A slowing Chinese economy and upcoming elections in India could both impact a hitherto robust demand outlook for the LNG industry, which currently occupies an enviable place in the energy universe. Demand growth has been on a substantially higher trajectory than any other hydrocarbon when compared with global GDP or the slowdown in international trade. LNG is on a virtuous relatively low-priced path of expansion in which its primary competitors are coal and oil products.
Global LNG supply has grown by nearly 30 percent over the last three years. Rather than resulting in a much-predicted glut, it has been absorbed by coal-dominated economies, principally China, in an effort to reduce both local air pollution and global carbon emissions. This is resulting in a new wave of project FIDs (final investment decisions), which should keep LNG pricing competitive.
While the industry has focused on the potential of new markets in transport, with some justification, these to a large extent remain icing on the cake in comparison to the potential for industrial gas demand, including fertilizer and petrochemicals, and the expansion of city gas use in Asia. This demand should be underpinned by coal-to-gas switching in the power sector in both Europe and North America, despite the growth of renewable energy sources.
A key reason for the underestimation of LNG demand has been the change in investment cycle times brought about by Floating, Storage and Regasification Units. This has shortened the time required to put LNG import capacity in place, meaning that demand-side investment can lag supply growth, with importers benefitting from greater market visibility, leaving the riskier investment decisions to be made on the supply side.
But even here the ability to get import facilities up and running in a relatively short timeframe engenders confidence that the rising number of project approvals, and thus forecast supply, will be met by new demand-side investment ahead of the completion of major new liquefaction projects.
The impact of FSRUs should not be underestimated. China has not opted for FSRUs because the scale and solidity of its LNG demand has warranted construction of permanent, larger onshore facilities. FSRUs have instead played a key role in opening up new markets, notably in South Asia, relatively small markets, and in meeting temporary demand, for example in Egypt and Israel. Over the period 2015-2018, of the roughly 111 million tons per annum of new LNG import capacity added worldwide, 45 percent were FSRUs. Excluding China, FSRUs dominated with 55 percent.
And if FSRUs have been positive for demand, so too has technology on the supply side. US gas production on a price versus output comparison has defied traditional economics for years. US gas prices have bumped along around $3/MMBtu on average, yet production has expanded hugely to record levels, owing largely to the associated gas produced alongside shale oil.
Despite growth in gas use on all fronts – LNG, pipeline exports, power sector demand, petrochemicals and transport – the US is still looking at surplus gas in the Permian basin, which is expected to keep feedstock prices low for new LNG projects. As US LNG grows as the marginal price setter for LNG markets globally, it is a reminder that just as oil and gas production remain closely tied, the competitive LNG prices required to expand market demand are also intimately bound to the health of the US shale oil sector. OPEC’s production curbs don’t just benefit US oil producers, but also the LNG ambitions of the US.
Slower Chinese economic growth is clearly a potential problem for LNG developers as China has contributed so much of new LNG demand in recent years.
However, while LNG demand was certainly boosted by industrial activity over Winter 2017/18, China’s appetite for LNG reflects a structural shift in energy consumption away from oil products and coal. This is policy driven, notably, by the northern province coal-to-gas switching program, rather than being solely hostage to the economy. China’s gas use remains low by developed country standards on a per capita basis and the government aims to increase its proportionate use, meaning it should benefit even in a lower economic growth scenario.
Most importantly, however, China has demonstrated the capacity – a few hiccups notwithstanding -- to expand its domestic gas system in line with its LNG and pipeline import capacities. This is a key uncertainty in the prospective major new LNG markets of South Asia.
For the moment, LNG imports are meeting long-standing gas supply deficits in India, Pakistan and Bangladesh. In none of these populous countries is domestic gas supply expected to challenge the requirement for LNG, while major import pipeline projects continue to prove tortuous to advance let alone complete. But problems will arise when these countries’ latent gas demand is satisfied.
South Asia is much more agrarian than China and pricing signals are heavily distorted by deeply entrenched subsides, which, as in India, assert their political prominence in pre-election periods.
Regulated pricing and subsidies affect everything from electricity and fertilizer prices to CNG use in transport. Rural electricity prices are often set below cost recovery for political reasons, which creates endemic debt problems, evident amongst India’s state level electricity distribution companies and the circular debt that has bedeviled Pakistan’s energy sector for years.
Fertilizer production is the single largest gas consuming sector in India and benefits from price pooling which serves to counter the difference in price between imported LNG and limited domestic supplies. Urea prices are also subsidized, which means, as in the gas-for-power sector, expanding demand creates a growing financial burden on government agencies.
As a result, while the current wave of LNG supplies should find willing buyers based on the combination of a rapid deployment of LNG import infrastructure and existing unmet gas demand, the following wave could find demand growth much more circumscribed.
Longer-term gas consumption in South Asia is based on expanding domestic gas infrastructure to connect more people and businesses to national gas grids. Given the lack of internal capital, delivering this capacity in a timely manner is likely to prove a significant constraint on long-term LNG demand.