S&P: LNG price convergence in the long term

S&P has a note out affirming that the ratings for LNG companies will be supported by favourable regional pricing for a few more years:

Global gas prices have increasingly diverged in the past two years, highlighting differing demand-supply dynamics and gas price conventions between regions. The divergence also demonstrates the arbitrage opportunities that exist between gas producers in stranded markets (regions with large reserves, weak local demand, and surplus supply)–such as North America, Australia, and Qatar–and gas consumers in high demand, supply constrained regions–such as East Asia and Western Europe. But could convergence of pricing around the world soon be in the cards? Not yet.

The positive operating conditions, coupled with government initiatives promoting the use of natural gas in the energy mix for environmental and economic factors, have significantly increased the development and consumption of liquefied natural gas (LNG) globally (see “What’s Behind The Boom In Global Liquefied Natural Gas Development?,” published April 20, 2012, and “How Liquefied Natural Gas Markets Around The World Are Adapting To Changing Industry Dynamics,” published April 20, 2012).

Standard & Poor’s Ratings Services expects natural gas consumption to continue to grow, particularly in Asia. At the same time, domestic gas supplies will remain constrained and the use of imported gas, namely LNG, will increase. With tight LNG supplies and the forecast for demand outpacing new liquefaction capacity until at least 2014, we expect positive credit conditions for LNG producers in the short term. The producers are likely to maintain favorable pricing power for the next few years, both in long-term contracts and spot pricing. These conditions should support the ratings on LNG producers over the next two years.

Asia especially faces a supply crunch:

S&P go on to argue that:

The longer-term outlook for LNG producers carries risks, however. Events that have the potential to significantly increase supply and increase gas-on-gas competition include new LNG capacity in Australia, potential shale gas exports from North America, a lifting on a development moratorium in Qatar, and the development of vast unconventional gas reserves elsewhere in the world.

These conditions could lead to lower LNG prices or force changes to current long-term, oil-indexed offtake contractual conventions. This could come at a time when there is rising pressure on domestic gas prices due to increasing contributions from comparatively higher-cost LNG, and it could create conditions for gas price convergence. However, we view the prospects for a convergence of the global gas market to eventuate at best over the longer term (post 2018) due to:

  • Potential delays in Australian LNG projects from cost overruns and shortage of equipment and labor;
  • Continuing debate in North America about the benefits and future effects of exporting shale gas production to the rest of the world;
  • Impediments to the development of other unconventional resources globally; and
  • Existing regulatory frameworks and contractual conventions in Asia-Pacific economies.

Plans to build LNG export plants in the U.S. have run into opposition from politicians, who are concerned that exports will lead to price increases for U.S. consumers, and environmental groups opposed to wider gas development. This, along with the need for several permit approvals, could delay any future development of export capacity.

Despite the significant potential in unconventional resources around the world, development of these resources has been slower than government expectations. We expect the pace of development in unconventional reserves to differ outside the U.S. for a variety of reasons including: lack of technological know-how in exploiting these reserves, less-defined environmental regulations that need clarity before large-scale investment can occur, and a wait-and-see approach by governments and the industry to see what environmental impact and health concerns could arise from the significant development of shale resources in the U.S.

Finally reserve profile matters. Unconventional resources in Asia-Pacific suffer from a combination of inadequate infrastructure, challenging terrains and have poor access to water, and may not be as easy to develop as U.S. reserves. regulatory frameworks and contractual conventions in Asia-Pacific economies affect domestic gas prices that are either heavily government controlled or influenced or those that are negotiated under long-term bilateral supply contracts with gas prices either linked to crude oil prices or to domestic reference points, such as cost of supply or economic indices.

The ability of gas prices in these countries to move to a more market-oriented pricing mechanism is likely to take time, particularly where the government’s involvement and influence on the domestic energy sector remains high. Government motivation and ability to control energy prices are likely to remain high, in our view, despite the prospect of rising imports. The impact of higher energy prices on domestic inflation, consumption, and economic growth is a big factor in government policy setting. All of this is likely to keep gas prices regionalized.

Some of this makes sense and some does not. Oil is a globally priced commodity yet that does not prevent many governments controlling its price at home. And it is the Japanese government that is pushing hardest to break the oil-price benchmark for LNG. This will continue.

Also, in the US there’s no doubt manufacturing and consumer groups want low gas prices but the price has to be high enough to generate the investment in unconventional sources. Moreover, the arbitrage between US and Asian gas prices is so big that there is more than enough scope to preserve a domestic gas price advantage, produced at say $5-6mmbl, and still ship large quantities offshore:

I therefore expect US authorities to approve US gas exports faster than this report does. And for global price convergence to transpire more swifly as well.

S&P still sees that outcome too but not until post 2014:

We believe that strong demand for natural gas in stranded markets and the high prices of LNG and oil-indexed long-term contracts should persist until 2014. These positive operating conditions should support the ratings on LNG producers, but they have also spurred the significant development of LNG supply. Combined with the potential development of unconventional gas resources globally, the longer-term operating conditions for LNG producers carries risks in the form of falling LNG prices and potential changes in LNG contractual conventions. These changes could threaten the economics of large LNG projects. We believe this risk could result in weakening credit quality for LNG producers post 2014. The marriage between gas producers in stranded markets and gas consumers in supply constrained regions has been sweet, but the honeymoon could be coming to an end.

In conclusion, this report supports the idea that it will be difficult to get finance for any new LNG projects in Australia.

David Llewellyn-Smith
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  1. There is no doubt the the push to convergence with continue. I would be surprised if this was achieved in 2014. US is several years from production on any scale, contracts for long-term reliable supply need be secured, at present many hurdles exist for supply to countries that have not signed FTAs, etc. But who knows, one this I will say is the US can build big stuff quickly and relatively cost efficiently.

    This is a pretty good layman’s guide to all things gas, including contract pricing anomalies and most is still fairly current.