Shell (RDS.A, RDS.B) was the first major Oil & Gas company to make a final investment decision regarding a Floating LNG facility back in 2011. Last week I wrote this article about Shell's new Floating LNG technology titled: "Why The World's Largest Ship Is A Big Deal For Shell". The article provides an insight in Shell's prestige Prelude Floating LNG project and the strategic advantages of Floating LNG facilities. The capital expenditure for Prelude will be around $10.8 billion to $12.6 billion. The competition is following Shell's FLNG project closely, because they experienced budget overruns at onshore LNG projects in Australia. On April 2, 2013 a consortium of ExxonMobil (NYSE:XOM) and British Petroleum (NYSE:BP) announced they are considering an even larger floating vessel for the development of their Scarborough natural gas fields in Australia. The consortium has not made a final investment decision yet. The final investment decision will be made in 2014 or 2015. This article argues why the consortium should invest in floating LNG technology for the Scarborough natural gas fields in Australia.
Demand for Australia's LNG
According to the comments on my previous article about Shell's Prelude FLNG project, some investors doubt demand for Australian LNG will keep growing in the future. Deutsche Bank estimated total global demand for LNG rose by a 7.6 percent per year in the period 2000-2012, three times faster than the average increase in total global demand for natural gas over the same period. LNG is growing at a faster rate compared to natural gas, because of a strong demand from Asia and several environmental issues. I expect demand for Australian LNG to keep growing at a faster rate than 'normal' natural gas, because of the following reasons:
1. Japan is allocating its national energy mix (see this article). Prime Minister Abe stated "his administration will try to reduce as much as possible Japan's reliance on nuclear power." I don't expect Japan to shut down their nuclear energy program completely in the long-term. Still, a shift in Japan's long-term national energy allocation could stimulate demand for LNG in the future.
2. Global warming is still an issue (see this article). To meet emission targets, nations are looking for cleaner fossil fuels. The production of natural gas at a power plant produces half as much carbon dioxide compared to the power plants producing energy out of coal. Because FLNG does not require transportation from a gas field to an onshore facility, LNG will become even cleaner.
3. Demand for LNG in China and India is growing fast. China reported their climate goals for 2011-2015 in China's 12th Five-Year Plan. According to the plan, natural gas will represent 8 percent of China's energy mix in 2015, more then double the 3.9 percent in 2010. If China realizes their long-term goals, natural gas will represent more then 10 percent of China's energy mix in 2020.
4. Strong demand for LNG in the heavily industrialized countries South Korea and Taiwan will continue to be strong. To support my argument, Shell signed an agreement with Taiwan's CPC Corp for the supply of 2 million tonnes of LNG per year for a period of 20 years (see this article), starting in 2016. It is most likely the supply will come from Shell's Prelude FLNG facility.
According to E&Y's report "Global LNG: will new demand and new supply mean new pricing?" the average annual growth in LNG demand will be around 5-6 percent per year through 2020. After 2020, the average growth in demand will be around 2-3 percent per year. As a result, total global demand for LNG in 2030 could be double the total global demand for LNG in 2012. The projected global LNG demand is displayed in the graph above. Demand for LNG in Japan, Korea and Taiwan (JKT) is stable and demand for LNG in Other Asia is growing very fast. This favors demand for Australian LNG in the future, while demand for Australian LNG depends on the demand from Asia.
Price for Australia's LNG
Global natural gas spot prices differ a lot. The price for United States natural gas is lower than the price for Asia-JCC natural gas (see the graph below). The price for the United States natural gas was 6 times lower compared to the price for Asia-JCC natural gas. This differentiation in prices can be explained by traditional supply and demand factors. Supply in Asia is tight and demand is strong. Demand for natural gas in Asia boomed after the nuclear crisis in Fukushima and the (temporary) closure of all nuclear plants in Japan, where supply did grow in a more moderate pace. This drove Asia-JCC prices through the roof. On the other side of the ocean, the United States shale gas supply boomed, where demand posted a moderate growth rate due the financial and economical crisis. Therefore, the United States natural gas price fell sharply in recent years.
