How to Avoid Getting Burned on LNG: Comment from Vienna

There are a lot of ways in which even the most cautious investor may lose money with LNG projects: the oil price could collapse, the construction costs could rise, the local exchange rate could rise, or the host government might decide to use the gas for the good of its national industry, and so on.

Some of these risks can be mitigated. Addressing the European Gas Conference in Vienna this week, Novatek's CFO Mark Gyetvay said his company was working on ways to lower the construction costs for its second Arctic project, using a gravity-based system instead of drilling multiple piles deep beneath the frozen sand of the Yamal peninsula.

This was not the approach used for Yamal LNG, whose first train is due onstream this year; but it might be used for Arctic LNG, if that project, based on different gas reserves but still in Russia's far north, receives the green light. That is expected this year. Merely by being in the extreme north helps keep down some of the costs of liquefaction projects.

Yamal LNG also benefits from simultaneous extraction of liquids – a sideline that helps the ultra-expensive end of the market too, such as Prelude LNG offshore Australia. Yamal LNG also benefited from state aid, including loans, and major infrastructure developments in the Russian port of Sabetta.

Yamal

(Credit: Novatek)

However the main focus is on LNG production in the US, where the holders of long-term capacity contracts are facing negative margins – unless there's a major turnaround in gas demand in Europe – because the world is entering a period of oversupply that could last at least another five years. There is some 150mn mt/yr of new LNG capacity coming to market based on recent final investment decisions; of that another 105mn mt/yr is yet to come.

Consultant David Ledesma pointed out at the conference the difference between the shareholders in the $54bn Australian Gorgon LNG project, whose money was already spent – and then some – and the capacity holders in the US. The former have to get on with selling as much LNG as possible to recoup their investment, while the latter need to justify spending half a billion dollars annually in what might be a loss-making business. The latter must take LNG out of the US and perhaps sell it at a lower price elsewhere, or leave it in the ground but remain stuck with onerous ship-or-pay terms.

As these terms were what the capacity seller took to the bank to raise finance, and therefore affect his repayment terms, changing them in the buyer's favour will require compensation. On the other hand, as another consultant Wolfgang Peters said, the European experience had shown that long-term gas sales and purchase agreements that consistently benefit only one side of the bargain are not sustainable in court. One tolling contract that could be legally picked over for weaknesses might be that between Toshiba and Freeport LNG in the US.

More optimistic was BP's Moscow-based economist, Vladimir Drebentsov, who said a $1/mn Btu spread could be enough to ensure US LNG flowed to markets in Europe. The spread might be bigger than that, in which case Gazprom, with its idle 100bn m³/yr of production capacity and investments in new pipelines in the coming years, should benefit. Nord Stream 2 is due on line by the end of this decade, for example. Gazprom will compete with the US and have a good chance of beating it, especially with US LNG prices being higher in all likelihood, he said.

Producers will perhaps also be keeping a weather eye on the politics of gas, and what impact the COP21 climate change agreement will have on demand for their output. As it is a fossil fuel "just like coal", some policymakers argue its days are numbered, and that gas not produced soon may end up never being produced. That could lead to more upstream projects being brought onstream in a less co-ordinated way, further destroying prices, delegates heard. 

On the positive side of the equation, giant energy consumers India and China would only need a trivial switch from coal to gas – perhaps just 3% – for the rising demand for LNG to drain the oversupply and lift prices to an attractive level for upstream investors once more.

William Powell