Weak Oil Prices Threat To LNG

Weak oil prices have worried the oil industry this year. But they are also of concern to natural gas producers who are turning their output into LNG.

As noted in the lead article about the upstream and downstream boom in Qatar, Ahmed Zaki Yamani, former oil minister of Saudi Arabia and now chairman of the Centre for Global Energy Studies (CGES), London, analyzed the relationship using Qatari LNG as an example at the Second Doha Conference on Natural Gas in Qatar in March 1997. His analysis is perhaps more pertinent now than then.

He said he considered the main problem that long-haul LNG from the Middle East is likely to face is weak oil prices.

Most LNG contracts, he explained, relate the LNG price received by the supplier at the point of delivery to a relevant oil price. Gas and oil are thus closely connected so that when the price of landed oil decreases so does the price of delivered LNG.

Large, fixed, transportation and liquefaction costs account for around 85% of the supply cost of delivered LNG in the case of Qatari LNG supplied to Japan. Large decreases in the price paid for delivered LNG would therefore greatly squeeze the netback to the producer in Qatar. In extreme cases, he said, the netback to the producer could dwindle to very low levels, threatening the viability of the whole project.

In order to guard against just such a possibility, the suppliers and their bankers have in the past managed to secure minimum or "floor" prices for delivered LNG.

He said, "I have said 'the past,' because it seems that the Korean Gas Corp. has managed to dispense with the floor price in its contract with Shell and its partners for Omani LNG (in return for an undertaking to purchase much more gas)."

Yamani also said, "And I hear that the same concession is being sought retroactively by the purchasers of Qatari gas. This is a significant development, for it opens these projects to a degree of risk from the oil price."

Numerical analysis

Yamani said press reports were the only information available on the QatarGas project but they were enough to permit some broad-brush estimates of the fully builtup costs after making certain general assumptions, such as a 20-year loan repayment period and a 10% rate of interest.

The overall upstream cost of producing the gas in Qatar, he said, is estimated by the CGES to be around $2.3 per barrel of oil equivalent (boe), of which $1.3 is the capital cost per barrel related to the $903 million expenditure on production facilities. The fully builtup cost of liquefaction of this gas is estimated at $7.6/boe, of which $5.2/boe is the capital charge per unit of output. Finally, the total unit cost of transporting the LNG is estimated at $5.8/boe, with operating costs accounting for $1.6/boe.

The aggregate supply cost of Qatari LNG landed in Japan is thus put at $15.7/boe (or $2.7/million BTU). The upstream cost is 15% of the total, the liquefaction cost is 48%, and the shipping cost 37% of the total.

The price received for Qatari LNG delivered in Japan at the moment, he said, "is determined by a provisional agreement, which expires, I am told, at the end of this month. At any rate, it is said to be $4.1/million BTU, equivalent to $24/boe, which is $8/bbl more than the estimated supply cost including capital charges."

"This yields," he said, "a 53% gross margin over the supply cost, denoting handsome profits indeed for the partners in the project. In fact, the position is even better than it looks, because of the condensates produced along with the gas in Qatar."

"I estimate," said Yamani, "the net value of the condensates at about $5/boe today, yielding a net margin for landed LNG after all costs of around $13/boe, of which 65% goes to the Qatari state via its shareholding in QatarGas.

He said the situation described represents the best of all worlds.

Consider that $24/boe for Qatari gas landed in Japan is already out of date, for it was set at a time of higher oil prices. I am sure that the Japanese clients of QatarGas are already negotiating for a more realistic price; today such a price is below $20/boe, giving a margin over the supply cost of less than 25%.

"However," he said, "who is to say that the price of oil will not descend-for argument's sake-to $16/bbl, fob in the gulf, even dropping below that for brief periods?

"This does not mean that Qatari LNG will be unprofitable. What it does imply, though, is that this huge project will not be the big money-spinner many believe it is if the price of oil drops to such low levels and stays there. As I see it, the project would have been a different proposition without the financial cushion of the condensates. The condensates enable all costs, including capital charges, to be covered even if the price of oil drops to $11.5/bbl fob in the gulf. This seems to be the true bottom line for Qatari LNG at the moment."