30th October 2014
LNG is proving to be the key to unlocking the traditional energy supply and demand model and improving security of supply. As with all commodity markets, pricing is fundamental to demand. Traded LNG supplies are no exception and need to be priced competitively to maintain existing markets and stimulate new ones.
Natural gas now accounts for up to 22 % of the world's energy consumption
LNG accounts for 31% of global gas exports
Total LNG volumes trade in 2013: 236.8 MMT
LNG liquefaction capacity, end-2013: 290.7 MMTp.a. (17 LNG exporting countries)
LNG regasification terminals capacity, end-2013: 688 MMTp.a. (29 LNG importing countries)
Japan is the dominant importer with 37% of the global LNG imports in 2013, whereas emerging economies accounted for 48%
Transport fuel sector anticipated LNG demand up to 160 MMTp.a. by 2035, both for marine and heavy road trucks
Long-term traditional oil-linked LNG pricing model under threat from gas-linked fundamentals
Short-term/spot transactionsaccounted for 27% of LNG market in 2013
Existing LNG contracts and the latest tranches of Australian LNG are mainly secured against long-term oil-indexed supply contracts. However, large regional differences in gas price have driven buyers to seek a shift away from traditional oil-linked LNG pricing, to one with more transparent prices based on gas-on-gas economics similar to other commodities. Many Asian buyers looking to trim costs have secured attractive long-term contracts linked to the U.S. domestic gas price (Henry Hub (HH)), which are being offered by planned U.S. (Lower 48) export projects. Many buyers believe that gas indexation-based LNG deliveries will provide lower LNG prices in the long term.
There is no shortage of recoverable gas resources, with many new discoveries announced and being developed to meet forecast global demand. However, given the high cost structure of new liquefaction projects, particularly outside the U.S., it is likely that this new capacity will have to be priced largely, if not fully, linked to oil to secure project finance. So will the new wave of LNG liquefaction projects be able to supply LNG at the market price required? Ultimately the market price ceiling for LNG will be LNG priced at a thermal equivalence to oil. In other words, buyers may want LNG at HH-linked prices, but such volumes are limited. Therefore demand will need to be satisfied by other projects, which may be priced higher but still less than crude oil equivalent.
Many new LNG import markets have opened or are opening up, such as Bangladesh, Kuwait and Argentina, primarily for gas to power generation. Typically, importing countries are supplementing domestic gas production or switching to cleaner and more efficient gas to meet new environmental emission policies. The U.S. has seen extensive substitution of coal by gas and, elsewhere, high crude oil prices have encouraged liquid fuel substitution in the power generation sector. These new LNG import markets require greater flexibility of supply and with buyers seeking contractual improvements such as options to resell.
LNG demand is also gaining rapid momentum from the transportation sector and is estimated to capture a significant new market share, particularly for high horse power (HHP) engines, such as for road trucks, rail and marine bunker fuels. This new LNG sector is driven by the divergence of oil and gas prices and benefits from significantly reduced emissions. Regional pricing of smaller volumes of LNG will be pivotal to stimulate transport fuel substitution and is unlikely to follow the traditional bulk LNG supply pricing formula.
Competitiveness of New LNG Supplies
There is a dash to monetise recoverable gas resources; Russia is developing its Arctic field (Yamal), East Siberian fields and has plans for Sakhalin gas to yield additional gas supply capacity. Elsewhere, East Africa is progressing slowly and tackling the initial challenge to develop adequate legislation and regulatory policies to underpin development of a coherent natural gas industry. U.S. and Canadian projects are pushing hard to compete and be the next LNG supply focus. Ultimately, the order of projects coming down the “LNG project conveyor belt” will depend on various parameters, including costs, perceived risks and overall benefits. Future LNG supplies planned from projects in East Africa, the Arctic and Russia will have to compete with existing price benchmarks to secure international buyers.
The cost of gas production (or gas feedstock) is critical to the competitiveness of any planned LNG liquefaction project, with upstream costs heavily dependent on location. However, rich gas plays can significantly improve project economics where liquids production can be commercialised. The cost of the gas liquefaction plant component has risen significantly in recent years, and has become more dominant than the cost of gas feedstock. Another key component is the transportation of LNG to the destination market, with the LNG shipping tariff effectively reflecting distance to market. In this regard, the strongest demand and best achievable delivered LNG prices emanate currently from Asia-Pacific.
