A single (world) market for LNG?

03-06-2016

The LNG market is undergoing major changes. The arrival of American LNG has led to a revolution in the LNG market.

The world LNG market is expanding rapidly and undergoing major changes in the process. The rise of two large producers, Australia and the United States, the increasing role of short-term (spot trade) and medium-term contracts, together with the introduction of spot-indexed (Henry Hub, but also TTF) LNG contracts play an important part in this. Whether by chance or not, it is still too early to tell; prices in Europe and Asia have already risen considerably in the direction of the cost of American LNG in Asia or Europe.

The point has often been made that the arrival of American LNG has led to a revolution in the LNG market. Not only has the standard oil price basis been replaced by a spot-indexed basis for this LNG (Henry Hub), there is also the fact that this volume can be deployed flexibly, as parties buy capacity in the LNG terminals rather than volume. In principle, LNG is in principle only shipped if the price is high enough to cover the marginal costs and this principle can also be applied within current contracts. In the present period of oversupply (see An LNG tidal wave?!?), LNG can therefore play a balancing role among the markets. Once it is on board ship, the vendor is, depending on the obligations in its portfolio, free to offer the cargo where the price is highest.



The surplus that now seems able to play such a wonderful facilitating role in linking markets, came about because parties have built production capacity at the same time. You might ask why this has happened. We can point to a number of causes. On the one hand parties such as the International Energy Agency (IEA), but also the international oil and gas companies (IOCs), have for years been issuing very optimistic consumption forecasts for natural gas. Problems were not expected, and so market players thought that they would be able to sell this gas without difficulty. On the other hand, Qatar, which is currently the largest exporter, left room for other players by not complying with the wish of Asian purchasers to conclude additional long-term contracts, opting instead for a strategy of trading more LNG on the spot market. It is these contracts that have formed the basis for the new Australian LNG terminals.

The construction of terminals in the US has also had its own dynamics. The opportunity to buy partial capacity in a terminal in the US at a relatively low price made LNG liquefaction capacity accessible to several parties. In some cases this capacity is being used not only to diversify gas purchase, but also to strengthen the negotiating position in long-term LNG import contracts. The fact that projects in Australia and the US were completed more or less at the same time now seems to have led to oversupply.

Hard times lie ahead for some parties that have invested in the new Australian LNG projects. Although they have already sold a large proportion of gas under long-term (oil-indexed) contracts, the returns at current prices are insufficient to cover the costs. Parties that have also opted for a strategy of selling a relatively high proportion on the spot markets rather than under long-term contracts (up to around 30% in the case of Chevron in Australia) will have great difficulty in making the projects profitable. The Wall Street Journal predicted in a recent article[1] that the total net debt of the five largest IOCs would, by the end of this year, probably be almost double what it was in 2014, and top $200 billion. The fall in the oil price is of course the major factor in this, but developments on the natural gas and LNG market have also certainly contributed. Natural gas is certainly now taking on a more prominent position in these companies’ activities.

It seems therefore that the road to one world market will be a bumpy one for a number of these parties. These players (but in fact all of them) will have to develop new strategies to hold their heads above water. Consequently, the possibility of a new round of consolidation in the oil and gas sector cannot be ruled out, and Shell’s takeover of BG last year could be seen as the springboard for this.

 


[1] Big Oil Deals: Don’t Hold Your Breath, Wall Street Journal, 22 May 2016

Geert Greving
Head Public Affairs

 

 

 

 

 

 

 

 

 

 

 

 

 


[1] Big Oil Deals: Don’t Hold Your Breath, Wall Street Journal, May 22, 2016.