A worrying time for LNG investors

Many uncertainties hang over the LNG industry in the short to medium term, but the long-term outlook remains bullish, writes Alex Forbe.

WITH GLOBAL liquefied natural gas (LNG) production capacity growing rapidly, it looks like a boom time for the sector. But a worsening gas-supply glut and unprecedented demand uncertainties are making life difficult for existing LNG projects and potential investors in new capacity. Leading the global supply surge is Qatar, which next year will hit its ambitious export target of 77m tonnes a year (t/y). This will confirm the country as by far the world's largest LNG producer, with a market share of around one-third some achievement, given that it loaded its first cargo less than 15 years ago. But Qatar is not the only country adding output. Between 2009 and 2013, some 130bn cubic metres a year (cm/y) (almost 100m t/y) of new LNG capacity will come on stream, half of it in Qatar and the rest in countries including Russia, Indonesia, Yemen, Malaysia, Peru, Australia, Angola and Algeria many becoming LNG exporters for the first time. This will deliver a 50% rise in global LNG output capacity in just four years. In 2014-15, two other projects, already under construction, are due to come on stream Papua New Guinea LNG (6.6m t/y) and Australia's Gorgon (15m t/y) adding another 22m t/y to global capacity (see Table 1). It is also possible that one or two more projects may reach a final investment decision by the end of this year, probably in Australia (see p6), adding further capacity to the 2015 total. Between 2009 and 2015, global LNG capacity could rise by around 130m t/y.

Bad timing It is an impressive ramp up. But the timing looks terrible. And it raises question marks over investment in new export capacity to come on stream in the second half of the decade. Most of the liquefaction projects starting up now were sanctioned between 2003 and 2005. But while the projects have been under construction the world has changed. The astonishing rise of US unconventional-gas production has seen the country's gas output rise sharply so much so that the US has overtaken Russia to become the world's largest gas producer, and no longer offers a real market for LNG exporters. The shale-gas revolution may yet yield more abundance, if the successes in the US can be repeated elsewhere. Consultancy Wood Mackenzie reckons shale-gas output could meet 35% of US demand by 2020, compared with just 6% in 2007. Meanwhile, the global economic downturn since the second half of 2008 has decimated demand for natural gas, yielding a glut to which the new wave of LNG has contributed. Spot prices have sunk. In 2009, says the International Energy Agency (IEA) US Henry Hub and UK NBP prices averaged $4/m British thermal units (Btu) and $5/m Btu respectively, while oil-indexed gas bought under long-term contracts in Europe and Japan averaged around $9/m Btu (see Figure 1). Clearing the glut depends on how quickly the global economic gloom dissipates, suggests the IEA's chief economist, Fatih Birol. The uncertainties created by the economic weakness are "unprecedented", he says, and they pose a threat to investment by LNG exporters. So far, the industry has escaped the full effects of the glut. Although 60bn cm/y of new capacity came on stream in 2009, global LNG trade rose by a relatively modest 5.3% over 2008 to reach 245bn cm (180m tonnes). This was because nameplate capacity is one thing and output another. Overall production was hit by a range of factors, including delays in commissioning; technical problems at many new plants, including the mega-trains being commissioned in Qatar; gas-supply issues in Nigeria and Algeria; and long ramp-up periods at some projects. Meanwhile, LNG demand has been recovering more quickly than many expected, partly because of a return to strong industrial growth in Japan, South Korea and Taiwan; partly as a result of increasing demand in developing markets, such as China; but also because of the emergence of new markets in Latin America and the Middle East. Even in Europe, where gas demand plummeted in 2009, LNG-demand growth has been much stronger than expected. Indeed, a key sign of the limited liquidity in the global LNG market over the course of 2010 has been the divergence of prices at Henry Hub and NBP. US LNG imports have been suppressed by the rise in indigenous production and this surplus supply in the Atlantic basin would be expected to depress prices at NBP. Instead, NBP prices have been significantly higher than those at Henry Hub for most of the year, because much of the surplus LNG has found its way to other markets. That is likely to change as the LNG output surge picks up pace. Statistics compiled by Andy Flower, an independent LNG consultant, show LNG supply in first-half 2010 was up by 24.3% on the first half of 2009, from 86m tonnes to 107m tonnes, and he expects global supply for the full year to reach 220m tonnes, close to 40m tonnes up on 2009. Strong growth will continue into 2011, as Qatar's last two 7.8m t/y mega-trains come on stream, along with the 4.3m t/y Pluto project in Australia. This will affect the regional LNG markets differently. In Europe, the IEA says it is "hard to see tight supplies before 2015". But the situation in Asia and the Pacific is much less clear. Chinese and Indian LNG demand growth could "really bite into LNG supply", the agency says. Between them, both countries will be capable of importing around 65bn cm/y, similar to Europe's LNG imports last year.

And it is not hard to find a more bullish outlook among some in the industry. If governments encourage greater gas use as part of strategies to meet medium-term climatechange targets, especially by displacing coal in electricity generation, demand could pick up faster than many expect. Shell's chief executive Peter Voser reckons gas consumption in 2020 could be 25% higher than today and almost 50% higher by 2030. The advent of unconventional production, along with rapid growth in LNG output, which Shell forecasts will grow at 6-8% a year, means policymakers can now be confident about the long-term security of gas supply, he believes. "The supply will be there," he says, "provided there's a market." LNG alone will meet a fifth of gas demand within a decade, predicts Shell. The majors are putting money where their mouths are. Voser says Shell's LNG output could reach 35m t/y by 2020, almost double its capacity today (see Figure 2). ExxonMobil does not say what its equity capacity is (although it is the largest foreign player in Qatar's LNG sector), but it is involved in projects with gross production of 65m t/y and has plans that would expand that to 100m t/y. BP is also plotting an expansion of its LNG production. Total is more confident than most on demand, partly because China's consumption is constrained now only by limited import infrastructure and that will change soon (see Table 2). This bullish message from the majors is based on a long-term faith in the growth of natural gas demand. It contrasts with the near-term outlook. The costs of liquefaction projects are now an order of magnitude higher than they were a decade ago and traded gas pri