LNG supply glut triggers delays and losses

China, India and other liquefied natural gas importers are moving away from long-term contracts and want to renegotiate contracts made at the peak of the energy cycle – potentially costing money for investors in production projects.

These trends have added to the uncertainty affecting the LNG sector, already dragged down by the oil price crash and uneasiness about delays to major projects. The Australian energy group Woodside’s Browse joint venture off the northwest Australian coast – which analysts estimate will cost more than $40 billion – was the latest to be put on ice in late March.

Many other big LNG projects are in danger as supplies continue to increase from Australia, North America, the Middle East and elsewhere while consumption growth is constrained by slowing economies. Analysts have forecast that a growing LNG supply glut could last half a decade.

The halt to Browse came as Asian gas prices plummeted in line with a 70% fall in oil prices since July 2014. In March, the benchmark Platts JKM index, based on spot prices paid by Japan and South Korea, the world’s two largest LNG importers, stood at $4.46 per million British thermal units, the industry standard, for April delivery – 38.7% down on the comparable month a year earlier.

Analyst are forecasting that prices may fall as low as $4 per million Btu in the next two years. Before the launch of the Platts index in 2009, prices reported ranged as high as $25 per million Btu.

Spot delivery prices are not directly related to retail gas prices, which vary between markets depending on a complex matrix of seasonality, levels of indigenous supply, national energy structures and government regulation.

However, analysts say the low spot prices will encourage buyers to force re-contracting onto producers, strengthening an existing shift away from long-term contract pricing, which used to underpin project financing. Existing long-term contracts often include clauses that allow buyers to renegotiate if gas prices change by certain percentages, or cross threshold price levels.

Asian LNG buyers have long complained that they have been forced to pay higher LNG prices than users in North America and Europe because of their dependence on long-term contracts. LNG producers have justified the practice by saying the long-term contracts ensure the financing of LNG projects in the region.

On March 9, China National Petroleum Corp. chairman Wang Yilin said the company was aiming to change the way its LNG supply contract with Qatargas was priced. This followed the successful recasting of a deal with Qatar’s RasGas by India’s Petronet LNG. The renegotiation cut prices in half over the 25-year contract, replacing the original prices with a more dynamic pricing system linked to an oil index that reflects changes in price levels.

In Sept. 2015, JERA Co. a joint venture between Tokyo Electric Power and Chubu Electric Power and which have more than 10 million metric tons of gas on long-term contracts until 2020, said it would in future buy gas at medium-term, short-term or spot prices. As in other bulk commodity markets, such as iron ore, the three-month spot price average has emerged as a popular short-term price option.

Analysts at Macquarie, an Australian bank, said that “in the current weaker LNG environment buyers are seemingly reluctant to sign long-term contracts.” Analysts at Citi, a U.S. bank, forecast that China and Japan would soon move to renegotiate contracts.

Such deals are affecting the economics of the entire sector, as Woodside made clear in a statement on March 22 announcing the postponement of the Browse joint venture, which includes Royal Dutch Shell, BP, PetroChina and Japan LNG Australia (a consortium that includes Mitsui & Co. and Mitsubishi Corp.). The Japanese companies each took a 40 billion Japanese yen ($3.65 million) impairment charge.

“Woodside remains committed to the earliest commercial development of the world-class Browse resource but the economic environment is not supportive of a major LNG investment at this time,” Woodside chief executive Peter Coleman said, adding that the company would use the additional time “to pursue further capital efficiencies for Browse.”

Second time around

This is the second time that Browse has stalled; a $45 billion onshore project was canned in 2013. It is one of five Australian LNG projects now on hold, analysts said, and the latest in a series of projects costing more than $400 billion that have been delayed since mid-2014, according to Wood Mackenzie, an energy consultancy.

Other Asian energy companies are also struggling with getting final agreement on huge projects. In Canada, the state-owned Malaysian energy group Petronas and its partners have been in talks with Ottawa for three years. The consortium is seeking a permit to build a $36 billion Pacific NorthWest LNG facility in northern British Columbia. It has already sunk $12 billion into the venture.

Petronas, which is under financial pressure from the dramatic slump in energy prices, announced in January that it would cut 50 billion Malaysian ringgit ($12.9 billion) in costs across the company. Three other major projects in Canada have been halted this year by other companies.

“Demand growth looks limited in the short term due to the slowdown of Asian economies and competition from renewables in OECD markets,” analysts at Macquarie said, referring to the Organization for Economic Cooperation and Development, the club of mainly advanced economies. These pressures had coincided with fresh supplies from a wave of new LNG production from Australian and U.S. projects, the bank said. Most were given the go-ahead when oil prices were at their peak.

Macquarie estimated that “excess supply will grow to a peak of about 70 million metric tons per annum in 2019 before returning to a balanced market in 2023,” based on forecasts of LNG supplies from current projects and those under construction and convervative estimates of demand.

Browse’s financial viability problems had been flagged by analysts for some months, and were confirmed by the energy group in February. The project was scrapped only a week after its rival, Chevron’s delayed and over-budget $54 billion Gorgon project off northwest Australia, began shipping gas. Gorgon’s original 2009 price tag was $37 billion.

Even the emergence of so-called floating LNG platforms, which were to have reduced Browse’s costs by about 35%, according to Woodside, has not proved sufficient. The company said in a statement that it would “explore further capital efficiencies” ahead of 2020, when it must make a final decision on the development of the field.

Floating LNG technology would allow the production, liquefaction and storage of LNG at sea before transfer to ships that would carry it directly to markets – but the concept remains unproven.

The LNG price collapse will benefit a range of nations in Asia – led by India, Indonesia and Thailand – as they move from coal to gas as their main fuel for electricity generation.

“We expect this medium-term oversupply will create opportunities for emerging economies to increase LNG use at a cheap price,” Citi said, adding that this would be particularly beneficial for India and Thailand. Analysts also noted that “cheaper for longer prices” have the potential to accelerate a shift away from coal generation in Europe.

But the main question in the medium term, according to Macquarie, is whether forecast growth in Asian demand for gas “upon which major projects were originally predicated” will be capable of absorbing supplies.

Source: Nikkei