LNG Outlook

Global LNG market is in transformation

Recent years have produced some of the most significant changes in the LNG business, prompted by geographic broadening of demand, increased numbers of buyers and growing supply competition. These trends will accelerate in the coming decade.

Gavin Law, Head of Global LNG and Frank Harris, VP, Global LNG, Wood Mackenzie, Edinburgh, Scotland

From the first commercial shipment in 1964 to the mid-1990s, LNG trade was based almost exclusively on rigid, long-term contracts. Dominated by Asia, the number of countries supplying and receiving LNG was limited. Indeed, the LNG trade defined a fairly exclusive group of countries and companies for over 25 years. Relationships between sellers and buyers were key, particularly in the Pacific basin. Maintenance of long-term security of supply was paramount.

No single event signaled a shift in the status quo since the mid-1990s, but the business has undoubtedly undergone more change in the last five to 10 years than in the previous 30 years. Key developments were:

• Emergence of new Atlantic basin supply projects (particularly Trinidad)
• Emergence of non-traditional players (particularly BG)
• Re-emergence of the US market and development of new markets
• Rapid expansion of Middle Eastern supplies 
• More flexible trading.

This evolutionary surge was induced by market requirements and the competition to supply them. These factors will transform the business at an even greater pace in the next decade, in terms of volume, geography and complexity.

RAPID DEMAND GROWTH
Wood Mackenzie forecasts that global LNG demand will grow at more than 8% annually from 2004 through 2015, with possible double-digit growth in the near term. These impressive rates are multiples of the projected 2.5% annual growth rate for overall global gas demand. A major implication is that the LNG market is set to double within the next decade. Undoubtedly, this is a key reason why LNG is attracting interest.

Such market growth will be visible geographically, and volumetrically. By 2015, we forecast that up to 16 additional countries, from small states such as Cyprus, to huge gas consumers like the UK, will import LNG. This is in addition to 14 countries that imported LNG during 2004. These new importers, combined with liberalization in current importing countries, will set the stage for many new entities to become LNG purchasers.

Demand for gas and, by extension, LNG, will continue to be driven by economic growth. In the established LNG markets of Europe and northeastern Asia, economic growth will create a steady, incremental increase in the requirement for LNG volumes. This is true for direct consumption as well as power generation.

However, significant LNG demand will also come from new markets that experience strong economic growth and development. The coastal provinces of China and India will, potentially, be important sources of demand. Environmental concerns will also help to drive the requirement for additional volumes.

Environmental pressure will be particularly important in Europe, where national and supra-national legislation will require power generators to switch from burning oil or coal to gas, to enhance emissions reductions. However, it is evident that environmental factors will play a key role in gas and LNG markets elsewhere in the world, including China.

DECLINING SELF-SUFFICIENCY IN GAS
Economic growth and environmental pressures will be important demand growth drivers. However, a more significant LNG driver will be the inability of some key countries to remain self-sufficient in gas. These countries face mature production and will be unable to maintain and/or provide sufficient new gas output to meet demand. They will be forced to import significant volumes through one or more mechanisms, including LNG. This scenario should rapidly become reality in two of the largest gas markets – the US and the UK – as well as in smaller markets like New Zealand.

Wood Mackenzie forecasts that the US and the UK will experience marked shortfalls between indigenous gas output and demand over the next decade, creating a significant import need. This opens the door to large LNG volumes in these markets, particularly the US.

As regards the US, indigenous gas output will fail to meet expected demand. Although more distant gas resources, such as Alaska, are available, LNG is proving to be an economic supply choice. In the UK, LNG can be delivered on more economic terms than gas from several competing pipeline projects. These projects originate in other European countries, Russia, Africa or Central Asia.

Thus, Wood Mackenzie forecasts that the UK and North America will have combined LNG demand of around 100 Bcm (3.5 Tcf) in 2010, compared to 16 Bcm (565 Bcf) in 2004. This volume is greater than the 2004 demand in Japan, which is the largest importer at more than 40% of the global market.

The belief that at least some of this incremental demand will be realized is evidenced by the number of LNG regasification projects proposed or under development. This is particularly true in North America, where LNG regasification capacity should treble by 2010.

CHANGING BUYER REQUIREMENTS
As well as volumetric growth in the global LNG market, there will be significant changes in the characteristics of LNG demand, most notably a greater requirement from buyers for price and volume flexibility. Historically, one of LNG buyers’ principal concerns was supply security, particularly in the absence of alternative gas 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 market vagaries, such as seasonal peaks, unexpected demand growth or shrinkage. However, liberalization (or threat thereof) of global gas markets is forcing buyers to adopt flexible contracting strategies.

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. Therefore, major buyers are increasingly using a portfolio of short, medium and long term contracts as well as optional volumes to increase operational flexibility but maintain security of supply.

