Hard Decisions for LNG Project Developers

November 2015, Vol. 242, No. 11

Larry Persily

The frustrations of an oversupplied LNG market and low prices were evident as about 100 LNG buyers, sellers, lenders, advisers and goods and services suppliers gathered in London earlier this fall.

“How do you plan your business in an environment like that,” said David Ledesma, managing director of South-Court Ltd., a UK-based oil and gas consultancy. “How are you going to go out and make final investment decisions?”

Spot-market prices for LNG cargoes delivered to Asia this fall are down two-thirds from the record $20 per million Btu in February 2014. Demand in China is not growing as much as was expected — just as new supplies are coming online from Australia and the United States — creating fears of an oversupplied market and low prices for several years.

Meanwhile, buyers are demanding shorter terms and more flexibility in their LNG supply contracts. Speakers at the fifth annual LNG Global Congress Sept. 23-24 said the oversupply could play itself out by the 2020s, creating opportunities for new projects to meet demand, but those investment decisions are getting tougher on LNG project developers.

“Gone are the days when you can expect to get 15% return on your LNG plant,” said Mike Fulwood, a principal in Nexant’s global gas consulting practice.

Low Prices to Build Demand

Conference speakers noted the price for LNG was way too high a couple of years ago but now it is far too low. The price needs to stay low enough to continue attracting new customers – which, the theory goes, would lead to increased demand and somewhat higher prices. That means producers will need to hold down costs for new projects if they are to make money in the low-price world.

“The industry needs to find new ways to get lower costs,” said Thierry Bros, senior European gas and LNG analyst for Paris-based banking and financial services company Societe Generale. “If you want to increase demand, you decrease prices.”

Kazumi Takahata, deputy general manager at Tokyo Gas, had the same message: Keep the price down and we’ll buy more. In addition to lower prices, Japanese utilities are looking for a more diversified supply portfolio, he said, listing North America (including Alaska), Russia and East African nations as potential suppliers.

A conference poll showed a strong majority believe LNG prices will stay below $10 per million Btu (roughly 1,000 cubic feet of gas) through the end of the decade. Although $10 would be a big increase from the $7 range sellers received for spot cargoes in September 2015, it’s still a long way from the highly profitable prices of 2012-14 that averaged over $15.

LNG Trade Changed

“We had this impression that the good times would never end,” said Vivek Chandra, CEO of Texas LNG, a smaller liquefaction project proposed for the Texas coast. “Instead of feeling sorry for ourselves, we need to embrace change.”

LNG markets used to operate in their own tradition-bound world of long-term contracts between a limited number of buyers and sellers. Now the market is behaving like any other commodity, Chandra said. Supply and demand dictate price and price determines customer decisions.

“When I buy chocolate, I look at Swiss or Belgium. … When I buy gas, I look at the price,” Bros said. Gas is a commodity, and there is nothing special about one country’s LNG over another. Bros said he stressed that point when he told a group of Canadians recently that their LNG is no better than anyone else’s and they should not expect a premium price. Developers are promoting two dozen LNG export plants on Canada’s western and eastern shores, though none have committed to construction.

The risk, many of the conference speakers said, is that developers of LNG export projects will shy away from final investment decisions (FIDs) this decade, setting the stage for supply shortages in the 2020s.

New Markets Developing

“Looking ahead, the current situation might delay FIDs and set the basis for the next cycle (beyond 2020) where demand grows faster than supply,” said Carmen Lopez-Contreras, senior analyst for the gas and power planning team at Repsol, a Madrid-based global oil and gas company. Lower prices will accelerate demand in new markets, she said, pointing to Pakistan, Jordan and Egypt as examples. “We have this amazing (demand) growth in Middle East countries that we have to watch.” Mideast countries are increasingly turning to natural gas for power generation rather than burning oil products.

In addition to the Middle East and Pakistan, growth markets are building in Southeast Asia (particularly Thailand), the Baltic region and Latin America, said Matthew Monteverde, vice president for generating fuels at Argus, a global energy news service.

The lower-cost and relatively quick development time (months, not years) for floating import terminals – ships that offload the cargo from an LNG carrier, store it, regasify it and pipe it to shore-based customers as needed – is making it easier for more countries to sign up for LNG deliveries.

Several speakers, including Stephanie Wilson, managing editor of the Asian LNG team at Platts news service, repeated the possibility of a tight market by 2025 if not enough new supply is developed. It won’t be easy for developers to make investment commitments for new supplies. More buyers are demanding shorter-term contracts of three to five years, she said, with diversified pricing to replace the traditional LNG price link to oil on an energy-equivalent basis.

“We know there will be shortages in the future because FIDs are not being taken,” said a senior adviser to a multinational oil and gas company. The deterioration of traditional long-term, take-or-pay contracts and the growth of shorter-term deals – with buyer flexibility to redirect or resell the cargo – is “uncharted territory,” he said.
Therein lies the conundrum.