The project developer will factor in their contingency and investment rate of return prior to offering long-term LNG supply contracts. Recent Australian projects have highlighted an industry weakness in developing megaprojects, which has seen 80% of projects in the last decade going over budget and schedule, which sellers will need to consider when determining achievable delivered costs.
The indicative cost to produce, liquefy and transport LNG to the Japan/Korea Market (JKM) for a selection of upcoming LNG projects is shown in Figure 1, to highlight the competitiveness in this consumer market. Where liquids production is anticipated alongside gas production, a credit is applied for the sale of these products. This credit is reflected by the orange boxes, whereby the cost of gas (feedstock) effectively starts from a negative price position.
Delivered LNG sales price lower than those shown for each individual project cost would effectively mean the project would operate at a loss. Therefore, these delivered costs can be considered the minimum LNG price for each project.
Delivered LNG Pricing
Significant LNG price deviation exists across the Atlantic and Asia-Pacific basins, with some Asian Pacific LNG importers paying approximately four times the amount paid for natural gas in the U.S. Asian LNG supply contracts are predominantly linked to oil and buyers have struggled since 2009 with an unprecedented divergence in the prices of oil and gas, whereas U.S. domestic gas prices have been low by comparison, due to the impact of the shale gas boom. Current Asian LNG long term proxy prices are tracking closely with oil parity as illustrated in Figure 2, well above the gas hub pricing (HH and the UK’s National Balancing Point (NBP)) in the North Atlantic markets.
This regional price gap is expected to continue until more flexible LNG supply terms develop and an efficient global distribution market is shaped. LNG is a commodity where market liquidity and pricing transparency still lag other commodities; however, new LNG buyers are seeking innovation with more flexible contractual terms, including eliminating destination clauses and providing options for re-selling cargos into the growing spot market. There is support for greater LNG spot market depth and pricing on the basis of LNG fundamentals, in an attempt to drive down LNG import costs. Having said this, it is still anticipated that 70-75% of global LNG will continue to be traded on long-term contracts in the coming years.
Asian LNG buyers are keen to secure gas-indexed long-term LNG capacity from new U.S. (Lower 48) export projects, in order to reduce their overall LNG portfolio price. U.S. LNG exports are being offered loaded free-on-board (FOB) under a pricing formula based on a percentage of the HH Futures prices (NYMEX) plus a fixed sales charge, which effectively relates to a gas liquefaction tolling fee, as shown below for Sabine Pass LNG sales.
- LNG Price (US$/MMBtu) = 115% of Henry Hub + fixed sales charge of US$2.5-3.0/MMBtu
Linking LNG supplies to a U.S. gas hub may not be the best long-term option for Asian buyers, especially considering that HH pricing has historically been volatile and based on factors which are independent of trends in Asia. Hence, in the long term this is not necessarily an appropriate LNG pricing index for Asia, such that the gradual emergence of an Asian LNG spot market looks likely. The attractive HH gas price forecasts has stimulated renewed pressure on existing sellers to renegotiate oil-indexed contracts to ones more closely aligned with gas hub-indexed prices available elsewhere.
The paradox is that, given the huge cost structure of LNG exporting facilities, it is very likely that a large proportion of globally-sourced LNG will have to be largely, if not fully, linked to oil to secure project financing. Consequently, safeguarding returns on large liquefaction plant projects, coupled with long-term oil-indexed LNG contracts currently in force, means that Asian LNG pricing will remain predominantly linked to oil, certainly to the end of this decade. The impact of future U.S. LNG export volumes on Asian prices is likely to be marginal.
