CAMBRIDGE, Mass., Nov. 17, 2005 -- High oil and natural gas prices, massive infrastructure commitments and emerging market integration have combined rapidly to transform LNG from a niche regional business into a global industry. Nevertheless, significant market fundamentals and business drivers remain sufficiently uncertain so that major investment and strategic decisions hover over many elements of the changing LNG industry, according to an analysis by Cambridge Energy Research Associates (CERA).
CERA expects the LNG industry to grow more in the next seven years than it did in its first 40 years, and that LNG will be a critical vehicle for the larger oil and gas companies to achieve organic growth. "Huge investments in LNG are under way and irreversible. On the upstream supply side, where most of the money is spent, global needs justify major spending increases. Planned LNG supplies are not an overreaction nor an overbuild" Michael Stoppard, CERA Senior Director, Global LNG, wrote in No Turning Back: The 2005 Update of CERA's LNG Scenarios. However "not all projects will make commercial returns, nor will all parts of the LNG value chain create value: returns will vary by project and across different parts of the value chain according to relative surpluses and constraints."
A number of basic conclusions underlie alternative scenarios for the evolution of LNG markets through 2020:
- Delayed supply response -- The supply response to high oil and gas prices has added more than 30 million metric tons (mt) to CERA's global liquefaction capacity inventory of projects that could be completed within 10 years. The total potential supply of 491 mt exceeds CERA's projections for actual trade. However, LNG markets are set to remain tight for the next 3 to 5 years until a sufficient number of new projects are developed.
- Current prices unsustainable -- The strong supply response in upstream liquefaction and pipeline projects means current natural gas price levels will not be sustained indefinitely.
- Atlantic Basin supply constrained -- Although CERA projects strong growth in Atlantic Basin LNG, the growth rate will be limited by upstream production and liquefaction constraints resulting from logistic challenges, cost escalation, partnership alignment challenges, host country cooperation and geopolitics.
- Pacific Basin depends on Australia & Iran -- Because the number of LNG projects exceeds the market's ability to absorb new volumes, the Pacific Basin faces potential overhang post-2010. However, future Pacific supply depends critically on the success of multiple projects in Australia and Iran, without which the Pacific Basin would be supply constrained.
- Middle East pivot point -- Given the different supply/demand profiles of the Atlantic and Pacific Basins, the Middle East will be the pivot point that balances the two markets.
- U.S. "global gas central bank" -- The U.S. is increasingly functioning as the "central bank" for global LNG, with prices for marginal spot trade across the globe being set with reference to U.S. prices. As long as spare regasification capacity exists, the U.S. market represents the opportunity value for spot cargoes.
- Atlantic market convergence -- With LNG's importance growing in both North America and Europe, and significant investment occurring in all parts of the value chain, pressure for prices on each side of the Atlantic Basin to converge will grow rapidly.
- Upstream organizational challenge -- Upstream development of exploration, production and liquefaction capabilities are likely to be constrained by the organizational capability of oil companies, the capacity of contractors, and a shortage of qualified personnel. These constraints are already leading to sharp cost escalation.
In this context, CERA has developed two scenarios describing alternative future paths for the global LNG industry to 2020 which industry participants can use to evaluate strategies and potential outcomes for the industry and its customers and suppliers. The principal differentiators between the scenarios, Competitive Rim and High Seas, are the level of economic growth, the state of international relations, and assumptions about pipelines, according to Stoppard.
- Competitive Rim -- This scenario includes friendly international relations, free trade, strong economic growth and easy access to capital, fast-track market liberalization, and increasing overall energy demand. These conditions are also favorable to development of major transnational pipeline projects, sometimes in direct competition with LNG.
- High Seas -- This scenario is characterized broadly by deteriorating international relations, fear of terrorism, retreat from free trade, poor economic growth and slow movement toward market deregulation. LNG will have advantages over pipe in terms of flexibility, security, and financing. A select group of players with strong balance sheets will dominate the gas scene, with second-tier players developing alliances to minimize new project risk.
Constraints and Value
CERA expects LNG to be value-creating, with most LNG projects earning target rates of return on a fully vertically integrated basis. Identifying surpluses and constraint points within the LNG value chain will be market participants' first step in developing value. CERA identifies five key parameters:
- Reserves -- There is no geological constraint on natural gas reserves through 2020; the critical issue is control and access to reserves for international oil companies (IOCs).
- LNG supply -- The anticipated strong build in LNG supply will be constrained by the industry's capacity to respond, as well as by non-economic challenges including host government relations, partnership alignment issues and geopolitical risk. Consequently, CERA does not expect LNG supply to be brought onstream in sufficient volumes to bring markets down to long-run marginal cost levels.
- Shipping -- Project sponsors' need for firm shipping arrangements and the availability of capital for speculative shipping investment will produce abundant LNG shipping and a liquid charter market. LNG shipping will often be value-diluting on a standalone basis, but a necessary investment as part of an integrated project.
- Regasification -- Regasification capacity will grow faster than liquefaction, implying some redundancy. This reflects the relative low costs of regasification and the value of flexibilty that it brings.. Returns in regasification will be very location-specific, and control of regas into constrained premium markets will be a source of value.
- Market -- The absence of a liquid traded spot market in Asia will constrain the ability to market LNG in the Pacific, and may hold back development of some projects. In the Atlantic Basin, where deeply traded spot markets can absorb large gas volumes, market opportunity will not constrain LNG development for Atlantic Basin or Middle Eastern supply.
Supply & Demand
The CERA analysis forecasts substantial growth -- from 150% to over 210% -- in LNG through 2020 under either set of scenario assumptions.
Under the Competitive Rim scenario, CERA projects that global LNG trade will rise 216% to 460 million tons between 2005 and 2020. Under the High Seas scenario, CERA projects that trade will increase almost 150% in the next 15 years to 360 million tons.
These forecasts imply compound annual growth of approximately 8% under the Competitive Rim scenario, and of about 6.5% in the High Seas scenario. If LNG market players -- IOCs , national oil companies and contractors -- are able to execute all projects currently scheduled and accommodate escalating project costs then growth rates would be higher still.
Cambridge Energy Research Associates (CERA), an IHS company, is a leading advisor to international energy companies, governments, financial institutions, and technology providers. CERA (www.cera.com) delivers strategic knowledge and independent analysis on energy markets, geopolitics, industry trends, and strategy. CERA is based in Cambridge, Massachusetts, and has offices in Beijing; Calgary; Mexico City; Moscow; Oakland, California; Oslo; Paris; Rio de Janeiro; and Washington, DC.
© 2005, Cambridge Energy Research Associates, Inc. All rights reserved. CERA and the CERA logo are registered trademarks of Cambridge Energy Research Associates, Inc.
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