The New Global LNG Dynamic

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(This story was originally published on March 25, 2011. It has now been re-published to make it in full available to non-paying members at FNArena and to readers elsewhere).

– Japan has an immediate need for LNG
– Japan, and the world, may now turn away from nuclear and toward LNG
– Australian producers will not benefit in the short term, but should in the long term
– US shale gas looms as a possible contender

By Greg Peel

A fortnight ago, investors were sitting back scratching their heads over whether the great Australian liquid natural gas (LNG) bonanza was, or at least threatened to be, a fizzer, long before proposed projects even come close to production. Yes, there is China and India to think about, and long term customers Japan and Korea. But while future demand may be unquestionable, what about the extent of future supply?

It was three years ago when Origin Energy rejected an initial bid from British gas giant BG. The target was Origin's reserves of coal seam methane (CSM) in Queensland which, like the natural gas being sucked from beneath the ocean off Western Australia, can be converted into LNG for export purposes. This bid came out of the blue and caught investors, and stock analysts, napping. Coal seam what?

A step-jump re-rating of gas stocks followed, particularly of anyone with a CSM interest such as Santos ((STO)) as well as Origin ((ORG)), along with anyone with LNG interest in general such as Woodside ((WPL)) and Oil Search ((OSH)) the latter which, along with Santos, has significant interest in PNG LNG. But then it all came to a screaming halt.

There was the small matter of a GFC, but once China was back on board with a vengeance the GFC didn't matter anymore. What did matter is the substantial time and cost involved in building the “trains” required to convert either natural gas or CSM into LNG, the long term sale agreements that simply need to be secured to provide both commercial viability and funding, and the sufficient confirmation of available gas reserves needed to satisfy the confidence of potential buyers Here, progress has been slow.

The reasons for slow progress have been many, including project delays, increasing capex costs and even the weather. The biggest problem has been a reluctance from potential buyers. These buyers are reluctant because there is simply so much natural gas in the world, and so many projects under construction or proposed, that gas prices have stagnated and the buyers can pick and choose. There is a race on, both within Australia and across the globe, and not everyone will be a winner. Some proposed projects may need to be scrapped.

At least, that was the state of play prior to the earthquake and tsunami hitting Japan, and the subsequent nuclear scare. Analysts across the globe are now in agreement on two counts: (1) Japan's lost nuclear capacity will mean an immediate need for alternative sources of electricity generation, and the obvious choice is LNG; and (2) the nuclear scare will cause Japan to rethink its nuclear energy plans and capacity, and may well have a ripple effect across the globe on the same basis. Here LNG also stands to be the big longer term winner.

Nuclear energy is considered “green”although there are plenty of arguments over the amount of energy expended in building a nuclear reactor and mining and transporting the required uranium. LNG is not considered “green” per se, being a fossil fuel, but it is a lot “greener” and indeed cheaper than oil products. It is not cheaper than coal, but coal is the dirtiest of all energy sources.

Japan is the world's greatest importer of LNG. Japan has no LNG of its own, nor anything much else of its own on the natural resources front, and there is no pipeline delivering natural gas to the island nation. Japan also has a significant surplus of regasification capacity, built with the future in mind as well as for a back-up in times such as these, so it stands ready to quickly restore electricity demand through LNG sources.

[There are two steps in the process of getting natural gas from producer to consumer. The natural gas has to be liquefied for transport, known as “liquefaction”, and then un-liquefied at the other end for consumption, known as “regasification”. It takes years and a lot of money to build liquefaction plants. It takes a lot less of both to build regasification plants.]

In the short term case (1) above, Australia is not in a position to benefit. There is some spare capacity available in the massive North West Shelf project but realistically whatever LNG being produced now is being produced for existing long term contracts. Qatar, on the other hand, has so much excess supply it effectively rations sales in order not to crunch the LNG price, and this year the last of Qatar's “mega-trains” will be complete.

Qatar sells most of its gas in the Atlantic region at spot but often secures term deals in the Pacific region as well if the price is right. It is Qatar which will thus stand to benefit from Japan's immediate extra LNG demand as it is the swing player with the capacity to quickly reroute cargoes. Analysts are not factoring in any benefit to Australian gas producers from immediate Japanese demand.

It is the long term case (2) above which is of most importance to Australia. Prior to the quake, Japan satisfied 30% of its electricity needs through nuclear and 30% through LNG, with the balance being coal and other sources. It has now lost 20% of its nuclear capacity – for good it would seem – and analysts agree there is not a big chance the government would look to restoring that balance and probably will completely rethink its future nuclear plans in favour of LNG.

Others may or may not do the same, and there is not an expectation China, which has far and away the greatest nuclear power ambitions, will much change its thinking. China also has huge LNG demand potential and LNG power plans and maybe even it will lean a bit further in the LNG direction now. Either way, Japan alone and a likely dampening of nuclear ambitions globally means expected longer term LNG demand has just been given a substantial boost.

That boost should prove to be the shot in the arm needed for Australia's plethora of proposed gas projects looking to reach financial decisions on either first trains or additional trains. Gas reserve security has been one stumbling block, but the biggest stumbling block has been contracts with buyers. (Note that we can here also throw in the search for required equity partners, which may mean gas company joint ventures or equity stakes taken by customers, to cover the significant capex funding requirements).

