Posted by ERCE on Thu, 05/07/2020 - 12:13

Source: The Mariner 2392/Shutterstock

LNG: the fuel of choice

Despite supplying only 11% of the global demand for natural gas, liquefied natural gas (LNG) has become a vital resource for many developing nations and is now the fastest-growing gas supply source. This colorless, non-toxic and non-flammable liquid is formed when natural gas is cooled to -162 ºC, causing its volume to be compressed to about 600 times in the process, making it easier and safer to store and ship. LNG is transformed back into its gaseous state at regasification plants upon arrival at its destination, and is consequently delivered into homes, businesses and industries. It is burnt for heat and generating electricity, while its various industrial uses include feedstock for petrochemicals and fertilizers.

Weather has been proven to be a key driver of the fuel’s use around the world as the number of LNG cargoes can be easily adjusted to meet seasonal demand peaks for cooling or heating.

Source: Bloomberg N.V., DBS bank

LNG is also increasingly becoming a preferred fuel as more countries attempt to transition away from coal. It is currently the lowest emission fossil fuel available, emitting negligible amounts of sulfur dioxides and 40 – 60% less CO2 for the same amount of Btu (British thermal unit) output than oil and coal. With improved cost efficiencies tagged to technological advancements, more countries – in all stages of development – are now embracing LNG in efforts to meet carbon emissions targets. An unprecedented number of coal phase-out announcements was made in 2019, with most of these reductions coming into full effect in the 2030s.

Europe absorbed the majority of 2019 supply growth as competitively-priced LNG furthered coal-to-gas switching and replaced declining domestic gas production. Global carbon dioxide emissions have been reduced by the equivalent of 57% of annual South American emissions since 2010 from the replacement of coal with gas. LNG is also an attractive complementary fuel to countries diversifying their energy portfolios and ramping up their gas supplies. Italy and Portugal are examples of European nations with ample pipeline connections that include LNG in their import mix as back-up power generation in the event of insufficient import pipeline flows.

Asia’s insatiable appetite

Asian demand currently exceeds 70% of global LNG trade volumes, which reached a historical high of 359 MT in 2019, more than double of what it was in 2016.

Japan, South Korea and Taiwan have traditionally been regarded as the key drivers of Asia’s LNG growth since the fuel’s introduction in the 1960s. However, the mild winters experienced at the turn of 2019 and 2020, combined with the startup of nuclear capabilities in South Korea and Japan and slowing economic growth in Taiwan, have resulted in sluggish growth across the continent. Demand from these relatively mature markets is thus unlikely to grow. In contrast, the rising industrial gas demand of China and developing south Asian countries has shifted the dynamics. China alone accounted for 63% of global LNG demand growth in 2018 and has now overtaken Japan as the world’s largest LNG importer, while emerging Asia is projected to consume half of the global LNG consumption by 2023.

Asian LNG spotlight: Bangladesh on the rise

Bangladesh has been racing ahead of India and Pakistan in terms of growth in recent years, maintaining its status as one of the fastest growing economies by averaging 7.8% increase since 2016 (source: Asian Development Bank).

Bustling crowds in Dhaka, capital city of Bangladesh

Source: Dmitry Chulov/Shutterstock

More than half of Bangladesh today is powered by gas, thanks to large onshore discoveries in the 1960s and 70s which supported the development of Bangladesh’s energy market by providing a cheap source of fuel. Gas supplies around 60% of overall installed generation capacity of 15.9 GW, with the remainder using furnace oil (22%) and diesel (9%). However, financial constraints combined with the lack of interest from international oil companies resulted in few new major gas discoveries to replenish reserves in the past 40 years. Reports of gas shortages around the country have arisen, particularly around the southern region of Chittagong after the abandonment of the Sangu field. For a nation where 30% of the 165 million populace live without electricity, energy security is paramount.

Bangladeshi installed generation capacity by fuel type, June 2018. Source: DBS Asian Insights

With the risk of domestic gas production declining in the future, the Bangladeshi government has proposed a long-term power generation plan which aims to increase their generation capacity to 24GW by 2021 and 40GW by 2030 (source: DBS Asian Insights). With well-established gas infrastructure already in place, increasing LNG imports would be the logical way forward in meeting these goals.

