Santos sheds light on LNG gloom

Natural gas bears believe the growth of US shale and a new pact between Russia and China will drive down the price of gas and harm the prospects of Australia's expensive new plants. Santos' David Knox thinks they're wrong.

Santos’ David Knox will no doubt provoke the LNG sceptics with his upbeat assessment of the sector’s prospects at a Brisbane Mining Club lunch today. It won’t be long before he and they get a glimpse of what is to come for LNG.

In his speech Knox referred to both the US shale revolution and the ‘’momentum’’ it is building towards exporting LNG as well as the $US400 billion, 30-year deal China signed with Russia last month under which gas will be piped from Siberia into China.

For the LNG sceptics the US shale gas revolution and the lengthening list of approved export LNG projects it is underwriting would alone undermine the economics of high-cost Australian LNG projects, both existing and, more particularly, those still on the drawing boards. Add Russian gas into the equation and for them the case against Australian LNG would be closed.

Russian gas is scheduled to start flowing into China from 2018. Even before then, indeed towards the end of next year, the first US shale gas-based LNG is scheduled to be shipped from Cherniere Energy’s terminal in Louisiana, the first of the US export LNG projects to gain an approval.

Next cab off the rank should be Freeport LNG’s project in Texas, where construction is supposed to start late this year. First production is expected in 2018. With the US streamlining the previously very lengthy and onerous approvals process for new LNG projects, the pace at which new projects enter the market could pick up quite quickly.

The pricing of the gas in China’s deal with Russia hasn’t been disclosed but the US projects will be based on Henry Hub domestic prices, which is why they are regarded as a threat to the Australian projects which traditionally have used oil-linked pricing.

Despite the amount of LNG capacity being brought into the market, and the big blow-outs in development costs (much of it currency-related) that have occurred in a number of the bigger Australian projects, Knox remains confident. Santos, of course, has a lot at stake given that it has big interests in three big projects -- PNG LNG, Darwin LNG and the coal seam gas-fed GLNG project in Queensland.

The foundation of that confidence lies in his assessment of the market for LNG. Gas demand in Asia, he says, is projected to grow at just over 3 per cent a year -- double the rate of the rest of the world -- through to 2030. LNG’s share of total Asian gas supply is expected to grow from 32 per cent to 52 per cent over that period. The Russian deal, Knox says, represents only around 6 per cent of China’s demand by 2030.

Knox says the end result will be a large and growing market for LNG where the gap between supply and demand by 2025 would be around 100 million tonnes per year.

Most of the existing Australian LNG projects, both offshore and onshore, are supported by long-term contracts with Asian customers (which are often joint venture partners in the projects) with oil-linked pricing.

Those projects ought to be shipping LNG before the end of this decade (the Queensland projects will all be in production by around the middle of next year) and before there is meaningful competition from the new US entrants to the sector.

The second reason for Knox’s conviction that Australian suppliers aren’t going to be destabilised by the impact of new competitors lies in the cost structures for US-sourced LNG.

There’s a general consensus (supported by the forward price curve) that by 2020 the Henry Hub price will be around $US6 to $US7 per unit of energy. By the time the costs of liquefaction and transportation and a “middle man” margin for sourcing the gas is added, the cost of that LNG to an Asian buyer will be around $US14 to $US14.50.

While Australian LNG has brought higher prices than that, prices around that mark are not dissimilar to the expectations of the local project sponsors and therefore within the parameters of their projects’ economics.

If the fairly anaemic US economic recovery were to strengthen over the next few years, of course, its domestic gas prices might well be even higher by the end of the decade.

It is also probable that, as in Australia where domestic gas prices are rising towards the international price (adjusted for the liquefaction and transport costs of LNG) meaningful exports of US gas will have an impact on its domestic gas prices -- an arbitrage will develop that would tend to put a floor under international prices.

The obvious concern for the Australian industry is not so much the existing projects despite the cost blow-outs, but prospective projects that would face the full force of the new competitors if they were brought on stream in the next decade.

It is unlikely that new greenfields offshore LNG projects (as opposed to brownfield expansions of existing projects) will be undertaken using conventional approaches. Woodside’s experience, where the estimated cost of an onshore plant to process gas from its Browse gas blew out to an impossible $80 billion-plus, has almost guaranteed that.

The floating LNG technology now being considered for Browse and other gas fields off Western Australia, however, proffers significantly lower costs and development risks and may be the key to lengthening the pipeline of new Australian LNG projects.

The other point Knox made in passing was that the Asian customer nations -- China, Japan, Korea and Malaysia are the biggest -- will want diversity in both price and sourcing of their gas. One wouldn’t expect China, for instance, to allow itself to become dependent on either Russia or the US for its longterm energy requirements.

It is inarguable that the entry of US and Russian gas into the regional market will have some impact on Australian LNG projects, existing and prospective, and on LNG prices. At this point, however, given the continuing backdrop of steadily rising demand, there is no reason to believe that, as some argue, it will completely undermine the economics of Australian LNG.

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