US LNG to compete with Australian gas
Mark Blood - Mon, 19 Sep 2016
My last column on why New Zealand would not replicate Norway’s exploration success, despite claims to the contrary, drew feedback across a spectrum of viewpoints.
It was intended to be thought provoking and a reminder that such claims lack scientific credibility and undermine efforts to promote New Zealand as a place to explore and develop hydrocarbons.
That said, the environmental case for reducing New Zealand’s use of fossil fuels remains, particularly in transportation. The country’s often lackadaisical approach to climate change, exemplified by its tepid commitment to COP21, frustrates many. With the rise of the electric car and significant advances being made in battery technology, oil’s hegemony on transportation – including air travel - is under threat. That though is another topic which I hope to address in due course.
In this article I want to revisit the LNG trade. A surge in US exports since the widening of the Panama Canal is poised to shake-up global markets and, significantly, compete directly with Australian LNG in the key Asian energy market.
The beginning
The story began on February 25 with the shipment of the first cargo of US LNG from Train 1 of Cheniere’s Sabine Pass liquefaction facility on the Gulf coast of Louisiana. Since then there have been a further 20 cargoes, totaling 69 billion cubic feet (Bcf) exported to the end of July. Most of these exports went to South America (39 Bcf) with smaller volumes going to the Middle East, Asia and Europe. During August and September there were a further ten shipments totaling 34 Bcf
U.S. LNG exports by region - February to August 2016
Train 2 of the Sabine Pass terminal commenced LNG production in August with the remaining three trains coming on stream by 2019. With all five trains operational, the US will have a total liquefaction capacity of 9.2 Bcf per day, the third-largest capacity after Australia and Qatar.
Cheniere Energy’s Sabine Pass export terminal in Louisiana (Source Bloomberg)
Impact of the Panama Canal
The newly expanded Panama Canal opens an entirely new transit route for Asia, rather than going around South Africa or South America. According to the EIA the widened canal is able to accommodate 90 per cent of the world's LNG tankers with carrying capacity up to 3.9 Bcf. Prior to the canal’s expansion, only the smallest LNG tankers - 6 per cent of the global fleet - could pass through.
The expansion significantly reduces travel time and transportation costs for shipments from the US Gulf Coast to previously regionalised LNG markets in Asia with a growing appetite for natural gas.
Approximate voyage times (Source EIA)
Today, Asia consumes more than 70 per cent of the world’s LNG. A shipment of LNG from the US Gulf Coast through the Panama Canal to Japan now takes 20 days, compared to more than 30 days for voyages around the southern tip of Africa or if transiting through the Suez Canal. Voyage times to South Korea, China, and Taiwan are also significantly reduced by transiting through the canal.
The EIA estimates that LNG cargoes through the Panama Canal to countries in the Asia region could reach more than 550 vessels annually, or 1-2 vessels per day, by 2021. Assuming an average 3.5 Bcf LNG carrier, that would translate to almost 2 trillion cubic feet (Tcf) of export gas annually and transforms the calculus for LNG trade globally.
Competition with Australia
Although Australia’s transportation costs to Asian customers are lower, and most of Australia’s new LNG export capacity will be available before new US capacity, the US has lower production costs and lower capital costs for liquefaction facilities than Australia. This makes it economically viable for US LNG to compete directly with Australian LNG.
Since the most recent LNG export facilities in Australia were completed in 2015 (Gladstone LNG and Australia Pacific LNG) market conditions have deteriorated. Not only is there increased competition from the US on the horizon but Australian suppliers face uncertainty in global LNG demand. Imports by Japan and South Korea declined slightly in 2015 and only marginal growth is forecast for 2016.
The greatest threat may be the massive expansion proposed for US LNG export capacity in the coming years. The image below shows a further 17 LNG projects – with total daily capacity of 26 Bcf – that have been proposed or have applications pending with the Federal Energy Regulatory Commission.
Combined with the five trains at Sabine Pass, that would increase US LNG export capacity to more than 35 Bcf per day, making the US the world’s largest exporter.
Planned North American LNG export terminals (Source EIA)
Convergent pricing
US gas is also having an outsized influence on how LNG is sold, with more spot trading taking place in lieu of long-term contracts. The impact of this is being felt on already low global LNG prices. The WGI Northeast Asia spot LNG price has averaged just USD $5/MMBtu this year, a premium of USD $2.83 over benchmark U.S. prices. Two years ago, the gap was about USD $10.
Previously prices in Asia were generally set through long-term contracts indexed to the price of oil. Until 2015 they also reflected the regional nature of the market.
For example, Japan LNG prices regularly topped USD $16 between 2012 and 2014. However, the fall in oil prices, coupled with an expected surge in US LNG exports, have caused Asian prices to fall and converge with US prices, as they have in Europe.
Should this convergence in prices become established it would mark a paradigm shift in gas pricing and would imply the US will become the price-setter for the Asian market even before meaningful volumes of US LNG arrive. Taking this one step further, it could mean the establishment a direct pricing link between US shale gas production and the Asian LNG market.
Regional natural gas prices (Source American Gas Association)
The softening in prices has already forced one Australian LNG exporter – Santos – to recognise an impairment charge of USD $1.05 billion against its flagship Gladstone LNG (GLNG) asset in its 2016 half-year accounts.
“At GLNG we are seeing the effects of a softer LNG market ,” Santos chief executive Kevin Gallagher noted. “We have therefore adjusted our assumptions regarding upstream gas supply and third-party gas pricing”.
What about New Zealand?
Assuming a sizable gas discovery (10 Tcf or greater) in one of the frontier basins, it is difficult to see how a future New Zealand LNG export facility would be able to compete in an over-supplied market where US exports to the region will significantly grow and depress prices.
Furthermore, BP’s latest annual report on global energy trends predicts growth in gas supply will come mainly from shale gas which will account for 25 per cent of global gas production by 2035, displacing expensive deep water gas developments.
The report also forecasts China will become the world’s largest contributor to growth in shale gas production, through the exploitation of its vast shale gas reserves in the Sichuan and other basins. These are estimated at 1,115 Tcf by the EIA and give China the scale not only to become self-sufficient in gas and shut-down its coal-fired power stations, but also to develop its own LNG facilities and become a major LNG exporter to rival the US and Australia at some point in the future.
Conclusions
Growth in gas demand is forecast to come mainly from exploitation of shale gas rather than deep water gas developments. This has economic implications for deep water exploration where the primary hydrocarbon type is likely to be gas.
The US is one of the world’s cheapest sources of gas and is set to dominate the global LNG market in the coming years. The rapid and material increase in US export capacity, coupled with the widening of the Panama Canal, allows US LNG to compete directly with Australian product and is already having a deflationary effect on Asian gas prices.
But China could make things worse. The country’s energy companies are determined to develop shale gas to clean up the horrific air pollution problems by shutting down coal-fired plants.
The forecast is for the global natural gas glut to get worse, especially if China is successful in developing its own shale gas industry.