How contested is LNG? Very…

Regular readers will know that I’ve been getting increasingly concerned over the prospects for Australia’s gas boom. This is based upon several coverging forces. The explosion in cheap US unconventional gas, as well as a Japanese push to break the oil-benchmark pricing system threaten long term supply contracts and double digit gas prices.

BREE’s March 2012 quarter Resource and Energy Quarterly listed ten US export projects with a combined export capacity of 104mt seeking approval to export to non-FTA nations (read Asia and less so Europe. Australia’s current capcaity is 20mt and will expand to 63mt when the current round of projects under construction is complete).

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.

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Comments

  1. A couple of thoughts:

    1. Regardless of contracts signed today, with so much cheap gas in the world, surely its only a matter of time until the contract system breaks down?

    2. The peak oil guys reckon shale gas peaks and declines very early, so the US gas glut might not persist for more than 5-10 years.

    • The linkage with oil and LNG will have to break at some point however to break it vis a vis the iron ore benchmark there would need to be some sort of spot market.

      There are graphs that show gas production from shale gas wells in America that decline about 60% in the first year. This is due to the fracking techniques and is common. It could be that the current gas glut in America will run out of steam within 5 years. In any case it would be hard to make the argument for the sort of long term investment that LNG terminals required on such production profiles.

      A link to graph: http://oilprice.com/Energy/Natural-Gas/The-Global-Prospects-For-Shale-Gas.html

      • @ tobyoptimum

        EXCELLENT ARTICLE!

        I think Summers captures the reality perfectly when he states:

        The main problem that I see, in the short run, for the average shale gas well is that (as noted above) the producer really needs a price of better than $6 per kcf (and Art would argue higher) to make any money on the well.

        And I’d say, given the average historical well performance in the Barnett Shale and the drilling and completion cost of these wells, the price needed to make drilling these wells economically feasible lies somewhere in the $8 to $10 per MMBTU range. Will the Fayeteville, Marcellus, Eagle Ford or Haynesville be more prolific producers? From the little bit of data Summers cites, it looks doubtful.

        But don’t a significant portion of the gas reserves in Australia also fall into the “expensive to produce” category? I’m under the impression (please correct me if I’m wrong) that the coal seam gas is also not that cheap to get out of the ground. And coal seam gas makes up a goodly portion of Australia’s natural gas reserve base, as this report points out:

        http://www.arcticgas.gov/australia-makes-bold-move-lng-supplier

        And like Summers says, we have to frame all this within a global and long term perspective. To flesh out a little bit of what he’s alluding to, here are the world’s proved natural gas reserves:

        http://petroleuminsights.blogspot.mx/2011/03/worlds-top-22-natural-gas-proven.html

        Summers says the estimated potential—-not proved developed or proved undeveloped—-reserves from all the shale gas plays in the United States combined is 60 TCF. But look how this compares to proved reserves in other nations:

        Russia: 1,680 TCF
        Iran: 1,046 TCF
        Quatar: 896 TCF
        Saudia Arabia: 275 TCF
        Turkmenistan: 265 TCF
        United States: 245 TCF

        Australia: 110 TCF

        So I think one can see the importance of the US or Australia in the grand scheme of things is rather insignificant.

        • One must also look at the geography of the thing too. Here’s a map:

          http://www.hydrocarbons-technology.com/projects/centralasiachinagasp/centralasiachinagasp1.html

          China is already connected to Turkmenistan’s reserves by overland pipleline (making the expensive LNG process unneccesary) and could connect to Iran’s massive reserves.

          Here’ another map:

          http://en.wikipedia.org/wiki/File:Yamal-europe.png

          Europe is connected to Russia’s gas reserves by overland pipeline.

          I think one can see from these reserve figures and their location what is driving much of the US’s military involvement in Afghanistan and Iraq and the constant drumbeat to invade Iran. On the other hand, I also think one can see that it will be a cold day in hell before China and Russia allow Iran’s vast natural gas reserves to fall into the hands of the United States.

  2. The “mismanaged” boom is an interesting concept.

    Often this refers to letting the costs of labour (volume and price and on-costs) get out of control. But if you look at the levels of dwelling and commercial/retail construction they are relatively low and have made way for the mining/resource construction boom to gain workers in a buyers market (adjusted for scarcity in the area where the developments take place and the costs to workers (mainly social) of fly in, fly out.

