Natural gas and LNG
trade a global
perspective
New
dynamics within the gas
industry will accelerate its ability to eclipse oil as the premier fuel
of the
world economy
Oil prices have been
very
volatile on the upside. However, oil prices are nothing compared to the
natural
gas (NG) price roller coaster. Why is NG now selling for about
$7/million Btu
(or Mcf, 1,000 cubic ft) when just a few weeks ago it was over $16?
Given the
short supply caused in part by hurricanes in the Gulf of Mexico and
strong
demand, some analysts were convinced that the $20 NG would be common on
the US
East Coast no later than Christmas Eve 2005. Of course, that didn't
happen.
Blame or credit warmer weather, NG prices fell.
So
what are the forces in play here? We believe that price is no longer
the defining
issue for the NG market. Supply is. And supply issues are
causing major price fluctuations. Even small supply-side
changes-excess gas or
a shortage of gas, real or perceived by as little as 0.5%-are being
amplified
by the market. This is a function of the cost of bringing new NG
supplies
online, especially the real intractability of existing sources.
Market
psychology, perhaps irrational in either direction, has taken over.
Four
years ago, we
calculated the "equilibrium price" of NG for the US using data and
full-cycle economic analyses. The calculation was done to find the
required
price for a company to get a return on its investment. We used
"activation
index" -how many dollars are required to deliver one Mcfd NG plus the
observed production decline rates and the reported operating costs. For
the US
as a whole, the average equilibrium price was about $2.50, but such
average
pricing is of little use because local equilibrium prices ranged from
$l/Mcf to
$4.75/Mcf.
Calculating the national
equilibrium price is an enormous headache to gather the required data.
Yet, the
equilibrium price would probably not result in much difference in the
price. This
is why, four years ago, we said that if anybody can bring liquefied
natural gas
(LNG) in the US for $3.50/Mcf would find a very inviting market share.
Several
companies acted on this advice.
What about domestic production?
Nothing shows the
maturity of the US oil and gas business than the hopelessness of
substantially
increasing domestic production no matter how much drilling is done and
no
matter how much politicians exhort the virtues of "energy
independence." Maturity in petroleum production implies several factors
in
a combination of one, two or all three factors: reservoir pressure
decline,
water influx into the production zone or exploitation of less and less
geologically attractive zones. Simply stated,
it takes 200 to 250 successful oil wells in the continental US to equal
the
production of one average Saudi Arabian well.
For NG, the situation is
actually equally bleak if not worse. For the last four years, the
number of
rigs drilling for gas increased from a little less than 700 to almost 1
,200-a
70% increase. And yet, NG production has remained flat to slightly
declining.
The geological and
physical requirements for increased production are simply no
longer there. The
increase in drilling activity, fueled by the recent unprecedented NG
price
increases, is barely slowing down the inevitable decline of domestic
production.
So
what does this mean for gas users and investors? Get used to
volatility.
Now that NG prices are declining, we believe they could fall yet
further. But
don't be surprised if NG prices increase to $16+ if we have a hot
summer and/
or a cold winter. This volatility will continue until the US begins
receiving
on a regular daily doses-several billion cubic feet (Bcf)-of LNG.
Importing LNG
is the only answer to US' predicament but the solution is at least two
years
away.
US is not alone on NG issues.
The UK, the world's other
major deregulated gas market, is experiencing similar
problemsdeclining
domestic production and how to secure supply in advance of completion
of major
import facilities.
Likewise, the UK is also experiencing highly volatile NG prices driven
by winter supply (or lack of it), with more substantial seasonal swing
than in the US. The forward price curves for NG in the UK and US
suggest such price volatility will persist, at least until 2008 when
new LNG (and pipeline in the case of the UK) import facilities become
functional (Fig. 1).
In 2006, the security of LNG supplies over pipeline supplies from
third-party countries was highlighted by two events in Europe:
• Ukraine and Russia disputes in January 2006 led to brief cuts in
Russian supplies to continental Europe.
• Inability of the Interconnector (Bacton to Zeebrugge) pipeline
connecting UK with mainland Europe to respond to market forces and
supply gas shortfalls in the UK's deregulated market at premium prices
with gas from substantially regulated markets of continental Europe in
spite of pipeline capacity being available.
