Commodities | Jun 02 2010
By Greg Peel
For Australia's burgeoning set of new LNG projects, both offshore and coal seam methane (CSM), to reach financial investment decision (FID) status, long term off-take agreements need to be signed. Or else projects need to partially or fully sold off to foreigners.
Japan is fundamental in the search for customers, but then whenever new gas projects are being announced in Australia one word always crops up as important – China. China is seen to be a major buyer of Australian LNG into the future.
There is, however, one small flaw in this argument, and that is China is looking increasingly well supplied with gas, as Macquarie notes. “Even under our significantly above consensus Chinese gas demand forecasts,” say the analysts, “the Chinese gas market already looks reasonably well supplied out to 2020 with significant growth expected in domestic production from conventional reservoirs”.
This is not what the Australian LNG industry, now possibly hit with an RSPT, wants to hear.
And that conventional gas is decidedly cheaper. It is still cheap despite the Chinese National Development and Reform Commission yesterday announcing a 25% increase in controlled domestic well-head gas prices to US$4.31/mmBtu. Funnily enough, that's right where the world's benchmark US Henry Hub spot natural gas price is trading right now, notes Macquarie.
Long term gas contracts are typically priced on a discount to “oil parity” basis. Oil parity is loosely defined as the price at which oil becomes a cheaper fuel import than, and thus substitute to, gas. Recent long term gas contracts have been settled at a 15-25% discount, but the Henry Hub spot price today represents a full 65% discount.
This is a big discount in historical terms, and represents simply a big historical discount between the benchmark US crude oil (WTI) and natural gas spot prices. While the oil price has rallied significantly post-GFC, the gas price has not. One reason is that US gas inventories remain historically high, but then so do oil inventories. The other reason is that oil is a speculator's trading commodity and gas is not. Hedge funds will actually buy and store barrels of oil as long as warehousing costs are not too onerous. Given gas has to be liquefied to be stored (a costly business) it is not the plaything of hedge funds.
The obvious question is: Why would Japan, for example, be buying gas at a15-20% discount when a 65% spot discount prevails? The answer is firstly, well yes – that's a good question. It is all about the cost of liquefying and then transporting gas as LNG, and it's all about the premium accepted for long term gas supply security. But it is nevertheless an historically wide gap.
Such a wide gap that analysts have been questioning all the excitement over Australia's LNG projects for a while now. The world is bulging with gas, and new sources (primarily shale gas, but also biogas and coal-to-gas) are rapidly becoming more commercial. Qatar, for one, has enough gas to supply the whole planet if it so chooses. But then it suits Qatar to limit supply over time and thus maintain a good profit margin.
In the meantime, it seems to be assumed that all you have to do is find some methane in Australia and the world, and particularly China, will become your oyster. Gas analysts have spent a year now scratching their heads.
The importance of the 25% price rise in Chinese domestic gas is not that it makes local gas more expensive for local consumers but that it makes local gas more profitable for local producers, and thus encourages greater production.
Macquarie had been forecasting this Chinese price increase, and expects it to “merely be the first round of a longer process of gas price reform in China”, although the next increase it not expected within twelve months unless the oil price runs amok.
At the same time, the longstanding intention to build a gas pipeline from Russia to China is still a very real one.