Shale gas shakes up global LNG market amid export rush

North American supply glut complicates long-term deals linked to oil prices

November 01, 2012

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Illustration Pete Ryan

Shale gas casts a wide net. In short order, the so-called supply revolution in North America has cut prices, battered stocks and hastened asset sales.

To make matters worse, the glut now threatens to undermine a pricing mechanism producers are counting on to justify the enormous cost of building infrastructure needed to export liquefied natural gas (LNG) from Canada’s West Coast. Energy-hungry utilities in Japan and South Korea are increasingly reluctant to pay oil-indexed prices for cargoes of the frozen gas, raising fresh risks that North American projects could be jeopardized.

“Right now, for the first time, you’ve got Asian buyers who are looking around the planet and saying, ‘how can I justify a price of $14, $15 or $16 per MMBtu, when on the other side of the ocean I know that that gas is being sold for $2 or $3?” says Tom Valentine, a partner in the Calgary office of Norton Rose Canada LLP and a former senior counsel with Qatar Petroleum, the world’s No. 1 LNG producer.

“And they’re saying, ‘with all that wonderful supply potential, why would we commit for 15, 20 or 25 years on a long-term price?’”

The question has dogged the leading Canadian export foray. Apache Canada Ltd. has struggled to find buyers since getting the go-ahead from Canadian regulators to export up to 10 million tonnes of super-cooled gas per year over 20 years to overseas markets from a new marine terminal at Kitimat, British Columbia.

One reason is price. “We could have sold this thing out a year ago, but we’re not prepared to sell it at dollars that don’t make sense,” Kitimat LNG vice-president David Calvert said Oct. 2 in Calgary. “We won’t do it.”

Houston-based Cheniere Energy Inc. has agreed to sell gas from its Sabine Pass export terminal based on Henry Hub prices. That arrangement has “created quite a ripple through the marketplace” and led to “unrealistic expectations” among Asian gas buyers seeking prices that challenge the economics of new, greenfield projects, Calvert said.

The emerging price war is unfolding amid broader market changes. Worldwide LNG production is poised to accelerate in 2015, as up to 114 billion cubic meters per year of new supplies hits global markets, according to a medium-term forecast by the International Energy Agency (IEA).

The surge will gradually lead to more gas-on-gas competition internationally, IEA executive director Maria van der Hoeven said Aug. 15 in Calgary. The three major regional gas markets – North America, Europe and Asia – will “converge more than they are doing now” as shale gas becomes a global supply source, she says.

For North American export projects, that raises questions about whether terms of legacy LNG sales contracts in Asia-Pacific markets– crude-based with a reference to the Japan Customs Cleared price, or JCC – can be maintained as natural gas becomes a more fungible product on the global stage.

The erosion of a hard link between oil prices and LNG is a “huge risk” for North American export schemes, according to Ken Medlock, who heads the natural gas program at Rice University’s Baker Institute. “That is the largest commercial risk that all these projects face,” he says in an interview from Houston.

“If that spot market emerges and fungibility grows, it’s going to be more and more difficult to maintain those terms long-term, and that’s exactly what will trigger a re-opening of negotiations around existing contracts,” he says.

Not everyone thinks the days of oil-indexation are numbered. A market assessment conducted by global brokerage Poten & Partners submitted to Canada’s National Energy Board (NEB) in support of the Kitimat LNG scheme dismisses the likelihood of a hybrid pricing mechanism emerging in the Far East, for instance, as “pure speculation.”

A market study submitted to the board by export rival Shell, while acknowledging “there is a growing desire to explore alternative pricing mechanisms” in Asia-Pacific markets, likewise stops short of heralding the arrival of a global gas market.

Japanese Trade Minister Yukio Edano is among those appealing for change. Japan, the world’s No. 1 importer of LNG, has turned increasingly to cargoes of the super-cooled fuel to offset power losses after the Fukushima disaster riled the country’s confidence in nuclear energy. Edano has called for a “paradigm shift” in the way the commodity is priced in part to rein in rising energy costs.

It’s not clear his demand will be met. “The idea that there will be a single pricing model that prevails in the next three to five years is not going to happen,” says David Bloom, a partner in the global project and energy group at Mayer Brown LLP in Washington, D.C.

In sales negotiations, LNG buyers will be wary of a full rebound in Henry Hub prices to historic spot levels, he says. Sellers will be just as cautious that prices could stay mired in their current funk. “We have a major new entrant into the LNG export business that uses a completely different pricing system as a practical matter than the rest of the world,” Bloom says, surveying the North American scene, “and we’re seeing this clash of cultures as it works its way through.”

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