In the past, long-term LNG contracts have been linked to the crude oil price. Nowadays, natural gas sellers find it harder to seal long-term LNG contracts with their customers. First, the link between oil- and natural gas prices is a contradiction. The supply for oil becomes more scarce, while there is plenty supply for natural gas available. Second, the customers become more price-sensitive, as a result of an increase in spot-price-based LNG exports from the United States and Russia. For example: the United States will become a net exporter of natural gas by 2020 (see the graph below). As a result of increasing export from the United States and Russia, Australian natural gas sellers face pressure on the prices for Australian LNG.
Major Asian customers would like to renegotiate existing LNG contracts. The customers would like to break the link between the oil- and natural gas price in their contracts and link the Asian natural gas price to the United Stated natural gas price. The customers expect this eventually will lead to lower natural gas prices in Asia. International Energy Agent's natural gas analyst Ann-Sophie Corbeau doubts this is a good idea: "Do they really want to make a 20-year bet that US gas prices are going to stay at $3?" Her statement implies she is convinced the United States natural gas price will not stay as low as it is right now. If so, this will mitigate the unfavorable United States export advantage to some extent, which is positive for Australian LNG producers.
The future price for Australian LNG seems to be a bit unfavorable for Australian LNG producers. First, LNG producers will face difficulties to seal long-term contracts. Second, LNG producers face price pressure as a result of low priced natural gas exports from the United States and Russia. This will partly be offset, because the EIA expects the United States natural gas price will not stay as low as it is. Still. I recognize some potential risks for Australian LNG producers (onshore and offshore), because today's investment decisions are based on a scenario where natural gas prices will steady increase.
According to this matter, Shell proved itself a favor by sealing a 2 million tonnes deal for their Prelude FLNG project. Shell secured more than half of Prelude's LNG production and also secured (to a certain extent) a long-term price agreement, although no statements were made regarding the price details of the contract.
CAPEX for Australia's LNG
In contrast to the United States shale gas, Australia's LNG is quite hard to produce. In recent years, the total capital expenditure (hereafter: CAPEX) for new onshore and offshore LNG projects increased significantly. In fact, average CAPEX more than doubled. According to Deutsche Bank analysts, the average CAPEX for recently announced projects is more than $2.6 billion per mtpa compared to an average of $1.2 million per mtpa for currently operating projects and Credit Suisse favors proposed LNG projects in North America and East Africa over the proposed Australian projects due to lower up-front CAPEX. This proves the need for more efficient production technology in Australia.
In my article about Shell's FLNG facility, I argued that FLNG technology has several cost saving advantages compared to traditional onshore production techniques. Shell's head of Australian operations confirmed my theory. He stated in a Western Australia government's hearing: "Liquefied natural gas technology can deliver 30 per cent-plus reduction in up-front capital costs over traditional land-based LNG plants." This will more than offset small differences in operational expenses. The statement by Shell in front of Western Australia government officials indicates the importance of FLNG technology for future LNG projects in Australia.
The demand for Australian LNG will increase more than the average increase in demand for natural gas, due to increasing demand in Asia (especially Japan, China and India) and environmental issues. On the other hand, the market doubts the future Asian-JCC price for natural gas will be as high as it currently is, because cheaper United States natural gas will become available for Asian customers and the Asian customers become more and more price-sensitive. However, the EIA questions whether the United States natural gas price will remain as low as it currently is. Finally, the sharp rise in CAPEX for proposed projects in Australia shows the need for major Oil & Gas companies to switch to more efficient production technologies, like FLNG. Considering all of the arguments mentioned above, the ExxonMobil and BP consortium should decide to develop a FLNG facility. They should also have to make sure they seal some up-front supply contracts, like Shell did with their Prelude FLNG project, in order to prevent budget overruns.
Disclosure: I am long RDS.A. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.