11th July 2016
There are six potential opportunities that could arise from new dynamics in the LNG industry. The six opportunities will spur demand for vessels or improve LNG shipping efficiency.
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Opportunity 1 - The balance of power has changed
Today, more than ever, there is nothing more important to gas monetisation than understanding the gas value chain that connects resources to the end user. For a gas project to reach final investment decision (FID) all the links in the chain must be aligned and risks shared out appropriately.
Figure 1: End to end economic analysis of gas value chain is essential for gas market participants
In the old world, we started with the gas resource in the ground or under the sea, which producers assumed, almost by default, would eventually find its way to a profitable market. The focus was mainly on the development plan and it was all the upstream that was driving the value chain, with an assumption that buyers would eventually sign up.
Figure 2: Shift in focus to end user markets driving gas demand
In the new world, the game has changed. Now, more than ever before, we are going the other way, with the customer in the driving seat. Market demand for gas and LNG are becoming the catalyst for individual developments, and only those assets that can appropriately meet the price and timing dictated by the market will be successfully developed. In the same way, buyers are more able to dictate shipping arrangements and delivery point, and we see a number of them taking a greater role in LNG carrier management and fleet optimization, sometimes through pooling portfolios. Two such combinations have emerged in Japan, with Tokyo Electric and Chubu Electric pooling arrangements under Jera, and more recently Tokyo Gas and Kansai Electric forming a similar buying consortium, with their own fleet of ships.
Opportunity 2 - Market reform (in Asia) will fuel multi-billion dollar gas growth
Energy Market Reform is now underway in Japan (the largest LNG market in Asia), which will inevitably have an impact on the region more widely, together with broader reform in South East Asia. As we saw in North America (80’s), here in the UK (90’s) and Continental Europe (early 2000’s), when supply alternatives multiply, customers will press for choice and value.
In all of the previous market reforms, there have been 3 main triggers for change:
1. Competing gas supply options – resulting in lower wholesale prices
2. Mounting customer discontent – wanting access to lower prices, with the threat of moving industry offshore
3. Governments having to be proactive about implementing policy and regulatory change to enable customers to access lower cost alternatives
This “trinity for change” is now present in many jurisdictions (not just in Asia), and we expect it to fuel demand growth, in turn leading to tonnage demand. The price discovery that has followed market reforms around the world is now panning out in Asia. This lower cost gas is starting to impact nations balance of payments quite materially, and in some ways is the equivalent of a multi-billion dollar stimulus package for some countries with a growing gas demand.
Figure 3: Lower gas prices creating billions of dollars stimulus for gas importing countries
Fossil fuel demand growth may be slowing, but natural gas appears to be poised to take a much larger market share from oil and coal, as a result of its structural price advantage and plentiful supply, in addition to major carbon based advantages which make gas the natural partner for growing renewable generation.
Opportunity 3 - One’s pain may be another’s gain…
The impact of the oversupply on LNG prices is less spoken about than oil, but the price of LNG could be in even more of a “lower for longer” mode. Looking at a simplified view of project returns given commodity price falls (oil prices on the left and long term oil linked LNG proxy prices on the right):
Figure 4: LNG pricing putting pressure on project returns and new investments
Above $100 oil, oil indexed gas projects were making good returns. As the price dropped below $100 returns became more modest, and in around 2013-14 there was also downward pressure on the price coefficients for many newly signed supplies to Asia, putting additional pressure on LNG project revenues. As the oil price dropped further, even with LNG prices lagging oil, we entered a period where equity returns started to come under pressure. Now in the current low price environment, debt repayments are starting to come under pressure and lenders are becoming increasingly concerned.
Given the approximate 5 month lag in oil based LNG contract prices linked to oil the recent modest recovery in oil will take time to have an impact and the next 6 months may see some restructuring of projects. Even if oil recovers more significantly, with wholesale prices responding to the oversupply and linkages with NBP forming, this may keep pressure on lower LNG prices.
