Market downturn beclouds new LNG projects

Low oil prices and sluggish demand in Asia have cast a cloud over the economic viability of new grassroots liquefied natural gas export projects.

That's the focus of a new study by the Oxford Institute for Energy Studies (OIES).

The study looks at full project details, including fiscal regimes and associated natural gas liquids sales, and takes actual price formulas for the Qatar Liquefied Gas Co. (Qatargas) and Oman LNG projects to calculate net cash flows for LNG projects in Qatar, Oman, and Yemen.

It estimates, for example, that Qatargas returns reach rock bottom at oil prices of $14/bbl of Dubai marker crude, assuming that this level is maintained in real terms over the lifetime of the project.

Turkish LNG deal

When tendering seven LNG cargoes with a total volume of 420,000 metric tons earlier this year, the Turkish state importer Botas found that potential suppliers were competing keenly for the contract, and prices subsequently drop- ped, OIES noted.

In February, the contract was awarded to Qatargas, the first Qatari LNG project to start up, in January 1997.

The contract award favored Qatargas over Australia's Northwest Shelf LNG project and Abu Dhabi Gas Liquefaction Co. (Adgas).

The price at which Qatargas agreed to supply LNG to the Turkish Marmara Ereglisi terminal, however, raised some eyebrows. The award was given for a trimmed fixed-price offer of $2.48/ MMBTU on a delivered basis. The company achieved a highly competitive rate of 67¢/MMBTU for shipping with Osprey Maritime after the Egyptian Suez Canal Authority offered a special reduction for Middle Eastern LNG carriers, lowering the transit fees from about 35¢/MMBTU to 25¢/MMBTU.

This leaves sales revenues of about $1.80/MMBTU at the LNG plant in Qatar, OIES concludes. This fob price is 70¢ below the minimum price clause Qatargas put into a letter of intent with its main buyer, the Japanese utility Chubu Electric. The letter of intent was signed in May 1992 for annual deliveries of 4 million tons of LNG at a minimum price of $3.60/MMBTU on a delivered basis. Transport and other cif costs are about $1.10/MMBTU, which means Chubu Electric initially guaranteed a jetty price of $2.50/MMBTU to Qatargas.

Both the minimum price clause and the pricing formula that the parties signed in the letter of intent have never been put into a formal pricing agreement, which is still under negotiation.

Price disadvantage

The current price formula with Chubu Electric would translate into a LNG price of about $2/MMBTU, if the minimum price clause were dropped, and hence the supply contract signed with Turkey is 20¢/MMBTU below what could be regarded as a sustainable level.

The Qatargas project thus is at a disadvantage compared with the other two Middle Eastern LNG projects currently under construction: the second Qatari project, Ras Laffan LNG Co. (RasGas); and the Omani LNG project. Both achieved major cost reductions in constructing their liquefaction plants. In addition, both rival projects signed more favorable price formulas with Korean Gas Co. in exchange for dropping the minimum price clause.

OIES estimates that the level of oil prices would have to fall to $10/bbl before it really starts to hurt investors in RasGas and OmanLNG, which translates into LNG prices of $1.70/ MMBTU at the plant outlet under the more favorable Omani pricing formula.

The Turkish supply contract should be regarded strictly as a marginal contract trying to place excess capacity, OIES contends. In principle, LNG companies can always sell spare capacity at low prices on a spot basis, while long-term contracts for baseload volumes produce adequate returns for investors. Spot cargoes could be sold at prices equal to operating costs, estimated by the OIES study at 65¢/MMBTU.

Caveats

Two caveats apply, OIES says. First, the problem with Qatargas is that the long-term, baseload buyer has so far not signed a price formula. By selling cheaply to Turkey, OIES contends, Qatargas is sending dangerous signals that will not be missed by Chubu negotiators. Second, if the current low level of oil prices is maintained over a considerable time, it means that even favorable baseload contracts will not produce adequate revenues. Current average prices of around $11/bbl for Persian Gulf oil mean that RasGas and OmanLNG are dangerously low on the comfort scale, and Qatargas is already hurting if the minimum price clause is dropped in exchange for a signature under a pricing formula. Spot cargoes are not likely to help much in this scenario.

In addition, the market is likely to see considerable excess capacity in the medium term, especially when the Omani and Nigerian projects come on stream. Too much free volume floating around, and investors desperately looking for buyers, could mean a mounting reluctance by Asian customers to sign long-term contracts. The comfort of the baseload customer might then disappear altogether, OIES warns.

Project viability

Low revenues are less of a problem for existing LNG plants, where investment has already been sunk.

The OIES study shows that the danger of operating losses on a year-to-year basis is negligible in all of the projects, even when the Qatargas minimum price clause is dropped. Even with low production volumes during an initial start-up phase, LNG projects produce positive cash flows. These can become very large once external capital has been repaid, increasing to a plateau of about $600 million/year even at current oil prices, of which about two thirds go to the government in terms of royalties, production, and profit shares-often earning LNG projects a description as "cash cows."

Low oil price levels and sluggish demand in Asia do, however, cloud prospects for grassroots plants that are now on the drawing boards. Yemen's project especially might yet again see lengthy delays, unless China and India enter the fray with a vengeance and in a relatively short time frame and produce a strong demand surge, OIES says.

But even then, extensions of existing plants, such as the construction of a third train for the RasGas project, will always have cost advantages over grassroots projects. This bearish outlook applies equally to the LNG project planned by Amoco Corp. on the Egyptian coast and to rumored Norwegian plans, says OIES, even though both are not much affected by the Asian turmoil, as that applies mainly to the costly Indonesian Arun project. OIES concludes: The LNG family might for some time yet remain a little smaller than predicted prior to the recent Asian developments and the collapse in oil prices.