The latter issue has caused several NG price spikes in UK between
October 2005 and March 2006. Price spike in March were made worse by a
fire in the UK's largest gas storage reservoir (Centrica's Rough
field), taking the facility offline for several months. On March
13,2006, UK NG prices at the National Balancing Point (NBP) rose from
60 pence/therm (~$10.5/MMBtu) to 200 penceltherm (~$35/MMBtu) across
the day. With the new LNG receiving terminals and direct pipelines from
Norway (2008), the UK's dependence on controlled continental European
gas market behaviors will become less important.
State of NG
NG is the world's second largest source of primary energy. It accounts
for about 23% the total world energy demand, currently estimated at 450
quads (quadrillion Btu). By coincidence, one quad is also very near one
trillion cubic feet (Tcf). Thus, the world consumes approximately 100
Tcf ofNG. In addition, NG also provides about 23% of the US' energy
consumption, which is about 105 quads.
NG is the cleanest burning fossil fuel and produces less emissions and
pollutants than crude oil or coal. Since the early 1970s, NG world
reserves have steadily increased at an annual rate of 5%. Similarly,
the number of countries with known reserves has also increased from
around 40 in 1960 to about 85 presently.
While NG abounds throughout the world, facilities to receive and
distribute this product to market are limited. These facilities include
pipelines across land masses and LNG transports across the oceans. Once
new LNG facilities come online in the US, starting in late 2007 or
early 2008, NG will undoubtedly emerge as the dominant fuel, first for
power generation then, in the longer-term for transportation-a far more
demanding energy transition.
Developing world
China and India are racing from the developing world to economic
superpower status. But nations are using very different approaches.
China is applying a manufacturing agenda; India is developing a
services
approach. Together, China and India will usher in a broader and more
powerful strain on globalization that will put more pressure on the
developed world.
The rapid growth in China and India over the last few years is
unprecedented, precipitating huge demand increases for all energy
resources. Result: The rest of the world is scrambling for the same
energy sources including NG. The US, with the largest and most pressing
energy needs, is hampered by the myriad of permit approvals required
for LNG siting.
Transportation is an
essential aspect of the gas business, since NG reserves are often quite
distant from consumer markets. NG is far more cumbersome than oil to
transport, and most gas is transported by pipelines. There is a
relatively well-developed network in the former USSR, Europe and North
America. However, in its gaseous state, NG is quite bulky. A
high-pressure pipeline can transmit only about a fifth of the amount of
energy per day, which can be transmitted in an oil pipeline, even
though gas travels much faster.
When gas is cooled to -160°C (-260°F), NG becomes liquid and is
much more compact-occupying 1/600 of its gas volume. Where long
overseas distances are involved, transporting NG in its liquid state is
more economical. The LNG industty is set for a large and
sustained expansion as improved technology has
reduced transportation costs of formerly stranded NG reserves as a
liquid to consumer markets.
New Liquefaction projects in
planning/development, 2005
Location of China's
new LNG terminals
This shift of the dynamics for the NG market will further commoditize
NG globally.
LNG carriers are up to
1,000 ft long, and require a minimum water depth of 40 ft when fully
loaded. The existing global fleet of LNG carriers in the first-quarter
2006 is 194 vessels with 11 million tons of LNG capacity. New building
orders for LNG carriers are 120; thus, the future fleet will have 300
vessels before 2010. The fleet was just 90 vessels in 1995 and 127
vessels in 2000. The current fleet annually transports more than 120
million metric tons of LNG (converted to 6.5 Tcf), about 25% of world
gas trade and 6.5% of total NG use.
LNG transport and trade
The need to transport NG across oceans has developed an international
LNG trade, with major investment in infrastructure required to
construct NG supply chains (Fig. 2). The first LNG shipments were made
on a trial basis in the early 1960s between the US and UK. In addition,
during 1964, startup of the first commercial-scale LNG project to ship
LNG from Algeria to the UK occurred. Since then, LNG trade has grown
steadily and has formed an increasing proportion of international
trade. International LNG trade began in 1954. Its success led to the
first commercial base-load international LNG project in 1964 between
Algeria and the UK for a 15-year contract. This was followed by
ventures between Algeria and France in 1965, and Alaska and Japan in
1969.
