On the week of June 20th, many professionals from across the Liquefied Natural Gas (LNG) industry assembled in Houston to share thoughts, ideas, and information on the past, present, and future of the industry. We are witnessing historic times, as LNG global trade has grown from 155 mtpa (million tonnes per annum) in 2006 to 258 mtpa in 2016 and is further expected to grow to 350 mtpa by 2020, resulting in a 15-year average annual growth rate (CAGR) of 5.5%, more than twice the U.S. GDP growth. U.S.-based suppliers are ramping up from essentially zero to being one of the world’s largest suppliers of LNG in the next few years. In addition to the 70 mtpa of domestic production already authorized and under construction, the Department of Energy has authorized an additional 75 mtpa of LNG to be exported to countries that do not hold Free Trade Agreements with the U.S. LNG as a fuel source has been a energy staple for many Asia-Pacific countries for decades, and is increasing in importance in other regions, as countries look to diversify their energy mix while lowering carbon emissions. The COP21 climate accord in Paris would further drive the value proposition for cleaner burning natural gas around the world, although the Trump administration’s current position against this agreement casts some doubt on the accord being an incentive for change. In spite of the recent success in LNG as a growing industry, there remain significant challenges to continued development, as outlined at the LNG Summit and summarized below.
Global LNG trade, past and projected, Source: Shell LNG Outlook 2017
A Brief Introduction to Liquefaction
LNG is subcooled methane, chilled through a “liquefaction” process, such as the Air Products C3MR process (diagram below), to approximately minus 250 degrees Fahrenheit. The equipment employed is essentially a large, industrial refrigeration system. The liquid cryogenic gas is then transported via specialized shipping vessel to other parts of the globe, where it is then converted back to gaseous state and injected into the regional gas pipeline networks for final consumption. LNG technology allows natural gas to be traded by parties that are not connected otherwise via pipeline, such as overseas trading partners. LNG export businesses require an abundant source of natural gas, since the liquefaction assets are long-lived and require a decades-long time horizon to justify the heavy capital expenditure. In the case of the U.S., massive natural gas reservoirs have been made available by modern shale rock production technologies, allowing the economic export of natural gas from the Lower 48 states for the first time in history.
A typical LNG liquefaction cycle, Source: Air Products’ C3MR Liquefaction Process
3 Takeaways from the Houston LNG Summit
1) A spike in global LNG supply has led to projected market saturation through atleast 2020
The industry is witnessing its third large wave of new supply, following Qatar in 2010, Australia in 2014 and now the U.S. The surge in LNG export facilities has led to a market viewed by analysts to be oversupplied until some time between 2020 and 2025. This has created a buyers’ market where long-term commitments are no longer the standard procedure and flexibility in contractual and delivery terms is expected. However, with the typical LNG export facility requiring atleast 5 years to develop, construct, and commission, the projected supply/demand profile implies that new investment will be required in the next couple of years in order to satisfy future demand.
There are many factors that could influence the demand trend in either direction. On the bullish side, the emerging LNG importers of China and India could significantly increase their share of LNG as their growing economies demand more energy. These economies are looking to supplement domestic production, while diversifying energy sources away from pipeline import gas. The mature markets of Japan, South Korea, and Taiwan are expected to remain flat, but could see some upside if these markets continue to prefer gas over nuclear power generation.
LNG Global Supply/Demand, Source: BP Statistical Review of World Energy 2017(Note: 10 Bcf/d = 75 mtpa)
As for the bearish argument, even though global prices for LNG have dropped considerably in recent years, today being quoted around $6/MMBtu DES East Asia (incl. shipping), they remain more expensive and volatile than coal for power generation. The emerging LNG importers remain price conscious, and a moderate increase in LNG price could substantially temper demand for the commodity. Furthermore, LNG competes with pipeline gas and domestic gas production in regional markets, which could also undercut price, depending on the situation. This is particularly true in the markets of Mexico, Egypt, and India, where there is substantial development of domestic gas production. The mature markets for LNG show little possibility for large growth, while the emerging markets show considerable challenges to convert from existing sources, such as fuel oil or coal, to LNG, namely credit quality, capital availability, and economic stability. As mentioned earlier, the U.S. withdrawal from the COP21 climate accord may cause a lack of economic incentive for other nations to convert their higher carbon energy supplies to LNG, which is often more costly from a capital investment perspective.
