LNG firms struggle with investments in volatile market

Uchenna Izundu
International Editor

BARCELONA, Dec. 18 -- Gas companies are uncertain whether to make LNG investments as gas demand falls due to high prices and the economic downturn, speakers said at the CWC LNG summit in Barcelona.

The financial crisis will affect the pace of future projects, cautioned Elizabeth Spomer, BG North America's senior vice-president of regional business.

Despite shaky demand, Spomer expects to see 50% growth in global LNG production capacity over the next 3 years resulting in choice for buyers, but she also warned of a supply crunch in 2012-15 as developers scale down plans for new production facilities. "We are about to see a supply surge…It is really unprecedented," she said.

Spomer estimated that 14 million tonnes of LNG would be delivered from the Atlantic basin to Asia in 2008—double what was sent in 2007.

But Asian demand is falling and operators are unsure of which projects to pursue, as it is unclear what global LNG demand will be. "Markets don't know how much gas they need," Spomer said. "With that kind of uncertainty it's very difficult to do business."

Return to fundamentals
However, Octavio Simoes, vice-president of commercial development at Sempra LNG, was more upbeat about the outlook for LNG. "We don't think there will be significant demand destruction" or that over the next couple of years prices will be greatly affected. "Natural gas is being driven because of environmental reasons," Simoes said.

Simon Bonini, director of LNG at Centrica Energy, said that as the UK becomes a major LNG importer, producers will have to take a long-term view on gas prices. By 2010, the UK will import 50% of its gas needs, and this will rise to 75% by 2015 as the decline of gas production on the UK continental shelf is steeper than anticipated.

"The effects of the new changes in the [global] LNG market have not yet been understood, and we have seen very extreme changes," he said. "We need to make sure that we diversify and have a quality portfolio."

With the steep increase in oil prices, LNG sellers increasingly have diverted cargoes upon arbitrage to higher priced markets, particularly the Asia-Pacific basin, leaving other buyers scrabbling for supplies. LNG buyers said good relationships with suppliers are essential, and they called for suppliers to charge reasonable prices in establishing contracts.

For emerging economies, the key issue will be: when will they realize their potential? "It's important to have long-term contracts between sellers and buyers even with the growth of spot LNG," said Kentaro Morikawa, senior vice-president of LNG Europe at Tokyo Gas Co. Ltd. "LNG can be sold at a reasonable price so that sustainable growth can happen."

His comments were echoed by Jose Simon, gas supply vice-president at Iberdrola, who stressed that the nature of the LNG business is long-term, and cooperation between producers and consumers is critical. Where to secure supplies has been a growing quandary, and a trend has emerged: Downstream companies have moved further up in the chain, and producers have moved downstream to offtake their gas.

Changing business models
The changing market means players have become more flexible in their commercial agreements, and they have changed their business models. Speakers agreed new technologies and operational concepts must be developed to address the new dynamics.

Steven Sparling, partner at US law firm Sutherland, called for operators to determine early in their LNG project whether their ships can access the planned terminals when desired. He stressed the importance of vetting information as many companies had failed to do so, assuming that someone else in the process had.

"You need to assess the state of play, commercial perspectives, operational flexibility, legal rights, and obligations—both regulatory and contractual. People need to find out who's at the terminal, what is their arrangement, and how will that affect yours."

LNG contractors have been hit by soaring costs of commodities, labor, and materials as demand has increased over 4 years. Gerald Humphrey, vice-president of business development for global LNG, Chicago Bridge & Iron Co. NV, said structural steel had gone up by 300-350% over the last 4 years, while copper had risen 350%. Currency fluctuations of 15% variance have added to project development costs. "Project complexity has also increased costs; we were doing trains of 3-4 million tonnes/year in size, but now, for example, in Qatar they are 8 million tonnes/year. Big projects put a strain on the chain." Contractors' net profits have been 1-5% on projects.

Operators are hopeful project costs will fall as have commodity prices. The question is: How long will prices drop, and at what level will they stabilize? These factors are influencing investment decisions, delegates told OGJ.

Humphrey estimated commodity prices would be stable until second-quarter 2009. With varying factors, his company is promoting to clients a "hybrid model"—not quite a lump sum contract or a reimbursable one—to help spread the risk. He told OGJ that a third of the firm's contracts with clients fall under this new model.

"The IOCs are accepting it very quickly, and some national oil companies are being hesitant …People now ask for bid validity, which was unheard of before."

Contact Uchenna Izundu at uchennai@pennwell.com.

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