Australia's LNG sector could boom if the price is right

Santos chief executive David Knox's optimism about Asian demand for Australian LNG has been reaffirmed by a new IEA report, but high construction costs and gas pricing could present challenges.

Santos chief executive David Knox’s unflagging confidence in the outlook for Australian LNG exports in the face of considerable scepticism has been given support by the latest five-year outlook for the sector issued by the International Energy Agency.

While not without some caveats, the IEA’s medium-term gas market report, issued overnight in Canada, sees China’s demand for gas rising 90 per cent between 2013 and 2019. It is generally optimistic about the industry's outlook.

It is that inexorable rise in China’s demand that underpins the Santos chief executive’s view there will be sufficient demand for LNG to support the massive increase in Australian exports over the next few years at prices that won’t undermine the economics of the Australian projects. This is despite the queue of aspiring LNG exports in the US and the recently-signed $US400 billion deal under which Russia will pipe gas into China.

In a KGB Interview, Knox said by 2020, Russia would supply about 10 per cent of China’s demand, falling to about six per cent by 2030. US Henry Hub-priced gas is likely to be capped at about 15 per cent of global demand in the longer term.

The IEA said demand for gas from Asia, which now accounts for about 75 per cent of the world’s gas imports, would grow by about 250 billion cubic metres by 2019, with about 100 bcm met by LNG imports. China’s demand would grow by about 13.3 per cent a year, or about half the world’s extra gas consumption.

One cautionary note in the outlook is that the IEA expects China’s domestic gas production from conventional and unconventional (shale and coal) gas to rise 65 per cent to 193 bcm over the next five years, while another relates to the continuing debate about LNG pricing.

The IEA says its projected growth in LNG imports by Asian economies is fragile and depends on prices. It also says that if gas can’t fulfil the region’s power generation needs, it would leave room for coal to fill the gap. Future gas pricing would also determine which of the ‘new generation’ of LNG suppliers would displace Qatar as the leading supplier over the next decade.

Japan has been leading an attempt to shift Asian LNG contracts from oil-linked pricing to cheaper Henry Hub-related prices.

Knox’s confidence in the future of Australian LNG has several foundations. The obvious one is that existing projects are underwritten by 20-year oil-linked contracts and tend to have key customers as equity holders in the projects. Australia has about half the world’s LNG capacity still under construction.

The second is the sheer growth in demand for gas and the third is the inevitable desire of the customer nations, particularly China and Japan, to protect their energy security by diversifying their sources of supply. China isn’t going to allow itself to become overly exposed to the US or Russia for its energy needs.

The IEA says that to meet the projected demand for gas in 2020, more LNG will be needed. With a typical five-year construction period, decisions would have to be taken now for the gas to reach the market by 2020. It says that while there are many projects at the planning stage, very few final investment decisions have been taken since 2012. Only one US LNG plant was actually under construction as of last month, it said.

The extraordinary escalation in the cost of Australian LNG projects is obviously a threat to new capacity being added here, particularly if the impact of Russian and US gas is to lower prices. Knox believes that there will be a market for “reasonably priced” LNG, and that brownfields expansions that leverage off existing infrastructure -- like the Darwin LNG project and the pipeline into the Browse field -- can still be highly competitive.

Floating LNG technology is another option for lowering costs. He also believes that as the existing wave of investment peaks and falls away development costs will fall and says that the industry has learned from its experience and would be able to develop new projects far more efficiently.

Both the IEA and Knox believe there is potential for gas to have a growing presence in the transport sector due to the increasing focus on improving air quality in China in particular, as well as Asia more generally.

There little doubt that there is a window in the Asian market for LNG over the next five years, which will benefit the existing Australian projects.

The longer term outlook and the prospects of another generation of export LNG projects remains dependent on China’s demand continuing to grow, the extent to which competitive sources of LNG like the US and Russia flow into the market and the success of Asian customers in significantly shifting the prices down from their current levels in the mid-teens.