Oh Canada, Another Threat To Australian LNG?

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This story was first published for FNArena subscribers on September 30 but is now open for general readership.

– Japan and Canada discuss LNG trade deal
– US government approves fourth LNG export terminal
– Russia and China agree to pipeline
– Pricing supported on near term demand/supply balance

 

By Greg Peel

“JP Morgan believe US regulators will be in no rush to commit to large amounts of export LNG, rather preferring to take a measured approach.

“The supply-side is nevertheless not wholly dependent at the margin on the US. Canada, too, is an LNG export aspirant and the same domestic economic issues are not going to be as important in this lower population nation. Goldman Sachs believes that Canada will become a major LNG export player over time, with two Kitimat projects owned by Chevron/Apache and Shell likely to be first cabs off the rank.”

• Could A Global Pricing War Dash Australia’s LNG Hopes? (FNArena, June 20, 2013)

“Already a big investor in Australia’s LNG business, Canada is Japan’s next preferred location, said Susumu Fukuda, Japan’s consul general in Calgary, ahead of the United States, where energy exports are seen as more complicated. Japan should also be a preferred Canadian energy customer. With a free and advanced market economy, large energy demand and relatively short distance across the Pacific, no other Asian country offers Canada such a close energy fit.”

• Financial Post (Canada), September 23, 2013
   

Is Australia’s burgeoning LNG export industry at risk from competition?

A major topic of conversation between the prime ministers of Japan and Canada, as Shinzo Abe began an official visit to North America last week, was natural gas. Since Fukushima, Japan needs lots more of it. Canada has plenty. The distance to Japan from Canada’s west coast is only slightly further than the distance from Australia’s LNG ports. Japan has been importing Australian LNG for decades from Western Australia and Japanese companies are heavily invested in LNG joint ventures on both sides of the country. But it is never wise to keep all one’s eggs in one basket.

Last week it was reported that US oil & gas giant Chevron is accelerating its Canadian LNG export plans by stepping back into the leadership role in Western Canada, with plans to build an LNG export terminal at Kitimat in British Columbia. Chevron owns the proposed Kitimat facility in a 50-50 joint venture with US energy peer Apache. As operator, Chevron also acquires 50% of a proposed pipeline which will bring gas from Canadian fields to the east in Alberta.

Kitimat is not the only possible point of export for Canadian LNG. Britain’s gas giant BG Group is looking to exploit the planned Prince Rupert facility, also on Canada’s Pacific coast. And plans are afoot for smaller companies to build export facilities in the US state of Oregon, tapping into Canada’s vast nearby gas reserves.

The problem for Canada has been the US shale explosion. Canada already pumps oil into the US, right through to the storage facility at Cushing Oklahoma where the West Texas Intermediate price is set. Now that the pipeline from Cushing to the Gulf of Mexico coast has been reversed, Canadian oil flows all the way to the Gulf refineries. Canada always assumed the US would be the obvious buyer of its natural gas reserves as well. Pipelines alleviate the need for expensive LNG conversion. But suddenly, with shale, the US has all the gas it needs.

And more.

Early in September, the US Department of Energy granted its fourth non-FTA natural gas export licence. Free trade agreements with some nations prevent the US government inhibiting LNG export, but controls are placed on exports to non-FTA countries such as Japan and China. Many major US FTA partners, such as Australia, already have their own energy supplies anyway. As noted in the quote above, Australian energy sector analysts have assumed the US government will keep a fairly tight rein on US LNG exports rather than see the benefits float away to economic competitors. Yet now Dominion Resources’ Cove Point LNG facility in Maryland has joined three Gulf facilities – BG Group’s Lake Charles and Sabine Pass facilities owned by Freeport and Cheniere – in winning export approval from the government.

Back when Australian oil & gas companies, and their international counterparts such as Chevron, Apache, BG Group and Japan’s Mitsubishi, started building new LNG facilities on the Australia’s Indian and Pacific coasts, there was never any assumption the US would one day become an LNG export competitor. Or Canada. With America beholden to oil exports from enemies in the Middle East and South America, it was always assumed US gas would only ever be consumed domestically and that excess Canadian gas would only ever be piped south. But US shale has changed the picture.

Not only does North American LNG throw up the possibility of competitive global LNG supply, but it also throws up the possibility of much cheaper LNG export pricing to the likes of China, Japan and Korea, thus potentially threatening the economic viability of further Australian LNG proposals. See Could A Global Pricing War Dash Australia’s LNG Hopes? as quoted above.

Should Australia be worried?

Not really. Consider that BG Group is now looking to sell up to $4 billion of pipeline and other infrastructure at its Queensland Curtis LNG facility with a number of specialist consortia keenly bidding for the assets. JP Morgan suggests that the nearby Gladstone LNG and Asia Pacific LNG facilities, respectively owned in part by Santos ((STO)) and Origin Energy ((ORG)), should look to do the same once a precedent is set. Such sales would add upside to Santos’ and Origin’s share prices.

