LNG Disaster

Jim Brown
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The LNG explosion is going to cause ripples felt all around the world. Five years ago, there was a race to build LNG export facilities worldwide. Today 75% of them may never be completed.

Five years ago, there were as many as 90 LNG projects in the planning stages. China, Japan and India were seen as insatiable markets that would devour all the liquid gas that could be delivered. Today IHS claims that only one out of every 20 projects will be completed.

A couple years ago, the cost of LNG delivered to Asia was $20 per BTU compared to $6 per BTU today. That 70% decline in price is due to the surge in LNG projects and the ready availability of the product.

Chevron's $54 billion Gorgon LNG Plant

LNG plants are very expensive. An average plant costs $4-$5 billion per train and some of the big plants have cost as much as $50 billion. Chevron is spending $54 billion to construct the Gorgon project in Australia. In order to finance these expensive facilities most companies pre-contracted for delivery for as long as 20 years into the future. Cheniere Energy in the U.S. contracted 75% of their future production for the next 20 years. They have a contract structure that guarantees them a profit regardless of gas prices. They sold the gas at a premium to Henry Hub delivery prices in the USA. Hypothetically, if natural gas sells for $3 per Mcf in the U.S. then the price for their LNG is $3.50 per MCF. The contracts also state that anyone not taking a shipment need only pay the premium and not for the gas.

Other companies have different versions of these contracts with some based on oil prices and some based on gas prices in Asia and Europe. The key is that most production for all plants currently under production has already been pre sold.

With LNG prices crashing and producers having trouble selling excess spot cargoes, the future of any plant not already near completion is grim. Spot prices in Asia have declined -56% over the past year.

LNG demand rose only +0.9% in 2014 according to Bank of America and that is the smallest rise since 2009.

When Japan suffered its nuclear disaster several years ago, the demand for LNG spiked significantly. They shut down all 43 reactors and are just now in the restart process. The first one to restart was in the last several weeks and there are 11 more scheduled for 2016. This will reduce Japan's LNG demand significantly and allow the market glut to expand.

Almost every week there is a headline about a LNG project that has been cancelled or shelved until demand recovers. The economic slowdown in China has caused a decline in energy use in China and all over Asia. China's imports of LNG have declined -3.5% in 2015 compared to the same period in 2014 when demand rose +10%.

As prices fall and projects are cancelled, the pace of the cancellations should accelerate. With every completed or nearly completed project struggling to sell spot cargoes there are no takers on long term contracts needed to fund the projects. LNG buyers realize they are in control and they are naming the prices and delivery terms.

More than 38 LNG terminals proposed in the USA may never be built according to Fitch Ratings and the Brookings Institution. There are five projects currently under construction in the U.S. and those will likely be completed because the financing is already in place. Another 20 terminals were proposed for Canada and only 1 or possibly 2 will actually be developed according to Goldman Sachs.

There are seven major projects under construction in Australia and once completed they will supply the majority of LNG to Asia where the largest demand is located. Plants elsewhere will have to face longer shipping times and costs, which will subtract from their realized prices. This may prevent them from ever being built.

Anadarko Petroleum has a major gas find offshore Mozambique. They have discovered a field with about 75 Tcf of gas and have been considering building an LNG export facility to sell the gas. To date they have received "non-binding" commitments for 65% of the 12 million tons per annum in expected production. They have secured 60% of the required funding for the project. However, the key word in those prior sentences is "non-binding" and that means those purchase commitments can evaporate in a heartbeat along with the funding for the project.

With 85 of the 90 proposed projects likely to be cancelled that is a serious problem for energy companies with gas in the ground that they cannot sell. Many of those projects were the only practical way for producers to sell the gas they found. Much of it is offshore and there are no pipelines to any major consumer. Without an associated LNG project on the closest shore, there is no buyer for the gas.

This will be a disaster for producers that have already put these reserves on their balance sheet. How much is 5 Tcf of gas worth, 300 miles offshore in 3,000 feet of water with no consumer in the immediate vicinity? Not very much is the answer. This stranded gas will have to be written down in value if the associated LNG project is cancelled and that means large charges to reserves on their earnings statements.

Global LNG capacity rose to 301 million tonnes per annum (MTPA) at the end of 2014. There is another 128 MTPA already under construction and LNG cargoes are already going unsold. When that additional capacity comes online there will be a huge glut of LNG that could last the rest of the decade or longer. Citigroup said there will be at least 25 MTPA of oversupply by 2018 and that could expand to as much as 35% of capacity being excess by 2025. That much excess capacity could cause prices to decline significantly from the $6 price today. This is a windfall for consumers but a disaster for LNG exporters with a higher gas cost than we have in the USA.

This is going to produce a "survival of the fittest" scenario where those with cheap input costs, inexpensive overhead and located close to consumers will be the winners. Everyone else will be fighting for the scraps of demand always looking for the cheapest price.

If your favorite energy stock is counting on an LNG project to pump up their earnings in the years ahead you should probably look hard at their justifications for that project and severely discount any gas reserves they are planning on selling into it.

About the only bright spot in this scenario is that LNG will be very cheap in the decade ahead and that means cheap electricity and the potential for stronger economic growth. Cheap energy, regardless of the form, has always contributed to strong economic growth cycles.

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Active Rigs

Active drilling rigs declined -14 to 795 for the week ended on Friday and that is a 10 year low . Oil rigs fell -9 for the week to 605. Active gas rigs fell -6 to 189. Active rigs have now declined -1,135 since the high of 1,931 in September 2014. That is a -62% drop. Active offshore rigs were rose +2 to 32, down -29 from year ago levels.

Oil Inventories

Crude inventories rose +3.1 million barrels to 461.0 million.

Refinery utilization fell from 89.8% to 87.5%. That is down from the high of 96.1% on August 7th.

U.S. production ROSE +76,000 barrels to 9.172 mbpd, down from the 9.61 mbpd and 40-year high in June.

Cushing inventories rose slightly to 53.1 million from 53.0 million.

Gasoline inventories rose +1.9 million barrels to 223.9 million.

Distillate inventories fell -2.5 million barrels to 149.2 million.

In the graphic below green represents a recent high and yellow a recent low.

Jim Brown

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