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March 2009 |
Issue #49 |
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LNG Economic Modelling To find out more about this topic, please consider MJMEnergy’s LNG Economic Modelling course running in Oxford from 12 – 15 May 2009. http://www.mjmenergy.com/LEM.htm LNG Supply Crunch! Up until the summer of 2008, the world was expecting a large LNG supply crunch in the coming few years. With rapid industrial expansion in the Far East, along with a growing preference for LNG over pipeline gas in many Western countries, demand was growing rapidly. Meanwhile delays or cancellations to a number of proposed liquefaction facilities led to concerns of a shortage of LNG supply over the next few years. Prices for short-term LNG cargoes reached as high as $18/MMBtu as Asian, European and US buyers scrabbled for available cargoes. At the same time, some voices were raised questioning the impact of the sellers’ market on future LNG demand. Petroleum Economist commented after the Gastech conference in Bangkok in May 2008 that “The growing shortages in LNG supply after 2010 could start to destroy demand, as potential buyers consider alternative fuels.” From a peak in Summer 2008, however, collapsing oil prices, the credit crunch and the recession have transformed LNG economics from being heavily weighted in favour of the seller; where many buyers were competing for their cargoes; to a problem of the opposite kind, where production is exceeding demand. With industrial production in the Far East severely slowed by the recession, compounded by one of the biggest LNG production facilities having just come on-stream in Qatar in order to, it seemed, quench the demand of an LNG thirsty world (which in actual fact realized that it was no longer desperate), has resulted in a wealth of LNG flooding the world markets. The LNG Markets In order to assess what impact this change is having on LNG economics, it’s important to first examine the three major geographical markets in which LNG is sold. There are three major pricing structures for LNG, which are based on region. Prices are generally linked to how gas is traded in these areas as this still forms the bulk of the supply. In Asia, LNG prices are linked to crude oil; in Europe LNG prices are linked to gas and fuel oil prices and in the USA LNG prices generally follow the market price for Gas at Henry Hub. In Asia, LNG prices are generally linked to oil with the JCC (Japanese Custom Cleared price: the average price of all crude oil imported into Japan) with a lag of about 3 months. It takes a few weeks for the change in oil price to be reflected in the JCC price, so the LNG price being linked with the JCC means that LNG price lags behind the change in oil price by a few months. This has the effect of dampening the volatility of the LNG price. Traditionally, the Asian LNG price has sat at a premium to crude oil and has been traded at the highest price of all the three markets. However, over the last few years the expansion in production in the Far East has caused new buyers in Japan, Taiwan, Korea, India and China to invite lots of prospective suppliers, often resulting in suppliers competing against one another and the sale price being driven down. This is very different to the more traditional way in which the buyer approached a single supplier and negotiated for price. In Europe, pipelines turn out about 92% of the gas supply. Thus traditionally, in order for LNG to be competitive, prices have been linked to long term contracts in gas. LNG prices in Europe are generally calculated on a quarterly basis using the value of gas some 3-6 months before. This also means that there is less volatility in LNG prices compared to those of oil prices. The re-emergence of the UK as an LNG importer in 2005 has introduced a market-based pricing structure for LNG deliveries to UK terminals and in some cases the Zeebrugge LNG terminal in Belgium. The existence of a liquid spot gas trading market at the NBP in the UK, and to a lesser extent at Zeebrugge, provides an alternative means of selling LNG. In the UK LNG producers such as Sonatrach, BP, ExxonMobil, Qatar Petroleum, BG and Petronas have acquired regasification capacity at LNG terminals, but have decided not to sign long-term contracts to sell the LNG on the market. Instead they are able to choose when to bring LNG into the UK, confident that they will be able to sell the gas on the NBP market. This provides a sink market to which LNG sellers can always turn to unload volumes, whilst exposing them to price risk, particularly if additional LNG volumes depress UK prices. The US gas prices are driven by the balance of supply and demand. Gas is freely traded between buyers and sellers at Henry Hub and the other hubs. LNG prices rise and fall with the Henry Hub price in order to remain competitive. As with the UK, the US operates as a sink market in which volumes can always be sold, albeit at the current market price. How will LNG economics change in the current climate? So, how will the recession affect each of these markets? And which will be the hardest hit? The hugely waning demand in China, India and Taiwan, due to a number of factories being shut down or cutting production suggests that the trend of competition amongst suppliers will increase further, and will drive prices lower. This is compounded further by new LNG sources coming on-stream soon which were initially planned to meet the spiraling demand of the early 21st Century. For now, Asian LNG prices will fall, following declines in the JCC index price, and falling demand. Further supplies, and particularly full production from the new Qatari liquefaction facilities, may put further downward pressure. There may be some rebuilding of demand in some markets, for example in Japan where lower gas prices might lead to higher utilization of gas-fired power generation. However, in general terms demand is falling, and more spare LNG cargoes should be expected to seek markets in the West Compounding this, the demise of a good number of energy intensive industrial factories in the Far East as a result of the recession has resulted in an even greater drop in demand. In Europe, prices are also likely to fall. In Southern Europe this is largely as a result of the oil price indexation in existing LNG contracts. In sink markets, such as the UK and the US, there may be a still greater impact. It is to these markets that many LNG producers may turn in order to offload spare LNG cargoes, as evinced by the number of cargoes arriving at the UK Isle of Grain terminal over recent months. The delivery of large volumes of LNG to these markets may push spot market prices further down, particularly in the UK, where one large Qatari LNG cargo could deliver 150mcm of gas into the market (daily UK gas demand is typically 200-450 mcm/day). In the short term therefore a flood of LNG could see significant impacts on UK prices. Already heavy LNG deliveries saw the UK exporting gas to the Continent in mid-winter. Should large-scale LNG deliveries continue into the summer, we could see the UK-Belgium Interconnector full in export mode and potentially crashing UK gas prices. What about the future and the recovery of the economy? In 2008 there were a number of reservations from suppliers as to whether it was prudent to expand. It was reported that “Investment uncertainties, cost increases and delays continue to be a major problem to security of supply and could threaten security of supply in the long run.” With the recession causing falling demand and a supply glut, and project financing problematic, development of supply facilities will be stunted further, since they will be even less economically prudent. As a consequence, when the economic situation begins to recover and demand for gas increases once again, it may be difficult for liquefaction capacity to expand at a sufficient rate to keep up with supply. This is likely to mean that LNG cargoes are directed to markets with long-term supply contracts, such as Far Eastern or Southern European markets, and sink markets such as the US and the UK could find themselves with much lower LNG deliveries. Although the market would be expected to respond, developing LNG facilities is a long-term process, and additional supplies may take a number of years to come onstream. written by Tom Wolstenholme
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