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Conventional Wisdom in LNG Markets : Turning on its head in 2014

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. The major LNG suppliers, especially large IOCs and some NOCs have, for decades, presented LNG as a ‘special’ commodity whose price should be artificially linked to oil and where security of supply should be a stronger driver of absolute price rather than demand / supply characteristics. The dynamic ‘new’ LNG marketplace could be a scary place for these dinosaurs who must learn to adapt – or face dire consequences.  LNG is a commodity and sooner everyone treats it as such, the more efficient the market will be.

Secondly, Conventional Wisdom expected US LNG exports to be constrained by US Government policy and opposition. LNG exporters, such as Australia, Russia and Qatar, have tried – in vain – to discredit and minimize US LNG export potential. It now appears that their efforts have been undermined by a determined push by the US Government to encourage LNG exports and streamline the permit process. Massive gas production rates in the Marcellus, Eagle Ford and elsewhere have reduced the arguments of large domestic gas consumers such as petrochemical plants that gas prices are likely to rise if exports will be allowed. Local opposition is really limited to West coast projects with limited impact on Gulf of Mexico projects.  Approvals of US LNG projects is likely to continue at the rapid pace – and the LNG markets globally will benefit from increased price transparency.  High cost LNG producers should be prepared for a world where LNG prices will be based on marginal cost of supply, not imposed and contractually bound prices.

Thirdly, we expected the mad rush of proposed LNG projects in Canada to result in actual projects. The reality is that Western Canada is not like the US Gulf Coast – in fact, it is like the US West coast but more remote, expensive, and more anti-development. The lack of cohesive government policy to support developments, uncertain fiscal terms, remote fields, expensive labor, difficult pipeline right-of-way discussions, sensitive environment, and the unrealistic expectations of project sponsors to receive oil-based pricing are not helping the situation. The pace of development will be much slower than expected – and price of LNG produced may not really be that much cheaper after all the costs are considered. Expect only a small fraction of proposed Canadian project to actually be developed…and expect less comparisons to US project characteristics.

 Lastly, we had expected average spot prices to remain above long-term contracted prices over the longer term.  This justified the strategy to reserve large proportion of cargoes uncontracted for resale into spot markets, or worst yet, contracted by parties (often the project sponsors themselves) who expected to be able to on-sell the volumes at a profit.  Greed may have overtaken sound judgement. Expectations of ever rising prices justified slack project development costs control and arrogance among sellers of LNG that buyers will pay any price for their precious supply. The last few months have seen spot LNG prices prices around $10.50 in Asia – it is hard to see how expensive suppliers such as Gorgon with large uncontracted volumes being able to compete in these markets. Expect project in Australia to slow start-up and to take large write-downs unless prices improve and buyers begin to commit to long-term contracts again.  Also expect existing buyers to push for renegotiations and relaxation of terms.

 The world of LNG is changing rapidly. Changes are usually good for everyone, except dinosaurs who refuse to accept the change and insist on continuing business as usual.

  Vivek Chandra, September 2014