After several years in which oil and gas companies moved quickly to plan, fund, and build LNG export facilities around the world, the LNG market is starting to show cracks.
As with most projects based on the whims of commodity prices, there are boom and bust cycles. First off, LNG prices have crashed in part because of the crash in oil prices. But, LNG is also experiencing a bust of its own.
Although there is no single market for LNG, there is suddenly an embarrassment of riches in terms of liquefaction capacity around the world…a trend that will only grow worse with time.
This should not take astute investors by surprise. After several years in which new LNG supplies only came online at a trickle (LNG export capacity grew by just 1.6 percent in 2014, for example), a wave of projects are set to hit the market at the same time in the years ahead. With huge expansions planned in Australia and the United States in particular – and many more on the drawing board – LNG export capacity is expected to skyrocket by more than 40 percent before the end of the decade, according to the International Gas Union: from just around 300 million tonnes per year (mtpa) to around 420 mtpa by 2020.
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The only problem is that even before all that new capacity reaches the market, LNG prices have already hit multiyear lows. The Platts JKM Marker – the benchmark price for LNG landing in East Asia – for September 2015 stands at just $8 per million Btu (MMBtu), down by more than half from the highs of near $20/MMBtu in early 2014. Back then, any and every LNG project seemed destined to make money. Now, much fewer will.
But the supply picture is not destined to balance out in the same way that oil markets will. Both LNG and major oil projects have long lead times, but unlike the oil market, individual LNG terminals can move the global supply needle much more than a single oil well can. The slew of LNG projects destined to come into operation before 2020, if they have not already secured contracts for delivery, may have trouble finding enough customers.
As mentioned above, Australia and the U.S. have a monstrous supply of new LNG capacity in the works. However, to make matters worse, there are several more recent developments that have not been factored into the supply picture.
For example, take the latest discovery by Eni (NYSE: ENI) in the Eastern Mediterranean just off the coast of Egypt. Eni just announced the largest natural gas discovery in the history of the Mediterranean – the Zohr discovery could hold 30 trillion cubic feet (Tcf) of natural gas. More importantly, Eni plans on moving swiftly towards development, and drilling could begin as soon as next year with production coming online a year or two later.
Most, if not all of that gas, is earmarked for domestic consumption. Egypt desperately needs the gas because its economy has suffered through periodic blackouts. As a result, LNG exporters might not be too worried. However, Egypt has recently emerged as quite a strong LNG consumer, agreeing to import LNG cargoes from Gazprom (OTCMKTS: OGZPY), Rosneft, Royal Dutch Shell (NYSE: RDS.A), and more.
Eni says that the Zohr will provide enough gas to meet all of Egypt’s domestic needs, and may even leave a little left over for export. LNG exporters currently selling to Egypt will lose that customer, leaving extra capacity on the global marketplace. This is bearish for LNG markets.
Moreover, the nearby Leviathan field, controlled by Houston-based Noble Energy (NYSE: NBL), could bring another wave of natural gas online. The field, located in Israeli waters, could hold 22 Tcf. That is more than enough gas for Israel, and while a concrete plan has not been put forward, Noble Energy plans on finding export routes for its gas. To be sure, the Eni discovery negatively affects the prospects of the Leviathan, but if the field is developed by the end of the decade as planned, another large source of gas will come online. Ultimately, these gas fields could be good for their owners – Eni and Noble Energy, respectively – but they will add to the abundant supplies of gas on LNG markets.
Another project, still subject to a great deal of uncertainty, is Iran’s massive South Pars gas field. Iran still needs to shake free of international sanctions and attract investment, but given the fact that it is sitting on some of the world’s largest natural gas reserves, if it can develop export capacity, it will upend LNG markets.
Another company pushing forward despite the writing on the wall is Anadarko Petroleum (NYSE: APC). The Texas company is seeking to build a major LNG export terminal on the coast of Mozambique, potentially transformating East Africa into a significant gas exporting region. Anadarko recently secured nearly all of its necessary permits for its $15 billion project, but it is waiting on making a final investment decision until it has a full green light for development from the host government.
To Anadarko’s credit, it has lined up buyers in Asia for more than 8 mtpa, nearly enough to move forward with investment. The project will have a total capacity of 12 mtpa. The timing is critical though – other projects in North America are also hoping to move forward, in an effort to reach Asia first. Anadarko said investment will only be forthcoming if the government of Mozambique moves quickly on approval.
The U.S. is set to become a major LNG exporter with the startup of Cheniere Energy’s (NYSE: LNG) Sabine Pass facility on the Gulf Coast. Several more terminals are under construction while many more are being considered. Petronas, a state-owned Malaysian firm, is moving forward on a massive multistage LNG facility on Canada’s western coast, a project that could ultimately cost $36 billion.
Despite the hype, many others may not move forward, as the market has suddenly become very crowded. Excelerate Energy just announced that it would scrap plans to build a liquefaction facility in Lavaca Bay, Texas. The move is notable – it is the first U.S. company to withdraw a federal permit application. The company cited poor project economics as LNG benchmark prices have fallen along with the collapse of crude oil prices.
With JKM prices now at $8/MMBtu, LNG projects that have not lined up customers will be unprofitable. Consider the costs. Henry Hub natural gas prices in the U.S. in the range of $3/MMBtu. After factoring in liquefaction, transportation, and delivery, LNG exporters from the U.S. need at least $10/MMBtu in Asia to make sense.
LNG markets are in the doldrums. With LNG benchmark prices linked to the price of oil, LNG prices have tanked over the past year. But even if oil prices do rebound, the coming wave of LNG capacity could keep LNG prices from rebounding in similar fashion. That could spell trouble for any companies moving forward on LNG projects if they have not secured customers under contract.
On the other hand, an LNG export facility is not the same thing as a shale well, for instance. It is long-term. It can operate for decades. That means even if LNG prices stay low through this decade, projects can still earn a strong return as long as prices rise at some point in the 2020s, a pretty likely scenario.
Still, for the short-term, investors should not be looking for LNG developers to rescue them from disappointing results in the oil markets.