Market awaits impact of NA LNG exports

Bill White

Researcher/writer for the Office of the Federal Coordinator

Asia’s natural gas buyers have taken small steps forward in their bid to unhinge supplies from today’s high oil prices.

They have signed a handful of definitive or preliminary agreements to buy liquefied natural gas at prices tied to the U.S. Henry Hub pipeline-gas benchmark. The oil-linked LNG prices they have been paying to suppliers elsewhere have hovered at up to five times above that U.S. benchmark price, though liquefaction and tanker costs would consume much of that spread.

Beyond this, at least one supply contract with BP that a Japanese electric company signed last year uses a British price benchmark in its pricing formula. And the trade press reports that some traditional LNG sellers have lowered the oil-linked-price formula to ease the financial strain buyers are enduring.

Price relief isn’t the only goal of Asian gas buyers. They also want flexibility to reroute LNG cargos to other markets rather than being locked in to taking a shipment whether or not they need it, as their purchase contracts commonly require.

All this is coming about as three events have converged on the marketplace: Asian LNG demand is soaring, Asian LNG prices are at orbital levels, and U.S. pipeline gas prices are so down to earth they’re the envy of the world.

To put numbers on it:

•Japan’s LNG imports grew 25 percent in the last two years.

•In 2012, Japan importers paid $16.62 on average per million Btu of LNG delivered to the dock.

•Last year, the Henry Hub pipeline-gas price averaged $2.75 (it’s closer to $4 now).

Tension between buyers and sellers is common in commerce, as anyone who has purchased a used car can attest.

But this clash of wills between Asian gas buyers and their suppliers — and the wide price gap between North America and Asia — have sent the global gas market into a tizzy.

LNG sellers defend oil-indexed prices as necessary to support multibillion-dollar investments in new liquefaction projects. It can take more than a decade for LNG sponsors to recover their investments, ranging from $10 billion to $50 billion for projects now under development.

Buyers, under political and economic pressure to soften the price impact on consumers, look at rock-bottom U.S. prices and question the long-time logic underpinning oil-linked prices.

Meanwhile, other developments are stirring the pot:

•To secure supply under flexible terms, Asian oil and gas companies as well as power and gas utilities also have been buying into actual gas fields and LNG plants — in North America, Australia and Africa.

•The Japanese government announced in February it could lend up to $11 billion to projects that would secure cheaper natural gas for the country.

•A couple efforts are afoot to try to replicate, perhaps only in a small way, the kind of competitive, liquid market for natural gas that helps keep North America prices low for now. The Japanese trade ministry said it intends to set up the world’s first LNG futures market. And the International Energy Agency is pushing for an Asian LNG trading hub that also would create the buying-selling liquidity that could help soften prices.

There’s skepticism that LNG producers would play along with a spot hub or futures market, something that would be needed for those markets to work. But Shanghai and Singapore already are maneuvering to become hubs. Storage tanks are under construction in Singapore to hold LNG while it is brokered for sale.

Some in the industry are doing their own maneuvering — BP, Shell, GDF Suez, BG Group and other companies with LNG trading or marketing desks have opened offices in Singapore.

A gas bonanza

North America is glutted with production from shale plays unfolding all across the continent. Over a dozen U.S. and half a dozen Canadian proposals to export some of this glut have materialized, including one involving Alaska North Slope gas that’s in its early stages of conception.

No one expects North American pricing to take over the world, at least any time soon. North American exports would comprise just a fraction of the world’s LNG trade. The agreements struck so far between buyers and producers total roughly 6 billion cubic feet a day that could be shipped outside the continent, compared with a global trade of about 32 billion cubic feet a day in 2012.

And setting up an Asia spot or futures market that everyone trusts could take many years.

Last fall, gas marketer BG Group’s outgoing chief executive, Frank Chapman, said as much at a London conference. Less than a half dozen Asian buying countries rely on supply from about two dozen LNG producers. “If you want a fully liquid market, you must have many sources of supply and many sources of demand,” he said.

Over time, Japanese utilities likely will get no more than 10 to 15 percent of their supply linked to the U.S. Henry Hub price and a like amount linked to the British hub price, a Japanese executive told trade publication ICIS Heren in December 2012.

Further, Japanese buyers are well aware that big new LNG projects need to lock in a high enough price to make their investments pay, Ken Kuroda, a Mitsubishi senior vice president for energy business, said at a conference in Barcelona late last fall.