Example of a FSRU in Bali, Indonesia.

Claudine Van Massenhove/Shutterstock

In 2018 the fledgling nation commissioned its first LNG import terminal, Moheshkhali FSRU (Floating Storage and Regasification Unit), under a contract with US-based Excelerate Energy. FSRUs have an advantage over land-based terminals in that they are cheaper and quicker to install. However, efforts toward building more LNG regasification terminals in Bangladesh have not been without challenges. Its first ever cargo of LNG was stranded off the coast and delayed for over three months, attributed to choppy seas, technical issues and construction delays. Several LNG terminal projects, including one FSRU proposal from India’s Reliance Power and FSU/fixed jetty proposal from Malaysia’s Petronas consortium, have been scrapped as the Bangladeshi government faced operational issues with the Moheshkhali FSRU. Nonetheless, a second LNG terminal, Summit LNG, came online in mid-2019, though it is not operating at full capacity as land-based pipelines from the coastal city of Chattogram to the capital Dhaka have yet to be completed.

Both FSRUs currently have a total regasification of 1 billion cubic feet per day (equivalent to 7.5 million tonnes of LNG a year). Another $2.5 billion deal was reportedly signed between Saudi Aramco and Bangladesh Power Development Board for an LNG-based power plant and terminal in Bangladesh in November 2019, consisting of power plants and a regasification terminal on-ground (source: Reuters).

Bangladesh is set to become a major LNG importer in Asia, with plans to purchase around 1 million tonnes of LNG in 2020 to capitalize on the current low prices. This figure could easily triple to at least 10 million tons by mid-2020s, according to Tawfiq-e-Elahi Chowdhury, energy adviser to Bangladesh’s prime minister. LNG may have been slow to take off due to infrastructure constraints and organizational delays, but the future is certainly looking hopeful for Bangladesh once these hurdles have been jumped.

How Global LNG is Priced

North American gas is usually priced at liquid trading hubs, of which the biggest and most significant is the Henry Hub in Louisiana. The United Kingdom uses the National Balancing Point (NBP), which is unique in that it is a virtual trading location. Both determine and publicly report price indices that some market participants view as global benchmarks for the value of natural gas.

Global natural gas trading hubs. Source: EIA

However, Asia does not have a unified pricing benchmark that reflects local market forces, having no suitable location with sufficiently developed physical infrastructure nor regulatory frameworks in place to accommodate the creation of a natural gas trading hub. While hubs in North America and Europe are pipeline-based (for example, Louisiana’s Henry Hub has access to natural gas infrastructure on the U.S. Gulf Coast), many countries in Asia rely on LNG as the primary source of natural gas. Asian LNG import terminals are at a distinct disadvantage in this regard due to the limited pipeline interconnectivity and the inevitable time lag between contracting and delivering large LNG cargoes.

Traditionally, long-term and fixed-destination LNG contract prices in Asia have been indexed to Brent prices, a rigid pricing structure which many Asian buyers are increasingly trying to move away from in search of more flexibility to accommodate consumer preferences. 

The diversification of Asian buyers has led to the increasing commoditization of LNG, creating more opportunities for spot trading (where trades are concluded for delivery in the next 90 days) and thus reducing the reliance on oil prices as a benchmark. 2019 saw the prices between oil-linked contracts and the JKM diverge widely for cargoes delivered into Asia. As oil prices remained relatively stable at above $60 a barrel through the year, the average long-term contract price was maintained between $9 - $11 / MMBtu while spot LNG prices plummeted (due to a variety of factors such as supply surge and stalling Asian demand, which will be discussed below), opening a $3.60 / MMBtu gap between them. With a wide gap between long-term contract and spot prices of a commodity, buyers and sellers may face hurdles in arriving at agreeable terms and conditions of sale.

