Algeria learns a lesson or two from oil volatility

Algeria's planned shift to short-term gas export contracts to force up prices will win few admirers in energy-insecure Europe, but is a predictable response to a rising market that gives producer states more control.

Senior Algerian officials say they are unhappy with prices under existing long-term contracts and will not sign any more of them, confident the move will not harm a solid reputation as a reliable supplier.

The north African country, which provides a fifth of Europe's gas imports, much of it under contracts of up to 20 years, has been very frank about its reasons for moving to four- or five-year deals. "Once you sign a long-term contract, the producer is in a losing position," Energy and Mines Minister Chakib Khelil, who is also Opec President, told the Wall Street Journal.

"You want more gas, you're going to have to pay me more," he envisaged himself saying to a customer under a short-term contract.

The plan may be years away from implementation, and it remains unclear whether any other producer will follow suit, but it reflects a concern among all producers to maximise gas export revenues in a market destablised by oil price volatility.

Gas is often priced off oil products, but because gas contracts have typically been drawn up for the long term, it has failed to keep pace with the rise of oil prices to record levels.

Khelil's frank talk has drawn attention, although experts say the move should not come as a complete surprise. "It would be surprising if the extreme oil price gyrations we have seen since 2004 had not given rise to problems," said Michael Corke of energy consultancy Purvin & Gertz. "Shortening the term of contracts would be a logical response to the present uncertainty."

Long-term deals have clauses allowing periodic price adjustments, but failure to agree leads to lengthy and costly arbitration. Under a short-term contract the seller would be free to seek a better price elsewhere.

Jonathan Stern, of the Oxford Institute for Energy Studies, said: "This is in a sense a tactical publicity thing to say to the Europeans… if you don't want to pay full value for the gas then we'll do it under short-term contracts and then well just go to the highest bidder when those contracts are up."

"It's the opposite to conventional European gas-speak where people go on and on about the importance of long-term contracts and how contracts are important for supply security."

"What I think they are also saying is 'we will maximise our liquefaction capacity and we might take gas out of the pipeline if we can get as higher return on LNG exports'."

Algeria, which supplies gas through pipelines as well as liquefied natural gas (LNG) transported in tankers, says it is not advocating cutting off exports to consumers. But it is talking to other producers about what could be done to align gas prices closely with oil prices.

The Gas Exporting Countries Forum (GECF), a group of gas producing nations, has said it will reassess gas pricing as part of measures to become more like the Organisation of the Petroleum Exporting Countries.

Algeria belongs to both producer groups. An expert who declined to be identified said Algeria was acting more out of pragmatic self-interest rather than nationalist ideology.

"Gas prices have gone so high with LNG prices moving more and more to oil parity, that some of these long-term agreements that Sonatrach has for piped gas are probably looking pretty unattractive compared to some of the deals that are being signed today," the expert said.

"Their opinion is that the security given by long-term agreements isn't required to the same extent now. It looks pretty much like you'll always have a market to sell gas."

Algeria's approach implies a bullish view on prices. "The economic rationale for long-term contracts has always been that the upstream sunk costs in the development of fields need to be recovered and the risk of periods of low prices avoided," said Dieter Helm of Oxford University. "The short-term contracts reflect the assumption of a rising price trend."

Reuters

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