Exuberance and Gloom: Adapting to a New LNG World

The LNG business is torn between exuberance and gloom. The exuberance comes from the belief that gas is about to become a global commodity that will be traded according to real-time supply and demand realities. The gloom reflects the realization that politics and economics are delaying gas-export projects around the world, just as more countries declare they want to use gas to boost their local economies instead of export it. The LNG mood is a mixture of exuberance about the present and gloom about the future.

Both are somewhat justified, yet both are also exaggerated. There is no doubt that liquidity is growing: 2007 was the first year where LNG showed its potential as a fungible commodity. Below-average demand in Europe and South Korea shifted cargoes to North America in the first half of the year, while the opposite was true in the second half. Even so, the spot LNG trade remains small, and spot prices affect only a small number of buyers and sellers. Nor are gas flows very responsive to price signals, mainly because there are few genuine price signals to begin with. Oil-linked prices remain the norm in Europe and Asia. In North America, gas is trading at two-thirds its calorific value – similar to import prices into Europe and Asia. Gas is not following oil to its ever-rising heights in any of the major OECD markets, even though spot prices can reach such levels.

The industry is still trying to understand this growing liquidity. Analysts look at the Henry Hub-National Balancing Point (NBP) spread to forecast relative LNG flows into Europe and North America. But the indicator is a poor one, explaining only 48% of the variation in US LNG flows in 2007. More importantly, the correlation in 2007 was incidental: when LNG flows into the US dropped after September 2007, the gas was moving to Japan, Spain, and South Korea, not the UK. Not that there is an easy alternative: based on power prices in Spain, Spanish buyers can pay around $15/mmBtu for LNG, far above Henry Hub prices, which is one reason LNG imports into Spain are already up year on year. But there is still no systematic historical correlation to rely upon.

Complicating matters further, a great deal of the market’s liquidity will be determined by how Qatar markets its LNG – and the industry can only guess so far where Qatari gas will flow. Qatar will account for 50% of the incremental liquefaction capacity from now to 2012, and its strategic location allows it to arbitrage easily between East and West. On the 2015 horizon, Asia is likely to remain Qatar’s main customer, with volumes shifting towards Europe and North America after that. Either way, Qatar remains a puzzle that will only reveal itself once all its projects are online.

So much for the exuberance: what about the gloom? The gloom is somewhat justified – look closely at any major gas export project in the world and it faces numerous obstacles: costs are high, the technical challenges are often large, the politics are difficult, the commercial terms may not be as attractive, and the risk can be excessive. And more and more countries are announcing that they want to use more gas at home to boost employment and diversify their economies: exporting gas is no longer the default choice for a gas exporter.

Yet, gas is a growing industry: LNG exports in 2007 grew by more than 11%, while PFC Energy expects liquefaction capacity to grow another 100 million tons (13.2 bcf/d) by 2012, a 50% rise. Granted, this is below industry expectations, but that is more a testament to unrealistic expectations than to underperformance.

In the 1990s, the industry believed that market access would be a serious constraint for LNG growth, and companies tried to position themselves against the competition by announcing projects with ambitious timetables. These often failed to materialize partly due to high costs, partly due to political and commercial risks, and partly due to the exaggeration of the initial plans. The gloom is as much a reaction to the perception of what growth should have been as it is to the actual slowdown in growth.

The result has been not just disappointment against expectations, but also a massive regasification overbuild to prepare for a rise in liquefaction capacity as well as to take advantage of the growth in the spot trade. This is most obvious in the US, though the UK may see a similar under-utilization of its import channels. In the US, PFC Energy expects a gap between US regasification capacity and available LNG that could be as great as 90 mmtpa (11.9bcf/d) by 2012. It may take until 2017 for the average utilization rates for US regasification terminals to reach their current levels. For importers who wonder how their terminals will be filled, these are indeed gloomy times, as more importers have chased after a relatively fixed number of exporters.

Growth in the LNG Trade:
1964-2007

The real case for optimism, however, comes from realizing just how much of the world’s potential reserves can still feed export projects. Three large gas holders have yet to show their LNG potential: Russia, Iran, and Venezuela. Also, in Libya, a flurry of exploration activity can add significant volumes in the 2020 horizon; and existing exporters such as Australia, Nigeria, and Indonesia have much gas that awaits the right impetus to be commercialized. Even in countries where there is a stated preference for using gas in the domestic market, this comes in tandem with export projects (Algeria, Indonesia, Qatar) or reflects an ongoing balance between domestic use and exports which may lead to the expansion of both (Trinidad and Tobago, Egypt). Moreover, this optimism does not include the prospect for floating liquefaction to unlock stranded gas or the potential for gas hydrates to become commercial – both of which are possible in the 2030 outlook.

In the end, PFC Energy looks at the LNG world with reserved optimism. There are many positive elements, including growing liquidity, much upcoming liquefaction capacity, a lot of regasification terminals for the LNG to flow to, and a great deal of future potential. But there are risks, too: political, commercial and technical. No time for exuberance and no time for gloom – just reserved optimism.

Key Conclusions:

Gas flows are not nearly as responsive to price signals – mainly because there are few genuine price signals.

LNG exports in 2007 grew by more than 11%, while PFC Energy expects liquefaction capacity to grow 100 mmtpa by 2012, a 50% increase.

The real cause for optimism comes from realizing just how much of the world’s potential reserves can still feed future export projects.

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Nikos Tsafos is an Analyst in PFC Energy's Upstream & Gas Group. For further information on this article contact Enews_ntsafos@pfcenergy.com.