Unpredictable energy markets – or just the turn of the architect

In the second installment of the famous Matrix trilogy, Neo meets with the Oracle just before his epic fight with Agent Smith and asks her what would be the purpose of the Architect. The Oracle answered that his purpose was “To balance the equation”.

Then he asked what the purpose of the Oracle itself would then be and he gets “To unbalance it”.

For a seemingly endless time (at least in terms of recent LNG history) we had endured the longest, hardest, and most unsettling so-called “Sellers’ market” in times recorded. Finally, after many brushes with death, this anomaly for market enthusiasts had come to a dramatic end. The Sellers’ market is no more. It’s a Buyers’ market now – but is it?

Let me clear up one thing right away so we start on the right foot. I hate the terms Sellers’ Market or Buyers’ Market as there can only be a market. As no one can own it, it’s no one’s market, to begin with, and if scarcity is the defining term, there is not much of a market at all but rather competition for the attention of the overlord. Let me direct my attention to that issue in another post.

Spot prices in Asia and Europe give us a good feeling of what the end of the Seller’s domination of the LNG world looks like. For the first time in years, some European terminals get actual LNG flushing through their systems. Some of them for the first time on a pretty consistent basis.

In 2013 I had predicted in a post on this very blog, that this would happen. Was it hard to predict? Not at all.

Everything that goes up comes down after some time in thin air. That’s one of the eternal laws of business. We just like to forget them when the spoils are so sweet.

Markets abhor high prices and just because 50 USD oil might not cover the cost stack of some ridiculously expensive project, this does not mean that this is a really low price. For some, it might be too low for comfort, but for many on the buying side, it might still be too high for comfort.

We all assume that the fall in prices has bottomed out and from now on all trends are upwards. How do I know that? Look at the positions and projects some companies pursue and you know that current LNG price levels can impossibly carry them.

Need proof?

Look at Yamal LNG as an example. Size-wise it’s comparable to the ridiculously expensive Gorgon LNG in Australia. But the price tag is cut by half. I will not try to say that Gorgon is a good yardstick for pricing LNG facilities but even if this is not the busiest corner of Australia, it’s still a very hospitable and nice patch of the planet compared to the Siberian coast on the Arctic Ocean.

This is Yamal, one of the most difficult terrains on the planet. You might be forgiven to think that you are on an entirely other planet altogether and work in those circumstances is never easy, let alone cheap. A 15 mtpa plant in those circumstances, is cheaper than one that is built in a comparatively easy environment – hard to believe. Isn’t it?

And it happens right when the market has nosedived. Or has it nosedived?

If you joined the energy world 5 years ago as a trader, you must believe so as for most of the last decade, prices were on the very high side. To you, it will be normality at its best. You have not seen anything else in the end, up until now at least.

But I can still remember days when a price like 5 USD/MMBtu was not considered low but rather normal. LNG sales prices of 2,5 USD/MMBtu were considered rather low and anything below 2 USD would have been really low.

Don’t throw the exchange rate evolution at me right now. This explains a dollar or two – but not up to 15.

What has changed? How is it that a little more than 10 years ago something was considered normal that is considered impossibly cheap today?

That’s simple. Humans are credulous and vain and whenever the price of something goes up – someone makes a fortune. Big industries – like energy – quickly get used to high price levels and it does not take long for them to take those levels for granted. As they are big companies with watermelon-like headquarters, they do what watermelons do best – they grow as big as they possibly can but unlike watermelons, they eventually reach a point where their weight crushes them.

The mechanics behind this are simple. Big companies have big management corpses and all those managers need to show great numbers to keep their careers healthy. In normal times, their urge to grow is kept in check by what the market can deliver but in times of abnormally high prices, their every whim suddenly goes through which makes them insatiable. They want ever more of the same – growth, growth, growth. They have pinned their careers not on who runs the company better but rather on, who brings the bigger numbers. And this race to big numbers can last for quite a while.

The last one in energy lasted for almost a decade and has blown everyone into a universe of obscene expectations. The old normal has become dangerously low so something has to be done about it.

But the lower prices today are a reaction to the market suffocating under monstrous prices. It has taken very long but finally, the market strikes back as it wants its old balance back. And now it has the upper hand as shale has handed it a weapon, classical producers cannot cope with effectively.

The right thing to do would be to scale back and shrink the watermelon. But that’s not easily done as managers usually go on borrowing sprees rather than cutting their might down to pieces and they will keep doing so until the company they work for is terminally wounded. Hence all the scrambling to get back what many still see as normal prices? Trust me, no matter what you do; it’s not going to happen.

So, what to do right now?

LNG sellers will have to become good at something they have ignored for a long time. They will have to do what all sellers of anything do – they will have to get good at marketing and customer service as there is a finite market facing infinite supply now.

The market is not going to beat a path to every seller of energy anymore – and it will also not sustain quite so many crazy projects anymore. The high-price market was like the Oracle that has unbalanced the equation and stirred quite some new developments. It brought the seeds of a new energy world that could not have happened otherwise. Now the architect takes over again and balances the equation.

Not everyone will survive but that’s also a good thing as it cleanses the market from those unable to evolve.

In the end, high prices were the best thing that could have happened as now the forces of change are armed with way more than a decade of new technological development. What we see right now is just the beginning. 10 years from now we might see those years as harbingers of a new energy world, one that we did not even dare to dream about 5 years ago.

A lot of work has been bottled up for the architect over those 10 years. And he will reboot our energy world which will blow away giants and get us bigger, better mousetraps.