With the price differential between oil and LNG sending mixed signals to the market, is the time right to look at small scale LNG? This article will outline six key reasons why the outlook is positive.
- The LNG market is currently in surplus, with global demand in 2015 only increasing by 700 million ft3/d while supply increased by 2.2 billion ft3/d.1 Volume upside from existing markets is limited, which opens the opportunity for new demand markets further downstream to soak up the growth in LNG supply. As a result of this oversupply, global LNG prices are low. Estimated landed LNG prices as of May 2016 were US$1.78/million Btu in the US, US$4.34/million Btu in Europe, and US$4.55/million Btu in Asia (Figure 1).2 Is it possible for LNG to get any cheaper? The buyer’s market will last only as long as the oversupply dynamic lasts. Tides turn, and US Henry Hub spot prices are expected to increase beyond US$4/million Btu by 2020.1
- The price differential between LNG and oil is expected to widen again as forecasts show an increase in crude oil price, thereby increasing the price advantage of LNG over diesel and other low sulfur oil derivatives. Nonetheless, while the current price differential between oil and gas is not as attractive as when it was at US$100/bbl, the cost of switching to LNG is not cost negative. At worst, it is cost neutral with a lower internal rate of return than two years ago (Figure 2).
- Small scale LNG infrastructure offers less risk to investors. Liquefaction providers now offer plug-and-play concepts with a reduced price tag, operating cost, and deployment time. This scalable and redeployment capability allows a fast response to market demand. The technology is no longer new but is proven thanks to early adopters: continuous innovations in gas engines and fuel storage tanks keep reducing CAPEX and increasing the IRR. Shell is now building retail LNG refuelling facilities in half the time and at a third of the cost of when it first started building them a few years ago.
- Shipyards currently offer availability and low costs for new ships and conversions. This is a silver lining from the slowdown in global trade and consequently oversupply of existing ships, which has left shipyards struggling and competing on cost. Recent discussions with US shipyards indicate they are struggling as much as their Korean competitors and are aggressively competing on price to stay afloat. Furthermore, low crude prices mean that equipment costs are at a historic low.
- Growing environmental awareness and climate change are pushing toward ever tighter atmospheric emissions limits. Public companies that have embraced a corporate sustainable strategy of reducing their environmental impact have shown faster growth than other companies. As such, many on-the-road good carriers, ferries, and cruise ships whose end customers are requesting greener solutions are switching to LNG. Examples include UPS, Ryder, Unilever, Seaspan Ferries, BC Ferries, and Carnival Cruise Line, which has placed an order for four LNG dual-fuel cruise ships. Cruise industry insiders believe 80% of new cruise ships could be LNG-fuelled by 2025.
- Governmental policies supporting the adoption of LNG are in place in many countries and are being developed in others. The EU parliament set out the Clean Power for Transport Package, which requires each member state to develop a national policy framework and develop LNG bunkering facilities at inland ports and maritime ports and LNG fuelling stations for heavy-duty vehicles by 2025/2030 (it will require LNG bunkering facilities in 139 ports by the end of 2030). US government agencies at federal, regional, and state levels have implemented tax incentives to encourage the purchase and use of natural gas vehicles. Moreover, LNG fuelling and bunkering codes and standards on a national and international basis are being worked on to improve standardisation across borders and provide an effective and safe framework for operations.
Figure 1. World LNG estimated landed prices - May 2016 (source: FERC).
Source: BRG. Note: Payback and IRR are based on an incremental investment of US$60 000 per vehicle, average annual travel distance of 104 000 miles per vehicle, truck life of 6 years (first replacement), and average retail LNG price (including federal tax) of US$11.78/million Btu in the US (US$0.88/LNG gal.).
It is happening
Early adopters are driving growth of the LNG market by slowly breaking down the chicken-and-egg paradigm. LNG adoption has grown in most oil-based fuel-consuming markets, including trucking, bunkering, rail, remote power, off-grid industrial, mining, and oil and gas market sectors, albeit at different speeds. Differing sensitivity to key growth drivers, as well as different drivers, have spread market sectors along the adoption curve. Marine bunkering and trucking are at the forefront, particularly in China, Europe, and the US.
