The LNG pricing pressure that could blow up supply

In holding out for cheaper LNG pricing, Asian buyers could be shooting themselves in both feet by causing gas supply projects to be delayed.

The buyers’ strike in the LNG market that appears to be unsettling Woodside Petroleum’s Peter Coleman is clearly impacting projects that haven’t yet been green-lighted. There is a tinge of silver lining, however, in that apparently dark cloud overhanging the sector.

Coleman, speaking at a conference in Tokyo, said that by holding out for cheaper prices LNG customers were potentially causing delays to final investment decisions on new projects, which could lead to an eventual supply “crunch”.

Woodside, which is looking to secure long-term customers to underwrite the economics of its Browse project off Western Australia, is obviously quite directly affected by the attempts by Asian customers, led by the Japanese, to drive down LNG prices.

The Japanese are trying to use the prospective entry of US shale gas-fed LNG into the market, based on US Henry Hub domestic pricing, as leverage in contract discussions. From Coleman’s comments, it would appear that the tactics are having a chilling effect on those projects still on the drawing boards.

The LNG producers haven’t, of course, helped themselves by allowing a massive escalation in the costs of developing new LNG facilities. Coleman said that over the past four years returns on capital from LNG had been below the cost of capital of the projects, destroying about $400 billion of value in the sector.

It’s worse for projects still under construction. The cost of Chevron’s massive Gorgon project has, for instance, blown out from the budgeted $US37 billion to at least $US54bn. The extent of the cost blow-outs is forcing producers to radically rethink the way they develop offshore gas resources to try to lower the capital and operating costs.

If a strike by LNG customers leads to a capital strike by producers, however, that could have a very positive impact on the economics of existing projects and those close to being brought into production, like the three big coal seam gas-fed projects in Queensland. The customers might be experiencing some short-term gains but exposing themselves to something quite painful in the longer term.

The aggression of the Japanese buyers and their attempt to change the industry pricing model from oil-linked pricing to Henry Hub pricing has been fuelled by the massive increase in US domestic gas production as the shale gas industry has developed. With a queue of potential export LNG terminals seeking regulatory approval, the US is seen as a major source of new and lower-cost supply that will help drive down LNG prices.

With oil prices now in the low $US80 a barrel range, and the forward curve for Henry Hub prices showing prices around the $US4 a unit through to the end of the decade, however, there is a question mark over when the rate of growth in US production will continue.

A delay in the entry of that US gas to the market, and/or a slower-than-expected build-up in the volumes of US exports, would weaken the customers’ negotiating position.

More to the point, while the supply of LNG has been growing dramatically and will continue to surge, demand growth in the Asia-Pacific region is expected to grow even more steeply.

The industry has been basing its outlook on demand in Asia growing at around 3 per cent, if not a bit higher, for the next decade and a half. Coleman told the Tokyo conference that Woodside believed more than 250 million tonnes of new supply would be needed by 2030 to meet demand and that the US could meet only about 30 per cent of that requirement. He’s warning of a supply shortfall as early as 2020 if new production capacity isn’t developed. He said the industry needs to add more than 50 million tonnes of new capacity a year over the next few years to avoid that shortfall.

That’s not inconsistent with forecasts by other LNG producers that there would be a 100 million tonne shortfall by the middle of next decade -- despite the possible entry of the US to the market and the massive deal the Russians signed earlier this year to supply China with pipeline gas -- unless new projects were commissioned.

If the buyers continue to hold out and the pipeline of new projects is truncated, the continuing growth in Asian demand -- about double that of the developed world -- will lead to an excess of demand over supply, with obvious eventual implications for LNG prices.

The short-term opportunism of buyers trying to use the threat of the US gas as leverage could create longer-term structural problems for them.

That might not be good news for companies with projects requiring long-term supply contracts before they can gain positive final investment decisions, but it could provide extra support for the medium-term economics of existing projects and of those, like the Queensland plants, that are close to first production.

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