Six Threats for the U.S. Liquefied Natural Gas Business
Combined with lower than expected growth, both oil-linked contract prices and spot prices have plummeted and narrowed the price differentials between the three major markets: the Americas, Europe, and Asia. Per WoodMac, "Up to half of US LNG at risk of shut-in over next 5 years." All businesses must keep on their toes by deploying constant SWOT analyses, so here goes six of the Threats for the current U.S. LNG industry.
1. Australia should surpass Qatar and become the largest LNG supplier by 2018. Over $250 billion has been invested since 2009, and Australia will soon have the world's largest, most modern, and technologically advanced LNG export industry in the world. Australia is physically much closer to Asia than we are, taking just 7-10 days to get there, so shipping costs are lower.
Asia already accounts for 70% of all LNG imports and is still see as the main growth market globally, based on rising needs in China and India. Moreover, most of Australia's new LNG export capacity will be available before most U.S. capacity arrives, giving Australia first chance to secure contracts. In many ways, Australian LNG is less affected by the global slump in oil and gas prices, projects pre-sold under long-term contracts, with only 8% of over 9 Bcf/day of new project capacity being un-contracted.
Australia's LNG export capacity now stands at 6.3 Bcf/day, and this could double to 12-13 Bcf/day by 2019. Australia is also installing floating liquefaction (FLNG) to monetize as much as 100-110 Tcf in offshore stranded gas. And Australia's per capita income is significantly higher than those in both the U.S. and Canada, so even though LNG project costs are higher in Australia, the economic (and talent) capacity is major competition.
2. Of the nearly 70% of the European Union's natural gas demand that comes from imports, about 85% arrive via pipeline. Russian piped gas will remain the largest source of foreign gas in Europe, now constituting over 30-33% of supplies. Russian gas is cheaper and operating costs are low: the export infrastructure has already been built. Most of the existing long-term gas contracts between Gazprom and its European customers will still be in place in 2025, strengthened by today's low oil prices.
Russia's spare capacity to produce natural gas is without equal. Gazprom produces about 43-45 Bcf/day but has the capacity to produce nearly 60 Bcf/day. This giant surplus will allow Russia to ramp up output if Europe's demand for gas increases, a low cost source of supply that could push out U.S. LNG.
Russia has the upper-hand in a price war with us to supply gas to Europe, and our ability to penetrate the European market could simply come down to the willingness of countries to accept higher prices just to reduce reliance on Russia.
If Russia tries to support higher prices and let go market share in Europe, U.S. LNG export capacity could operate at 75%. But, if Russia lets prices fall to hold market share, like Saudi Arabia did to U.S. shale oil, our utilization rates could be just 40%.
Note that China and Europe will NOT be competing for the same Russian gas sources. Europe is the designated market for Russia's current and future gas production in the traditional West Siberian gas basins, so there's great incentive to remain price competitive in Europe. At over 1,150 Tcf, Russia has three times the proven gas that we do. Normally rigid Gazprom has proven to be more flexible under the current oversupply, discounting Lithuania's prices by 25%.
Russia needs Europe more than some realize: domestic demand is declining and LNG and projects to Asia are not progressing as quickly as hoped. The European Union is around 80% Gazprom's gas sales. From 2013-2015, Gazprom reports the average gas production cost fell from $1.20 mmBtu in 2013 to $0.84, and Gazprom might choose to flood Europe with cheap gas to damage U.S. LNG prospects.
3. China might be the world's largest incremental gas user and importer, but likely based on piped gas, not LNG. China has signed a $400 billion gas deal with Russia, comprising a framework whereby Gazprom would supply gas for 30 years commencing in 2018. "A $27 billion natural-gas project in the Russian Arctic has secured the billions in financing it needed from Chinese banks."
Already sharing a nearly 2,700-mile border, a gas alliance between Russia, the 2nd largest gas producer, and China, the largest energy consumer, is a natural match, and eventually the disagreements on price and route preference will be straightened out.
One estimate has China more than doubling its gas demand to over 40 Bcf/day by 2020, with about 40% of that coming from imports (63% pipelines, 37% LNG). Turkmenistan is committed to maintaining its 50% market share of China's imports, and two huge pipeline projects with Russia could block U.S. LNG. Other resource-rich former Soviet Republics like Kazakhstan have their sights set on China, and China also wants new prices in its 25-year gas deal with now more flexible Qatar.
Other factors could limit China's LNG imports, such as domestic production and shale gas. China's gas production has quietly been booming, up nearly 35% since 2010 to about 12 Bcf/day. China has a solid 125 Tcf of proven natural gas, and holds the largest technically recoverable shale gas reserves at 1,115 Tcf. In fact, the most important question for the future global LNG market could be how shale gas develops in China.
The Great Wall is a perfect example of China's ingrained dedication to self-reliance, so rising gas (and oil) imports are a known problem that won't go unmitigated. China will remain a coal-based economy, and the Large Substituting for Small program has been installing some of the most efficient coal plants in the world, with super- and ultra-supercritical units reaching 45-50% efficiencies, versus the global average of under 33%.