Gas exports grew about 10 fold between 1966 and 1980. For exporting
countries, flared gas in Abu Dhabi and Libya, or surplus NG, could be
exported as LNG to generate foreign exchange. LNG projects provided an
important option for developing countries with abundant, under-utilized
NG reserves. Most of the global LNG supply comes from countries with
large NG reserves. These countries include Algeria, Australia, Brunei,
Indonesia, Libya, Malaysia, Nigeria, Oman, Qatar, and Trinidad and
Tobago. Egypt is the latest nation joining the LNG exporters in 2005.
In the near future, countries such as Norway and Russia, with the most
impressive NG reserves, will join the league of LNG-exporting nations.
In spite of holding large NG reserves, political instability continues
to delay Iran and Venezuela from exporting significant gas either by
pipeline or LNG. Recently, plans to construct new gas liquefaction
plant have mushroomed around the world with many new countries entering
this industry.
Consuming countries are
developing LNG infrastructure.
These nations are looking at LNG not just in terms of diversification
and cleaner energy production (Fig. 3), but also because they are
moving toward or already experiencing energy supply deficits.
Therefore, LNG is attractive to many consuming nations: o Those
without significant reserves, seeking reduced oil dependence, such as
Japan, South Korea and several European nations
Those whose indigenous industries have hit or passed peak output, such
as the US and UK, which have highly developed gas delivery
infrastructures but are increasingly becoming net energy importers.
Developing economies that are energy hungry for fast domestic economic
growth such as China and India. Both nations have underdeveloped
delivery infrastructures but possess the potential for huge growth for
end-users.
China has
dominated the world energy action over recent years and will become
even more active in the future. China's oil majors-CNOOC, Sinopec and
CNPC-have embraced LNG.
Currently, 18 LNG regasification facilities have either been announced
or are under construction (Fig. 4). CNOOC is Chinas leader
in the LNG race. Chinas first LNG terminal in Guangzhou (a joint
venture between CNOOC and BP) was scheduled to be online by mid-2006.
This facility will receive the first LNG shipment with Australia as the
originating country. China's second LNG terminal, also controlled by
CNOOC, is located in the Fujian Province and is expected to be in
operation by the end of 2007. A third regasification terminal is
planned for the Zhenjiang Province. Given the rising LNG price in the
global market, we expect several of Chinas LNG projects to be delayed.
Some delays may become cancellations (Fig. 5).
Chinas decision to sanction LNG receiving terminals in 2002 and 2003
were fortuitously timed in a buyer's market. China was able to secure
excellent long-term prices for LNG (nearly $3/MMBtu). In the high oil
and gas price environment that has evolved, sellers' price expectations
have increased substantially. The latest round of regasification
terminals being planned in China (and India) are struggling to reach
price agreements with LNG suppliers. Indeed, some contracts signed in
that LNG buyer's window of opportunity (2001 to 2003) are now under
pressure from sellers to renegotiate the gas price upward. High prices
are expected to slow down or even postpone several planned
projects.
There are 52 LNG receiving terminals located worldwide, primarily in
Japan, South Korea and the US (as shown in Tables 1 and 2). Several
European countries also import LNG. For countries that entered the LNG
trade before 1973, imported gas prices were cheap, especially when
compared to alternative resources. Between 1973 and 1979, LNG prices
remained competitive, although they were increasingly linked to the
prices of petroleum products. In countries with a serious pollution
problem, LNG had a premium value as a cleaner fuel. For other
importers, LNG provided an economic way of diversifying energy sources
to improve the total security of supply. For both buyers as well as
sellers, LNG became a proven means of supply, which was technically
reliable and safe and also offered the most economic means of bringing
large NG volumes to markets where delivery by pipeline was impractical.
In the 1970s, much larger projects were planned to exploit economies of
scale in liquefaction and to meet growing energy demand. The first
large-scale project was the Brunei exports project to Japan in 1972.
LNG trade grew more rapidly than the gas-export market as a whole, and
its share increased from 7% to 19% of total gas trade in 1982. However,
in 1983, when the actual implementation of projects under construction
began, international LNG trade virtually stopped growing. Some proposed
projects-such as the ones from Iran to the US and Japan, and from
Algeria and Nigeria to the US and Europe-were not carried out due to
economic and political reasons. Some projects were cancelled, while
others are waiting to be reactivated in either their original or a
different form.
Currently, trade is concentrated in two main areas-the Pacific Rim and
Atlantic Basin. In the medium term, LNG exporters will be more diverse
than their gas reserves may suggest. LNG exporters, until 1999, were
predominantly concentrated in the Pacific Basin, exporting to Japan and
South Korea, for whom LNG comprised their national NG consumption.
