LNG oversupply faces slowing Asian demand

This new capacity has led some to predict a prolonged LNG oversupply. Buyer-friendly terms are arising in LNG sale and purchase contracts as a result, including greater volume and destination-flexibility and more seasonality in deliveries.²

India's Petronet also shook up the market by opting to buy spot LNG cargoes instead of honoring its contract to purchase LNG from Qatar's RasGas, taking less than its required cargoes under the RasGas contract.³ RasGas and Petronet have since negotiated a new contract price at a 50% discount, with RasGas reportedly waiving recovery of $1 billion otherwise due from Petronet as part of the agreement.⁴ Following Petronet's success, China National Petroleum Corp. (CNPC) announced it also intends to renegotiate its LNG price with Qatar.⁵

Other buyers have publicly stated their intention to use flexibility in existing contracts to resell cargoes in the spot market or simply procure more supplies in the spot market than under long-term contracts. If other buyers follow suit, this development could affect financing for new LNG export projects, as lenders place more scrutiny on the risk of buyers not honoring the terms of long-term, take-or-pay contracts. Even where buyers simply use their contractual flexibility to divert cargoes into the spot market, such actions could mean more competition for producer-sellers looking to place excess cargoes.

Large FLNG

When Shell launched the Prelude LNG project off Australia, it was heralded as the beginning of a new era for floating liquefaction technology. Such exuberance has been dampened by more recent events, from Browse LNG's (in which Shell has a 27% participating share) cancellation to shipping company Hoegh LNG's exit from the floating liquefaction business. The Indonesian government also recently rejected Inpex's floating liquefaction proposal for the Masela Abadi project on its belief that an onshore solution offers more economic benefit to the country.⁶

When Shell made its FID on Prelude LNG, however, oil was trading near $120/bbl⁷ and it was the sole owner and developer of the project and made its decision on the basis of equity financing. The more recent announcements similarly reflect the economic circumstances in which they occurred, with current oil prices also cited in Petronas's delay of its second floating liquefaction project.⁸

While large floating liquefaction projects have been touted as cheaper, faster to construct, and more effective for certain locations, whether a large floating liquefaction project is successful ultimately depends on the same factors as a land-based project. Overcoming these factors, including permitting, attracting buyers, and procuring financing, is more challenging for all LNG export projects in the current climate of high oil prices and plentiful LNG supplies.

Business impacts

Even though most US LNG export projects aren't yet running, early movers into the industry have sold or want to sell-down committed liquefaction service capacities or LNG volumes. Lowered domestic demand prompted GAIL (India) Ltd. to offload some of its Cove Point capacity and Sabine Pass volumes.⁹ Pertamina also sold Total 0.4 million tpy of its contracted volumes from Corpus Christi LNG starting in 2020 in exchange for Total supplying it 0.4-1 million tpy from its global portfolio.

LNG oversupply has likewise led to a drop in LNG shipping prices. At the end of 2015 charter rates were $32,000/day, 50% lower than the previous year.¹⁰

Available capacity in the secondary market could, however, lead to a lower cost of entry into an industry traditionally dominated by a handful of players. Some shippers of other commodities are already pushing into the LNG industry, helping fuel the rapid expansion of the LNG spot market. Non-traditional LNG players such as Glencore, Vitol, and Trafigura all recently began or expanded LNG trade,¹¹ with Trafigura doubling its LNG trading volumes in just 1 year.¹² Market veteran Total is aiming to double its LNG trading volumes by 2020.¹³

Along with the portfolio players, traditional LNG buyers are seeking opportunities to participate in spot LNG trade. These developments could lead to exponential growth in the LNG spot market.

Mergers, acquisitions

The recent merger between Shell and BG combined 33 million tpy of LNG production in one company.¹⁴ Woodside's bid to take over Oil Search (whose assets include a stake in Papua New Guinea LNG) was rejected and ended in December when Woodside withdrew its proposal.¹⁵ Other LNG companies (such as Santos and Excelerate) targeted for takeover have generally rebuked such efforts. Market observers viewed Woodside's refusal to increase its offer price for Oil Search as an indication that oil prices have not yet bottomed.

