Poring over the biggest stories of 2013, it quickly becomes apparent that the energy industry of then was awash with bright hopes for the future; for reduced energy poverty, for renewables, and – most of all perhaps – for LNG. Born of advances in technology and changing consumption patterns, its ready availability and proximity to major consumers has handed the industry, particularly in Asia, a much-needed pick-me-up (see Fig. 1)
“Liquefied natural gas has experienced remarkable developments in commercialisation and export capacity in a span of just 50 years”, wrote Craig Pirrong, Professor at the Bauer College of Business University of Houston, in a paper entitled Fifty Years of Global LNG. “The world now stands on the cusp of another major surge in capacity.”
Treading on the tailcoat of America’s shale revolution, LNG’s relative cleanliness and easy availability hinted at a not-too-distant future wherein natural gas rather than oil would be the lifeblood on which the global economy would feed. Advances in drilling technology, together with supply constraints in Japan, China and in Eastern Europe paved the way for a gas-fired transition, and significant discoveries in Canada, Mozambique and Australia, to name a few, have ignited a fire under the industry.
Reduced emissions and improved energy efficiency are the promises of an LNG revolution, and, assuming these to be true, a spike in consumption looked in 2013 to be nailed on with certainty. Two years on, however, and the global energy market is a changed proposition.
Blow after blow
An oil price collapse at the turn of the year – which needs no explanation here – was significant not just for oil producers, but also for rival energy companies. And where, prior to the decline, LNG’s competitiveness gave rise to a string of ambitious projects, the Brent price swing has reset the price differential and dialled down its prospects. Fresh from a hard knock in the summer of 2014, courtesy of ExxonMobil’s Papua New Guinea project, LNG prices – in the wake of the oil price collapse – have suffered another blow, and margins in many instances have been squeezed to borderline unmanageable extremes. What’s more, with the price of natural gas so closely tied to Brent crude fluctuations, analysts at the turn of the year were united in the opinion that the resource, after a half century-long rise, was headed only one way.
In South Korea the return of nuclear power has contributed to an almost 20 percent decline in
LNG imports
“The first quarter of 2015 could be the last hurrah for LNG prices for a while”, said Trevor Sivorski of Energy Aspects, speaking to Reuters at the time. Far from the optimistic outlook that has so characterised its 50 year rise, analysts – many for the first time – have started to fear for the immediate future of LNG, as the fall in global oil prices has unearthed weaknesses not seen until now.
For a resource that is yet to carve out a niche, at least as far as pricing is concerned, its value is dictated still – some would say illogically – by long-term fixed contracts indexed to the price of oil. Existing as a means of injecting stability into an otherwise unstable supply/demand equation, the ties also mean that any bad news for the black stuff is bad news for natural gas. However, the emergence of LNG as a global contender – soon to eclipse iron ore as the second most traded commodity after oil – means that this formula is seen by many as inadequate to reflect the commodity’s true value.
According to Bloomberg, around 73 percent of global LNG is sold in this manner, and the majority of the rest sold as Asian spot cargoes, with neither priced according to the resource’s own fundamentals. Under this framework, expectations at the year’s onset read that LNG prices would fall from $15 to $16 per million British thermal units (Mbtu) to around $10 or $11, and in doing so render billions of dollars in planned projects unviable.
Speaking about LNG’s close ties to oil, Andrew Grant, Financial Analyst at Carbon Tracker, said that the falling price of crude is “very significant,” adding, “LNG prices have fallen significantly, both on a long-term contract basis and spot basis. Further, following market tightness in recent years [and particularly since Fukushima], the market has swung into oversupply that may last for several years.”
One key reason why these contracts can prove so destructive, both to planned projects and to the overall health of the market, lies in Asia, where there’s good reason to seek an oil alternative, preferably one that is more readily available and cheaper. However, in linking the value of LNG to that of oil, Asian buyers are unable to realise the benefits on its own terms.
It could even be said that low LNG prices fail to reflect the value of the resource itself, yet talk of oil-delinkage is premature, given that most sellers would rather keep the long-term guarantees tied to existing price mechanisms rather than the gains associated with independence. True, the price hit has impacted key segments of the LNG business, some critically so, though the issues go far beyond pricing, and extend also to the undue importance placed on the resource in days past.
