One of the first articles in GasTerra's newsletter discussed LNG exports from the United States and its impact on the LNG market. That was in September 2013: LNG spot prices in Asia were sky-high, an enormous amount of LNG was about to hit the market, China had not yet concluded a deal with Russia and Viktor Yanukovych was still president of all of Ukraine. In short, the gas industry was about to be hit by huge changes. In the light of recent developments, it might be good to have another look at the future of the LNG market.
In 2014, a number of developments took place that have a major impact on way the global supply of and demand for gas, and LNG in particular, will evolve over the next decade. The enormous production of shale oil in the US, for example, has led to a fall in oil prices. Since 2010, the West Texas Intermediate (WTI: the most common oil index in the US) had been showing a drop compared to other oil indices, such as Brent. The reason for this drop was a lack of infrastructure, meaning the supply of shale oil to the world market was limited. With a difference in 2011 of about $30 per barrel between WTI and Brent, it was expected that the infrastructure bottlenecks would be cleared and the two indices would come closer together. Very few analysts suspected that the prices would almost go into a free fall from September 2014, both on WTI and Brent.
The cause of the low prices was mainly attributed to lower economic growth in China – in addition to an increasing production of shale oil. OPEC (read: Saudi Arabia) has indicated not to want to downscale its production quota and retain sufficient availability of spare production capacity.
In Asia, the low oil prices resulted in a sharp drop in the LNG spot price. The reason for this is that countries like Korea, Japan and Taiwan are purchasing more gas from long-term oil-indexed contracts, which currently offer favourable rates for them, which has resulted in a drop in the demand for extra volume – in the form of spot cargos. LNG publications point at the difference between spot cargos and oil-indexed import rates in Asia. The latter have now fallen to about two dollars per MBTU, to the advantage of spot cargos. An ideal time to meet the volume requirements in the long-term contracts. With these spot prices in Asia, which were around $10 MBTU in December, the Asian premium has all but disappeared compared to the European market. The price differences appear to reflect transport costs and the sale of LNG on the European market is cautiously increasing.
Besides the impact on gas prices with an oil link, which still occur in e.g. (LNG) export contracts, the low oil price also affects investment decisions for new LNG projects. Although, in 2014, the average Brent rate was still around $100 per barrel (oil and gas companies tend to base their investments more on annual averages than on a current rate), this drop in price will certainly have an impact on the decision-making process regarding the projects in Mozambique, Russia and Canada. Canada was already having a hard time making projects economically viable, given the relatively large distances between the production zones and the export terminals. But Russia will also encounter problems financing an LNG project in the Arctic Circle, quite apart from any sanctions imposed. The said spot price in Asia is also approaching the minimum required to bring in gas as LNG from the US to Asia. The export projects in the US that are currently in the pipeline or already under construction, probably won’t be affected much by the current price situation, but for projects that are still in their initial stages, it might become harder to secure the business case.
Another event that has major implications for the future demand for LNG is the deal between Russia and China, for the supply of around 70 billion cubic meters of gas per year. Although most analysts have been taking this deal into account, the volume is considered to be of such a magnitude that it will impact the LNG demand in Asia. Especially since the price of this gas, with an expected city gate rate of $12 MBTU in Beijing, is lower than what the majority of new LNG projects can offer. The new export terminals in the US might form an exception. But, with an estimated cost of about $5.5-6 MBTU on top of the current Henry Hub rate, they won’t be able to offer a structurally lower rate.
For the European market, the change of power in Ukraine has put gas high on the European political agenda again. The European Commission has set out on a course which should ensure that, in time, the EU will be a stronger party for suppliers like Russia. According to the Commission, LNG will play an important role. The contracting demand for gas in Europe and the reduced rates, however, don’t manifestly prove this scenario will become a reality.
Maybe the most important event for the gas market, and probably also the hardest the calculate, was the climate deal struck in November between the US and China. Both countries expressed their support for drastic measures to reduce climate change. Besides the fact that China will try to make a case for a twenty percent share of renewable energy in its energy mix, there is already much speculation on how fast China should expand the role of natural gas to fulfil its promise to the level off the immense rise in CO2 emissions. This convention also has big implications for the US (and its gas sector). Although shale gas has helped the US to, de facto, meet its Kyoto targets, there is plenty of room for improvement in the US gas industry. The US will, for instance, have to curb shale oil gas burn-off. Consequently, the costs of extracting this oil, especially in areas that are farther away from existing infrastructure, will increase. Greenhouse gasses are also be looked at more from a life cycle point of view. For example, in May the American Department of Energy published a study which shows that from a climate viewpoint, it is not desirable to export shale gas from the US to China for use in power stations as a replacement of locally produced coal.
To summarize, the uncertainty about the developments of the LNG market have only increased in the past year. While in 2013 all the lights were still on green for a large influx of LNG on the world market, the increased uncertainty about the development of demand has now also manifested on the supply side. The fact that investment decisions fail to materialize in potentially large production zones, is a prime example. Finally, the fact that the differences in rates gas between regions are currently a good reflection of the transport rates is more a result of a slump in demand for spot cargos in Asia than of an increasing role of LNG in the world gas trade. For Europe, in any case, the widely available LNG spot cargos offer a comfortable back-up in the event of disruptions in the supply of Russian gas.