Even after COP21, LNG import leaders Japan and South Korea are also using more coal, with a combined 61 coal plants set to be built in the next 10 years. Coal for electricity in Asia is much cheaper than LNG: Accenture has coal costing 5 cents/kWh, compared to 11 cents for LNG. COP21 commitments will lower coal prices, enticing coal use. With nuclear just 4 cents, South Korea and developing Asia drive "strong growth" in nuclear power.
4. Over 90% of India's LNG imports come from mighty Qatar. Petronet LNG, the country's biggest importer, recently revised its contract with RasGas of Qatar. Penalties will be waived and Petronet's gas price will be halved to $6-7 per mmBtu, demonstrating how key gas and LNG suppliers are willing to alter contracts to maintain market share.
Qatar, "the world's richest country," already exports 12 Bcf/day and is well positioned to ride out low prices because it focuses on efficiency and lower costs, owning "the value chain from start to finish." About 33% of Qatar's export LNG volumes are unsold and could push higher cost suppliers out.
India is easily the most energy derived nation on Earth and seeks all gas (all energy really) from all available. India has inked a $20 billion deal to invest in Iran's oil and gas industry. Iran has the world's 2nd largest gas reserves at over 1,200 Tcf, and opening this endowment to international investment will cause major problems for all gas exporters. And "Russia, India Inch Closer To $40 Billion Gas Pipeline."
Shockingly to most I'd bet, India's natural gas demand has actually been falling, down about 25% since 2010 to under 5 Bcf/day. And just like China, coal-based India is also installing some of the most efficient coal plants with its Ultra Mega Power Projects program. Coal India wants to double output to over 1 billion tonnes by 2020.
5. The estimate is that over half of U.S. total LNG production is destined for Europe by 2020. Cheniere said in January that it can profitably sell LNG despite lower prices, though margins may be as little as $1 per million Btu to Europe.
But, all of Europe's key gas suppliers, Russia, Norway, the Netherlands, and Algeria, will be doing all they can to maintain market share in their most important export market. In the first quarter of 2016, Norwegian and Russian gas to Europe reached record levels. Russian gas will be helped even more when sanctions are lifted.
Europe's gas market has been contracting; efficiency improvements, more renewables, little economic growth, and low carbon prices that discourage coal-to-gas switching. Overall gas demand in the European Union is down 15% since 2010.
Europe's LNG needs could depend on higher coal prices, which is unlikely anytime soon because of huge oversupply and COP21 commitments that will constrain coal use around the world thereby making coal more available and cheaper. And now, low gas prices and lower usage continue to reduce investment in critical infrastructure. Gas demand projections for Europe have continually been overstated, and most of the ones now indicate a slight incremental gain or even a drop.
Eastern Europe is where U.S. LNG is needed most to lower reliance on Russia. The problem is that there's not enough infrastructure in the area to take in much LNG, or to even import gas from other parts of Europe. Less environmental regulations and a long over-influence of the former Soviet Republics have hurt gas market liquidity in Eastern Europe, where "gas markets remain fragmented and divided."
Spain holds over 30% of Europe's LNG re-gasficiation capacity, and the lack of infrastructure to move supplies eastward is a major bottleneck: "they say the French have refused to allow these interconnections." The overall gas transport system in Europe runs east to west.
And policymakers have been clear: Europe's energy policies are based on making sure that renewables and efficiency, not natural gas, come to dominate, regardless of the cost. "France studying possible ban on import of U.S. Shale gas."
6. The global LNG market is still 70% dominated by the long-term, oil-indexed gas contracts that U.S. LNG is expected to help scale down. But, "less than 15% of contracted volumes expiring in next 5 years." Even these long-term contracts are becoming increasingly flexible, shown by Gazprom's move toward new market-driven tools.
The competition for the U.S. LNG business will be increasingly fierce. In past years, high oil prices and rising reserves bettered the economics of exporting LNG, driving investment in a new wave of liquefaction projects that will be coming online just as U.S. projects get ramped up.
The global gas glut seems without end, and still: supply in the LNG market will increase by 40% from 2015-2020, the largest 5-year supply increase in the history of the market. The oversupply could be as high as 4 Bcf/day persisting through 2018 as global LNG demand struggles to grow. "The average spot price in Asia for LNG for delivery in May dropped by 42.5% year-over-year to $4.241 per million Btu, the lowest monthly average since July 2009."
Slow economic growth that slows demand would make matters worse. Adding to the glut after 2020, there's great potential for numerous liquefaction facilities in Canada, and recent large gas discoveries in Mozambique and Tanzania could also be transferred into LNG.
A transformative technology, FLNG facilities will help old and new suppliers alike reach stranded gas assets, expanding opportunities to produce and export. There's now 20 LNG exporters, and potential new ones will see lower entrance barriers from evolving tech like small-scale LNG.
And in contrast to the assumption that liquefaction and sales contracts are between the terminal owner and an overseas gas user, most contracts (including 60% of the volume under construction in the U.S.) are not with end users, but with LNG traders who would act as intermediaries for terminals looking for buyers. This is supply that could be dumped on the spot market, leading to a substantial fall in world prices.
Some say it could be until the late-2020s until the world has LNG supply issues. Stated by Deloitte a few months ago:
"As few as one in twenty planned projects may be needed to meet demand through 2035 and only those with lower costs, direct access to markets, and signed buyers will move forward."