Buyer deals, seller mergers show changing dynamics in LNG market

Nothing shows the changing nature of the global liquefied natural gas (LNG) market than the creation of super-sized producers and buyers.

The $70 billion merger of Royal Dutch Shell and BG and the joint fuel procurement venture between Japan's top utilities, Tokyo Electric Power Co and Chubu Electric Power Co, are flip sides of the same coin.

On the one hand Shell is trying to create a natural gas giant, with quality assets around the globe, able to bank on economies of scale and have the ability to meet the needs of a diverse range of clients.

On the other, Tepco and Chubu have created the world's biggest buyer of LNG to secure the best possible deals and ensure that the balance of market power permanently shifts toward consumers.

Both sets of companies are responding in their own ways to the reality that LNG is a market that is moving from global deficit to oversupply.

While not as dire as iron ore, there are some similarities in the way the LNG market has developed.

Just like iron ore, major LNG producers took the view that demand growth for the super-chilled fuel would be strong for an extended period of time, led mainly by China, but also in emerging economies in Southeast Asia and in India.

This led to a surge in projects, with seven greenfield LNG operations starting construction simultaneously in Australia in the past years, with additional plants being built in other countries, including the United States and Russia.

While Chinese demand has continued to rise, its gains haven't been quite as fast as producers had expected, with imports rising 10.3 per cent last year to 19.85 million tonnes.

This is still well short of forecasts for 60 million tonnes of annual imports by 2020, a figure that is achievable but will rely on not only the Chinese building planned import terminals, but also on continued policies to limit the use of coal.

Price will also play a part in China's import growth, with the current low prices likely to support demand, especially as LNG moves ever closer to cost-parity with coal when used in power generation.

Spot Asian LNG prices <LNG-AS> held steady at $7.10 per million British thermal units (mmBtu) last week, but are down almost 30 per cent so far this year and are about one-third of record $20.50 per mmBtu reached in February last year.

Structural LNG Change

With the first of the seven new Australian ventures now exporting, and the others due to start in a range from later this year to 2018, the market is likely to enter a structural surplus, which will keep a lid on LNG prices.

This will be even more the case when the four U.S. plants currently under construction start to add their fuel to the market from 2016 onwards, with both the U.S. and Australian producers largely targeting the same Asian buyers.

The iron ore experience also shows that the producers best placed to survive a supply-led price slump are the ones with the lowest cost of production and sufficient scale.

While this may sound obvious, it largely explains the motivation behind Shell's deal with BG.

The two companies' operations in Australia provide a case in point, with BG already producing from its Queensland Curtis coal-seam gas to LNG project while Shell shelved plans for its Arrow venture with partner PetroChina.

Putting the Arrow assets into the Queensland Curtis facilities is likely to add significant value to projects, as well as guaranteeing sufficient reserves for any future expansions.

The combined company will also have about 20 per cent of the global LNG supply, which will likely provide an advantage in negotiating sales in a market that is increasingly favouring buyers.

Tepco and Chubu's fuel-buying venture, to be called Jera, will account for about 16 per cent of global demand and will knock Korea Gas Corp off the perch as the world's top buyer.

It's likely that the new venture will be seeking to lock in the gains already made by buyers, who are keen to move away from inflexible, oil-linked contracts while still maintaining security of supply.

Once trends start, they tend to become hard to change, and the trend in LNG pricing is now toward shorter-term contracts, more flexible pricing and fewer restrictions on destinations or re-selling.

This works in the buyers' favour for as long as the market is in oversupply, as it increases their options on where to source cargoes and how to pay for them.

But LNG's surplus may not last as long as buyers hope, given the enormous cost in bringing new capacity to market.

Already there are signs that the major capacity expansions planned in the United States, Canada and East Africa may not go ahead in light of the current low prices and uncertainty over the strength of future demand.

But the beauty of Jera is that it will be valuable to its owners in both good times and bad, just as Shell bulking up with BG may give it an edge over competitors.

COMMENT NOW