Will liquefied natural gas catalyze a global natural gas market?
Even as critics still debate whether liquefied natural gas (LNG) can be made economical to compete against regional gas sub-markets, the growth in LNG trade has many convinced that it has the potential to create the basis for a global gas market.
In fact, LNG trade has more than doubled in the past 15 years. Consumption of LNG is increasing [at a compounded annual growth rate (CAGR) of 4.9 percent] more rapidly than the consumption of pipeline gas (CAGR 3.6 percent). This growth is due to falling investment costs for liquefaction, shipping, and regasification. The cost of liquefaction has more than halved since the late 1960s. Compared to pipeline gas, where transport costs develop proportionally to the number of kilometers covered, LNG already shows a cost advantage upwards of a 2000-km transport route.
The future growth of the LNG market will be driven by four key factors:
- Diversification. Creating a balanced portfolio of procurement resources and supply routes is gaining significance for today's market areas. Japan, representing around 55 percent of the world's LNG consumption, reflects potential shortfalls from producing countries such as Indonesia, Malaysia, Brunei and the United Arab Emirates in its risk management strategies. The European Union (EU), already the world's largest energy importer, will increase its dependency on imports to around 71 percent by 2030. The case of Russia in particular, which currently provides 41 percent of EU gas imports and in the future will supply up to 60 percent, clearly highlights the need to diversify the country risk. In comparison, the EU oil and coal supply is more diversified.
- Purchasing cost optimization. The procurement portfolio of gas suppliers is shaped less by annual purchase volumes and more by availability along the various phases of the load curve. As part of market deregulation, the creation of a procurement portfolio offers the potential to considerably impact margins. This becomes particularly clear if we look at the increasing demand for storage capacity. Since LNG trade has become a lot more flexible in recent years and contracts have become shorter, LNG can play a key role in controlling peak loads on the spot market.
- Network bottlenecks. Despite their enormous supply areas, neither the United States nor Europe has a completely well-balanced network structure at its disposal. According to a GTE (Gas Transmission Europe) survey, 66 percent of the 55 border facilities in the EU lack sufficient capacity. Capital expenditure requirements for a physically integrated EU gas market have been forecast at more than $200 billion over the next 20 years. Additional LNG receiving terminals could at least partially compensate for these network-related market imperfections.
- Intercontinental arbitrage opportunities. New opportunities in intercontinental business are emerging due to enhanced tanker capacities and the availability of other financial instruments, thus enabling new trading strategies, as well as facilitating arbitrage operations. Tanker capacities can now be used for spot markets. LNG arbitrage will enable traders to realize earnings through price differences between market regions.
Due to variations in the initial positions of the three key sales regions, the above factors are responsible for the heterogeneous development of LNG activities. On account of its geographically isolated position, Asia is assuming a key role with 75 percent of LNG imports. Today's LNG market in the Atlantic Basin is still very minor, but could gain importance as producing portfolios undergo change. Increased efficiency in liquefaction and regasification, gas price volatility, and future shortages in existing pipeline gas supplies are making LNG increasingly interesting for the European and United States sales markets.
LNG Development in Europe
Around 90 percent of the current European market consists of pipeline gas; existing LNG import capacity stands at around 51.5 billion cubic meters compared to gas imports of 459 billion cubic meters. Europe is made up of a large number of highly diverse sub-markets. This is explained on the one hand by the varying speed of deregulation in the downstream market, and on the other by the lack of network integration.
Thus it is hardly surprising that in the Iberian sub-market, LNG already covers 44 percent of gas consumption, because the area is not integrated with the rest of the EU. In Spain, 20 percent of the planned capacity for trade activities is not under long-term contract. Following the liberalization of the gas market in France, LNG offers the potential for penetrating the oligopolistic market structure. In 2006, once the contract with Algeria has expired, there will be potential in Zeebrugge for opening an LNG terminal and creating a spot market.
To date Italy has focused its procurement on Algeria and Nigeria. An oversupply of gas is anticipated for Italy based on continued use and additional expansion of the LNG terminal in the North. The road to Central Europe and Germany could run via Italy-thus providing central European energy companies with a new gas procurement option.
LNG Development in the United States
LNG imports to the United States have remained relatively constant in the past and only make up a very low percentage of the American gas supply (under one percent). The relatively high transport costs of LNG imports to the Midwest are only relevant if American gas prices are high. Imports from the Atlantic Basin are economical due to the markedly lower transport costs on the East Coast, starting at gas prices of $3/MMBtu.
