Can it be that it was all so simple then? Senior executives in the LNG business will look back wistfully at the halcyon days of the trade in global gas, not long ago. A tight knit group of suppliers; a handful of dominant, well financed buyers with growing demand; the two closely tied by rigid long term contracts all but guaranteeing cash flow visibility for supplier, and molecules for buyer.
The LNG market in 2017 is irreversibly changed, now challenging for seller and buyer alike. Gas is flooding into the market. Since 2015, seven LNG projects have started operations, another 15 are in build. LNG output could grow by more than 100 Mt by 2020 to more than 360 Mt. There is a widening range of suppliers democratising access to LNG supply, not least infrastructure developers in the US.
Global demand is growing, but more slowly than perhaps anticipated, and the market is fragmenting.
Big legacy demand centres like Japan and Korea are in decline, the newly emerging markets immature. Spot LNG prices have sunk to cyclical lows, driven down by oil prices, cheap Henry Hub-linked gas on the high seas, and by the sheer volume of gas looking for a home. Producers and buyers are long of volumes. A dystopian landscape? It’s real enough now, and may get worse still.
How do traditional LNG suppliers, a group dominated by some of the biggest oil and gas producers, play a part in sorting things out? As the industry gathers in Tokyo for Gastech, we think there are four main elements that need addressed.
First, costs. Suppliers need to get lower down the cost curve. The mantra of the oil industry is ‘managing for margin’, to position for prices that may be lower-for-longer. LNG is no different. Managing for margin is about refocusing on the detail - analysing individual asset performance and profitability; managing operations and processes more efficiently. It’s also about portfolio high grading. The step up in LNG M&A activity over the last year is likely just the beginning.
Second, responding to buyer needs. The emergence of a buyers’ club is a sign of stress. Legacy long term contracts offer limited flexibility around the core elements of volume and price. Yet buyers’ markets are changing – gas demand growth affected by the changing fuel mix, advent of renewables and competition for customers as markets liberalise. Volume requirements may be more variable than in the past, or just lower. An uncompetitive cost of gas could spell the demise of a buyer.
Adjusting destination clauses or rescheduling volumes could ease financial pressures on buyers and preserve a long term relationship that might otherwise sour. Flexibility on price, typically sacrosanct, may come into the equation.
New contracts will have a very different form, shorter term and with more built-in flexibility.
Third, ‘portfolio’ wins. Optionality is key in a fragmenting, oversupplied market. Access to multiple sources of gas; prices linked to oil, Henry Hub and regional spot; complemented by trading; these form the bedrock of a modern LNG supply portfolio. Noel Tomnay, our VP of Gas and Power Consulting, argues that traditional, monolithic sellers are already migrating towards this value chain model. Point-to-point suppliers can still thrive, but need to be very low cost.
Fourth, build new markets. Emerging LNG markets are multiplying, but vary in size and timing. A few, like Pakistan or Bangladesh, are plug-and-play – a floating re-gas unit can hook up to an existing gas network. Others need built from scratch. Kerry-Anne Shanks, our Head of LNG Research in AsiaPac reckons these new consumption centres could, potentially, increase the market size by as much as 155 Mt or more than a third in the next 10 years.
But it won’t just happen. The industry needs to do a better job in gas advocacy to ‘sell’ the merits of the product - that LNG is plentiful, clean, reliable and competitive; and should be a platform fuel to support any growing economy in the 21st century. A concerted effort by LNG suppliers could bring wide benefits, enhancing longer term growth and gas penetration, and underpin a new generation of upstream projects. Failure to seize the opportunity risks prolonging the current glut.
Gas has a buoyant future, certainly compared with other fossil fuels.
The downturn presents suppliers with a great opportunity to reshape strategies, reposition, and bolster LNG’s role in the growing global energy market.