Welcome to the largest, steepest, most prolonged drop in prices the liquefied natural gas (LNG) industry has ever faced. Since the giddy highs of LNG prices a few years back, prices have collapsed by over two thirds. And structural LNG oversupply is only beginning, which will see spot LNG prices remain depressed through to early next decade.
There is still plenty of under construction LNG supply capacity to come online, without demand to meet it. Global LNG supply availability rises by over 160 bcm between 2016 and 2020, while LNG demand outside of Europe increases by only half that. This will leave around 80 bcm of supply looking for a home in the market of last resort – Europe. However, it will be competing with pipeline gas from Russia, Norway and Algeria, and there simply wont be enough demand to soak it all up. As a result LNG supply will have to be curtailed.
LNG supply will be curtailed where the short run marginal cost is highest: US LNG projects and the coal seam gas (CSG) fed projects on the east coast of Australia. These unconventional gas fed projects have to spend big dollars each and every year to keep plants full. US LNG capacity will feel the brunt of the curtailment, as LNG prices won’t cover short term production costs. For the first time in the industry’s history, brand new LNG plants are being deliberately run below capacity on an economic basis.
Rising liquidity amid rising tensions
With US LNG capacity lying idle, US gas prices will begin driving – and surpressing – global spot LNG prices for the first time. Events such as M&A activity or sand cost inflation in an oil basin like the Permian in the US, will have repercussions for electricity prices in India or Australia.
This will place increasing tension on legacy LNG contracts, signed during the boom at relatively higher oil linked prices. There will be an unprecedented level of pressure placed on contract sanctity, as buyers try to renegotiate for better terms. And buyers remain reluctant to sign up to new contracts, which are becoming shorter, smaller in size and more flexible.
Being a ‘portfolio player’ is the new buzz word in LNG marketing: at low prices, optimised trading and shipping can make all the difference. And flexibility is a differentiator. We are witnessing the rise of the traders – the likes of Gunvor, Trafigura and Glencore – who didn’t exist in the LNG market five years ago, shunned by the industry. Today they account for an increasing market share, welcomed by producers for helping open up markets and manage counter party risk.
The next wave builds from increments to elephants
While there is a lot of LNG sloshing about now, around ten new LNG trains could be needed by 2025 once the market has rebalanced. But with many supply sources chasing this market share, cost will be king. High cost greenfield projects of the recent boom will remain little more than ideas on paper. Indeed, the LNG cost curve has become progressively lower and longer since 2014, as industry focus on cost cutting. Incremental debottlenecking volumes, followed by expansions at Qatar, Papua New Guinea, backfill of Australian legacy plants, and a modest second US LNG wave, are next off the rank. The elephant in the room will be onshore Mozambique, which could displace a lot of competing volumes. With ExxonMobil in, once the Mozambique trigger is pulled, the large resource base will stretch to many LNG trains, displacing competing projects.
Swings and roundabouts
Buyers will take advantage of the glut to improve their position, but it may well come back to bite in the future. Any buyer threats to renegotiate existing contracts now will impede their ability to underpin new supply projects when they need to in the future. And buyers push to remove destination restriction clauses may provide benefits over the near term. But once the market tightens, it risks leaving buyers exposed to a greater burden to manage their operational requirements, as sellers baulk at also providing volume flexibility allowing free arbitrage options. Moreover, refraining from signing long term LNG contracts now risks the market being undersupplied and prices spiking later. And the cyclical nature of the industry will prove itself yet again. The LNG market has seen numerous periods of alternating buyer and seller favoured conditions over the last 20 years, through financial crises in 1997 and 2007, the Fukushima tragedy in 2011, inter alia. But LNG projects typically have over 30 year lives. They ride out the cycles.