“Japanese buyers have different views to each new source of supply,” Kuroda said. “Australia is viewed as a stable and reliable source, but buyers may have to support the launch of a new project through agreeing a strong (oil-indexed) price. ... On the other hand, other potential long-term supplies could augment supply flexibility, and that is why all the Japanese importers are trying to realize U.S. projects, as flexible U.S. LNG can be offered on a free-destination basis.”

Ernst & Young, in a new report on global LNG pricing, said that with LNG from North America, Africa and elsewhere possibly flooding the market starting around 2020, “there will most likely be a gradual but partial migration away from oil-linked pricing to more spot or hub-based pricing” over the medium to long term. “LNG sellers are reluctantly facing the realities of pricing and are offering concessions in order to remain competitive. However, LNG pricing should not collapse, simply because the cost to supply is high and incentives to develop new capacity must be maintained. ... LNG is a very expensive game, and prices — however they are formed — must reflect this reality.”

Cheniere’s coup

The first moves involved Cheniere Energy Inc., a quick-footed Texas company building an LNG export terminal in Sabine Pass, La. — the first such plant since the nation’s only LNG export plant, at Nikiski, Alaska, went up in the late 1960s.

Cheniere hopes to ship its first load of LNG to market in late 2015.

Over 100 frenetic days in late 2011 and early 2012, Cheniere inked four buyers that together will take about 2.2 billion cubic feet a day of natural gas as LNG:

•British marketer BG Group, which has customers all over the world and could sell the U.S. gas to any of them.

•Spanish marketer Gas Natural Fenosa, a leading gas marketer in Europe and Latin America. But Gas Natural could sell the gas anywhere.

•GAIL India Ltd., a major energy company whose deal with Cheniere breaks the lock of oil-linked prices that has prevailed for India gas imports.

•Korea Gas Corp., the world’s largest single LNG importer which, like GAIL, sought to bring pricing diversity to the traditional oil-linked prices of its home market.

Cheniere is actively pursuing buyers for a Sabine Pass plant expansion and has a tentative deal with French energy company Total to take LNG from an expansion. Cheniere also is proposing a second LNG export plant project in neighboring Texas.

Right behind Cheniere are 18 LNG export applications waiting for U.S. Energy Department approval. Most will not be built, but their prospect adds to the pricing discussion.

Cheniere established the model for how to price North American gas in foreign markets. Buyers will pay:

•The Henry Hub price plus 15 percent for the gas — the 15 percent buys the gas consumed during liquefaction. Liquefaction is a muscular process that superchills vaporous gas to minus 260 degrees to compress it into a liquid form that is more economical to ship.

•A liquefaction fee. BG, the first buyer to sign, will pay the lowest fee for most of its gas: $2.25 per million Btu of gas (about 1,000 cubic feet). The others will pay more, ranging from $2.49 to $3.

The buyers are on their own for shipping the gas to market. Tankering LNG from Louisiana could cost perhaps $2.50 to $3 per million Btu to Asia, less to Europe, according to many estimates. (It would cost about $4 today, but a wider Panama Canal that can handle the big LNG tankers should open in 2015, shortening the route.)

For Asia utilities, gas priced at about $4 at Henry Hub — the price in mid-March — would get delivered for roughly $9.50 to $10.50 per million Btu. If that price can hold, and oil prices remain stratospheric, this trade will prove to be quite a bargain. In mid-March spot deliveries to Asia of LNG at oil-linked prices were running $16 to $17. Long-term contract prices have been somewhat less lofty.

Not everyone thinks this jaw-dropping price-arbitrage opportunity for North America gas in Asia will last.

For one, Kenneth B. Medlock III, an energy economist at Rice University in Houston, argued in a 2012 paper that North America prices are artificially low and Asia oil-linked prices are artificially high due to unique market forces in both regions. These forces will lose their oomph, he predicts. When North America prices inevitably migrate up and Asia prices fall to more sustainable levels, the arbitrage opportunity will vanish, making it unprofitable to export U.S. Gulf Coast gas long-term.

One more note about Cheniere customers. Where were buyers from Japan and China, two of the world’s largest LNG consumers?

“We were in negotiations with them; they were a little bit slower than they needed to be,” Cheniere CEO Charif Souki said of Japan in a December interview.

What about China? “They’re mad at me because we didn’t sell them from the first four trains (at Sabine Pass), as they were too slow,” Souki said. “They’re absolutely convinced that we did it on purpose. It’s not true.”

Part 2 of this story will run in the April 28 issue of Petroleum News. Editor’s note: This is a reprint from the Office of the Federal Coordinator, Alaska Natural Gas Transportation Projects, online at www.arcticgas.gov/market-awaits-impact-north-america-lng-exports.