LNG players struggle with transformed market

Australia's $170 billion plan to tap into the much-vaunted "golden age of gas" has turned into something even more costly and a lot less rewarding than anyone had in mind.

Standing on the cusp of becoming the world's largest exporter of liquefied natural gas, the country's industry is facing a hugely different market than when most of the new LNG projects started construction in 2009-11.

Part of the Chevron LNG project on Barrow Island, Western Australia. Part of the Chevron LNG project on Barrow Island, Western Australia. Photo: Ray Strange

Not only are prices much lower than envisaged, but competition has intensified, from rival producers and competing fuels. Multiple new importing countries have emerged, while big buyers face an uncertain demand outlook in their home market. Traders and other new types of industry player are complicating the traditional dynamics. Demand has been unexpectedly flat in recent years and imports even dropped in China in 2015.

"We all know what the transformation looks like," Shell vice-president of integrated gas projects Hilary Mercer said at the LNG18 conference in Perth this week, attended by 6000 industry participants.

"Growing buyers of flexible, traded LNG, abundant accessible and cost-competitive LNG, and a diversification of markets, buyers, sellers, business models and strategies."

The changes have left the industry grappling with how to carve out a profitable path, despite broad agreement on the positive demand outlook.

Driven down spot prices 

The prospect of about 100 million tonnes a year of supply hitting the market by 2020 – that's about 40 per cent of the current global market – mostly from Australia and the US, has driven down spot prices in Asia to about $US4.50 a unit, from $US20 in early 2014.

For producers, the changing shape of the industry with so many more buyers and sellers is forcing a collective rethink.

The number of countries importing LNG has surged from just 11 in 2000 to more than 30. Shell expects nearly half of future LNG demand increases will come from countries that did not use LNG in 2010, including prospective new markets such as the Philippines, Bangladesh and Colombia.

The dramatic expansion was accompanied by a new set of expectations from customers, Woodside Petroleum chief executive Peter Coleman said.

"Many of the emerging customers want choice in terms of product," he said. "They want to see portfolio flexibility and a range of supply sources. LNG sellers need to adapt to this changing market . . . this is the future."

With several new projects stalling, such as Woodside's $40 billion-plus Browse floating venture, a "meeting of minds" is necessary between buyers and sellers to ensure forecast demand can be met, many argue.

Power shifted to buyers

But with the market currently awash with supplies and plenty of new projects vying for customers, the power has shifted firmly into the hands of buyers.

Japan's Inpex Corporation president Toshiaki Kitamura said suppliers would not be able to avoid making sales contracts more flexible to accommodate the diversifying needs of buyers.

"In which case, the development of a liquid market, in which surplus LNG can be easily sold, would be meaningful even for suppliers," he said.

However, Woodside's Coleman cautioned that increasing liquidity in trading networks posed a challenge for suppliers, creating uncertainty and suppressing new investment.

Hiroki Sato, vice-president of fuel buying for JERA, the giant LNG buying venture formed in 2015 between Tokyo Electric Power and Chubu Electric, backed a co-operative approach by LNG buyers and sellers to work towards long-term contracts to get projects off the ground but acknowledged economic pressure to opt for cheaper LNG on the spot market.

As heavy investors also in supply projects, the problem is a joint one, large importers say.

"Please remember we are on the same boat," said JERA president of fuel buying Yuji Kakimi, who offered a positive but pointed commentary on the new Australian ventures.

Great survivors

"In the middle of a harsh LNG market that is changing fast I expect that they will not only turn out to be great survivors but will also spare no effort in ever improving their cost efficiency."

Datuk Wan Zulkiflee Wan Ariffin, president of Malaysian oil and gas company Petronas and a partner in Santos' $US18.5 billion ($24.1 billion) GLNG venture, took buyers to task for sidelining long-term reliability and security of supply in favour of immediate cost savings.

"Like it or not, the shift in the buyers' priorities will have an impact on the LNG producers' investments in new projects, as the outlook for returns fall below expectations," he said.

Project returns are under scrutiny, given the drop in prices and some severe cost overruns, including $US17 billion at Chevron's new Gorgon venture in Western Australia.

US-based consultancy Independent Project Analysis director Neeraj Nandurdikar said the industry's record over the past decade "can only be described as dismal", with larger projects the worst offenders.

RISC chief executive Peter Dawson blamed management planning and bad decisions on project locations.

"The initial planning and development decisions – not the pay rates for an Australian electrician or welder – have often been the issue and E&P [exploration and production] producers have to recognise that," Mr Dawson said.

Debate on huge projects

The problems and changed market have triggered debate whether extremely large projects will give way to smaller, more flexible, and perhaps floating plants.

Meg Gentle, marketing president of the US's new LNG export player Cheniere Energy, said the industry needed to find a way to reduce costs for smaller-scale LNG projects, which were better able to satisfy customer demand.

Others say the huge projects, supported by sales contracts lasting perhaps two decades or more, will still have their place in the future, as part of a portfolio of supply options.

KPMG's global LNG head Mary Hemmingsen said many buyers still wanted to lock in long-term access to vast gas resources, meaning that a large green-field venture such as those proposed for Canada's Pacific coast "still presents as an attractive opportunity in a diversified portfolio".

Chevron chief executive John Watson also denies any regrets about the decision to proceed with Gorgon.

"When you look at the cost of Gorgon and look at depreciation rates – in other words per barrel and operating costs – [the break-even price] would be under $US30 a barrel," he said.

"And so Gorgon will be profitable at any kind of reasonable prices."

But only the most competitive projects will succeed in winning customers, with marketing of LNG seen much tougher in the next few years, despite an expected fillip from the Paris climate accord.

"We have been good in the last 10 years to build new projects. Selling them was easy because you had big demand," Total's global chief Patrick Pouyanne said. "Today the times have changed and so the industry must shift again to develop the demand for gas."

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