A market consensus view has developed that the global LNG market will remain tight for the rest of this decade. LNG buyers are nervous about being caught short on supply as gas import demand from developing economies surges. The post-Fukushima squeeze is fresh in mind. Producers are also projecting a tight market to support their investment cases, given billions of dollars flowing into new liquefaction capacity. While this consensus is currently supported by a range of buyers and producers, it is increasingly coming under challenge.
The tight market consensus has developed with some justification. Since the Fukushima disaster new supply has struggled to keep up with demand growth. This has driven a structural premium of Asian spot LNG prices over European prices as shown in Figure 1. However, a number of key factors driving the global LNG supply and demand balance remain uncertain and this uncertainty warrants the consideration of alternative outcomes.
Figure 1. Global gas price evolution (source Timera Energy).
An uncertain future
Uncertainty around the global supply and demand balance increases significantly from 2015. Most forecasts of the LNG market balance show a steady growth in demand met by an equally steady increase in supply (see Figure 2, where BG has overlaid a number of consultant demand forecasts on its estimates of supply growth). But the actual outcome may not follow such a smooth path.
Figure 2. Global LNG demand and supply growth projections (source BG Group).
On the supply side, large and lumpy volumes of new liquefaction capacity are being developed. History shows that project delays are common, which supports the tight market thesis. But delays can also result in large volumes of gas coming to market at a similar time.
There is also the potential for a major new ‘wave’ of supply in the 2018 to 2023 time window (encouraged by the current tight market price levels). There is clearly significant uncertainty around the magnitude and timing of this new supply. But once projects are committed, it can be difficult for the industry to respond to developments in market dynamics, given the lengthy (~4 year) liquefaction construction period.
On the demand side, the extent of LNG demand displacement from nuclear restarts is unclear. But the elephant in the room is non-Japanese Asian demand. Strong LNG demand growth projections (shown in Figure 2) are heavily dependent on growth in Chinese and Indian demand. Between recent IEA and Chinese forecasts the uncertainty for China’s 2020 gas demand ranges from 330 to 400 billion m3/year. If China’s LNG imports are the ‘residual’ balancing item in the global market then they reflect a highly uncertain future.
The tight market view
If Asian LNG demand growth continues to outstrip its dedicated supply for the rest of the decade, European LNG supply will likely retain its current global balancing role. In other words, significant spot price premiums over European hub prices will attract cargoes away from Europe, to be replaced as necessary by ‘back-filling’ Russian pipeline supplies.
The majority of US exports will likely flow to Asia in a tight market. However, the more flexible structure of US export contracts will increase the influence of Henry Hub on LNG spot market price dynamics. Spot price volatility will likely remain, as the marginal drivers of LNG arbitrage dynamics change over time e.g. due to seasonal factors and timing of new supply. So there may be temporary increases in cargo flows to Europe (as the global balancing market) in times of lower Asian spot prices.
Under these conditions of market tightness, oil-indexed contract pricing is more likely to remain dominant. The LRMC of new projects in Australia, Canada and East Africa will be an important benchmark when long-term contracts are signed. In other words, it is likely to be a seller’s market where Australian and North American export volumes are absorbed without a structural impact on market and contract pricing.
A transition to oversupply
There are a number of factors that could derail the consensus view. But perhaps the most obvious one is a failure of developing economy demand to materialise to the extent that has been forecast. This could be, for example, due to an Asian economic downturn (major setbacks in emerging economies are common even if only temporary). Or it could be due to a combination of Japanese nuclear restarts and the displacement of large volumes of Chinese LNG demand by Russian pipeline imports from the back end of this decade.
Whatever the potential causes, the result of an oversupply situation is likely to be the flow of surplus gas into the LNG spot market. This will place pressure on global LNG prices to re-converge as they did in 2009-10. It would also tend to dampen LNG spot price volatility and could significantly reduce the value of LNG portfolio flexibility (which is currently at a premium).
LNG volumes ‘in excess’ of Asian requirement would find a home in Europe (as they did in 2010 and 2011), placing pressure on Russia to either reduce pipeline supplies to maintain hub prices at ‘target’ levels or alternatively engage in a price war to reduce US LNG exports. Such dynamics, in addition to seasonal weather effects, could increase price volatility albeit around lower LNG price levels. This is unlikely to be a good outcome for LNG producers and large portfolio players and unsurprisingly some larger players are starting to downplay the risks around an oversupply scenario (perhaps a barometer for concern).
Such an oversupply scenario may be relatively short lived (e.g. the period over 2009-10) as a result of a temporary mismatch in new demand and supply. But this could be enough to disrupt long-term contract pricing dynamics and to shift the balance in favour of LNG buyers.
The 2009-10 period was a key driver of the development of hub price liquidity in Europe. A similar oversupply situation later this decade could be the catalyst for an increase in influence of hub pricing on Asian LNG supply.
Written by David Stokes (Director, Timera Energy), Olly Spinks (Director, Timera Energy), and Howard Rogers (Senior Advisor, Timera Energy and Director, Gas Research OIES).
Edited by Callum O'Reilly
The full version of this article is available here: 'Considering an alternative view on global LNG pricing'
Read the article online at: https://www.lngindustry.com/liquid-natural-gas/19052014/global_lng_pricing_an_alternative_view_614/