Some may say these financial pressures may actually be good for the industry, eliminating the cost inflation and lack of cost control we have seen in recent years, and creating improved capital and project discipline to support investment in the current climate. In addition, barriers to entry may lead to the LNG industry becomes more diverse, with a larger group of participants bringing fresh thinking to an industry that has so far been the preserve of a handful of companies.
Opportunity 4 - Traditional pricing models put to the sword…
In the current market structure, we have in essence three competing price mechanisms: (i) The standard long term take or pay contract price, based on oil, (ii) increasing amounts of LNG priced on some form of Henry Hub linked price plus a liquefaction toll, and (iii) a growing portion of the global LNG volumes that are traded on short or medium term contracts at prices reflecting global and regional supply and demand.
If Asian and indeed global gas prices follow the progression we have seen in North America, UK and Continental Europe, we will gradually see a merging of these pricing mechanisms into some kind of hub or potentially multiple hubs addressing key markets. The development of a Singapore hub, or a Japan hub, is being talked about in LNG shipping circles.
Figure 5: Shifting LNG pricing paradigms
Given the significant new flows of LNG currently coming to the market, natural gas in Asia is likely to increasingly develop its own pricing mechanisms that could be largely delinked from oil. In doing so, even in Japan and Korea, we could see natural gas losing its pricing equivalence with crude oil, and growing market share as a result. There are several benefits to hub based pricing that are evident from markets where it has become established. It provides a less volatile, more stable pricing platform on which to build demand and spur economic growth. It could also be a better long term basis on which to make LNG investment decisions, arguably avoiding some of the boom and bust gas prices which create problems for investors and end users alike. Finally, it supports a more reliable and liquid futures traded market for gas, adding to the price stability and security of supply.
Opportunity 5 - Small > big
Now more than ever before, projects need to be fit for purpose. Hence “small” may actually be the new “big”. The LNG growth trend has historically followed a single path; bigger trains, higher volumes. The same has been true of larger and larger vessels. In the last 2-3 years, that trend shows signs of strain, especially as alternative technologies are gaining a foothold.
2016 could be the year to revisit our perceptions about what an LNG project should look like. Big projects, benefiting from economies of scale and government involvement may become fewer in number and smaller projects, leveraging new technologies with faster development times and lower market risk could take an increasing share of market growth.
Figure 6: Two tier project market is evolving
Barriers to entry are now lower (lower capital commitments, shorter time to market, less technology risk) providing opportunity for new and existing players. FLNG (Floating LNG, though some might call it Flexible LNG) is a great example of this; a potential game changer which can benefit from lower, modular cost, transportability and quicker construction times.
The true impact of FLNG is not yet fully apparent (but may become so during 2016). New and innovative tariff / tolling and vessel chartering structures are becoming common which may enable multiple smaller projects to proceed. At least 4 projects are due to come to the market shortly, with several more at various different stages of development. Market participants are being ever more creative and innovative, helping to drive costs down. All of this fit for purpose, flexible, lower cost optionality is being matched by significant growth at the other end of the value chain with Floating Storage and Regas (FSRU), a beacon of activity among an otherwise uncertain marine outlook for LNG carriers.
Opportunity 6 - New developments will support gas growth
Technology advances beyond just FLNG and FSRUs are also playing a part. Cutting edge railway locomotive technology is now based on LNG and a growing number of ships propulsion systems are moving to natural gas or hybrid engines. At the high end of the shipping market, Carnival cruise lines having ordered four LNG-fueled mega cruise ships carrying over 5,000 passengers, while a range of less glamorous tugs and ferries are also switching fuels. In coming years marine LNG requirements could mop up the equivalent of the output from one major liquefaction plant, though we are at least a decade away from that. In the road transportation sector, diesel engines are now being superseded by purpose built LNG engines being used today in FedEx Tractor Trailer units among others, saving up to a third in opex. Public transport and municipal vehicles are also rapidly switching to gas, and while much of this has been CNG based, LNG is also starting to make in-roads with Class VII and VIII trucks (HGV’s in UK parlance) and long distance buses favouring LNG.
This article was originally published on Lloyd's List.
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