However, the exporting countries and destinations for LNG exports are
expanding rapidly: o LNG trains came onstream in Trinidad and
Tobago, and Malaysia in 2003.
Egypt joined the ranks of LNG exporters bringing the total number to
15, from 9 in 1997.
The Spanish Egyptian Gas Co.'s (SEGAS) LNG Source SP Statistical
Review, June 2005 complex in Damietta came onstream in fourth- quarter
2004 and will export LNG to the Spanish market via a new receiving
terminal at Sagunto, Spain.
Iran, which has the world's second largest NG reserves, has three
projects underway. Combined capacity of the projects is approximately
24 million tpy, which is equivalent to 1.15 Tcf. The entry of
companies such as British Gas (BG) into the market and the re-emergence
of the US market are reshaping the LNG/NG market. One change is the
relationship between suppliers and buyers, the point of origin and the
end-point of LNG shipments. Historically, one of the LNG buyers'
principal concerns was supply security, particularly in the absence of
alternative NG sources. Thus, many buyers developed a portfolio of
long-term, relatively inflexible contracts with suppliers. In addition,
some buyers used spot or short-term purchases to manage seasonal peaks,
unexpected demand growth or shrinkage. However, changes in the global
NG markets are forcing buyers to adopt flexible contracting strategies.
Buyers and sellers
Buyers do not want to get into a situation where they lose key
customers to competitors and suffer a significantly reduced LNG
requirement. At the same time, they do not want to be required to pay
for volumes that they don't need under the take-or-pay provision of an
inflexible, long-term supply contract. So, major buyers are
increasingly using a balance of short-, medium- and long-term contracts
as well as optional volumes to increase operational flexibility but
maintain supply security. Buyers are also using new types of
indexing in contracts that link LNG purchase prices to factors other
than oil price. In some cases, LNG price is linked to spot-market gas
or coal prices in which these fuels are the main energy alternative.
LNG buyers have expanded along the LNG value chain. They have become
involved in shipping, trading, liquefaction and distribution. This
strategic change is motivated by the buyers' need to develop greater
operational flexibility for dealing with seasonality and price/volume
risks. This relates to the need to diversify revenue streams and to
take advantage of increased buying power in a market of potential
excess supply.
Stranded gas
Globally, NG reserves are increasing. Commercialization of stranded gas
is becoming important to both international operators and host
governments. The potential supplies exceed 4,000 Tcf of gas currently
discovered but, as yet, not contracted. While other gas monetization
methods such as gas-to-liquids (GTLs) and compressed NG are becoming
competitive, LNG is still the most prominent, feasible option for
maximizing stranded gas values (Table 3). Thus, competition in LNG
supply is growing.
A trend toward increased competitiveness has increased the economies of
scale-from expansion of existing LNG receiving facilities to
construction of larger liquefaction trains and ships. Higher materials
and services costs and skilled manpower shortages in the LNG industry,
due to the high demand, have put a slight damper on progress toward
lower unit costs for facilities. However, few expect such challenges to
seriously impact the growth of the LNG industry in the medium- and
long-term.
In areas where significant, relatively low-cost gas resources are
present, companies and governments will look at developing integrated
complexes incorporating LNG, GTLs and other gas-monetization processes.
Such complexes are now developed in Qatar and Equatorial Guinea. In
addition, suppliers have identified the value of integration within the
LNG value chain. Historically, suppliers focused attention on supplying
customers and building relationships. Now, greater competition and
market liquidity have increased the importance of proprietary LNG
processes and improved margins at every point across the value chain.
Companies, such as Shell, BP and BG, recognized that access to markets
and the ability to control each part of the value chain would assist in
monetizing reserves. It also would allow the flexibility required to
exploit evolving opportunities. Other key players in LNG supply have
followed their lead.
Although projects historically required a high proportion of long-term,
off-take commitments before a final investment decision was made, a
greater level of volume risk is now adopted by new supply projects.
This risk can be traced partly to buyer need and partly to competitive
effects. It is offset by the companies' ability to utilize their
integrated positions to transport and place additional, uncontracted
volumes.
The LNG industry continues to be supported by long-term agreements
between suppliers and buyers. But there will be increasing market
liquidity and increasingly integrated portfolios. A greater proportion
of the market will be traded on shorter-term or more flexible
arrangements because of the buyers' stronger market position.
