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Why are 3 Year Gas Contracts Cheaper than a One Year?

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Shale gas has been pushed by many institutions; especially by the UK Government. It was claimed to have a significant impact to the UK energy supply mix. However there is a significant counterargument for a number of reasons:

Lord Bowne, who is the chairman of one the forefront fracking companies in the UK, Cuadrilla stated last week, “I don’t know what the contribution of shale gas will be to the energy mix of the UK. We need to drill probably 10-12 wells and test them and it needs to be done as quickly as possible. We are part of a well-connected European gas market and, unless it is a gigantic amount of gas, it is not going to have material impact on price,” he said.

The main reason for the forward curve being lower than the prompt is the correlation between WTI and European Natural Gas. As we can see from the chart above the two main oil indices (WTI & Brent) are in ‘backwardation’, where future prices are lower than the Day-Ahead.

Why are oil prices in decline? US production of oil has increased significantly in the last year and continues to grow stronger in the future. Such is the future for US oil production that there are talks of it being one of the top producers in the world. However demand for the oil is not rising at the same pace. The U.S. met 87 percent of its own energy needs in the first six months of 2013, on pace to be the highest annual rate since 1986, according to the EIA.

Rising US oil output is expected to keep a lid on Brent prices. Expectations that more Iranian oil will come back to the market may also weigh in on Brent oil. Iran and six world powers clinched a deal last Sunday to curb its nuclear programme in exchange for initial sanctions relief.


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