China boasts the largest number of LNG trucks (more than 200 000 vehicles) and will remain the dominant market for at least for the next decade. It is implementing an aggressive LNG refuelling infrastructure that aims to build approximately 3000 CNG/LNG refuelling stations by 2025, driven by China Gas Clean Energy Company and ENN. It has also built 19 LNG bunkering pontoons and plans to build another 23.
The European small scale LNG market, kick-started by established LNG importers and EU funding, now offers small scale LNG services in 84% of existing European LNG import terminals, and all future large-scale LNG terminals will include LNG bunkering services. Currently, 69 LNG-fuelled ships operate in Europe, with another 60 on the order books to be delivered by 2019.3 The growth in LNG demand has led the number of trucks loading LNG out of northwest European terminals to more than triple in the last two years. LNG refuelling stations are now appearing on the EU major trunk lines. The main suppliers in Europe include Skangas, which has a near monopoly in Sweden; Gazprom in Germany; Gaz Natural Fenosa and Enagas in Spain; Engie in France; and Liquigas in Italy.
In the US, the advent of shale gas has spurred a number of small scale LNG liquefaction plants and virtual pipeline projects distributing gas beyond pipeline reach, displacing oil-based fuels in power, industry, and transport. Small scale LNG capacity in the US in 2015 reached 1.5 million gal./d. An additional supply of almost one million gal./d was due to start in 2015, but the crude slump put developments on hold. Based on recent press releases, one can expect an additional 750 000 gal./d to come online by 2018 from projects slated as ‘on-track.’ This will bring US small scale LNG production in 2018 to 2.3 million LNG gal./d. There are currently six LNG-fuelled ships in North America, with 10 more to be delivered this year and another 16 to be delivered by 2022.3
Remote power is gaining interest from island nations and archipelagoes. Gaslink’s delivery of LNG in ISO containers to Madeira’s power plant proved the concept economically viable. Just like in the Indonesian archipelago, in the Caribbean developers are exploring the possibility of power plant conversion projects and ‘hub and spoke’ LNG distribution projects. Jamaica, for example, just received its first US LNG cargo from the Miami Hialeah small scale facility to power the recently converted 120 MW Bogue power plant in Montego Bay.
The LNG virtual pipeline has fostered conversions to natural gas in the off-grid industry sector, including paper mill conversions, asphalt plants, corn-drying application, bottling plant, and food processing customers. The mining and oil and gas sectors witnessed early adopters, particularly in the Americas and Australia before the commodity market slowdown. The Stornoway diamond mine in Canada will be the first mine site fully powered by LNG.
The rail industry has undertaken a number of pilot projects, and the world’s first operational LNG-fuelled locomotive was delivered in Russia last October. While LNG adoption in the rail sector is lingering behind on the adoption curve, it will speed up rapidly once cost-effective supply chains specific to the rail industry and safety regulations are ironed out.
The shape of things to come
To promote further growth, early adopters are shifting their business models toward greater integration of market players, offering end-to-end solutions to reduce the risk to end users. Fuel wholesalers, for example, are moving downstream, partnering with LNG distributors and developing infrastructure to offer a solution from the wellhead to the dispenser. Equipment providers are partnering with EPC firms to offer a complete engineering package beyond their sole proprietary technology. Developers are partnering with LNG wholesalers and equity firms and applying the ESCO (Energy Service Company) model, whereby the end user's conversion costs are financed by the savings gained from switching to LNG to repay the loan from the investor. This industry evolution is also dropping the barrier to entry for new players.
Small scale LNG providers are now superseding the super-majors in the development of new LNG plants. Smaller plants are being constructed in response to the growing market demand for smaller cargoes, which are both easier to finance and also allow the buyer the option to diversify its supply.
