The Fuse

LNG Markets Remain Oversupplied, But Industry Confident for the Long Run

by Nick Cunningham | October 18, 2017

A number of oil majors have spent a combined $725 billion on natural gas projects over the past decade, according to Wood Mackenzie, many of which have come online recently or are in the process of ramping up. The oil majors defended their massive investments this week, citing rising demand in China and India. “If I’m bullish about gas generation in China and India, then I’m bullish about natural gas,” Robert Franklin, ExxonMobil’s vice president for gas and power, said at the Oil & Money Conference in London.

The glut of supply could last years, threatening to keep prices low until the 2020s. But the oil majors are playing the long game, expecting the demand for gas to grow substantially over time.

But the large increase in LNG export capacity has led to a crash in prices, with the current spot price in Asia—the JKM marker—down by half since 2014. The glut of supply could last years, threatening to keep prices low until the 2020s. But the oil majors are playing the long game, expecting the demand for gas to grow substantially over time.

Supply increase

The oil majors have made strategic bets that natural gas will increasingly represent the largest growth market going forward as crude oil faces an uncertain future with fears about demand eventually peaking. The IEA projects that gas consumption will rise by 1.5 percent per year through 2040, whereas crude is set to expand by only 0.4 percent per year.

The oil majors have made strategic bets that natural gas will increasingly represent the largest growth market going forward as crude oil faces an uncertain future with fears about demand eventually peaking.

Against that backdrop, the largest oil companies are in the process of transforming themselves into big gas players. Royal Dutch Shell became the largest LNG exporter in the world after it paid $50 billion to acquire BG Group. ExxonMobil has made large investments in gas production and exports in Papua New Guinea. Chevron and Shell have each spent tens of billions of dollars on a handful of massive LNG export projects in Australia, including the massive Gorgon, Queensland Curtis and Wheatstone LNG export terminals. Today, Exxon and Shell produce more gas than they do oil.

LNG export capacity jumped nearly 12 percent in 2016 versus the previous year, rising to 336.1 million tonnes per year (mtpa), and the supply surge is not over yet. A massive 114 mtpa was under construction as of January 2017, which means LNG export capacity will expand by a third by the early 2020s.

The wave of new supply has depressed LNG prices. In early October, the Platts JKM spot price for November delivery was trading at $8.60 per million Btu, less than half of the February 2014 peak of just over $20/MMBtu.

LNG a long-term bet

The bullish predictions for long-term gas consumption largely hinge on China.

While LNG markets appear soft today, the majors have not lost confidence in their long-term wagers on natural gas, particularly because gas will play a pivotal role both in achieving environmental goals as well as improving local air pollution in places like China and India.

The bullish predictions for long-term gas consumption largely hinge on China, which represents the largest source of demand growth over the next few decades, according to most estimates. “China’s gas market has entered a new golden age,” Neil Beveridge, an analyst at Sanford C. Bernstein & Co, wrote in a recent report. “Growth in 2017 has shown significant improvement over 2016, as government policies to stimulate gas demand growth are starting to pay dividends.”

Bernstein predicts that by 2040, China’s gas demand could triple to 600 billion cubic meters (bcm), a jump of around 400 bcm from current levels. No other country comes close to matching that demand increase. India and China combined are expected to account for nearly a third of the total global increase in gas demand through 2040.

Risks for LNG remain

The Golden Age for gas is not assured, however. While gas will eat into coal’s market share in the electric power sector over the coming decades, natural gas will still face pressure from renewables if prices rise too high. A recent study from the World Energy Council, cited by Bloomberg Gadfly, compares the breakeven prices for natural gas versus renewable energy. The upshot is that LNG will likely have to be priced below $7/MMBtu in order for gas to compete with renewable energy in the long run. That will likely raise concerns for LNG exporters who spent billions of dollars a few years ago using much more bullish assumptions for demand and prices over the next few decades. Natural gas is often billed as a bridge fuel to a “cleaner” energy future, but there is a great deal of uncertainty over how long that bridge will prove to be.

Stoking demand

The enormous increase in supply has companies such as ExxonMobil, Chevron, and RoyalDutch Shell scrambling to promote new markets. Several sectors could be ripe for growth: Maritime shipping, freight transit, and petrochemicals are a few of the promising opportunities where LNG can make inroads and where renewables will struggle to compete.

The enormous increase in supply has companies such as ExxonMobil, Chevron, and RoyalDutch Shell scrambling to promote new markets.

International regulations regarding sulfur emissions from marine fuels are set to significantly tighten beginning in 2020, opening the door for relatively cleaner LNG to take market share from bunker fuel. Last year, ExxonMobil forecast that LNG would account for 10 percent of marine fuels by 2040, up from just 1 percent in 2016.

Infrastructure presents a major challenge for LNG suppliers. While there may be a need for gas in many parts of the world, regasification infrastructure is capital-intensive and requires time to build, confining LNG imports to a limited number of places. The market is growing–there were 39 countries at the end of 2016 that could import LNG, up from just 17 a decade ago.

But as the Wall Street Journal reported on October 15, LNG exporters are actively trying to stoke demand to soak up excess supply. As a result, they are weighing investments in riskier markets. Companies such as Shell are considering investing in LNG import terminals and power plants in countries where they hope to ship LNG, an integrated approach that carries risk and demonstrates the lengths to which the industry feels it needs to go to lock in sales. “The next wave of LNG consumers are less creditworthy, less experienced, less organized, and politically less predictable,” Jason Feer, head of business intelligence at consultancy Poten & Partners, told the WSJ.

Evolving market

The LNG market is rapidly changing as more suppliers and more importers create a larger, more liquid market. The supply wave has quickly eroded the longstanding practice of fixed supply contracts using prices linked to crude oil. Instead, the spot market is growing, more cargoes are shipped on short-term contracts or on a spot basis, and regional LNG prices are converging. In short, the LNG market, once idiosyncratic due to the dearth of suppliers and the difficulty of moving supply, is increasingly resembling the market for other widely traded commodities.

LNG developers have poured money into export capacity, betting that demand will strengthen and fundamentals will shift.

The changes underway have favored buyers over sellers. LNG contracts have routinely included clauses prohibiting reexport, but LNG suppliers, no longer able to dictate terms, are doing away with such destination requirements. A “buyers’ club” of sorts emerged earlier this year, with top LNG importers in South Korea, Japan, and China pressuring suppliers into price and contract concessions.

Nonetheless, LNG developers have poured money into export capacity, betting that demand will strengthen and fundamentals will shift. While the investments may eventually pay off, suppliers have inflicted short-term damage by overbuilding. Just as in the oil market, consumers are set to benefit from more choice and lower prices—for now, at least.

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