Companies have also shown more interest in strategic divestments of certain assets, especially minority stakes in LNG projects, to raise capital and reduce debt. Activist shareholders drove Apache to sell its stakes in the Wheatstone and Kitimat LNG projects.¹⁶ And while Santos rejected a takeover offer, it did sell an 11.7% stake in the company to Chinese LNG newcomer ENN Energy Holdings Ltd. As part of merging with BG, Shell sold off its stake in Kinder Morgan's Elba Island project while retaining its right to LNG capacity there. Shell is now considering a divestiture of its North Sea oil assets.¹⁷

Other companies, however, see the potential to increase their LNG-related stakes in the midst of the current downturn. TransCanada recently announced its $13 billion acquisition of Columbia Pipeline Group, which will help position it "to transport North America's abundant natural gas supply to liquefied natural gas terminals for export to international markets."¹⁸ To fund the acquisition it will sell its merchant power assets in the Northeast US.¹⁹ ExxonMobil is rumored to be pursuing a stake in Eni's Mozambique project.²⁰

LNG buyers, meanwhile, have increased collaboration. The major example completed in 2015 is the fuel-procurement venture Jera, between Tokyo Electric Power Co. and Chubu Electric Power Co. Inc., which created the largest LNG buyer in the world, with about 40 million tpy of annual demand.²¹ Jera has entered into LNG collaboration MOUs with Singapore's Pavilion Gas, the Electricity Generating Authority of Thailand, GAIL, South Korea's Kogas, and China National Offshore Oil Corp. and CNPC. Tokyo Gas has entered into similar MOUs with Taiwan's CPC Corp. and fellow Japanese utility Tohoku Electric. These collaborations are, in part, aimed at further increasing buyers' leverage in LNG negotiations.

Major buyers additionally are seeking the right to divert or resell cargoes without obtaining the seller's approval. Pricing index variations emerged in 2015 seeking shorter contract terms and supply flexibility based on seasonality. Cheniere Marketing has taken the lead in exploring new pricing indices, inking sales contracts based on European gas indices. Tokyo Gas called for pricing index diversification in its efforts to procure another 2-3 million tpy for 2020.²²

Tokyo Gas has also noted its preference for 5-10 year terms.²² Jera similarly said that it will be relying more on short and mid-term contracts to fulfill its LNG demand, notwithstanding that such terms may not be adequate for LNG export projects' financing requirements.

The degree of seasonality extracted by PetroChina from Qatar may end up being a major concession. Seasonality is desirable for LNG buyers who have historically looked to spot cargoes in managing seasonal demand fluctuations. But seasonal deliveries are hard to manage for LNG export projects that have to sell and perhaps transport full production throughout the year. While Qatar's arrangement with PetroChina is limited to 2016, Qatar has left open the possibility of extending the arrangement.

LNG shippers, meanwhile, are joining forces to improve cost efficiencies. Golar LNG, Dynagas, and GasLog Ltd. announced an agreement whereby they will contribute certain LNG ships to a pool available to the spot market. Sinotrans has also announced five joint ventures with Dynagas and China LNG Shipping to provide LNG ships for the Yamal LNG project.²³ Industry analysts are predicting more joint ventures and mergers in 2016 as the LNG shipping industry deals with a low charter-rate environment.

New demand

Traditional Asian LNG buyers have cut their forecast demand. Assuming the successful restart of numerous nuclear reactors, Japan predicts its LNG demand will decline to a 5-year low of 79.6 million tpy starting in 2016.²⁴ Korea, the second largest LNG importing country in the world after Japan, also expects its LNG demand to fall.²⁵

China and India dominate the list of import terminals under construction and the Middle East the list of floating import terminals placed into service this year. New LNG importers Egypt, Pakistan, and Jordan bought a total of 5.5 million tonnes of LNG in 2015.²⁶ According to the International Energy Agency (IEA), China and the Middle East will be the big centers of overall gas demand by 2035.²⁷

Some additional demand should be created by the six additional floating storage and regasification units (FSRU) delivered or contracted in 2015 (Table 2).LNG import projects under development suggest that the next wave of LNG buyers will be smaller and new. The main problem such buyers pose for exporters is access to sufficient credit.