“The banks still will need a long-term offtake from a creditworthy customer,” said Ian Catterall, senior vice president and head of natural resources at the Bank of Tokyo Mitsubishi. “Good projects will always be financed. I’m not sure which projects are the good projects.”

Conference speakers raised several other topics:

  • LNG imports have gotten so cheap for China that the average prices are less than pipeline gas deliveries from Central Asia, Platts’ Wilson said. Meanwhile, smaller, private buyers are gaining access to China’s LNG terminals controlled by the nation’s biggest importers, providing a new market for more import cargoes.
  • India will take an increasing volume of LNG as long as prices are low, Bros said. The government holds down the retail price of natural gas, putting pressure on importers to avoid high-cost contracts. India’s main LNG importer is pushing Qatar to negotiate lower prices on a long-term contract that dates back to 2004.
  • China wants to develop its substantial shale gas resources, to help reduce its reliance on imports, but “that’s moving much more slower than the official plan,” said Victor Perez, partner at consultancy A.T. Kearney‘s energy practice. Geology and a lack of technical expertise are the hurdles.

85% of Planned Projects Doomed?

Meanwhile, a report from Bloomberg said that “85 gas projects are endangered by today’s low-price environment.” An Oct. 8 article noted that five years ago, energy companies began planning as many as 90 terminals to send natural gas around the world. Now, it seems the world only needs five more, the report said.

Consulting firm IHS Inc. says only one in every 20 projects planned are actually necessary by 2025 as weakening Asia economies, cheap coal, the return of nuclear power in Japan and the ever-expanding glut of shale supply in North America temper demand for the power-plant fuel, putting tens of billions of dollars worth of export projects at risk.

Barring an unusually cold winter in Asia, global LNG supply will outstrip demand by next year, Trevor Sikorski, an analyst at Energy Aspects Ltd. in London, told Bloomberg. Seven new plants in Australia will flood the market over the next two years. Cheniere Energy Inc. is planning the startup of its Sabine Pass terminal in Louisiana this quarter.

“The global LNG industry now resembles a game of ‘musical chairs’ with far more projects than the market can absorb,” said James Taverner, an IHS analyst in Tokyo. “There is a very narrow window of opportunity for new projects that want to take final investment decision by 2020.”

Four years ago, the International Energy Agency predicted global demand for the heating and power plant fuel would climb 16% by 2016. Now, it’s projecting 11%, and terminal developers are taking note. Excelerate Energy LP’s floating terminal in the Gulf of Mexico has been postponed. Inpex Corp. delayed the start of an LNG project in Australia by almost a year to the third quarter of 2017.

“It will be increasingly difficult to convince financial institutions to put major sums of money on the table to construct additional capacity,” Tim Boersma, acting director of the Energy Security and Climate Initiative at the Brookings Institution in Washington, said by phone.

North America

Over half of the 38 terminals proposed for the contiguous U.S. may never be built, according to Fitch Ratings Inc. and the Brookings Institution, a nonprofit research group. Besides Cheniere’s Sabine Pass, projects in development include Freeport LNG Development LP’s terminal in Texas, Dominion Inc.’s Cove Point in Maryland and the joint Lake Charles LNG venture in Louisiana between Energy Transfer Equity LP and BG Group Plc.

Twenty more terminals are planned for Canada, according to Energy Aspects, including the Kitimat project proposed by Chevron Corp. and Woodside Petroleum Ltd. in British Columbia. The higher costs associated with projects there, in part because of environmental opposition, makes it even less likely that they’ll be built, Jeffrey Currie, head of commodities research at Goldman Sachs & Co. in New York, said in a Sept. 24 interview.

This deluge of North American gas exports was once seen as displacing some foreign supplies linked to the price of oil. Then the oil market crashed and crude lost half its value, and now that gas from abroad is looking cheap.

The pace of project postponements will pick up as the supply glut expands, Noel Tomnay, head of global gas and LNG research at Wood Mackenzie in Edinburgh, said in a Sept. 3 report. Development of even half of the capacity may keep the Asian market oversupplied through 2025, he said.

Australia’s Gas

While the U.S. LNG projects already under construction will probably come to fruition, any supply not already contracted will be difficult to find a home for, particularly in Asia where Australian gas is easy to get, Currie said.
Spot LNG prices for delivery to Northeast Asia have slid 56% over the past year, according to data compiled by World Gas Intelligence. Shipments to Japan will average $5.80 per million British thermal units in 2015, a 65% decline from 2013, according to Energy Aspects.

The world’s demand for gas, meanwhile, expanded by only 0.4% in 2014, the smallest gain since 2009, because of shrinking imports to Japan, South Korea, India and China, Bank of America said in an Aug. 21 note to clients.
“Given the price environment and the supply that’s going to come online in the next five years or so,” said Dino Kritikos, an analyst at Fitch in Chicago, “many of these projects are at an inherent disadvantage.”

Editor’s Note: The author a can be contacted at lpersily@kpb.us

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