Australian LNG – The Waking Giant

Harper Bernays’ research: Australian liquefied natural gas (LNG) – The Waking Giant

Recent media commentary concerning prospects for Australia’s liquefied natural gas industry suggests an increasingly competitive landscape may scuttle future developments. We analyse the sector to understand its future prospects with our report and findings set out below.

Guy Broggi, a senior geoscientist at French oil and gas company, Total, was one of the first people to note that Australia could overtake Qatar as the world’s largest producer of liquefied natural gas (LNG) by 2020. Speaking at a conference in London, in late 2011, M. Broggi noted an anticipated five-fold increase in gas liquefaction capacity this decade due to facilities under construction all around the Australian coastline. At least five LNG projects had been sanctioned at the time and further plants were being considered; there are actually seven now under construction.

Two years on, however, the outlook is slightly less certain. Doubtless there will be an enormous lift in LNG production as the aforementioned projects are all under construction. But, the dynamics of the global LNG market have shifted dramatically since 2011, to the extent that further developments in Australia may not go ahead. Key for investors in Australian developers then is an understanding of how the global LNG market might evolve.

On the one hand, demand in the Pacific Basin – the end market for Australian LNG exports – has grown dramatically. Japan mothballed all but two of the country’s 54 nuclear reactors within twelve months of the Fukushima nuclear disaster of March, 2011. The last two were idled for maintenance in September, 2013. Removing nuclear reactors that produced 30% of Japan’s electricity has seen increased demand for coal, oil and in particular, LNG. Japan will likely import 88 million tonnes of LNG in 2013, accounting for more than one third of total global consumption[2]. This fillip to LNG demand may only be temporary if Japan re-starts some reactors and in the long-term, there is likely to be a much greater focus on renewable energy generation. However, Japanese demand alone is likely to keep LNG prices firm until at least the middle of this decade.

LNG demand has also increased in other Asian countries. In 2011, Malaysia, a top LNG exporter, announced that it would also start importing LNG, enabling it to arbitrage the commodity as well as satisfying the demands of its rapidly growing economy as its own gas reserves decline. It completed its first import re-gasification terminal in mid-2012 and from 2015 it will be a key customer of the Gladstone LNG facility currently under construction in Queensland. Thailand and Indonesia have also joined the LNG importing club in recent years.

China, despite its massive population and burgeoning economy, will import just 15 million tonnes of LNG in 2013 – a fraction of Japan’s demand. Currently, China pipes a large proportion of its gas from the Central Asian Republics and over the course of the next five years this will be supplemented by new pipelines from Myanmar and Russia. Nevertheless, the frenetic pace of economic expansion and a desire to ensure diversity of supply will likely see China importing 52 million tonnes of LNG per annum by 2020.

However, China’s future LNG demand is the most difficult to forecast of all Asian countries, if only because of its vast un-tapped shale gas reserves. To date, Beijing’s attempts to stimulate a shale gas boom similar to that seen in the US in recent years have come to nought. Despite shale gas resources double those of the US, meaningful production quantities are unlikely in China before the second half of this decade. State energy giants, Sinopec and PetroChina, were the first companies to be awarded rights to exploit China’s shale gas reserves, but more than two years after the grants, there has been little progress. Both companies have struggled with the cost and complexity of drilling for shale gas in China. Wells costing around $15 million each have failed to deliver meaningful gas flow rates from the complex shale geology being targeted. Neither company has been keen to keep pushing down this path when returns from other oil and gas investments are far more promising (including Australian LNG – Sinopec is a substantial partner in Australia Pacific LNG being developed in Gladstone whilst PetroChina has invested in Arrow LNG which is also looking to develop an LNG export facility in Gladstone).

There was no further progress when China tried to induce other companies to drill for shale gas late last year. The government is currently considering a third round of awards, but the obvious solution – to bring in foreign companies that have the requisite shale gas skills and experience – is unlikely to be embraced any time soon. As such, China’s shale gas remains a resource with potential to disrupt domestic market dynamics; but, they are far from becoming a reserve that can be readily exploited.

Overall, then, the regional demand side of the equation for LNG looks intact for now. But, Australia isn’t the only LNG supplier eyeing the lucrative Asian market. New export facilities are also under construction in the US and Papua New Guinea and a slew of further developments are being considered for Tanzania, Mozambique, Canada, Russia, the US and Indonesia. This has given rise to fears of a supply glut with operators in lower cost countries crowding out Australian supply.