LNG Price History, Source: BP Statistical Review of World Energy 2017
2) The macro trend toward short-term deals, away from long-term supply agreements will require innovation in financing for new projects
The first wave of U.S. projects have been underwritten by banks based on long-term (20 year) supply agreements with major, creditworthy buyers. As the market has become saturated with long-term deals, emerging market buyers are now looking for more flexible, short-term deals, which will require a considerable change in how these large export projects are financed. Short-term agreements, which recently hit a high of 25% of total LNG trade, provide less visibility into future cashflows and debt service coverage for banks, export credit agencies (ECAs), and international financial institutions, such as the World Bank, to be able to confidently lend money against the assets. With the spot price of LNG being volatile and recently hitting its lowest level in a decade, the concept of a “merchant” LNG facility (one without a contracted anchor customer) is difficult to conceive and execute to the satisfaction of all stakeholders. This is coming at a time where some buyers are requiring destination restrictions, a common contractual element, to be eliminated, thus providing more options and flexibility to the buyer. Therefore, there must be a new commercial solution for financing large LNG export projects, which provides adequate visibility for the lenders, investors, and customers, while minimizing capital risk and providing the possibility of a satisfactory return on debt and equity investment. This is an area where the portfolio players, companies who purchase LNG to subsequently distribute through their own marketing channels, provide great leverage in making LNG a viable long-term market. The portfolio players, often large companies with substantial balance sheets, help to provide liquidity in the market, apart from long-term counterparty contracts.
With a lower project LNG market price, it is imperative that project developments be executed at a minimal cost. In recent times, the industry has been plagued with cost overruns, with projects escalating in cost from $1,000/tpa a decade ago to over $3,000/tpa most recently in the Gorgon LNG project. It is evident that proposed projects with all-in budget cost estimates, which include the often costly feed gas pipelines, at a range above $1,000/tpa will be a longer shot to be funded than those that are more cost competitive. The most competitive project developments may target a cost of approximately $500-700/tpa using the advantages of sunk costs in prior asset development, design standardization, and larger individual train capacity. However, even at this ambitious cost target, projects may have difficulty achieving the pro-forma financial returns necessary to be fully funded in today’s environment.
LNG plant capital costs as a function of train size and year of installation, Source: A Historical Review of Turbomachinery for LNG Application (Apache Corp.)
In this area, it appears that U.S. gulf coast developments may have an advantage, as many of these projects are being sited on existing “brownfield” facilities with existing infrastructure, such as storage tanks, jetties, pipework, and shipping lanes, that may be reused in the export facility, thus reducing capital cost. In addition, the U.S. gulf coast already has an established network of pipelines, which makes the development of feed gas pipelines to the terminals less onerous. That being said, there are projects in other locations that do have their own distinct advantages and strategic plays.
3) Floating Storage and Regasification Units (FSRU’s) have been vital in opening up emerging markets
The FSRU has come into development within the last decade and is recently starting to scale at very significant levels. An FSRU is a mobile, floating facility which reconverts the LNG back to gaseous form on an offshore receiving site, rather than a permanently-installed, land-based site. Therefore, FSRU’s maintain the advantages of speed to market, lower capital expense, fewer regulatory hurdles, and flexiblity in location, over the traditional land-based regasification design. With most import terminals having utilization rates of only 30-60% due to seasonality of demand, there is ample room for efficiency improvement. In this respect, the FSRU holds a key solution in the ability to re-deploy regasification capacity as market demand shifts.
The FSRU has been responsible for opening up new markets, namely, the Caribbean, South America, Pakistan, as well as parts of the Middle East. It has aided in the transformation of the LNG industry from a slow-changing, long-term counterparty contract based market, into a dynamic, short-term, trading-based market, providing more liquidity and routes to market for LNG suppliers. The flexibility of FSRU’s, which can be transported from site to site in response to market demand, has allowed developers to underwrite new FSRU vessels through lenders, thus providing more routes to market for companies looking to secure LNG offtake agreements.
LNG continues to progress as an influential source of global energy due to abundant supplies of natural gas, advent of cutting edge technologies, and highly available capital funding for projects. The global market appears to be supply-saturated for atleast the remainder of this decade with the U.S. supplying 70 mtpa out of the projected global supply of 400 mtpa. There are many factors which could influence the demand curve in either direction, leading to further new project development, or atlernatively, causing producers to temporarily shut-in facilities from lack of demand. In either case, it appears there will remain a baseline of LNG trade for many years to come as several major nations have solidified long term deals to feed their domestic energy infrastructure with LNG.
Article authored by Eric M. Robken
Eric is an experienced engineer in LNG equipment design and manages Ashland Heights Investments, a private practice which provides investment management services. He holds degrees in Mechanical Engineering, MBA-Finance, is a Licensed Professional Engineer (Texas), and is a Series 65 registered investment advisor.