A significant developments occurred this week affecting the US gas market.
New LNG Futures Contract
As reported in the Wall Street Journal, Singapore Exchange Ltd has created a market for LNG futures and swaps. Trading could begin as soon as January. The contract will be called the Singapore SLiNG. (The name alone is worth the price of admission) What does this mean?
The first impact will be to provide greater transparency to the price of LNG. Most cargos are sold under long term contracts, often not visible and with opaque terms for origin, destination, transportation charges and pricing and adjustment provisions. This makes estimating the true market value a guessing game at best.
Growing LNG Spot Market
Although the number of long term contracts has declined and spot trades have climbed to 29% of total volumes, pricing has mainly been privately negotiated between counter parties. Re-exports of cargos under long term contract increased from 14 to 109 in 2014. Both buyers and sellers are seeking greater flexibility and for that they will need better price information.
Narrowing Price Differentials
LNG currently trades at an order of magnitude greater than well-head prices in the US. At the beginning of the year prices in NW Asia were north of $19/MMBtu. The huge capital cost of liquefaction (estimated at $10/MMBtu for new Australian projects) has been the key driver. Going forward, existing plants will have some advantage, having recouped their initial investment. Newer brownfield plants are estimated to cost significantly less, $2.00 to $5.00. This would include the Chenier plant in Lousiana and possibly others on the gulf coast. Falling cost, large supply in both the middle east and the US suggests there will be completion for market share. That paints a picture of falling prices for LNG, narrowing the spread between well head and re-gasified prices.
LNG Basis Trades
Following Henry Hub, new trading points emerged in the US. Expect the same to happen in Asia. At first there will be a trading point in Japan followed by Shanghai, Western Australia, US Gulf Coast, and others. Rather than an all-in price, expect there to be a SLiNG+/- basis pricing. Not only will the commodity trade, but space on the tankers will trade, perhaps like oil tankers, but probably more like pipeline capacity since LNG tankers are significantly more expensive. That expense caps the number of new entrants, much like certification caps new capacity. Owning capacity may create a competitive advantage, but also higher risk.
Opportunity for US Producers
Currently, the US is not a player in the global LNG trade, but will become one soon. Note the map produced by the LNG trade group GIIGNL showing LNG flows.
Will these developments offer heart burn relief for US producers? Not in the near term. If the US develops a robust LNG industry it could in the longer term. Attracting the capital to build more export facilities will be a big challenge. Long term supply contracts supporting these plants are largely a thing of the past. Thus future plants built in the US will need to be responisive to market prices. That means they could be merchant plants, taking all the risk and reward, or they could be tolling facilities, processing pipeline gas into LNG for a fee. Indeed the Cheniere Energy plant operates that way, under long term contracts.
The big Australian and Arabian Gulf producers got a break with Fukushima, but Japan’s power market is not likely to grow significantly. The big market is China, but they have their own shale resource and a very hungry Russia ready to supply much cheaper pipeline gas. Europe may be an option, but competition with African and Caribbean suppliers along with Russia could limit market potential.
Low Cost Provider
The answer seems to be to design and build these plants to be the most efficient, low cost producers in the world. That could work. The top US and Canadian upstream companies are the lowest cost producers in the world, at the wellhead. The large North American pipeline network with multiple receipt and delivery points suggests getting the commodity to port will be a cost advantage. Using brownfield sites and leveraging existing port facilities could mitigate permitting and land costs. One of the biggest operating expenses for LNG is energy. Low cost natural gas along with highly efficient gas combined cycle power generation is another potential cost advantage. Finally, the EPC costs (Engineering-Design, Procurement and Construction costs) need to be driven to the lowest possible level. Standardization and production optimization are methods that have proven successful in other industries. That is not to say this is easy or will happen overnight, but I believe it could happen.