LNG’s future: promise, peril

Jan. 2, 2006
Recent years have been good ones for the oil and gas industries. This year seems set to continue that trend.

Recent years have been good ones for the oil and gas industries. This year seems set to continue that trend.

The LNG industry in particular certainly has reason to view events since about 2000 with affection: Driven by increased worldwide demand for natural gas, LNG’s prices have risen to record levels and floated the fortunes of many project participants with them.

Despite problems in the last 2 years with supply deliverability, construction has pushed ahead for LNG carriers and LNG regasification terminals. In fact, carriers are practically in a glut, and many new terminals are regasifying at less than their capacities.

But these are good problems; right? These are problems of growth; these are problems of prosperity. And the LNG industry certainly should know what prosperity looks like, having known the stagnation of the 1980s.

A recent study by the New York-based shipping consultant Poten & Partners Inc., however, sees problems ahead for the industry that it doesn’t need, problems not unlike those plaguing upstream oil and gas companies.

The firm’s November 2005 issue of LNG in World Markets published a study of LNG construction costs that concluded “they have fallen victim to escalating raw material prices and the tight contractor market.”

Liquefaction hit

Poten’s study focuses on the supply end of the business, that part that has lagged transportation and regasification. And it begins by reminding us that before 2004, technology and better economies of scale “consistently pushed liquefaction plant construction costs down.”

In fact, plant construction costs dropped to near $200/tonne of capacity in some instances. LNG thus competed strongly against pipeline gas and alternative fuels.

The boom was on.

But some recent engineering, procurement, and construction contracts, the study says, are hovering near $350/tonne of capacity. And, despite the undoubted economies of scale of the newer mega-trains, other factors are “driving up their unit construction costs as well.”

The study cites contracts in the past 18 months awarded for RasGas III ($256/tonne) and Yemen LNG ($300/tonne). And it names the 7.6 million tonne/year Tangguh project as the “clearest example” of cost escalations: A delay of 18 months in the final investment decision resulted in a cost increase to $1.8 billion from $1.4 billion “after the original EPC bid expired.”

The well-documented troubles of Sakhalin II and Norway’s Snøhvit projects also come into the discussion, although their troubles, the study acknowledges, “are perhaps more project-specific.”

Not surprisingly to anyone who (in any language) can spell China, the culprit has been the sharp cost increases seen since 2003 for many raw materials used in LNG projects.

From January 2003 through December 2004, says the study, steel prices rose by more than 130%. Current prices are now double that earlier level. Nickel, important for cryogenic and stainless grades of steel, shot up to more than $17,000/ton midway through last year, from $7,000/ton in early 2003. Nevermind that they had fallen back near $12,000/ton by yearend 2005.

And what else? Red-hot general construction markets in the US and China drove cement costs “skyward.”

And what else? People. Or, rather people who have the skills and knowledge EPC contractors have been desperate for and who demand sharply higher wages and salaries.

The Poten study points out that, until 2003, the world’s major EPC contractors completed one or two LNG trains/year. But now, those companies and others are looking at as many as 10 LNG trains scheduling completion by 2009.

The future?

The Poten study points to a forecast in early 2005 by engineering consultants Merlin Associates. That forecast said that LNG inflation through 2010 would run between 7.5% and 10%/year.

If such a prediction proves true, LNG players could be looking at a hard choice: Eat the production-cost increases to preserve markets or pass them along and risk the kind of demand destruction many in the wider natural gas business have been fearing.

So, 2006 and beyond appear, depending on a forecaster’s disposition, years of a half-full or a half-empty glass, years of steady and profitable growth or of difficulties and danger.