Deutsche Bank has thus rolled out the obvious list of potential Australian winners. They include Woodside with its Pluto expansion and Browse and Sunrise prospects, Santos with its Gladstone LNG expansion and PNG LNG expansion, Oil Search for PNG LNG and Origin with its Asia Pacific LNG project.

We must not forget there are also plenty of other projects underway or proposed in Australia which are foreign-owned. The obvious stand-out is Gorgon, but there is also the substantial Ichthys project in which Japan is a major stakeholder, making it an obvious LNG source. The bottom line is that while service contracts, jobs and taxes are gleaned from all projects, Australian gas companies are still competing with the world in their own country.

Then there is the small matter of US shale gas.

There is a lot about America that boggles the mind, but the fact that there is an oversupply of natural gas in a country that is totally beholden to oil exports from its enemies is right up there. It wasn't always the case, as years ago there were companies looking to build regasification plants in the US for the importation of LNG to meet rising gas demand. But now the boot is completely on the other foot, notes Barclays Capital, as those companies are now talking about building liquefaction plants so as to begin exporting LNG.

When coal seam methane suddenly hit the front page a few years ago, it wasn't new, and indeed CSM LNG had been already commercially produced in the US. But at that point a light bulb lit up somewhere, and before we new the fastest growing energy industry in the US became that of shale gas – a not dissimilar concept. It is the “undisputable success” of shale gas development, notes Barclays, that could make the US a viable LNG exporter for the first time.

That's not news Australia wants to hear. Since 2009, notes Barclays, a record number of liquefaction facilities have come on line in a short period. Initially, LNG flooded a market which saw demand suddenly drop as a result of the GFC, and for two consecutive years the world has been able to produce more LNG than demand growth could account for. Demand has been reflected in the construction of regasification plants, which have not kept pace.

But as noted, regasification plants can be built in a much shorter time frame than liquefaction plants, and expected demand growth from the likes of China and India, and now Japan, means the tide will shortly turn. Global gas demand increased by 60% from 1990 to 2010, and that rate is expected to accelerate as new residential and commercial demand opens up. Barclays now estimates that the Japan effect alone will bring LNG demand and supply roughly into balance this year.

Analysts had already assumed a deficit situation would be reached some time before 2014 given the timing gap between the projects which came on line by 2009 and the next wave of new projects under construction which would take a few years to go online. It is in 2014 that supply is expected to commence from the Curtis and Fisherman's Landing CSM LNG projects in Queensland, the Gorgon project in Western Australia, as well as Indonesia's offshore Donggi Senoro project.

Between 2014 and 2016 or later, we will see another wave of Australian supply (assuming they all go ahead) from the likes of APLNG, PNG LNG, Pluto, GLNG, and perhaps Browse and Sunrise, among others. “The uncertainty on their commissioning times,” says Barclays, “is too great to bear a reasonable significance in our analysis. Most of the ones targeting FID [financial investment decision status] in the next two years are still searching for buyers”.

The Japanese disaster has distorted the picture, such that Barclays sees liquefaction capacity falling far short of regasification capacity growth in the 2012-13 gap. The majority of regasification growth will come from Asia, but Europe should come in second. (Note that all of Europe occasionally suffers from natural gas shortages when Russia turns off the pipeline to meet demand at home). The picture then changes quickly again in 2014-15. 

This is the window of opportunity for all gas hopefuls, from WA and Queensland on to the US shale gas fields to capture the buyers. Even if there were enough demand, with Japan a new element, to make all Australian projects viable, the entry of US shale LNG would quickly rebalance the global market, Barcalys suggests.

But it may not be until 2016 before the first US shale LNG hits the market. Australia, notes Barclays, “has the lead”, and US shale might find a market already in balance.

Beyond that, Barclays believes China's potential LNG demand growth is “seemingly boundless”. India's gas markets are growing rapidly as well. Japan (pre-quake) and Korea have already been making the shift away from petroleum products and towards natural gas while in Europe and North America, natural gas is far cheaper than petroleum products and as such competing with coal for power generation.

On the counter side, China and India may well be able to source their own shale gas. India has large offshore gas reserves yet undeveloped. China also has pipelines being built from gas suppliers in Iran, which owns the other half of Qatar's vast Persian Gulf supplies, and the former Soviet Union. There are also alternative energy developments to consider.

Either way, and as tragic as the situation has been, the Japanese earthquake may just be the catalyst a seemingly foundering Australian LNG market might need. Stock analysts have long priced in the potential for earnings growth once various projects reach production, while acknowledging the risks of finding enough gas, finding enough money, finding joint venture partners, and the simple, obvious risks of massive infrastructure investment with a long lead-time. Investors had begun to lose hope, and started discounting further-out projects such as Woodside's Browse and Sunrise down to zero. Additional train expectations at the likes of Pluto, GLNG and PNG LNG have also been taken more recently with a pinch of salt.

The biggest impediment has been a lack of willing buyers. Perhaps the time has come.

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