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What the rally in gas prices tells us about gas markets and energy security

Nikos Tsafos

The rally in natural gas prices, which was already unprecedented, has now become historic, as prices for liquefied natural gas (LNG) in Asia have broken every record. The story, by now, is familiar: cold weather in Asia and Europe interacted with bottlenecks—not enough production, not enough ships, not enough passage through the Panama Canal, not enough storage capacity, not enough liquidity in the market, and so on. It is, to use the cliché, a “perfect storm,” with power systems struggling in places like China, Japan, the United Kingdom, and others.

As with any price spike, the aftereffects are easy to predict. Suppliers might invest more in their ability to supply—in production capacity and ships. Consumers might think anew about their reliance on the spot market and their aversion to long-term contracts. Countries betting on gas to aid them in the energy transition might reassess how much they want to use a commodity whose price can swing so unpredictably. Regulators might look to make sure there was no foul play, in gas markets but also in electricity, to which gas is connected. Governments will announce some “measures” to enhance energy security. But this crisis also helps us revisit some assumptions about the gas market—some entrenched myths, if you will.

The first myth is that of the “global gas market.” We have never had a global market, of course, not if you define “global” as a market in which shocks affect everyone equally (more or less). We have seen, over the past few years, excess gas output lead to a convergence in prices—in that sense, the surplus of one region, North America, has become a global surplus that lowered prices in Europe and Asia. Coupled with uncertainty about the long-term prospects for gas, this surplus created an unusual glut in gas markets.

But while surplus might be a global condition, scarcity is not. Scarcity is not necessarily a general inadequacy of supply; often it is an inability to secure a specific volume at a specific place and time. Surplus is general; scarcity is often particular.

Prices have risen in places that cannot secure enough gas in a specific time and place—which today means Asia and, less so, Europe. North America, which has a different system, is disconnected from that crisis. And so, at this point, in mid-January, the price for spot LNG in Asia is seven times higher than the price for spot gas in the United States. So much for a global market.

The second myth we should question is the assumption that liquidity and flexibility are a good proxy, synonymous even, with energy security. The narrative is familiar: any analyst describing the evolution of gas markets chronicles how the business has evolved from one dominated by inflexible pipelines and inflexible long-term contracts to one increasingly shaped by flexible LNG and flexible commercial arrangements that allow gas to be redirected, at short notice, to customers who want it. This is certainly true—and it has improved energy security in important ways.

We can also see the limits of that thinking, however. Pipelines might be geographically inflexible, but they are volumetrically mo-re flexible than LNG.

Cross-border pipelines often carry two or three times more gas in the winter than in the summer—a fluctuation that LNG cannot matc-h. In fact, the spot market for LNG is largely about optimizing the flow of an existing stream with modest fluctuations in output. It is a game of redirection m-ore than a game of adjustment.

But energy security comes from spare capacity, from infrastructure that sits underutilized for months or years but which, when the crisis comes, can help meet demand. It is too expensive to provide that flexibility with LNG, which is why energy security needs other investments—in storage, in domestic production, in pipeline imports, in fuel switching, or in arrangements to curtail deliveries to users when needed (so called “interruptible supplies”). The obsession with one type of flexibility—of spot LNG—has often come at the expense of thinking about that system more generally.

The third and final myth is that the energy transition has rendered moot the conventional ways of thinking about energy security, that because we are (slowly) moving away from fossil fuels, we can ignore the concerns that preoccupied policymakers in decades past. In some ways this is true—as the market adjusts, so must our definition of energy security. As I have written before, some of the concerns about Russian gas in Europe, for instance, should be reassessed in light of how the market has changed and where the market is going.

But energy is, above all, a physical system where the costs of disruption are enormous. Each system is balanced differently, but they all rely on a combination of redundancy, spare capacity, complexity, flexibility, minimum requirements, and so on. And because that balance is so fine, it is often upset. This is especially true when old structures are replaced by more complex and decentralized systems, where no one is “in charge” and clearly responsible for “energy security.”

As we have come to rely on more sophisticated instruments to provide energy services, it is easy to lose track that, in the end, the buck must stop somewhere. Someone must be responsible to make sure the system does not fall apart.

If nothing else, this recent spike in prices should remind us that this challenge remains as true today as ever before—and that the role of government is, above all, to fine-tune this system and ensure it can withstand whatever shock comes its way.

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