US LNG: Game Changer or a Good Marketing Ploy?

Dec 29, 2017

US LNG: Game Changer or a Good Marketing Ploy? - Maria Belova, Head of research, VYGON Consulting

The United States as the home country of Philip Kotler, founder of the marketing theory, has always succeeded in sales. As of the end of 2016, 6 US LNG facilities signed 41 contracts to sell US LNG for a total of 47,8 mt per year including 28 long-term (20 years), 2 short-term contracts (up to 5 years) and 11 heads of agreement (HOA) for 7.7 mt.

Since the Sabine Pass 1st train startup in February 2016, the revolution in the global LNG market did not occur. Almost 90% of the US natural gas is sold under long-term contracts and, same as Russian gas, have a «take-or-pay» obligation – importer should purchase LNG under FOB terms, egardless of gas withdrawal volumes, and is liable for liquefaction payments based on previously agreed capacity.

200 cargoes with US LNG left the Gulf of Mexico through September 2017 totaling 13.3 mt, which composed around 5% of global LNG trade in 2016.

Latin America was in the top of American LNG purchasers as it consumed nearly 40% of the total US exports. Asia-Pacific was the second largest region purchasing US LNG in 2016 and 2017. 62 tankers shipped 4.3 mt of LNG (32% of total exports) to South Korea, China, Japan, India, Taiwan, Thailand and others.

US LNG is also supplied to such exotic nations as Kuwait, UAE, Jordan and Egypt (14% of total US exports in 2016-17). Only 14% of US LNG total production headed to Europe (1.9 million tons) – mainly to those nations that have no contracts with Gazprom. Financial performance is the reason why the European market is so unattractive: despite a number of favorable shipping conditions and historically low Henry Hub prices, US LNG exports to Europe resulted in average losses of $0.6/ MMBtu in 2016.

Latin America (Brazil) and Asia (China located within the almost same range from the Gulf of Mexico, have secured the exporter a profit of $2/MMBtu due to higher selling prices in their markets.

The key determinants of LNG deliveries cost from the USA to European and Asian markets are Henry Hub spot prices, liquefaction and shipping. In 2016, the Henry Hub price, an indicator of American LNG contracts, was at its lowest level since the beginning of the 1990s. The EIA longterm projection demonstrates signs that the natural gas glut in the domestic US market will be diminishing as LNG export capacities emerge and availability of new oil and gas resources and their development technologies shrinks1 . The EIA projects that Henry Hub prices can grow $1 to $3 per MMBtu by 2020 versus 2016. Its Minimum Case Scenario assumes a rise in prices to $3.6/MMBtu and the Maximum Scenario to $5.4/MMBtu.

In addition, average liquefaction costs are expected to grow because of higher costs at Corpus Christi ($3.5/MMBtu) reflected in the contracts terms. Based on that, the average unit cost of gas liquefaction at LNG plants scheduled to come online will soar by $0.5/MMBtu to represent about 30-40% of the final LNG price in European and Asian markets.

Signs of changing shipping costs also have a negative impact on the future competitiveness of US LNG. LNG freight rates has touched the bottom in 2015-16, and then has been on the rebound. According to Affinity, wider tanker uses by LNG producers would dampen the existing LNG shipping demand/supply imbalances already in the second quarter of 2018 with resulting impacts on the freight rates. Fearnley, an international marine broker firm, estimates, that a comfort freight rate for an LNG tanker is $80,000 per day.

At such shipping rates, we estimate average freight costs to rise 2.5 times up to $0.4/MMBtu.

In addition, Brent crude prices that are expected to grow from 43 to 63 USD/bbl in 2016-2020 (according to World Bank projections) will lead to a rise in the average bunkering costs by $0.15/MMBtu. The cost of boiled-off gas will also vary proportionally with the explant LNG price.

Assuming the crude oil prices to elevate to 63 USD/bbl by 2020, LNG price in Europe (Belgium), according to our estimates, will be $6.9/MMBtu.

Therefore, even under the minimum Henry Hub price scenario projected by the EIA for 2020 US LNG exporters are likely to carry losses in Europe.

American LNG exports to Europe could be viable, if the average import price was in the range from $5 to $7 per MMBtu. However, if the European price is below this range, the American LNG exporters will prefer halting their deliveries and simply paying for liquefaction capacity they contracted.

The exporters have two strategies to minimize their losses: use predatory pricing in European markets (i.e. offer its LNG for $5-7 per MMBtu instead of the desired $8.2 and current prices of $7 per MMBtu) or ship its LNG to more attractive markets in Asia or Latin America, where they can offer a price premium during seasonal price hikes.

Based on an assumption about regional gas market globalization due to expanding LNG trade, we project the further LNG prices alignment in the importing regions. The price differential between Europe and Asia/Pacific was $3.1/MMBtu in 2015, $2.3/MMBtu in 2016 while by 2020, according to our estimates, it will shrink to $1-2 per MMBtu. With the expected LNG price in Belgium of $6.9/MMBtu, the price in Japan will be in the range from $7.9 to $8.9 per MMBtu. This corresponds to the World Bank’s forecast of $7.8/MMBtu. Since demand in Japan unlikely to grow further primarily due to the national nuclear energy policy regaining its focus, and taking into account overall LNG supply growth in the Asia/Pacific region as a result of domestic gas market liberalization launched in 2016, we expect that the price of LNG will be closer to the bottom value of the forecast range.

Cost of supply of the American LNG in Japan may vary from $8.6 to $10.7 per MMBtu. Thus, the economics of LNG supplies from the United States to Europe and Asia remains extremely questionable in the medium term.

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BLUE FUEL (Gazprom Export Global Newsletter, December 2017 / Vol. 10-11/ Issue 4-5) link: http://www.gazpromexport.com/presscenter/publications/

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