Low oil prices could hobble the US' LNG hopes

The slide in oil prices is already undermining the economics of US-sourced LNG and delaying new projects, much to the benefit of existing projects in Australia.

If the loading of the first shipment of LNG from BG Group’s plant at Gladstone in Queensland this week represented a major milestone in the development of the local LNG sector, then the freezing of one of the most advanced US export LNG projects might provide a preview of another.

BG’s $US20 billion coal seam gas-fed plant is the first of the three export facilities at Curtis Island off Gladstone to begin shipping gas. The Origin Energy and Santos-led consortia behind the other two plants are scheduled to begin operations next year.

They will be doing so in an environment where oil prices have plummeted, with Brent crude trading below $US60 a barrel. Australia’s LNG prices are linked to the oil price.

While the fall in the oil price, if sustained, would clearly impact the returns on the $US60bn or so of capital that has been sunk into the projects -- and from the existing and developing conventional LNG projects off Western Australia -- it could also avert the threat to Australian producers from a proposed host of US projects.

According to a Reuters report overnight, the development of Excelerate Energy’s planned 8 Mtpa export LNG plant in Texas has been frozen because of the dive in oil prices. Excelerate reportedly told the US Federal Energy Regulatory Commission it was now conducting a ‘’strategic reconsideration of the value of the project.’’

The Lavaca Bay project is one of only four proposed US export LNG projects that has obtained US regulatory clearance. There are another 14 in the pipeline undergoing environmental impact investigations. Excelerate had planned to begin exporting LNG in 2018.

The problem confronting the US sponsors of export LNG plants is that the plunge in the oil price has undermined the pricing advantage they held over Australian projects.

The US projects were predicated on Henry Hub domestic gas prices whereas the Australian (and other existing LNG producers) sell their gas at prices linked to oil prices.

When the Henry Hub price was around $US4 per MMbtu (and after a 15 per cent price premium imposed by US processors who are positioning themselves as middlemen between suppliers and buyers) the US gas could have been landed in the Asian markets for an all-up cost, including liquefaction, transport and re-liquefaction, of around $US10 to $US12 per MMbtu. Until the oil price cracked, existing producers were getting prices in the $US15 to $US16 per MMbtu range.

With LNG spot prices now around the $US10 per MMbtu level thanks to the dive in oil prices, the economics of US-sourced LNG no longer stack up -- even with Henry Hub prices around $US3 per MMbtu they would be landing gas at a higher cost than the existing producers.

The nose-dive in the oil price has come at a bad time for the aspiring US LNG players, given that none have contracted buyers for all their planned production (Cherniere Energy, the most advanced of the US projects, has contracts for less than half its proposed capacity) and only two (Sempra Energy is the other) have reached final investment decision points.

If low oil and LNG prices remain a feature of the decision-making framework for any sustained length of time, that queue of US projects will shrink dramatically.

In the near term the slump in LNG prices clearly isn’t a positive for the Australian projects but their capital has already been spent, they have 20-year contracts with high-quality customers and have cornerstone customer equity partners within their projects to support their sales.

While their returns on capital at current oil prices would be meagre, they would at least be positive and would generate positive cash flows. Origin Energy’s Grant King has said in the past that the Gladstone plants would cover their costs at an oil price of about $US40 a barrel and their cost of capital at about $US50 a barrel.

The question mark over the US projects has arisen at a delicate moment. Buyers, particularly the Japanese, had been encouraging the development of a US export LNG sector to create competition with existing producers and to drive the price down.

Woodside’s Peter Coleman referred last month to a 'buyers’ strike', which he said was causing delays to final investment decisions on a number of Australian projects. Earlier this month he pushed back the timing of a final investment decision on the $US40bn Browse floating LNG plant by a year to mid-2016.

Low oil prices will not only truncate the queue of potential US export LNG projects but will likely push out by a considerable period the point at which US gas has a material impact on the LNG market.

That would be a major medium-term positive for existing producers and projects, like Chevron’s massive $US54bn Gorgon project, still under construction and still looking for customers.

There is a consensus within the sector that over the next decade the growth in demand for LNG within Asia will outstrip the growth in supply -- a consensus that had factored in the development of a US export LNG sector that would meet about 30 per cent of the demand growth over the next decade and a half.

Woodside has warned there could be a supply shortfall (which implies a price spike) as early as 2020 if more new production capacity isn’t developed. Santos has said that 45 new LNG trains each producing about 4 Mtpa of LNG a year would need to be added to meet the expected demand growth over the next decade.

Given that these are projects whose success will be measured over decades rather than months or even a year or two the delaying or even driving out of new projects (particularly the US projects with their different pricing base) ought to ensure significantly higher returns for the established players.

In the near term, of course, they’ll suffer (or at least experience) the opportunity cost of lower prices and earnings.