Issue Number: 97   June 2013

"Australia has important conventional and unconventional gas reserves and is, presently, the world's fourth largest exporter of LNG. Strong growth in domestic and global demand for gas is expected to underpin the development of new gas fields and LNG capacity in Australia. Based on the projects currently in operation, and those that are committed or under construction, Australia's LNG exports are projected to increase from about 20 million tonnes to over 63 million tonnes annually by 2016-17".

Copeland, Grafton, Hitchins, Syed, BREE-2012, iv

"However, the cost of building new LNG projects has increased tremendously in the past decade and is now about 20-30 percent higher than that of the competition in North America and East Africa".

Ellis, Heyning, Legrand, Australian LNG, 1.

The two quotes shown above highlight both the success and the challenges facing the LNG industry in Australia. In this article we will try to examine, albeit very briefly, the key issues surrounding the future of LNG in Australia and assess whether the future is really as gloomy as some analysts and commentators suggest or whether Australia will continue to grow but at a possibly slower rate. The issue is not so much will Australia succeed Qatar as the world's largest LNG exporter, which according to MJMEnergy's own analysis will occur around 2019/2020, but rather what happens next? Australia is to a large extent moving into uncharted territory - for example no country has undertaken the construction of so many LNG export projects at the same time, neither has it experienced such close public and governmental environmental scrutiny.

An increasing cost base

Australia's LNG industry is experiencing a number of financial/commercial challenges that are significantly changing the commercial environment within which Australian LNG is being developed. In particular the growing strength of the Australian dollar in comparison with other major currencies in the world such as the US Dollar, the Japanese Yen, the Euro and the British Pound is making it increasingly difficult for Australian LNG to compete on price in the world's LNG market.

The following graph shows the variation in exchange rate between the Australian Dollar and the currencies listed above on a percentage basis indexed to 1st January 2009. In particular the Australian Dollar has appreciated against the US Dollar by around 40%, the Japanese Yen 60%, the Euro 57% and the UK Pound 37%. Whilst some of these changes could be attributed to economic policies and activities in those economies the overall trend is one of an increasingly strong Australian Dollar making LNG exports less economic.

Comparison of Australian Dollar exchange rates since 1st January 2009

There are also a number of technical, environmental and financial challenges associated with using CSG (Coal Seam Gas) that might reduce the competiveness of Australian LNG especially when using CSG as a source gas. For example the production of CSG in Queensland was hindered during 2010/11 by extreme weather and flooding, making access to the drilling sites difficult but more importantly limiting the ability of the drillers to undertake multi-well operations, and handle co-produced water. In addition with the growth in the use of CSG as a source gas the availability of experienced personnel has been an issue with a corresponding increase in the cost of scarce skilled labour. This is especially true in Western Australia where Woodside Petroleum has postponed FID (Final Investment Decision) on the Browse LNG project due at least in part to escalating costs. These additional costs were also exacerbated by an apparent increase in industrial action in Australia, which as can be seen in the graph below, has reached a high of 273,200 strike days lost in 2012. All these factors combine to create a higher cost base than some of Australia's competitors in Africa and North America resulting in the overall cost base for Australian LNG being 20-30% higher.

Analysis of industrial disputes and working days lost due to strike action in Australia 2009-2012

The changing technological environment

In response to the combined pressures of rising costs, increased strikes and shortages of skilled labour LNG developers have looked in part to technological solutions. For example where possible, some LNG developers have contracted for pipework to be constructed outside Australia in a modular fashion to counteract rising costs and skills shortages. In addition the ill-fated Browse LNG project that has recently been cancelled due to increasing outlay may be reconfigured as a FLNG project.

The changing regulatory environment

In addition to rising development and production costs, the Australian LNG industry is also experiencing increasingly strict environmental legislation from the Australian state and federal governments. For example the Australian government has recently authorised increased examination of CSG projects from an environmental perspective and introduced a carbon tax that is expected to have a detrimental impact on the overall economic viability of operating LNG export plants in Australia. Another example of environmental legislation that could have a detrimental effect on the development of Australian LNG has been the introduction of stricter environmental regulations for coal seam gas exploration in New South Wales, where the state government has introduced an embargo on CSG exploration within two kilometres of residential and residential growth areas. This action is probably indicative of an environmental debate over the real or perceived risks associated with CSG exploration that the LNG industry appears to be losing. In particular local communities are concerned about the impact of CSG extraction on farming land and groundwater. Whilst it is not the intention of this article to debate the environmental rights and wrongs of extracting CSG in Australia, these actions will further add to the cost of LNG production and may slow the rate of expansion.

The changing commercial environment

Apart from the impact of an increasing cost base, greater environmental scrutiny and legislation, carbon taxes and lobbying over CSG, the fundamental concern for Australian LNG must be its vulnerability to either significant long-term price reductions or a move away from the lucrative oil-based indexation currently used by its Asian LNG buyers.

In particular Australian LNG exports could be vulnerable to the price impact of LNG exports from the US which is beginning to develop its LNG export capability following recent approvals by the Department of Energy. Whilst the US would have to export significant volumes of LNG to move long-term LNG prices, the introduction of additional volumes of Henry-Hub priced gas will only increase the desire of many of Asia's markets to move away from oil-indexed pricing. This desire for lower LNG import prices in Asia is evidenced by the cancellation of LNG deals worth some $60 billion between South Korea and Chevron Corp. The first of these was a 20-year agreement originally negotiated in a 2009 agreement to sell $30 billion worth of LNG from the Gorgon LNG plant on Western Australia's Barrow Island to Korea Gas (KOGAS), which failed to win approval from the South Korean government and collapsed in 2011. The second deal, which fell through, was for $28 billion of LNG produced from Chevron's Wheatstone project.

In addition LNG prices would experience a further downward pressure if the US shale gas boom was to be replicated in China, which has increasingly become a key market for Australia's LNG. Whilst providing a threat, it also serves as a timely reminder for prospective projects, that it would be wise to ensure long-term contracts are in place before starting construction of facilities. Otherwise they could become subject to the volatile 'spot' market.

Future growth

In the light of the above one might expect that Australia's role as a significant exporter of LNG could be dramatically reduced, however the reality is different. In terms of the future of LNG exports there are really three project categories as follows:

  • LNG projects that are either in existence or under construction - These projects are already underway and will be completed. In the majority of cases they already have signed LNG SPA's in place for all the available capacity. However even where additional un-contracted capacity is available this will be easily absorbed by the spot market.
  • Brownfield expansion - These projects are those that are based at an existing LNG export terminal and involve the incremental expansion of the facility. In many cases much of the required infrastructure is already in place, which means that the incremental costs are lower than a new green field site. In addition, environmental approvals and relationships with the local communities will have been developed which should theoretically make the process easier.
  • Greenfield expansion - This is the third category of projects and the ones least likely to go ahead as a result of the cost and the regulatory and environmental pressures highlighted above. Nevertheless, LNG developers may already have considerable financial and emotional commitments to some of these projects, therefore in the light of rising costs developers will be looking for creative solutions to make the projects profitable.

In the light of this breakdown we have drawn the following chart that shows LNG export capacity for existing projects and projects under construction peaking at around 80mtpa in 2019/2020. Where there are opportunities for incremental expansion of existing brown-field sites an additional 20-30mtpa of LNG export capacity could be added, although the timing of these incremental additions will be subject to local economics etc. New green-field sites without FID will be much more speculative and will only happen if the price available to those projects is feasible.

Australian existing and future LNG export potential 2009-2035

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June 2013 MZINE