Production shutdowns

Producers shut down almost 25 million tpy of LNG production in 2015 at four export terminals. Egypt's gas shortage continues to hinder operations at both the Idku (7.2 million tpy) and Damietta (5.5 million tpy) export terminals. BG has declared force majeure at the Idku terminal and the owners of the Damietta LNG plant (Union Fenosa and Eni) are pursing arbitration against the Egyptian Government to restart gas supplies and LNG production. While there have been two recent major gas discoveries offshore Egypt and BG has agreed to buy Noble's stake in the Aphrodite field off Cyprus, intending in part to supply the Idku terminal,²⁸ these measures are unlikely to permit Egypt to restart LNG exports in the near term. Egypt is now an emerging LNG buyer, procuring two floating regasification units to import LNG and seeking a third for delivery within 2 years.²⁹

Angola LNG (5.2 million tpy), which was shut down in 2014 for a major rebuild, has yet to restart. Chevron had hoped for a restart by end-2015 but is now targeting July of this year.30 Upon restart, the industry will keep a close eye on its reliability.

Yemen LNG (6.7 million tpy) has been shut since April 2015 due to civil unrest by Houthi rebels.31 There are no signs production will resume soon.

Other export plants have also suffered unforeseen curtailments. In late December force majeure was declared at Nigeria LNG due to "acts of sabotage" on a pipeline to the terminal.³² The force majeure may affect deliveries to long-term buyers in Italy, Spain, Turkey, Portugal, and France.³²

Project costs

One potential bright spot from the downturn in oil prices might be decreased construction and development costs. While this did not occur in 2015, the completion of three projects this year and increased contractor competition resulting from the scarcity of new export project FIDs, may yet help reduce overall project costs.

Labor costs, however, are region-specific and will vary. North America labor costs remain below historical average³³ and Woodfibre LNG is one project that believes it can take advantage of lowered labor costs to cut construction costs.³⁴

LNG export projects may also look to new project designs or technology to lower costs. Magnolia LNG credits its proprietary optimized single-mixed refrigerant (OSMR) technology for its $500/tonne of capacity construction cost vs. an average of $800-900/tonne for other US projects.³⁵ The costs at Lake Charles LNG are an estimated $512/tonne, which could yield a liquefaction toll cost of less than $2.00/MMbtu and a delivered price of $6.50/MMbtu into Asia.³⁶ Fortuna LNG in Equatorial Guinea has reportedly cut capital costs from $800/tonne to $600/tonne and secured an HOA with a customer willing to prepay for LNG in its initial stages of production.³⁷

The lowered cost and shortened development time for floating LNG regasification units (FLRUs) have facilitated smaller LNG users' entrance to the industry. In the western hemisphere, FLRUs are planned for Hawaii, Puerto Rico, and Jamaica. Cheniere appears to be preparing for the increase in demand for small-scale LNG, requesting government approval to permit its Sabine Pass terminal to load LNG into LNG-fueled vessels and handle containerized LNG.³⁸ AES Dominicana is seeking to capitalize on its existing onshore LNG terminal in the Dominican Republic to provide LNG transshipment and bunkering services for the Caribbean and Latin American markets.³⁹

Small-scale LNG's potential has also been recognized by Singapore's Pavilion Energy. Pavilion points to the fact that 65% of all contracts signed in the past 5 years are for less than 1 million tpy as a sign of the potential growth in small-volume business.⁴⁰ The company views the many small islands of Southeast Asia as a great fit for small-scale LNG solutions and is in talks with several parties regarding collaboration in this area. Gazprom and Fluxys have announced collaboration on developing a small-scale market in Europe.⁴¹

The growing use of FSRUs in LNG-to-power projects may provide a new source of LNG demand for liquefaction projects, potentially opening up new countries for LNG imports. AES Panama LNG, for example has been awarded the tender to build Panama's first gas-fired power plant and associated LNG import terminal.⁴² LNG-to-power projects are also under development in Africa (including three in Ghana alone), Latin America, and Asia.