    On the other hand, one could readily argue that the unions did more to ensure that much of the benefits of the sale of our resources by governments to mining went to Australia. Higher wages, more spending, demand for locally made accommodation, demand for airline capacity, services for plant & equipment. These captured more of the value for Australia than the Mining tax has so far, and we got our projects off the ground before the US gas glut and price fall and likely increased coal exports.

    • one could readily argue that the unions did more to ensure that much of the benefits of the sale of our resources by governments to mining went to Australia.

      That’s radical thinking Explorer. I mean, we don’t want mine workers getting a slice of the wealth do we? That rightly belongs to foreign multinationals or Aussie “heroes” like Gina, Twiggy, Clive and Nathan. Actually, scratch Nathan.

  3. All of the attention appears to be on the supply side. Has anyone looked at the growing demand for LNG?

    This article states that worldwide demand in 2035 is anticipated to be 5 trillion cubic metres,
    http://afr.com/p/business/companies/demand_to_soar_in_global_gas_rush_7CwnDLJNFjjITZBpT0TIiL

    The same article has BHPs petroleum CEO confirming Santos’ statement that the transport differential is $7 per MBTU to Asia from USA.

    Given it is an inexpesive and low environmental impact form of energy that there is going to be a massive supply of in coming decades, it will become a natural choice for new energy dependent projects and technological innovation, to allow it to replace oil, coal and nuclear options where possible.

    Who knows, by 2035, the family car could be running on natural gas.

    • We know the long term prospects are very good. But like most bubbles, the investment runs tends to miles ahead of the reality. Thats is what has happened here in my view.

      The US railways bubble was right in the end. The tech bubble will be right in the end.

      Doesn’t mean they ain’t bubles.

    • Who knows, by 2035, the family car could be running on natural gas.

      Sure, but CNG is less energy dense and much more difficult to handle than liquid fuels, so in many ways it will be backward step. The energy transitions in the past — e.g. wood-to-coal and coal-to-oil — have always been to more convenient and more energy dense fuels.

      IMO electric vehicles are more likely. Either way, it will be one hell of a challenge!

        • There have been CNG buses running around Sydney for a long time as well. I’m still to walk into a car showroom and see a shiny new CNG car though. OTOH, I’ve seen diesel grow from something you put in tractors, to challenging petrol for dominance in passenger vehicles, in less than 10 years.

          I can also buy a dozen or so hybrids, and one or two pure EVs.

          Just sayin’

  4. Exuberance abounds in regard to prospects for the US LNG export market. Realities are somewhat more circumspect.

    Regulatory hurdles are a real impediment. Approvals from a range of Departments, judicial submissions from various vested interests (green energy groups, domestically domiciled industrial energy users, groups concerned with upstream cost increases to domestic supplies are but a few).

    Substantial projects require substantial infrastructure, liquefaction terminals, LNG carrier construction (some used on spot basis, more generally purpose-ordered for specific liquifaction plants to carry sub-zero cargoes on specific routes.

    In regard to the shipping it is felt that Pacific Basin will require 40mill/tonne incremental LNG shipped and that the shorter haul intra Pacific trade will displace Atlantic-Pacific trade when new projects come on line (Australian). Australia is once again ideally geographically located.

    Most Asian import terms can’t accommodate Qatari Q-Flex carriers – upgrades of facilities required. It is claimed that even when Panama Canal works are completed there will not be sufficient capacity for the scale of LNG carrier required to make routes viable.

    I have no doubt that when our grandchildren are in China or Japan either on a Gillard Asian Century language exchange (or performing au pair duties…) they will be enjoying energy supplied by Australian sourced gas.

    http://www.ogj.com/articles/print/vol-110/issue-8/transportation/regulatory-hurdles-economics-cloud.html

    The Outlook for US Gas Prices 2020: Henry Hub $3 or $10
    http://www.oxfordenergy.org/wpcms/wp-content/uploads/2011/12/NG_58.pdf

    • Ahh of course, regulatory hurdles and green groups holding things up again. Is there nothing they can’t be blamed for? At least they’re working in the interests of Aussie miners this time eh?