In early 2017, we asked whether liquefied natural gas (LNG) might be the energy market’s next bubble. We weren’t alone. Analysts at HSBC predicted demand for the super-cooled, easily-transported hydrocarbon would fail to absorb the scale of new output sanctioned in the first half of the decade. In a broadly held view, the bank warned of "a period of significant oversupply in the global LNG market that could persist into the beginning of the next decade".
Events have proved less catastrophic. In fact, market fundamentals exceeded gas producers’ hopes in 2017, and demand is on course to rise heavily again this year. The principal reason for this, as is so often the case when commodity market predictions fall flat, has been surging Asian demand, specifically in China.
The People’s Republic added 12.7m tonnes (mt) of imports in 2017, the largest ever instance of annual growth by a single country, says the International Gas Union. In turn, that made up just under half of the 29mt rise in total global LNG imports, which was around 30 per cent more than initially expected.
The trend is set to continue. This year, Bloomberg New Energy Finance (BNEF) predicts global demand will jump 8.5 per cent to 308mtpa; with the increase split roughly between China on the one hand, and Japan, South Korea and India on the other. Asia, where a large proportion of electricity consumption is still powered by coal, will remain the most active buyer for the next decade. "The region will add a total of 143Mt in 2017-30, accounting for 86 per cent of the world’s total LNG demand growth in the period," predicts Maggie Kuang, head of Asia Pacific LNG analysis at BNEF.
A maturing market
Although this trend makes LNG the fastest-growing gas source globally, according to consultancy Wood Mackenzie, the challenge for both buyers and sellers has been to turn long-term, lumpy contracts into a more liquid market. There are signs this is now happening. Around a quarter of production is now sold on the spot market, while the average offtake contract length has almost halved in four years.
That doesn’t mean volatility is disappearing, however. In June (when global demand tends to soften) spot LNG prices briefly leapt to $11.60 (£8.80) per million British thermal units (mmbtu). That was more than 15 per cent of the price of a barrel of Brent crude, a ratio level normally only seen in winter months, when demand is higher. The same HSBC analysts who predicted oversupply at the start of 2017 suggested the spike pointed to "genuine market tightness", and now state that the "cycle is turning faster than we expected".
For the world’s biggest LNG players – Royal Dutch Shell (RDSB) and BP (BP.) among them – the recent shift in supply-demand fundamentals has served to vindicate a collective strategic bet on the market. Conscious of the slowing demand growth for oil, increasing demand for lower-carbon energy sources, and the need to meet Asian economies' rising appetite for energy and better air quality standards, the world's supermajors have put LNG at the centre of their own plans.
In 2017, this supply growth story centred on two countries. Australia added 11.9 million tonnes (mt) of production, thanks in the main to expanded output at the ConocoPhillips (US:COP)-operated plant on Curtis Island, and the Chevron (US:CVR)-operated Gorgon project in Western Australia (in which ExxonMobil (US:XOM) and Shell both hold 25 per cent stakes). In the US, where shale gas production continued to recover, LNG output climbed 10.2mt, thanks to new trains at Cheniere Energy’s (US:LNG) Sabine Pass plant on the Louisiana-Texas border.
Mismatches and tariffs
However, this cosy picture of rising demand and supply may obscure two important choke-points for the market. The first is what Shell in its 2018 outlook for the market termed a "mismatch between buyer and seller needs": buyers' increasing taste for the short-term contracts which keep them competitive, but which come at the expense of producers’ long-term revenue certainty. In effect, this could constrain supply in the next decade, unless financiers can adapt their terms, or deep-pocketed suppliers can rely on lofty demand projections to fund massively capital-intensive projects alone.
To the latter point, Wood Mackenzie research suggesting "emerging signs of improved execution", might provide some comfort, regardless of what the consultancy terms a "looming wave" of projects set for an investment decision.
The second issue involves the latest shot in the trade war – Chinese threats to add a 25 per cent tariff to surging US LNG imports. That risk has added considerable pressure to investments in US LNG projects, (to the potential benefit of proposed developments elsewhere, including Shell’s $40bn project in Canada). Indeed, Morgan Stanley recently estimated that more than $60bn-worth of projects could be stalled or rendered obsolete by a Chinese import hike. Given the scale of US LNG exports to China, we wonder if this may prove an escalation too far for US business.
