Vivek Chandra presents his first 'video blog' where he recaps developments in 2016 and looks ahead to trends in 2017.
Please visit Vivek Chandra's youtube channel to view the blog - click here.
Changing Players, Changing Structures, Changing Strategies
The fundamental structure of the international LNG industry has remained largely unchanged for over 40 years. The model has recently begun to experience fundamental changes, heralding an exciting and turbulent future.
The previous model has been dominated by large companies exporting to customers in North Asia and Europe. The links between the upstream asset and the LNG plant, as well as the link between the plant owner and importer were strong and inflexible. Only these large companies had the financial, technical and project management skills to develop LNG export projects. Out of the 28 identified LNG “complexes” around the world operating pre-2015, all except three projects involved a large IOC as a sponsor or buyer of LNG following this commercial model. Looking forward from 2016, there are an unprecedented number of LNG projects proposed – but out of the projects likely to be sanctioned, nearly all of them do not involve the traditional IOC companies and follow non-traditional models. New players are able to access new sources of financing, freely available technology, and have realized that the project management record of large companies is less than stellar.
Much has been written about the competitiveness of Australian LNG in global markets. Until a few months ago, this discussion centered on comparison of commercial terms of Australian contracts versus the threat of US hub-based pricing terms. However, as oil prices have plummeted by 50% since mid 2014, the debate has now become one about relative cost of supply between future LNG projects. On this basis, Australian projects do not compare favourably to the coming onslaught of US LNG exports into traditional LNG Asian markets. In fact, a recent Harvard study stated that ‘most Australian LNG schemes are unprofitable’ due to their costs in the range of US$3000/t as compared to the US projects which have costs in the US$700-$900/t.
The recent dramatic drop in global oil prices has taken the world by surprise. Though history is littered with periods when oil prices have overshot as well as ‘undershot’ price expectations, the current drop has been precipitous. As of writing this article, oil prices have dropped around 50% and WTI is priced close to $50/bbl for the first time in over five years.
For consumers of LNG, especially those in Asia that buy most of their gas on oil-linked contracts, purchase price of LNG has dropped as oil prices have fallen. If their contracts have a ‘floor’ oil price, the impact on LNG prices may be dampened and not as dramatic. Coincidently, prices of coal, a substitute fuel for LNG in power generation, have also dropped over the past six months – though at a lesser extent than drop in LNG prices. Together, these factors have also impacted the LNG spot market where prices have similarly dropped. More affordable LNG will encourage more consumption for power generation, residential, commercial and transport use. Electricity demand is growing in many parts of Asia and even in places where demand is flat, cheaper LNG will encourage switching of fuels from dirty and politically sensitive sources such as coal and nuclear, to cleaner burning gas.
Much that Conventional Wisdom believed it knew about LNG seems to be turning on its head…what a crazy few months it has been!
First, we expected demand for LNG to grow unabated. We were led to believe that supply was the key issue – unmet demand was always ready to take more LNG. This was especially supposed to be true for growing markets such as China and India. We now see Asian buyers, especially those with large future commitments, hustling to defer their future supply or seeking buyers in other markets, such as Europe, who would be willing to take over the contracts. Even mature buyers like Korea have been forced to reduce their imports due to oversupply, over commitments, and mild weather conditions. These occurrences may be short-term phenomenon, but it does indicate that LNG is, in fact, a commodity with both short and long term demand / supply characteristics and prices that should move accordingly.
After many years of promoting the idea that oil-linked pricing for LNG contracts is a concept that has out-lived its usefulness - and its main reason for continued use is to protect the margins of the large LNG producers, I was pleased to see this article in the Australia Financial Review on October 15 2014. Kudos to BHP for being the first large company (that I am aware of) that has accepted reality that the days of oil-linked prices should be limited and the future should be one of more transparent prices based on gas-on-gas economics - just like any other commodity!
BHP SPLITS WITH ENERGY PRODUCERS ON GAS PRICING
BHP Billiton has split from Australian gas producers by pushing for a move away from oil-linked pricing, potentially threatening returns for one of Australia’s largest export earners. Japanese power companies have campaigned for several years to sever the link between LNG prices and oil prices because it was forcing them to pay more for gas than consumers in Australia and North America.