There is still a case to be made for oil-linked contracts. Firstly, they provide the guarantee of demand needed to by developers to launch new LNG projects and are not as vulnerable to the volatile spikes as the spot market would be. Secondly, apart from providing stability, these contracts offer forward visibility on future pricing and supply security. Nonetheless, some 32% of the entire Asian LNG trade is currently conducted on a spot basis, implying that LNG prices are slowly but increasingly reflective of the supply and demand of the commodity itself.

The most commonly used reference for spot physical cargoes within Asia is the S&P Global Platts’ Japan Korea Marker (JKM), which reflects the spot market value of cargoes delivered ex-ship (DES) into its eponymous markets, as well as deliveries into ports in Taiwan or China with the same minimum cargo size of 135,000 cu m as these countries equate to the majority of global LNG demand.

To promote itself as the region’s premier LNG hub, in 2017 Singapore’s stock exchange began publishing its own spot price index, Sling, but this was met with unenthusiastic participation rates and has since been discontinued. Nonetheless, Singapore has been expanding its LNG infrastructure by increasing its storage capacity and adding capabilities to bulk-break cargoes to remain competitive.

Global LNG exporters: Australia leads the pack

As of January 2020, Australia has officially inched ahead of Qatar to become the world’s leading exporter of LNG, topping global export performance on an annual basis. With volumes boosted by the Prelude and Ichthys projects that came onstream, Australia exported an estimated 78 million tonnes of LNG in 2019, a 11.4% increase from the previous calendar year.

Countries supplying 90% of global LNG in 2018. Source: ERCE

Qatar has traditionally held that title for over a decade, producing some 75 million tonnes per year. Despite stable production rates, Qatar’s market share has fallen to 24.9% in recent years due to a fixed liquefaction capacity from 2011 and exponential growth from international competitors. For example, in 2013 Qatar’s contribution to China’s supply was 37%, whereas the figure declined to just 20.7% in 2017. The Prelude and Ichthys facilities have increased Australia’s export capacity from 2.6 bcf/day in 2011 to more than 11.4 bcf/d in 2019.

Australia LNG export capacity buildout by project, 2005-2019. Source: EIA

In efforts to remain competitive, the Qatari government left OPEC at the turn of 2019 to focus on natural gas production and has put in place aggressive strategies to increase its natural gas production capacity to 126 million tonnes by 2027.

The North American Shale Revolution

In an unprecedented event in global energy history, North America has rapidly transformed itself over the past decade from being a net importer of LNG (prior to 2016) to a significant global LNG producer, thanks to technological advancements in hydraulic fracturing (“fracking”) of the Permian Basin, Marcellus Shale and Eagleford Shale plays (amongst others). This phenomenon saw production surge despite the global commodity downturn from 2015 to 2016. The US exported 21 million tons of LNG in 2018, a 600% jump from 2016, and the production growth is expected to sustain and continually exceed demand for the foreseeable future. Five LNG export terminals are now in operation in the US, with the latest addition being the Freeport LNG company, located about 70 miles south of Houston.

Source: EIA

The USA’s natural gas ambitions do not end there, however. More LNG export terminals with an expected 32% increase are on track to come onstream in the next five years. The Golden Pass LNG in Port Arthur remains under construction while a third, the Louisiana-based Calcasieu Pass LNG export terminal, is said to have just reached a final investment decision. This facility is expected to have two trains running by 2022. 

The North American Shale Revolution: Global Impact on Fuel Pricing

In terms of global impact, the boost in US exports provided opportunity for diversification of supply sources and caused a shift in market structures by diversifying pricing formulas (towards more flexibility, as discussed above).

Global gas prices (Jan 2013+).

Source: ERCE Energy Review (2019)

More significantly, perhaps, is the easing of global energy supply-demand balance and lowering of oil and LNG prices. From 2011 to early 2014, when crude oil prices hovered above $100 per barrel on average and LNG prices were largely linked to that of crude oil, LNG prices soared to $16 - $18/MMBtu in Japan, as compared to the Henry Hub gas pricing of $2 - $3/MMBtu. When the Fukushima Daichii disaster hit and nuclear power plants across the country were subsequently shut down, Japan was forced to purchase enormous quantities of LNG and oil to make up for the loss of power generation, and corporations and national livelihoods were hit by energy price surges.