Indeed, much has been made of the threat to the Australian LNG industry from cheap American gas. The US shale gas boom of recent years has created a wall of supply that has greatly depressed domestic prices: the current benchmark price is US$3.68/mmbtu[3] whereas it rarely traded below US$6.00 from 2005 to 2008, and the price frequently spiked much higher. Excess supply encouraged US gas producers to look for new markets and east Asia, right across the Pacific Ocean from the US, where Australian LNG currently fetches around US$15.00/mmbtu, looked irresistible.

Enormous US shale gas reserves and the differential between natural gas prices in the US and LNG prices in Asia has led many to suggest that lower cost US LNG will completely supplant ‘traditional’ (including Australian) sources of supply over time. Yet, further consideration of LNG market dynamics suggests a slightly different outcome.

For a start, the price differential is not so great after liquefaction and transport costs are considered. Liquefaction in the US will likely cost ~US$4.60/mmbtu on to which must be added the cost of shipping gas to Asia, at ~US$3.00/mmbtu. Thus, the cost of US LNG landed in Asia would be ~US$11.28/mmbtu at current US natural gas prices.

Then there is the issue of physical liquefaction capacity in the US. 14 different LNG export developments have been mooted, but, to date, only one has been approved by both the US Department of Energy (DoE) and the US Federal Energy Regulatory Commission (FERC) to export gas to countries not covered by a Free Trade Agreement with the US[4]: Sabine Pass LNG in Louisiana is currently under construction and first production is scheduled for the fourth quarter of 2015. The approvals cover a potential 18 million tonnes per annum (mtpa) of LNG output, but the first stage will likely see ~8.4mtpa exported in 2016. Admittedly, another two US projects have DoE approval (Freeport LNG in Texas and Lake Charles LNG, also in Louisiana), but neither have FERC approval yet. The important point is: the DoE considers applications on a sequential, first-in-first-out basis and for each and every application, the DoE applies a national interest test, weighing up whether the value of exports surpasses the benefit to the US economy of low-priced domestic gas supply. Thus, it’s reasonable to surmise that if earlier applicants’ projects are approved, later developments are likely to face too much competition from compatriots to be viable and they’ll have a lower probability of passing the national interest test.

Nevertheless, LNG will be exported from the US, and in sizeable quantities. Credit Suisse predicts ~60mtpa of LNG exports from the US by 2020 versus ~250mtpa of LNG demand from Asia.

On paper, then, it would appear that the US is well positioned to meet a large share of Asian demand. Yet, to date, Asian buyers have committed to buying less than 20% of planned US supply. Exporting LNG is a new and largely unproven US industry and the regulatory environment is constantly evolving. Asian buyers crave certainty of supply as much as they do good prices. As such, they have so far proceeded with caution towards this new source of supply and they will ensure that their LNG supply comes from many, geographically dispersed, sources.

Vendors, also, are cautious about marketing US LNG – none are interested in seeing premium Asia pricing evaporating. 70% of all planned US LNG export capacity to 2020 is controlled by major international oil and gas companies. These producers typically sell gas on a portfolio basis, i.e. customers are offered LNG from various sources and assorted pricing schedules may be used. Should these producers sense market prices weakening, they may postpone development of new LNG facilities.

Admittedly, the US appears to have a cost advantage over Australia. Credit Suisse has estimated that the capital cost of developing a new LNG facility in the US is US$1,500 per tonne of liquefaction capacity. In Australia, the cost is estimated at between US$2,600 to US$3,500 per tonne. The low end of the scale is typical of a fixed facility sourcing gas from onshore coal seams; the upper end of the scale is typical of a fixed facility sourcing gas from offshore, deep-sea fields. However, capital expenditure for the life of a coal seam gas fuelled LNG facility is anticipated to be so much higher than for ‘conventional’ offshore fed facilities as thousands of wells will need to be drilled to support the liquefaction facilities over their 30-40 year projected lives. This makes coal seam gas fuelled projects less attractive than ‘conventional’ alternatives. To further lower the capital cost of development, it is likely that future Australian LNG projects will be giant offshore platforms, i.e. floating liquefaction facilities that will be cheaper to construct and operate.

Overall, then, the global LNG market is likely to see tight supply until around 2018, by which time all seven of the LNG facilities currently under construction in Australia will be complete. US supply will doubtless capture some of the premium Asian market, but the number of LNG export facilities developed in the US is likely to be less than currently mooted. Also, new producers have no interest in seeing the Asia price premium evaporate. As such, there will likely be room for further Australian LNG developments, but they will probably be cheaper, floating facilities. Even so, Australia still looks likely to be the world’s greatest gas exporter by the end of the decade.

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