Dealing with over capacity
Occupying a two-thirds majority share of the global LNG trade, unfavourable demographic trends in Asia have contributed to a glut in supplies, and in doing so stifled the industry’s growth.
In Japan, as one of the three traditional LNG buyers alongside South Korea and Taiwan, a nuclear retreat has done much to ease the transition to natural gas and reinforce the country’s existing commitments to the oil alternative. If only for the simple reason that Japan is a credit-worthy buyer willing to invest in LNG, investors in the 1960s ploughed billions of dollars into its development, to the point that the resource today is often mentioned alongside oil and coal as a stalwart of the energy market. Adopted first as a low-pollution alternative in a time when environmental regulations were beginning to take hold, a nuclear retreat inflated LNG’s prospects.
Accounting for about a third of all global LNG shipments, Japan last year spent over $63bn on the resource, although spending in the first half of this year is down on the last. What’s more, public opposition to nuclear is waning and the government looks dead set on a restart, which together suggest that the window of opportunity for LNG is narrowing. Also, in South Korea the return of nuclear power has contributed to an almost 20 percent decline in LNG imports, whereas in China sluggish growth has contributed to a nine percent decline.
While in Asia demand for the resource is slowly falling, production remains a constant, with the resulting excess finding its way to lesser consumers, mostly in Europe, which, while useful, contributes to some of LNG’s spiralling price. Whereas on the one hand pricing mechanisms and changing consumption patterns in Asia are part of the decline, discussion on the subject has focused mostly on oversupply and its consequences for planned projects.
“Partly due to the long lead time, LNG supply is covered for a low demand scenario for the next decade. Beyond this LNG with supply costs below around $10/mmBtu delivered to Japan will be needed”, according to a Carbon Tracker report on the subject, entitled Carbon supply cost curves: Evaluating financial risk to gas capital expenditures. “But there are $283bn of high cost, energy intensive LNG projects that would continue to be deferred if demand disappoints. In particular the number of LNG plants in the US, Canada and Australia could disappoint those expecting large LNG industries to develop.”
Stumbling over hurdles
An explosion of export capacity is yet to come online, with a great many projects having hit a roadblock recently courtesy of price concerns, and with many projects still underway, the implications for the industry at large are unclear. Insofar as supply is concerned, some analysts fear that a string of completed projects could inflict price pressures on the industry reminiscent of the shale boom. Having enjoyed a prolonged stint in which supply has been equal to or just shy of demand, early signs show this is no longer the case, and that the imbalance could be setting in for the long haul.
“We see the main challenge as the large number of LNG projects that have recently come on stream or are being built. We expect the LNG market to grow over the next 20 years, but the build out of capacity has been such that the market is oversupplied already, and there remains a large pipeline of further projects that have been proposed”, said Grant. “In our recent gas report, under a scenario where LNG demand grows by 3.5 percent over the next 20 years, no new developments are needed at all until 2024.
Beyond this, some projects will be able to go ahead in the next 20 years, but only the most efficient and cost advantaged – we see a limited amount of additional US Gulf Coast supply, Mozambique, brownfield Pacific and some other projects as being the most likely. A significant number of the proposed projects, however, are simply not needed.”
In North America at least, a procession of multi-billion dollar export terminals are scheduled soon to reach conclusion, which, while important for the continent’s low carbon drive, could depress Asian prices further.
The only thing keeping prices from falling through the trapdoor is a spill over of uncertainty stemming from the oil price collapse. In this sense LNG has suffered from the decline and benefitted, as cautious investors choose not to resume LNG projects, and, in doing so, keep prices relatively stable until the oil price picks up.
Having said that, there’s a consensus that the uncertain situation in the oil market is staving off the inevitable, and may even magnify the consequences, given that the LNG market has been made vulnerable already by a spate of uncertainty. Ultimately, LNG looks on course to perform well in the years ahead (see Fig. 2), though its recent short-term setback has highlighted the dangers of the reigning pricing structure and the risks associated with a sudden explosion in supply.
