How contested is LNG? Very…

Since March, the US export approval requests have swelled to 15 projects. It’s not clear how much the combined capacity is but obviously a lot more.

So, right now, there are applications to export LNG from the US that are something like 6-7 times current Australian capacity and likely more than double projected capacity (a bit less than I claimed yesterday).

The following questions were asked in comments yesterday, from Tobyoptimum::

I think what is missed in the MB comments on LNG projects is the important of signing customer contracts. There is no LNG spot market and projects wont get FID until they have the majority of their capacity under contracts. its like the Iron Ore industry before BHP/RIO got rid of benchmarking, its a buyers market.

One final comment, is that its a grossly profitable and politically risk adverse industry. Australia is well placed to attract investment, even at a premium price.

And Alex Heyworth:

I would have thought Asian customers would want to get away from a link to oil prices because they fear rising oil prices, not because they want to take advantage of a short term low price anomaly in US gas. If there is one thing most Asian customers involved in the energy industry can be guaranteed to do, it is to take a long term view. That is why they are willing to sign long term contracts. Reliable supply is worth paying a premium for.

In answer, here are some calculations from reader Glen5875:

The first permit to produce LNG in the United States was awarded to Cheniere Energy, Inc.

They owned a facility that was built to import and gassify LNG called Sabine Pass. The permit they received was to modify this facility so that it can be used to produce LNG for export. They have a nice illustration of what the existing facilities look like along with the planned facilities. “We expect to commence construction of LNG trains 1 and 2 during the first half of 2012 and begin operations in late 2015,” the annual report reads.

They have four customers. All of their contracts are based on “115% of the final settlement price for the New York Mercantile Exchange Henry Hub natural gas futures contract for the month in which the relevant cargo is scheduled” plus anywhere between $2.25 and $3.00 per MMBTU. The NYMEX spot price today closed at $3.62, with futures prices near $4 per MMBTU.

So that means that today the delivered LNG price would be somewhere between:

$3.62 x 1.15 + $2.25 = $6.41

and

$4 x 1.15 + $3.00 = $7.60

I have no idea how what the difference in transportation charges from Lousiana to Asia as compared from Australia to the Asia might be.

I don’t know what the differential in shipping costs is either but the following from Santos vis the AFR offers clues:

“The longer forecasts for US gas pricing are shaped by a view that it will take a price of maybe $US6Btu to sustain and grow gas production. So let’s make that a starting point for our discussion. The most recent US export contract (one that might underpin a terminal) is set on a multiple of 115 per cent of the Henry Hub price. Add to that an inflation-adjusted transport cost of, say, $US7.50 and you quickly get to $US14.40 landed cost.

The interesting thing about that price is that it is so damned close to the current Asian price set under the oil-linked metric. The current formula has the price indexed 90 per cent to the oil price and 10 per cent to inflation, with ready reckoner being that LNG trades at a discount multiple of between 14 and 15 per cent of the oil price. So, when oil is trading at $US100 a barrel, the landed LNG price is about $US14.85.

“At the moment, you have people eyeing the American market and saying, ‘I like that, I want a bit of cheap stuff’. And suppliers from other areas are saying, ‘I don’t want to be selling my gas at that price, I like my oil linkage’. So there is a little bit of a stand-off,” Cleary said.

“But when we look at the demand picture we see that the stand-off has to end at some stage. Because if you value security of supply, as our Asian customers do, then you have to lock in that supply.”

I find this hard to believe. The key term may be “inflation adjusted”. What’s the inflation number? Why would shipping costs inflate? Why not deflate as happened in the second half of the bulk commodities boom as Asia provided a tsunami of new ships?

Indeed, the evidence from the IEA is that shipping is more like $1 now and maybe $1.75 by 2020 (h/t hzubrica73). And note the gigantic fracking margin:

On Santos’ larger point the evidence is the opposite to the claim as well. The one US project with export approval is not oil-linked, and is a much more short term and floating pricing mechanism. Japan is on the record as trying to break the oil benchmark. Alex Heyowrth is right. It is a long term thinker in energy so you can be certain that it is not doing so lightly. It clearly sees enough supply to keep LNG much better priced than oil.

Santos went on argue that its contracts are rock solid:

“What changes is around the margins,” Cleary said. “That means it [the price] can only move within a band of 5 per cent up or down against previous prices under the contract. And the influencing factor on those adjustments is a reference to other Australian LNG supplied into the region – not the price of supplies from other regions such as the Atlantic Basin or the Gulf Coast of the US.”

A fair enough argument for Japanese and Korean customers but not Chinese who happily change with the tides. And that’s the point. Like it or not, pricing mechanisms are shifting towards that old wisdom in commodtiy markets: the cheapest marginal tonne of supply wins the contract, whether it’s short term or long. We did it to Asia on iron ore. They are doing it to us on gas. And if the supply is there over the long term, why would we expect otherwise?

Don’t get me wrong, I do not expect a sudden crash in the LNG boom. It’s been a life saver for the economy even if mismanaged. But I do expect long-term margin pressure. Future investment looks a lost cause and current project cut-backs are a realistic prospect.