Societe Generale Cuts U.K. Gas Forecast as Crude Enters Bear Market

Societe Generale SA cut its UK natural gas price forecasts by as much as 7.3 percent as crude slumped into a bear market, helping reduce the cost of supplies bought in contracts indexed to oil.

Gas prices in the U.K., Europe’s biggest market, will average 54 pence a next year and 52 pence a therm in 2016, the bank said in a report today. That compares with previous estimates of 56 pence a therm. Prices will be 7.3 percent lower than forecast at 51 pence a therm in 2017, 2018 and 2019, it said.

Oil prices slumped into a bear market last month amid the highest U.S. crude production in three decades and speculation Saudi Arabia and other nations in OPEC won’t do enough to reduce the resulting glut. Gas prices will follow the slide to a certain extent as part of Europe’s supplies are bought from countries including Russia and Norway at oil-indexed contracts.

“Spot prices could, in the future, become more expensive than oil-derived ones if oil prices were to drop significantly for an extended period of time,” said an analyst at the bank. The bank cut its forecast “to partially take into account this drop in oil prices, but not fully as most of the gas is sold on spot markets in Europe.”

Brent crude fell 30 percent to $80.53 a barrel on the ICE Futures Europe exchange since reaching this year’s high on June 19. Prices are trading near the highest in seven days today on speculation Iran’s Oil Minister Bijan Namdar Zanganeh may propose a 1 million-barrels-a-day production cut when he meets Saudi Arabia’s Ali Al-Naimi before a meeting of the Organization of Petroleum Exporting Countries Nov. 27.

Oil Indexation

Less than 50 percent of wholesale gas in Europe is indexed to oil, with a lag of three to nine months, according to SocGen. While gas will follow oil lower, Russia and Norway, Europe’s biggest suppliers, will adjust flows to reach a price that’s acceptable to them. Gas prices will be above a level at which it can compete with coal in power, highlighting a “bearish view on European gas demand going forward.”

Lower oil prices may be “problematic” for liquefied natural gas projects with high capital expenditure, with three plants in Australia potentially facing negative returns, the bank said. Tumbling oil will also mean projects with high costs will produce as much LNG as possible when they start, “adding to the bearishness of the situation,” according to the report.

“But unlike the European situation, lower LNG prices could boost gas demand in China and India, which are price sensitive”.