Daily LNG price update (how low?)

The Brent oil benchmark was more or less stable overnight. That should have left the contract LNG price where it was. However, I shifted from WTI  to Brent yesterday in my charting the Japanese Crude cocktail (JCC), which is the underlying price used for LNG, and in the process discovered a glitch in my old calculations. I’ve been far too generous in filling in some of the gaps in the JCC formula and it turns out that I’ve overestimated LNG contract prices by roughly $1mmBtu.

So, here is the new LNG contract chart, based upon Brent oil, today around $12mmBtu:

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You’ll have to forgive me, the JCC is a pain the proverbial. In the wider oil market, the news is all about OPEC, from the FT:

This week’s meeting of the Opec producing countries is set to be the most important and widely followed since 2008, when the cartel announced a series of deep production cuts in the wake of the financial crisis. This time the cartel will discuss the outlook for a market which the International Energy Agency recently described as starting a “new chapter” in its history.

…As they prepare to respond to the changing market, the Opec nations are broadly split into two groups. In one camp are countries such as Venezuela and Iran that need higher oil prices to balance their budgets and bolster their short-term fiscal positions. Keen for the cartel to curb further price falls, they have been immersed in diplomatic activity over the past few weeks.

“We are all worried about oil prices”, Rafael Ramírez, Venezuela’s representative at Opec, said recently. He added that he would seek to defend prices that were falling “for no apparent reason”.

In the other camp are lower-cost producers with large foreign exchange reserves, such as Saudi Arabia and other Gulf nations, which are more willing to tolerate today’s prices in order to gain market share over the longer term.

As Opec’s largest producer and the only nation with spare capacity, Saudi Arabia will call the shots. In the event of any cuts to production, only the kingdom can really take action.

This is politics not economics so calling an outcome is for fools. Reuters reckons $60 is on without a cut:

Some commodity fund managers believe oil prices could slide to $60 per barrel if OPEC does not agree a significant output cut when it meets in Vienna this week.

Brent crude futures LCOc1 have fallen by a third since June, touching a four-year low of $76.76 a barrel on Nov. 14.

They could tumble further if OPEC does not agree to cut at least one million barrels per day (bpd), according to some commodityfund managers’ forecasts.

“The market would question the credibility of OPEC and its influence on global oil markets if there was no cut,” said Daniel Bathe, of Lupus Alpha CommodityInvest Fund.

We shall see.

In the LNG market, the pain continues with the Japan/Korea marker swap futures for January falling another 8 cents to $10.16mmBtu:

Capture

It appears we’ll be into single figures soon enough. Exactly how low we will go is now the question. By this time next year Australian and US producers will between them pump another 45 million tonnes per annum of LNG to the Pacific market. And, like iron ore, they will pump it.

The economics of LNG are all about capital costs. The investment is upfront, in the construction, after which costs plummet. The three QLD projects for instance are all considered to break even somewhere around $12mmBtu once built but the operational break even is far lower:

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These figures (from the QLD government) include capital costs. For liquefaction the capital costs are about 90% of the overall cost (the link breaks it all down for you). For production, capital costs are about 0.3 to 0.5  the costs, but you have to keep drilling wells and so the upper end is probably right.

So, total operating costs are probably in the $3.5-$6 mmBTU after converting everything and adding some cost inflation.

In short, the big projects coming on stream can pump LNG like mad down to their fixed costs at $6. My view is that whether via oil or the LNG spot market, contract pricing will erode and at some point producers will take write downs as the price keeps on falling. Then they’ll begin to print money. In short, the LNG price is going much lower and the stocks are not worth owning until the pain trade arrives.

In wider news, Korea’s Kogas is making more waves:

Korea Gas of South Korea is targeting a stake sell down in the LNG Canada project that would liquefy natural gas for exports to Asian markets.

LNG Canada’s spokeswoman, Katharine Birtwistle told Reuters that Kogas is investigating divesting some of its share interest in the project, but that LNG Canada remains committed to bringing the project forward together.

The $35.6 billion project, located in Kitimat, British Columbia, is currently under environmental review.

Royal Dutch Shell owns 50% and is the operator of the project with PetroChina holding 20% and Mitsubishi Corp owning the remaining 15%.

That tells you a lot about where the Koreans think the LNG price is headed. And more gas is still coming, with the US has approved Alaskan LNG FTA exports:

Alaska’s proposed liquefied natural gas project has secured an approval from the U.S. Department of Energy to export the chilled gas to countries with free trade agreements with the United States.

The decision authorizes exports to South Korea and other nations that have the free trade agreement with the U.S.

Alaska LNG also applied for authorization to export the LNG from its proposed LNG facility to be constructed in the Nikiski area of the Kenai Peninsula in south central Alaska, to any country with which the United States does not have a free trade agreement. Alaska LNG requests this authorization for a 30-year term.

I expect the broader approval in due course. Alaskan gas is stranded from the mainland and there are no political implications to a “yes”. This is one the last North American LNG projects that I expect will go ahead.

David Llewellyn-Smith

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

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