The influx of US shale oil has eased the supply-demand balance in the international market. The Organization of the Petroleum Exporting Countries (OPEC) responded by prioritising their market shares, which caused crude oil prices to fall. In turn, this resulted in similar price falls in Japan and the rest of Asia.

US-China Trade War

Ongoing U.S. and China trade disputes have seen the two superpowers exchange retaliatory tariff impositions throughout 2019. Subsequent weaker economic growth in China has moderated its coal-to-gas switch policies, causing a slowdown in the LNG demand. Asian spot LNG prices fell sharply to levels of around US$4.5/MMBtu in July 2019, more than half of its high of over US$9/MMBtu in 2018. Such prevailing low prices may contribute to stimulating demand in emerging markets with lower income levels, but questions are being asked about their long-term sustainability.

China’s move to increase the current 10% tariff on LNG imports from the US to 25% will cause US LNG to trade at a higher price, reducing demand for US LNG in China and putting a dampener on LNG contracting activity between the two superpowers.

It is reported that China has the tenth largest natural gas reserves in the world (~5,440Bcm as of early 2018 based on EIA data) and the world’s largest for shale gas reserves (~1,000bcm as of early 2018 based on the China Mineral Resource Report 2018). However, geological challenges such as mountainous terrains and virtually non-existent pipeline infrastructure and regulatory support have made extraction difficult and costly. Several oil majors have abandoned projects since drilling began in 2010. For example, BP has reportedly exited two shale gas production sharing contracts with the state-owned CNPC in Sichuan province due to discouraging drilling results (source: Reuters). Chinese gas production is likely to lag, and the country will continue to depend on gas imports to meet demand in the near future.

Russian LNG supply

Russia is another rising star in the LNG export world, holding roughly 8% of the current market share and with plans to boost production capacity. A $9 billion megaproject between Exxon Mobil, a Japanese consortium (including its Ministry of Economy, Trade and Industry as well as Itochu, Japan Petroleum Exploration and Marubeni as shareholders) and the Russian state oil company Rosneft and Sakhalin Oil and Gas Development is underway, with planned production to begin in 2027 (source: Nikkei Asian Review). This would be the third Russian LNG development project with Japanese investment, following Sakhalin 2 and Arctic LNG-2 (planned launch in 2023), and one of the largest in the history of Japanese-Russian relations. The launch of Arctic LNG-2 will boost Russia’s efforts in reaching its goal of producing 120 to 130 million tonnes of LNG annually in the coming years, and raise its share in the global LNG market to up to 20%. 

LNG of the future: a long-term relationship

LNG has enabled countries previously hindered by limited reserves or insufficient gas production to gain access to natural gas, especially when faced with inadequate physical infrastructure. Australia, the United States and Qatar are likely to remain the top three LNG suppliers, and the lion’s share of their exports will still be going to Asian countries.

Source: GrAl/Shutterstock

All eyes will be on China, which will likely be the key driver of global demand. However, with its current oil import dependence at almost 70% and gas import dependence at 40%, the Chinese government will likely begin exploring other methods to improve energy security. Should technological advancements allow the Chinese government to tap into its own gas reserves to increase domestic production, such endeavors will undoubtedly be given a higher priority, and shift much of the demand to emerging markets in Asia.

Overall the future of LNG will depend on economic growth rates, the intensity of environmental regulations (for example, Europe has already put in place gas decarbonization strategies), price affordability and competition from other energy sources such as other fossil fuels, nuclear, or renewable energy. Its pricing is expected to remain largely oil-indexed, but increasingly influenced by gas market factors.

ERCE has worked extensively across the Asia Pacific region on upstream, midstream and downstream gas projects. We have performed and support LNG project M&A due diligence, commercial studies, market analysis, economic modelling, screening studies, gas Reserve certifications and legal expert work. Our clients have included National Oil Companies, Majors, large independents, financial institutions, legal companies and service companies.

To find out more about how ERCE can support and guide you on the LNG business please contact