Meanwhile, a final investment decision on Kitimat, for example, is still 18-24 months away.

In other words, new Australian LNG development has progressed to the point all of PNG LNG (owned in part by Oil Search ((OSH)) and Santos) and the three big Queensland coal seam gas LNG projects (QCLNG, GLNG and APLNG) will export their first gas over the next two years. That puts Aussie LNG up to maybe five years ahead of the Americans and perhaps as much as ten years ahead of the Canadians. The North Americans still need to build their infrastructure. The Aussies are already looking to sell theirs off.

Canada clearly has the potential to become a major LNG competitor to Australia, one day. The US is never likely to offer up destructive competition, analysts suggest, even if North American pricing undercuts Asian pricing. The pricing issue is one being pushed by government representatives in the likes of Japan as well as India, JP Morgan has found, while the actual corporate gas buyers in Japan and Korea still value security of supply over price. On that basis, JP Morgan concludes the appetite for LNG among major Asian buyers at US Henry Hub-based pricing is likely to be limited to around 20% of imports.

Indeed, the JP Morgan analysts recently set off on an inaugural LNG tour of Japan and Korea and returned believing the fundamentals for global LNG remain positive. They see a tight market in the medium term with supply risks, rather than abundance, and hence likely upward pressure on pricing rather than downward.

While the Queensland coal seam gas LNG projects look set to exploit a valuable window of first mover opportunity over the next five years or so, uncertainty over just when Japan might restart its nuclear reactors offers up 2013-14 as a likely peak period for LNG pricing, JP Morgan suggests. This plays right into the hands of Woodside Petroleum’s ((WPL)) recently ramped up Pluto facility in WA alongside the legacy North West Shelf operation, in which Woodside and BHP Billiton ((BHP)) both hold stakes.

Goldman Sachs analysts have also recently toured Asia to assess the prospects for LNG demand. They expect strong global LNG demand growth of around 5% to 2020, driven by Asia. They, too, note “heightened Asian price sensitivity” but expect US export volumes to be limited.

Interestingly, Goldman cites oil/gas forward prices curves in suggesting that within five years, LNG buyers will be “indifferent” between Henry Hub-linked and oil price-linked gas prices. On the other hand, price reforms would also draw out greater demand from Asian countries finding current contract pricing somewhat steep. They include India but also China in terms of increased demand, while Thailand and Singapore could become significant new markets, Goldman notes.

The implication here is that while global LNG pricing may suffer some downward pressure once US exports hit the oceans by 2020, the marginal demand response will be such that prices could never fall too far. Moreover, the cost curve for potential new LNG supply projects outside of the US is currently at a level which suggests tenuous economic viability.

While the US has been a first mover on shale gas (through twenty-first century technological advances in extraction, not because no one knew the shale was there), it has no monopoly on shale reserves. Australia, as it turns out, boasts abundant potential supply, and even China can lay claim to plenty of its own shale deposits. Yet the prospects of either exploiting these riches are a very long term consideration.

Goldman Sachs global equity analysts are suggesting investors seek exposure to a growing LNG market, through low-cost producers, those engineering and contracting companies which will build and maintain the infrastructure, and companies which will build the many more LNG ships that will be required to traverse the world’s oceans. Goldman includes Oil Search and Santos among its producer picks.

It must not be forgotten that seaborne LNG is not the only means of exporting gas to the likes of China. After a decade of negotiation, the basic conditions for a long term energy cooperation deal between China and Russia was agreed to early in September. Expedience has become more necessary for both camps, BA-Merrill Lynch suggests, as Russia looks to the potential for US LNG exports to undermine its dominance of the European gas market, and as China looks to a domestic shale gas industry which is falling well short of Beijing’s 2015 targets.

Piped gas is far cheaper than LNG given the very costly and time consuming process of building facilities to convert gas into liquid for seaborne export. One nevertheless still has to build the pipeline.

On balance, it appears existing Australian LNG export businesses in WA are set to enjoy solid profits through to 2015, while the PNG and Queensland businesses set to come on line between now and then will also benefit from a window of tight global balance, with the supply-side in a position to dictate pricing. By 2020 US exports will come into play, potentially applying some downward pressure on pricing but only for limited volumes.

Russia might complete a pipeline into China but then Russia often has to turn off the pipes to Western Europe when domestic demand dictates. Canadian exports are some ways off, and the development of shale deposits elsewhere in the world is presently more of a dream than a near term reality.

Recent FNArena LNG stories:

Could A Global Pricing War Dash Australia's LNG Hopes?
The Plot Thickens For LNG
How Do Australia's LNG Majors Stack Up?
A Revised Outlook For LNG: The Road To Riches Or A Waste Of Time And Money?
 

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