LNG as a tradable commodity is emerging into a full-fledged financial
complex, and will add to that complex by providing a physical arbitrage
between different regional markets. While neither a political nor an
environmental panacea, LNG offers a global commodity that can meet the
greater demand for NG. The combination of secure energy supplies,
higher NG prices, lower LNG production costs and rising NG imports with
increasing demands for clean energy in developed and developing
nations, and the desire of gas producers to monetize NG gas reserves,
are setting the stage for increased LNG trade. Global LNG demand has
grown from the first 260-Mcfd commercial LN G export in Arzew, Algeria,
in the early 1960s to a forecasted demand of200 million tpy in 2008.
This is equivalent to almost 11 Tcf of NG, more than 40,000 times the
volume of that first trade. This demand is expected to exceed 500
million tpy by 2030 with the average plant sized at 5 million tpy.
To meet this demand, the LNG industry is rapidly expanding its export
facilities. Until 2000, the trend was to increase the liquefaction
train capacity to fully benefit from the economies of scale. Since
2000, the wider spread in train capacity ranging from 3 million tpy to
8 million tpy per train. High-capacity trains are the most economic
when reserves are abundant and easy to produce. Projects with
lower-capacity trains can also be economically attractive, if not all
of these conditions are fulfilled
One obstacle is a possible short-term response from the strategists of
the US and UK governments to respond to short-term gas price volatility
and recent winter gas price spikes by sanctioning new nuclear-power
plants on a massive scale. This would probably not dampen growth in the
gas infrastructure developments in the medium term, but could have a
long-term impact on the share gas ultimately takes in the primary
energy mix. It is certainly in the interests of the gas industry to
explain very clearly to government that price volatility is something
that can be cured by investment within LNG infrastructure.
Outlook. The US and the UK have entered a new era of importing NG.
China is about to join them. These new importers will provide a new
dynamic to the NG industry that will accelerate its ability to eclipse
oil as the premier fuel of the world economy.
Saeid Mokhatab is an advisor of natural gas engineering research
projects in the Chemical and Petroleum Engineering Department of the
University of Wyoming, as well as an international associate of David
Wood & Associates in Lincoln, UK. His expertise lies in the area of
design and operations of natural gas transmission pipelines and
processing plants. He has participated as a senior consultant in
several international gas-engineering projects, and has published more
than 50 academic and industrial-oriented papers, reports and books. He
served on the board of SPE London Section during 2003-6 and is
currently a member of Offshore Technical Committee for Pipeline Systems
Division (PSD) of ASME's International Petroleum Technology Institute,
ASME/Offshore Technology Conference's General Program Committee, ASCE
Pipeline Research Committee and SPE.
Michael J. Economides is a Professor at the Cullen College of
Engineering, University of Houston, and the Managing Partner of a
petroleum engineering and petroleum strategy consulting firm. His
interests include petroleum production and petroleum management, a
particular emphasis on natural gas, natural gas transportation, LNG,
CNG and processing, advances in process design of very complex
operations, economics and geopolitics. He is also the Editor-in-Chief
of the Energy Tribune. Previously, he was the Samuel R. Noble Professor
of Petroleum Engineering at Texas A&M University and served as
Chief Scientist of the Global Petroleum Research Institute. Prior to
joining the faculty at Texas A&M University, Professor Economides
was the Director of the Institute of Drilling and Production at the
Leoben Mining University in Austria. Before that, Dr. Economides worked
in a variety of senior technical and managerial positions with a major
petroleum services company. Publications include authoring or
co-authoring of 11 professional textbooks and books, including The C%r
Of ai/ and 200 journal papers and articles. Dr. Economides does a wide
range of industrial consulting, including major retainers by national
oil companies at the country level and by Fortune 500 companies. He has
had professional activities in over 70 countries. In addition to his
technical interests, he has written extensively in wide circulation
media in a broad range of issues associated with energy, energy
economics and geopolitical issues. He also appears regularly as a guest
and expert commentator on national and international television
programs.
David Wood is an international energy consultant specializing in the
integration of technical, economic, risk and strategic information to
aid portfolio evaluation and management decisions. He holds a PhD from
Imperial College, London. Research and training concerning a wide range
of energy related topics, including project contracts, economics, gas I
LNG I GTL, portfolio and risk analysis are key parts of his work. He is
based in Lincoln, UK but operates worldwide.
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