic basin producers than most other markets in Europe next year, with the hub supported by aggregate demand increases y/y and with Algerian pipeline imports likely to be low.  But it is unlikely that Algerian supply can be turned much lower than this year. And it is possible that some Iberian buyers will contractually have more Algerian supply to take next year, depending on their take-or-pay obligations. This will limit the additional LNG that Spain can absorb in 2020.

Spanish system operator Enagas forecasts that in 2020 Spain will log its highest aggregate gas demand since 2010, after which demand collapsed amid the country’s financial crisis. Enagas pegs demand at 389.6 TWh (37 bcm) in its base case and at 417.7 TWh (39.7 bcm) in its high demand scenario. Our forecast is currently between the two, at 38.8 bcm for 2020.

Enagas expects the demand increases to be driven by the industrial sector, offsetting weaker power sector gas demand. Our forecast has industrial gas demand rising to 21.3 bcm from 20.6 bcm this year, underpinned by growth in economic activity (Spain’s GDP grew by 2.1% in H1 19, down from 2.4% over full-year 2018). We also see y/y demand growth from the residential and commercial sectors, as heating demand should grow in Q1 20 on a low base.

We expect Spanish power sector gas demand to edge down y/y in 2020 but remain much higher than the five-year average. Spanish gas substantially increased its competitiveness against coal  in the generation mix this year, boosting gas use in the power sector y/y. There is some scope for further displacement of coal by gas in the power sector early in 2020 but little remaining scope later in the year. The planned closure of eight of Spain’s remaining 13 coal-fired plants by mid-2020 will provide only modest upside to power sector gas demand. A return to normal hydroelectric generation next year would reduce the call on thermal power output. Hydroelectric output was 16.3 TWh over January–September, down from 28.8 TWh for the same period last year.

If growth in aggregate gas demand continues next year, it will support Spain’s ability to absorb increases in LNG imports. We expect Spain to import 26.8 bcm of LNG in 2020, up from or forecast of 22.6 bcm this year.

Question over Algerian supply

The main headwind to Spain taking substantial additional LNG in 2020 is a limited ability to turn Algerian pipeline imports lower. Some Iberian firms may even have to import additional gas that they did not take this year, but this depends on the take-or-pay flexibility they have in their contracts with Algeria’s Sonatrach.

There will be an incentive for Iberian buyers to reduce Algerian imports to a minimum in 2020 because hub prices will continue to be well below the cost of importing Algerian gas under long-term oil-indexed contracts. Sharp drops in EU hub prices this year saw them opening up a considerable discount to oil-indexed prices. Imports were 0.52 bcm per month lower y/y in January-September 2019. We expect Iberia’s Algerian imports to total 11.9 bcm in 2020, down from our forecast of 12.3 bcm for this year and imports of 17.5 bcm in 2018.

Take-or-pay obligations on Sonatrach’s contracts with Iberian buyers may limit the y/y drops in pipeline supply in 2020. We estimate that Iberian buyers have 14.9 bcm of contractual supply with Sonatrach that will still be in place in 2020. Any gas not taken in a given year that is below the contractual minimum is typically paid for and then taken in subsequent years under take-or-pay contracts (make-up gas). But the contracts do have tolerances, which can be plus or minus a percentage of the annual contractual quantity.

If the tolerance in Iberia is 20%—used in a number of European long-term contracts—it would allow for annual imports of 11.9–17.9 bcm. Our 2019 forecast puts Algerian imports at the low end of this range, but it would mean that firms would not have to take make-up gas in the coming years unless they breached the lower end of their individual thresholds. Buyers have raised their nominated supply for Q4 19 y/y, suggesting they are aiming to prevent having to take make-up gas in future periods or at least reduce the volume.

The downside limit on Algerian imports will constrain how much extra LNG the Iberian market can absorb in 2020. The volume of LNG that we see Spain importing next year already factors in low imports from Northwest Europe at the French border. The Iberian limit on LNG import growth puts pressure on LNG suppliers to deliver incremental LNG into other markets in Europe next summer. We already see Europe struggling to absorb the incremental supply being brought online, implying US exporters cutting liquefaction next summer.

The limited scope to absorb additional LNG has depressed the PVB front-summer market relative to the TTF. The PVB 2020 contract was trading at a 0.54 $/mmbtu premium to the TTF on 30 September. PVB M+1 prices averaged an 0.63 $/mmbtu premium to the TTF from 2 January to 30 September.


Fig 1: PVB-TTF M+1 spread, $/mmbtu Fig 2: Spanish LNG imports, bcm
Source: Argus Media Group, Energy Aspects Source: Enagas, Energy Aspects

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