An LNG import capacity of 2-5 million tpy and higher exposes some of these projects to the same need for long-term offtake contracts or financing as LNG export projects. Activities in the Philippines (which is expected to import LNG given the depletion of its only major gas field) illustrate the problems facing these projects. While a few different parties are evaluating LNG-to-power projects there, progress has been delayed while long-term buyers, or partners to provide financing, are sought.⁴³

References

1. The Canadian Press, "Pacific Northwest LNG Decision on Hold 'To Get it Right,' Minister Says," Times Colonist, Mar. 21, 2016.

2. Vukmanovic, O., "Qatar and PetroChina Alter LNG Supply Deal, Winter Spot Price Fallout," Reuters, Aug. 26, 2015.

3. "Qatar to Waive $1 Billion Penalty on India for Lower Gas Offtake," The Financial Express, Nov. 23, 2015.

4. Bhardwaj, M., "India's Energy Muscle Helps Petronet get Better Qatar Gas Deal," Reuters, Dec. 31, 2015.

5. Paton, J. and Shiryaevskaya, A., "China Joins India Seeking Better LNG Contracts for Buyers," The Washington Post, Mar. 11, 2016.

6. Da Costa, A.B. and Jensen, F., "Indonesia rejects Inpex's Mega Floating LNG Projects, Wants to Stay Onshore," Rigzone, Mar. 23, 2016.

7. Treadgold, T., "One Floating LNG Dream Sinks as Another Get Ready to Float," Forbes, Mar. 23, 2016.

8. Sustaita, M., "Petronas Delays PFLNG 2 Amid Slump," Offshore Engineer, Feb. 29, 2016.

9. Vaijayanthi, M.C., India's Gail Sells Another 1 Million Mt/Year From US LNG Contracts," Platts, July 16, 2015.

10. Wallis, K., "LNG Shipper Brace for Wave of Consolidation as Freight Rates Sink," Reuters, Dec. 20, 2015.

11 Gronholt-Pedersen, J., "Glencore Vies with Trafigura, Vitol in Thawing LNG Market," Reuters, Sept. 17, 2015.

12. Shiryaevskaya, A., "Trafigura LNG Trading More Than Doubles on New Buyer Demand," Bloomberg Business, Dec. 14, 2015.

13. Abreu, A., "Total Outlines LNG Ambitions," Platts International Gas Report, Nov. 2, 2015.

14. Shell, "Recommended Cash and Share Offer for BG Group PLC by Royal Dutch Shell PLC," Feb. 15, 2016.

15. Stewart, R.M., "Australia's Woodside Abandons $8.4 Billion Bid to Take Over Oil Search," The Wall Street Journal, Dec. 7, 2015.

16. Macdonald-Smith, A., "Woodside Petroleum Closes $US2.8 b Purchase of Apache Australia Assets," The Sydney Morning Herald, Apr. 3, 2015.

17. Clark, P., "Shell Weighs North Sea Assets For Potential Sale," Financial Times, Mar. 27, 2016.

18. TransCanada, "TransCanada to Acquire Columbia Pipeline Group for US$13 Billion," Mar. 17, 2016.

19. Penty, R., "TransCanada Bought a Plant Only to Sell It Six Weeks Later," Bloomberg Business, Mar. 17, 2016.

20. Reuters, "ExxonMobil In Talks to Buy Into Eni's Giant Mozambique Gas Field," Fortune, Mar. 26, 2016.

21. Tsukimori, O. and Obayashi, Y., "Japan's Jera Says Will Significantly Cut Long-Term LNG Contracts," Reuters, Oct. 21, 2015.

22. Abreu, A. and Amaha, E., "Tokyo Gas Seeks More LNG," Platts International Gas Report, Nov. 2, 2015.

23. Liang, L.H., "Sinotrans Seals Joint Venture Deals for Five Arctic LNG Carriers," Seatrade Maritime News," Dec. 22, 2015.

