Cycle and trends, together, drive this structural shift | KPMG | GLOBAL

Cycle and trends, together, drive this structural shift

Cycle and trends, together, drive this structural shift

The makings of the market and technological trends in LNG have been simmering for the last decade.

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The rapid transformation in LNG business models did not happen until cyclic conditions were supportive. On the supply side, a wave of new supply — and supply options — is combining with uncontracted volumes to drive down prices. On the demand side, buyer power has emerged. Quicker, cheaper and more flexible access is combining with cost and environmental drivers to create new markets.

Supply glut driver

The first change is the shift in the LNG market from a period of undersupply and high prices in 2011–2014, to a glut of new supply. The identity of the new suppliers is as important as the volumes. The previous supply surge, around 2008–2009, was led primarily by Qatar, which as a dominant player could manage the market to ease oversupply.

Now, Australia and the US, each with a variety of private-sector suppliers, are the main contributors. Post–2020, Canada, East Africa and others may join. From a time when liquefaction was essentially the preserve of the supermajor and large national oil companies, smaller companies and new entrants are able to participate, such as Cheniere in the US, Santos in Australia, Oil Search in Papua New Guinea and possibly Perenco in Cameroon. Oversupply has coincided with the fall in the price of oil from mid-2014, driving down both spot and oil-indexed prices. Floating LNG plants in Australia, Malaysia and elsewhere offer potentially shorter-cycle production on a more modular scale (see the KPMG report Floating LNG: Revolution and evolution for the global industry?, November 2014). US exports, typically priced on the basis of feedstock cost (Henry Hub), plus the capital and variable costs of liquefaction, feature a completely different pricing scheme from traditional oil-linkage. This period of oversupply may be extended as far as 2025 or, as Shell predicts,1 it may clear by the early 2020s as low prices encourage demand growth. While weathering tough times now, LNG producers also need to look ahead to a future supply deficit given the usual long lead times of these projects.

Significant volumes uncontracted

And in weathering the times, the industry will have to accommodate significant uncontracted volumes that will push further downward on prices. Of about 3,800 million tons (Mt) of LNG expected to be sold in the 10 years (2016–2025), 856 Mt is currently uncontracted. 409 Mt comes from plants over 20 years in age, which could price close to marginal cash cost if required to capture customers.

Buyer consolidation

In response to recent high prices, buyers have sought to improve their competitive positions. Most notably, JERA (a joint venture of TEPCO and Chubu Electric), was formed in April 2015 as the world’s largest LNG buyer, with 35 million tons per annum (Mtpa) of long-term LNG contracts. Other buyers have explored cooperation, for instance between Chubu Electric and India’s GAIL, and between Tokyo Gas and Korea Gas. After forming in 2015, a series of firsts was marked in 2016: In September, JERA resold its first cargo to South Korea. In December 2016, it made Japan’s first purchase from the US mainland2. In November, the Japan Fair Trade Commission started an investigation into destination clauses that forbid the reselling of LNG to third parties. The removal of destination clauses would free up LNG to be resold to other markets when Japanese buyers are over-committed — or simply when a better trading opportunity presents itself. The impact of this consolidation is greatly propelled by the shift to a buyer’s market.

Cheaper and more flexible regasification

On the buyers’ side, one of the biggest changes is the emergence of Floating Storage Regasification Units (FSRUs). FSRUs are quick and relatively cheap to install and capable of serving smaller or seasonal markets or those uncertain about their longer-term demand outlook. First deployed in the US Gulf of Mexico in 2005, FSRUs have now become a standard technology. New importers such as Kuwait, the United Arab Emirates (UAE), Egypt, Pakistan, Bangladesh, Jordan, Lithuania and Israel have opted for FSRUs. Established importers, including China and India, are also choosing FSRUs to add to their capacity.

New Markets

Archetype 1: Developing economies with limited gas resource

  • Rapid energy demand growth, usually as a result of rapid population growth and/or industrialization.
  • Low natural gas resource availability (but may be high for alternatives such as coal and renewables).
  • Affordable gas import supply and infrastructure required to increase role in energy mix.

Archetype 2: Developing economies with abundant gas resource

  • Rapid energy demand growth, usually as a result of rapid population growth and/or industrialization.
  • Resource availability for natural gas is already high.
  • Natural gas and power midstream infrastructure required to increase gas role in energy mix.

Archetype 3: Advanced economies with limited gas resource

  • Low/negative energy demand growth due to stagnating population, deindustrialization and more efficient energy technologies.
  • Low natural gas resources but high availability of alternatives (coal, renewables, nuclear).
  • Affordable LNG/pipeline imports and alternative policies required to grow use of gas.

Archetype 4: Advanced economies with abundant gas resource

  • Low/negative energy demand growth due to stagnating population, deindustrialization and more efficient energy technologies.
  • Material domestic natural gas resources (although dwindling in certain cases).
  • Appropriate policies and market mechanisms required to increase role of gas.

Competition from new — and old — energy sources

After a period in which LNG was simply too expensive to capture many new markets, falling prices have made it newly competitive. There is an important implication — to thrive, LNG suppliers need to keep their costs down. But, though cheaper than oil, it faces competition. New renewable sources — notably wind and solar — are dramatically improving their costs, and becoming the lowest-cost source of power in suitable areas. But they still require complementary sources to match intermittency, with flexible gas usually the best option as an affordable resource to cleaner energy systems. And in this capacity, reasonably priced gas is likely to be the resource of choice for feedstock to chemicals and the fertilizer industry and for home heating. Nuclear power is still struggling to maintain, let alone grow, its market share in most areas. Coal, to date, has remained highly price competitive and has limited the expansion of gas in China, India and parts of Europe. It offers diversity of supply, and often sustains local jobs. Even some Middle Eastern countries are showing interest in introducing coal power. Gas' environmental performance — on air quality and carbon dioxide — is, of course, far superior, making it attractive for governments seeking cleaner alternatives for Asian megacities. But even if gas gets a boost from policy, its premium to the coal price cannot be too wide. To capture new markets from oil — notably in shipping and ground transport — LNG does not simply have to be cheaper. It needs to overcome the costs of conversion, the more complex logistics and the technical conservatism of users.

Footnotes

1 Shell launches first LNG Outlook, http://www.shell.com/energy-and-innovation/natural-gas/liquefied-naturalgas-
lng/lng-outlook.html
2 I.e. excluding previous purchases from the small Kenai plant in Alaska.

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