Asian buyers sweat on a shale gas solution

The high cost of oil-linked LNG contracts have become a burden for Japan and other Asian countries, but a shift to contracts linked to US shale gas could bring prices down and revolutionise the market.

The tension between LNG producers and their Asian customers continues to rise, with Japan’s Economy, Trade and Industry minister, Toshimitsu Motegi, telling a conference in Tokyo today that Japan would work with other customer nations to reduce prices and announcing that Japan would work with India to form a multilateral buyers group.

Japan and India plan to ask South Korea and Singapore to join a proposed LNG ‘’study group’’ of customer nations. The producers want to maintain long-term contract-based pricing linked to the oil price because of the scale of the investment required in LNG projects, and have warned that moving towards spot pricing could undermine the energy security of Asian customers.

At the same conference, the chief executive of Freeport LNG, which is awaiting final approval from the US Energy Regulatory Commission to proceed with a two-train (and potentially three-train) export LNG facility in Texas, said contracts linked to the US Henry Hub domestic gas pricing benchmark would revolutionise the Japanese market.

Michael Smith, whose company also announced the signing of contracts for the proposed facility with Japan’s Toshiba and SK of Korea this week, also said, however, that oil-linked LNG contracts could still dominate the global market.

It is worth noting that the Freeport agreements (it has previously signed deals with Osaka Electric, Chubu Electric and BP) are all tolling arrangements. It would be the customers who bear the gas price risk, with Freeport receiving flat fees.

Motegi told the conference that the rising cost of importing LNG after the Fukushima nuclear plant disaster had become a burden on the Japanese economy. Japan and other Asian economies are unhappy that they face higher gas prices than Europe or the US and blame the pricing formula, which links LNG to oil prices, for their escalating costs of energy.

They see the US shale gas phenomenon as an opportunity to break that link by introducing Henry Hub-priced LNG into the market. Smith said Freeport LNG would be able to deliver LNG into Asia for about $US7 per MMBtu on top of the Henry Hub price (currently around $US3.60 per MMBtu), which would be well below the $US16 to $US17 per MMBtu the current LNG producers are receiving.

Despite the proliferation of new LNG projects — including the Australian projects off Western Australia and at Gladstone in Queensland — import terminals are being constructed across Asia in response to the continuing rise in energy demand in the region.

Even if Freeport (and the other US group that has regulatory approval to export US gas, Cherniere Energy in Louisiana) do export gas into Asia, the supply and demand equation appears likely to remain tight. Freeport, if it gets approval, would be producing LNG by the end of 2017 at the earliest from its initial train, with the second train in production from the second half of 2018.

There are about 20 potential export LNG projects queuing up for approval in the US, although no-one seems to believe that anything like that number will be allowed to proceed as any meaningful exports of US gas would clearly have an impact on US domestic gas prices. Even if a sizeable number of projects were eventually approved, it would probably be the latter part of next decade before they could have a significant impact on the LNG market and its pricing structures.

In fact, it may not take meaningful exports to push US domestic prices (and consequently US export LNG prices) up.

As we’ve learned from BHP Billiton’s experience, the economics of US shale gas are very sensitive to both the price and the proportion of liquids in the shale. BHP Billiton has essentially stopped producing dry gas while stepping up its production from those resources with liquids.

To get the kind of increases in production that would enable the US to have a major impact on Asian LNG markets and pricing would almost certainly require a meaningful increase in US domestic prices, which is why the issue is a sensitive one for US manufacturers, particularly the chemicals and plastics industries.

The extensive domestic gas pipeline network in the US means that getting the gas to export LNG plants shouldn’t be particularly expensive, but liquefaction and transport costs would add about $US8 per MMBtu to the cost and there does need to be some return on the large amounts of capital involved.

US gas should be able to under-cut current prices, inflated by the soaring oil price, but the margin probably won’t be as significant as it might appear today. The relatively limited volumes of US gas likely to be sold into Asia may not be the game-changer that the customer nations would like it to be, but more of a moderating or threatening influence on prices, pushing them back towards the low to mid-teens levels.

Most of the Australian LNG producers have sold their output under long-term contracts and are factoring in (and basing their own project economics) on significantly lower oil prices and therefore LNG prices, so the prospect of the price drifting back to the mid-teens or a little lower over time isn’t concerning them. What matters is the growth in demand. The growing agitation within Asia about the cost of LNG suggests that isn’t likely to be a major issue.