24. Tsukimori, O. and Sheldrick, A., "As Japan's Oil, Gas, Power Use Stalls, Coal Imports Hit New Record," Reuters, Jan. 25, 2016.

25. Lee, C., "S Korean Kogas Records Sharpest-Ever Decline in LNG Sales in Dec to 3.49 mil mt," Platts, Jan. 19, 2016.

26. International Group of Liquefied Natural Gas Importers, "The LNG Industry in 2015," http://www.giignl.org/publications.

27. Bloomberg, "China, Middle East to be New Gas-Guzzlers by 2035," The Economic Times, Nov. 12, 2015.

28. Kambas, M., "Britain's BG Group Pays $165 mln for Stake in Cyprus Gas Field," Reuters, Nov. 23, 2015.

29. "Egypt to Charter Third FSRU Late Next Year," LNG World News, Oct. 26, 2015.

30. Agencia Angola Press, "Angola LNG Resumes Gas Production in July," Mar. 16, 2016.

31. Clark, A. and Hong, C.H., "Yemen's LNG Plant Halts Supply as Fighting Worsens Security," Bloomberg, Apr. 13, 2015.

32. George, L., "Eni Declared Force Majeure on Nigeria's LNG Export Plant Loadings," Reuters, Dec. 21, 2015.

33. IHS, "Commodity Prices May Have Reached Bottom, But the Rebound Will be Very Slow," Mar. 23, 2016.

34. Hoekstra, G. "Woodfibre LNG Seeks to Cut Construction Costs to Offset Gas-Price Drop in China," Vancouver Sun, Dec. 13, 2015.

35. Magill, J., "Magnolia LNG Signs Contract to Build Lake Charles, La., Project," Platts, Nov. 17, 2015.

36. Good, A., "Barclays: Lake Charles Positioned as Lowest-Cost US LNG Export Project," SNL Financial, Nov. 19, 2015.

37. Maslin, E., "Ophir Inks Fortuna LNG Deal, Reduces Cost," Offshore Engineer, Dec. 9, 2015.

38. Fisher, J., "Sabine Pass Seeks to Add Containerized LNG Capabilities," Natural Gas Intelligence, Dec. 3, 2015.

39. Michel, M., "Dominican LNG Firm Gets Syndicated Facility," Global Trade Review, Dec. 23, 2015.

40. Woo, J., "Home-Grown LNG Player Eyeing Small Regional Projects," The Straits Times, Sept. 10, 2015.

41. Devitt, P. and Winning, A., "Russian's Gazprom to Cooperate with Fluxys on Europe's Small-Scale LNG Market," Reuters, Mar. 29, 2016.

42. AES, "AES Awarded Panama's First Natural Gas-Fired Generation Plant," Sept. 11, 2015.

43. Cheang, C.Y., "Shell, Total Mull LNG Terminal Projects in the Philippines," Rigzone, Mar. 25, 2016.

The authors
Monica Hwang ([email protected]) is counsel in King & Spalding's Houston global transactions practice group. She has advised LNG projects globally, including (on the liquefaction and export side) in Australia, Canada, the US, Mozambique, and Colombia and (on the import and regasification side) in Canada, the US, the Caribbean, and South America. Hwang holds a JD from the University of Houston Law Center and a BBA in finance from the University of Texas at Austin.
Philip R. Weems ([email protected]), based in Houston, is a partner at King & Spalding and is co-head of the firm's global energy practice. He has more than 25 years of intensive experience in the LNG industry, including as lead in-house attorney for the Tangguh LNG Project and associate general counsel of Virginia Indonesia Co. (a major supplier of gas to the Bontang LNG Plant). He served as President of the Association of International Petroleum Negotiators (AIPN), 2003-04. Weems has a JD from Texas Tech University School of Law (1982), a Master of Laws from the University of Sydney, Australia (1984), and a Certificate of Advanced Study (1989) from Thunderbird, The American Graduate School of International Management, Glendale, Ariz.