Air quality improvement initiatives are becoming more prevalent as climate change awareness is growing and local smog reduction campaigns are being implemented. The Paris Agreement signed in December 2015 and agreed to by US and Chinese leadership will be a driver of shifting pollution trends in the coming decades. The number of Emission Control Areas (ECAs) are likely to grow with some locations already under consideration such as the Mediterranean, Japan and Norway, and others being implemented voluntarily such as in China.
China's Ministry of Transport launched a five-year action plan in 2015 for the prevention of pollution from ships and in ports, with the aims to cut SOx, NOx, and particulate matter (PM) emission by 65%, 20%, and 30%, respectively, by the end of 2020. Three SOx ECA have been established — the Pearl River delta, River Yangtze, and Bohai Rim — with a plan to build a total of 156 bunkering infrastructures. The Hong Kong maritime department also set notice that ships at port must use bunker fuels with no more than 0.5% sulfur.
Further, the International Maritime Organization (IMO) is expected to cap global SOx emission down to 0.5% by either 2020 or 2025. A decision on the exact implementation date is to be agreed by the IMO’s Marine Environmental Protection Committee in October 2016. The decision will depend on preliminary results of a study into compliant low sulfur fuel availability. Implementing the sulfur cap in 2020 will realise emissions reductions sooner and boost LNG adoption, but it could drive up the price of low sulfur fuel and subsequent shipping costs as a result of the sudden increase in demand.
There are strong indications that the IMO could implement the restrictions sooner rather than later. Russia is upgrading its refineries, and the Middle East will add new refinery capacity by 2020 to meet the growing demand for distillates. India’s largest state-owned refinery (Indian Oil Corp.) is said to be investing US$26 billion in expanding and upgrading its exiting refineries.
Although not covered by the Paris Agreement, the reduction of greenhouse gases (GHGs) from shipping activities lies within IMO’s priorities, and the IMO’s actions will be crucial to accomplish the overall objectives of the Paris Agreement. The IMO is also likely to address CO2 emissions in the next decade. While there are currently no IMO CO2 emission restrictions, the IMO recently approved a measure mandating ships to record and report their fuel consumption as of 2018 to quantify CO2 emissions. This can be interpreted as a first step toward potential future CO2 emissions restrictions, which again would benefit LNG over oil-based fuels.
The time is now
Volatility in crude oil will always remain a source of risk. LNG has emerged to offer greater price stability than petroleum-based fuels. The retail price commodity percentage, which is prone to volatility, is only 24% in LNG as opposed to 45% in diesel. This significant difference reduces the impact of volatility on the retail price and affords LNG greater long-term price stability and forecasting accuracy, reducing the need to hedge and allowing capital to be focused on development.
Further, natural gas offers a good combination with renewables in providing a reliable and easy-to-ramp-up energy source as the industry gradually moves toward greener distributed energy resources. Its evolution as a transport fuel may push it to become not just a bridging fuel but the fuel of the future.
Developed and developing nations are undertaking feasibility studies seeking to understand the techno-economics of shifting their economies (power and transport) from oil to natural gas. Developers are shaping their business strategies waiting for crude prices to pick up to go to market. For example, Engie confirmed recently that it plans to spend €100 million over five years on rolling out its small scale LNG supply investments as LNG replaces diesel in the long-term.
To summarise: supply exists, price is low, technology is proven, infrastructure is building out, and regulations and standards have been ironed out, mostly in Europe. Now is the time for even greater collaboration among the supply chain stakeholders to further reduce risks and costs to capture opportunities. Focusing on supply reliability in this developing market may also prove more successful than competing on price.
Written by Joanna Martin Ziegenfuss, Associate Director, Energy, Berkeley Research Group LLC.
- PEDERSEN, C., ‘The US enters a brave new world as it begins LNG exports,’ S&P Global Platts (2016), available at: http://blogs.platts.com/2016/02/10/us-brave-new-world-lng-exports/.
- Federal Energy Regulatory Commission, ‘World LNG Estimated Landed Prices’, (May 2016).
- LNG Fuelling, (2016).
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