A significant impact on the delivered price of LNG is the price volatility of crude oil. Asia typically uses the Japan Crude Cocktail (JCC) as the oil benchmark, which is particularly sensitive to global supply and demand trends. Figure 3 illustrates the impact on Asian LNG oil-indexed prices from a fall in crude oil prices (futures) by approximately 20%, which is effectively what has occurred in the Autumn of 2014, and compares this to the U.S. (Lower 48) LNG price delivered to JKM. Oil-indexed LNG contracts are shown using a typical range of slopes, 13% and 14.8% of JCC. The recent reduction in JCC oil price of around US$20/Bbl effectively reduces the long-term LNG price by US$4.0/MMBtu. This makes oil-indexed supply contracts more competitive with U.S. exports indexed off HH futures, such that for long term futures forecast there is only a US$2-3/MMBtu difference between delivered LNG pricing based on oil and gas indexation. An additional 10% reduction in oil prices or increases in HH gas futures could see the competiveness of U.S. exports disappear.
Potential fluctuations in oil- and gas-indexed LNG prices is a significant factor in assessing risks on LNG pricing and one that buyers need to fully evaluate and hedge before committing to long-term supplies. Buyers are pushing for inserting price renegotiation clauses to improve the degree of fairness from the impact of price divergence caused by market volatility.
LNG Demand Growth
Asia will dominate new LNG demand growth, especially China and India, but there is uncertainty with projected volumes due to competing factors, such as new pipeline gas supplies, cheaper coal alternatives and enforcement of new emission policies. However, competitive delivered LNG pricing is critical and higher prices will stunt growth.
New markets are also opening up in Asia and the Middle East, such as Thailand, Vietnam and Bangladesh; moreover countries such as Bahrain and Kuwait are becoming LNG importers to supplement modest domestic gas production and growing energy requirements. New import markets are being enabled by floating storage and regasification units (FSRU), which have reduced lead-times and the cost of access to gas for energy-hungry countries. Many countries are switching to gas as a cleaner and more efficient fuel, which can satisfy new environmental emission policies.
The next wave of LNG demand gaining momentum is stemming from the transportation fuel sector, the incentive coming from the divergence of oil and gas prices, plus the global push for cleaner fuels to meet new emission regulations. Certainly, the abundance of low-priced natural gas in the U.S. has led to predictions of rapid growth in LNG as a transportation fuel, particularly for HHP vehicle engines, such as road trucks and trains. Currently, China is leading the way for LNG-fuelled vehicles followed by the U.S. and, internationally, there is a strongly growing uptake of LNG for marine ‘bunker’ fuels. The stage is set for the evolution of a multi-segment small-scale LNG network for wholesale and retail markets. However, there is a threat to LNG demand growth from the “chicken and egg” syndrome, with key players waiting to see adequate facilities are in place before committing to fuel switching and enforcement of emission standards. The transport sector will offer a significant new LNG market, estimated at up to 160 MMTp.a. by 2035.
This smaller-volume transportation market will need to be competitively priced against the substitution fuels, such as heavy diesel and low sulphur marine bunkers, and likely to be at a premium to bulk traded LNG volumes.
The future of LNG is positive with steady demand growth in its traditional markets for gas to power generation and a whole new batch of countries opening up new markets and players. Only high LNG prices will threaten to dampen the enthusiasm for gas demand, as many countries are increasingly unwilling or unable to afford high-priced supplies. There is growing momentum in multi-segment small-scale LNG and opportunities for the use of LNG as a transportation fuel substitute, which is being driven by the divergence of oil and gas pricing, plus LNG’s environmental benefits as a cleaner burning fuel.
Delivered LNG pricing is key to opening new markets and growing demand. The days of the traditional oil-indexed LNG supply contracts are under threat and the future looks to be one with more transparent prices based on gas-on-gas economics. Asian buyers have recently clamoured to secure planned U.S. LNG exports linked to the low HH gas price and priced competitively when compared with oil-indexed LNG contracts, especially with recent high oil prices. However, pricing linked to US domestic gas is probably not the best solution for Asian buyers, but it will take a while before LNG price based on LNG/gas market fundamentals emerges in a market dominated by oil-linked pricing.
New and upcoming LNG export projects are not without their own challenges and are capital intensive, so securing finance will require LNG export prices that recognise acceptable risks. Based on upcoming projects (not including Floating LNG) planned or in construction, a delivered LNG price to JKM in the range US$ 9.1 - 13.5/MMBtu is necessary to cover the costs of project development, which effectively provides a minimum Asian market price for these new projects.
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