An interesting example was a contract that TEPCO signed with MLNG Tiga in 2003 that is renewable on an annual basis. The need for flexibility is also driven by seasonality of gas demand, something that could be a requirement in the US and UK markets.

Buyers are also managing price risk, by seeking new types of indexing in contracts that link LNG purchase prices to factors other than the oil price traditionally used. Examples include linking prices to spot market gas prices (such as NYMEX) or to electricity prices, where LNG is used primarily for power generation, and the generator does not want to be at a cost disadvantage against competitors.

There have also been examples of contracts being linked to other competing fuels – for example, to coal in the Iberian market. In the Pacific basin, the Guangdong contract signed between CNOOC and North West Shelf LNG in 2002 signaled a shift toward pricing focused on reducing volatility, and the use of competitive tendering rather than bi-lateral negotiation. However, regional and global market conditions will dictate how flexible suppliers can be.

The other major change on the demand side is that LNG buyers are becoming more active. This compares to their historically passive stance, where they just handled LNG from the discharge port onwards. Key purchasers have expanded along the LNG value chain. They have become involved in shipping and, in some cases, trading, and even liquefaction and upstream.

Motivation for this strategic change is diverse and complex, ranging from a need to develop greater operational flexibility (an example is ownership of shipping) to coping with seasonality and price/ volume risks. This relates to the need to diversify revenue streams, and to take advantage of increased buying power in light of potential excess supply.

ABS expects steady stream of new and larger LNG carriers        With the global LNG market growing at more than three times the rate for oil or traditional gas markets, a constant flow of newbuild LNG carriers and newly developed offshore terminals will be required to accommodate this demand, says international marine classification society ABS. Along with the demand for new vessels come issues that impact the safe development and regulation of transportation technology, and the timely, profitable development of new LNG markets, says William Sember, ABS vice president of Energy Development. These issues include structural design and loads; containment systems; process facilities; mooring systems; cargo discharge and/or loading systems; risk assessment; and risk-centered maintenance approach. “Next-generation LNG ships require advanced technology that addresses the transport system,” said Sember. As of mid-January 2005, the global LNG carrier fleet totaled 175 active vessels. This compares to 154 active vessels on Jan. 1, 2004, for a net gain of 21 ships. The number of new orders for LNG carriers stood at 107 as of mid-January. This compares to just 56 orders on the industry’s books on Jan. 1, 2004. The current number reflects one delivery made, plus two new orders since the beginning of the year. Total capacity among the 175 active ships is 20.6 million cubic meters, a 16.6% increase on the 17.7 million cubic meters available at the beginning of 2004. “Continued LNG demand – increasing from 125 million t/year to a forecast 200 million t/year by the close of the decade – will drive the need for more LNG carriers,” says Sember. According to his figures, there will be 336 ships in the worldwide LNG carrier fleet by 2015. He anticipates fleet growth at a rate of 9.2% annually from now through 2010. Then, from 2011 through 2015, the growth rate is projected to be 4.2% per annum. If the math holds up, the global LNG fleet capacity will grow 46% in just the four years between 2004 and 2008. These new carriers will require greater load capacity to accommodate changing trade patterns. “We’re moving from regional LNG trading to global LNG trading, with longer routes,” says Sember. “Ship sizes, consequently, are expected to nearly double to 250,000 cubic meters from 145,000 cubic meters.” The evolution of LNG carrier capacity has seen boom-and-bust periods. From an original level of just over 25,000 cubic meters in 1965, average capacity grew to about 120,000 cubic meters in the 10-year period ending in 1975. However, over the next 20 years, average capacity increased only 15,000 cubic meters, to roughly 135,000 cubic meters by 1995. Issues impacting the need for larger LNG carriers include terminal compatibility, propulsion, structural design and vessel performance, says Sember. “Containment systems represent a critical component in the evolution of LNG terminals,” he explains. “The three basic containment system designs include membranes, spherical tanks and self-supporting prismatic tanks.” Embodying the latest transportation technology, the Arctic Discoverer LNG carrier was launched on Nov. 2, 2004, in Chiba, Japan. Beginning in 2006, it will transport gas produced from Statoil’s Snøhvit field, offshore Norway. While the shipping industry has perfected LNG containment systems for LNG transportation, the systems, in general, can be migrated in a fairly straightforward manner to terminal applications, according to Sember. This is an important, helpful attribute, considering that no less than 40 to 50 new LNG terminals are proposed worldwide. “We see viable applications being considered for use of both the membrane and independent tank concepts presently in use,” he adds. “The shipping industry has enhanced the basis of design for membrane systems, thus enabling containment systems to handle partial loading conditions and to sustain sloshing loads anticipated with expanded LNG trade.”