Due to the expansion of existing train services and the relatively low associated investment costs, we can anticipate shipping LNG from Trinidad to the United States for around $2/MMBtu in the future. In order to reduce transport costs, there are an increasing number of swap contracts. For example, cargo from Africa destined for U.S. ports sets sail for regasification terminals in Europe, as a swap for cargos from South America initially destined for European ports, who then supply the U.S. terminals "directly."
High volatility in U.S. gas prices will continue to increase the importance of LNG, since price signals triggered by the shortage of supply can only be compensated for by LNG imports, and not production. The ships usually serving the Asian market that have recently been rerouted at short notice to the United States show that the LNG market, which had previously been dominated by long-term contracts, is increasingly receptive to short-term spot trading, and is developing into a flexible market.
New projects such as the involvement of El Paso Global LNG in Snovit, Norway and the activities of Royal Shell/Mitsubishi in Venezuela, both probably destined for Cove Point in the United States, plus the increase in activities at the U.S. import terminals, underline the growing importance of LNG for the United States.
The United States, with its highly liquid gas market, is an interesting sales market for LNG if price formation is based on netback to Henry Hub. Realizing cost effects and exploiting arbitrage opportunities will be key factors in successfully playing the market in the future.
LNG will therefore continue to gain importance for all three sales regions described above. Driven by the upstream business, the arbitrage opportunities in the Atlantic Basin will link the European and American downstream markets. The direct impact on the availability of total volume, or even the price indication above and beyond the Atlantic, appears unlikely in the mid-term on account of the established role of pipeline gas in both regions. Only major changes, such as the collapse of Russian gas exports, could make the LNG market adopt something approaching a bridging function in the interests of a global gas market.
A variety of strategic options are emerging in the downstream market on account of the increasingly significant role of LNG.
1. Procurement and retail issues. The geographical spread of volumes from different (compatible) supply sources with flexible access to a broad base of consumption markets can enhance the exploitation of arbitrage options. Having LNG in the procurement portfolio will give power producers and gas resellers a competitive edge in markets with high volatility in natural gas prices, by providing greater flexibility in handling peaks of gas demand (gas/power synergies). LNG is adopting the function of optimizing the gas procurement portfolio and reducing purchasing costs, with an additional diversification option. Even if projected growth is realized, LNG trading will remain a comparatively small market with limited liquidity. LNG trading activities will only pay out initially if downstream and upstream positions are held. Yet appropriate skills are needed for making the most of this kind of flexibility, especially in the area of risk portfolio management. As deregulation spreads, this will also boost LNG's importance in the retail sector. A detailed understanding of pre-suppliers' price curves and developing flexible procurement strategies will become more and more important.
2. Positioning in the LNG value chain. Players in the LNG market use a wide range of business models to extract value from LNG growth with different levels of integration and globalization. In a simplified matrix, we find four clusters of business models in the LNG market.
The first group can be described as integrated global players like Shell and the ENI group. Their business model covers the full value chain of the upstream and downstream markets. Their future direction will be to expand gas and power trading business activities, and even create a market for gas and LNG by investing in physical assets such as plants or networks. Power plants are seen as a perfect route to optimize the value chain and maximize margins from the integration of gas/LNG and power multi-utilities.
The second cluster contains domestic specialists. Sonatrach could exemplify this kind of upstream-driven model, and might need to expand its position outside the Atlantic Basin. In the third cluster you will find players like Gas de France (GdF) and Gas Natural Repsol, best described as downstream-driven players. Monitoring the movements of single players could indicate how this segment will develop in the future. Gas de France is increasingly focusing on acquiring and developing upstream assets and will become more upstream driven. Growing investments in Latin America indicate geographical expansion.
The fourth cluster could be described as integrated energy players. They can provide gas to end customers, as well as their own power generation businesses. Scale and economics of scope are driving both business segments. Here we find players such as El Paso, Tractebel, Iberdrola, Endesa, Union Fenesa, and Centrica. El Paso is a downstream player with significant upstream assets to support its gas supply operations. Its future direction will be to take a leading role in regions moving towards deregulation in Asia and Latin America. Tractebel will focus on exploiting arbitrage options within the Atlantic Basin and promoting new LNG ventures in Turkey, Mexico, Korea, and the United States.
It is above all the utilities-downstream-driven companies-that have to make some important fundamental decisions with regard to their procurement portfolios. It is here that LNG can play a key role. Involvement along the LNG chain, even it simply takes the form of a long-term contract, creates the potential for emancipating suppliers from the classical importers, and thus achieving a stronger negotiating position. LNG is the key to linking the traditionally distinct upstream and downstream worlds.
-W.H., B.H., M.W., and M.W.
Articles found on this page are available to Internet subscribers only. For more information about obtaining a username and password, please call our Customer Service Department at 1-800-368-5001.