COMMERCIALIZATION DRIVES GAS SUPPLY COMPETITION
Gas reserves across the world continue to increase. Commercialization of stranded gas (i.e. gas that cannot be readily piped to a proximal demand center) is becoming increasingly important to both international operators and host governments. While this presents a significant challenge to the industry, the potential rewards are immense, with more than 4,000 Tcf of gas currently discovered but, as yet, uncontracted.

While other monetization routes – GtL, DME and CNG – are gaining momentum, LNG is still the most prominent, feasible option for maximizing stranded gas values. Thus, competition in LNG supply is growing.

Like the growth in LNG demand, there will continue to be an increase in the scale and diversity of LNG supply, Fig. 1. In 1995, global LNG output totaled 67 million t from eight countries. By 2004, it had reached 112 million t from 12 countries, including such new suppliers as Qatar and Nigeria. Within the next decade, overall supply should double, with five or more new countries entering the supply side.

Fig. 1. In just nine years between 1995 and 2004, global LNG output grew by two-thirds. Based on new projects expected to take place (above), global LNG output could double again over the next decade. Click for enlarged view

However, the number of proposed projects has increased exponentially. By 2010, potential supply could exceed incremental demand by a factor of two or more. It is clear that not all projects will meet their proposed timetables. Many projects must be competitive, or be delayed, deferred or abandoned.

BIGGER IS BETTER
An obvious trend toward increased competitiveness has been a focus on economies of scale; from expansion of existing LNG facilities to construction of larger liquefaction trains and ships. Indeed, in the early 1970s, typical liquefaction trains were around 1.3 million t annually, and ships were no larger than 75,000 m³. By contrast, the near future will see trains in excess of 5 million t annually, and ships as large as 200,000 m³. Accordingly, companies continue to strive to reduce unit costs, to maximize returns and their competitive positions.

Although significant scale developments (train and ship sizes) will occur in the next 10 years, it is not yet clear whether this momentum will continue beyond this timeframe. With increasing scale comes the challenge of marketing larger gas volumes and potentially restricted flexibility. It is likely that only large-volume players, such as Qatar and Nigeria, will see further scale developments in both train and ship size tied to long-term, point-to-point trades.

It is also likely that in areas where significant, relatively low-cost gas resources are present, companies and governments will increasingly look at developing integrated complexes incorporating LNG, GtL and other gas monetization processes. Such complexes are being developed in Qatar and Equatorial Guinea.

In addition, suppliers have identified the value of integration in the LNG value chain. Historically, suppliers were content to focus attention on supplying customers and building relationships. Yet, greater competition and market liquidity have meant that creation of market “pull” for proprietary LNG, and exploitation/ protection of margin across the value chain, are growing in importance.

Companies, such as Shell, BP and BG, were the first to identify 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. Indeed, in the last two years, many other key players in LNG supply have followed suit.

INCREASING SUPPLY FLEXIBILITY
While technology developments and integration trends will certainly influence the future LNG supply business, it is the pressures coming from buyers, and the competition for them, that are most fundamentally impacting LNG trade. The shift by buyers toward portfolios of more flexible contracts to manage future uncertainties is forcing a far greater requirement for supply flexibility.

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 being adopted by new supply projects. This risk can be traced partly to buyer need and partly to competitive effects. It is offset, to some extent, by companies’ ability to utilize their integrated positions to transport and place additional, uncontracted volumes.

Companies (such as Shell, BP and BG), through their portfolios of supply, shipping and regas assets, can offer much greater flexibility to buyers without compromising the commercial integrity of supply projects.

Having said this, the industry will continue to be underpinned by long-term, off-take agreements between suppliers and buyers (even if buyer and supplier are different units of the same company). 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, thus meeting the buyers’ demands. 

THE AUTHORS
	Dr. Gavin Law is head of Global LNG, responsible for directing Wood Mackenzie’s worldwide LNG business. He has extensive experience in the analysis of the global LNG sector, with particular focus on the Pacific basin. Prior to his current position, Dr. Law was responsible for all of Wood Mackenzie’s research and consultancy focused on the Asia-Pacific region. Before his 11-year tenure at Wood Mackenzie, he worked at British Gas plc, and as an independent consultant in the UK and Indonesia.
	Frank Harris is vice president, Global LNG, at Wood Mackenzie, having worked at the firm for more than seven years. He focuses on delivering gas/ LNG consultancy engagements, using his expertise in strategy development and market analysis. Prior to joining Wood Mackenzie, Mr. Harris spent four years as a member of Andersen Consulting’s utilities team. During his 11 years in the energy industry, he has been involved in a variety of markets in Europe, Asia, Australasia and the Americas. He graduated from the University of Bradford Management Centre in 1991 with a First Class BSc (Honors) degree in Business Studies.