Having commented on oil in recent posts, the recent announcement of a giant 30tcf gas discovery offshore Egypt by ENI is a great segue to thoughts on gas.
It will have been hard to miss the Shell-BG merger announced earlier this year. This deal was seen by many in the immediate aftermath of the announcement as a read-across that Shell was betting on a high ($85) future oil-price. Many took comfort from this. This view was however generally quite short-lived, with the significant synergies in the BG and Shell gas businesses, both upstream and mid-stream; it looks much more probable that Shell have in fact taken a strategic view that gas is the fuel of the future. More recently the Woodside-Oil Search potential merger is largely about gas also.
As if to ensure we get the picture, Shell recently suggested dropping “oil” from its usual name “Shell Oil” (admittedly from the US subsidiary only). And the industry/finance interface The Oil Council has rebranded itself the Oil & Gas Council. Is there a hidden message here somewhere?
Whilst this gas-driven M&A and re-branding activity was going on, Kosmos announced a very significant gas discovery offshore Mauritania (probably spilling across the border into Senegal). Based on the discovery well, resources were being quoted as 5 tcf, 12 tcf and in some cases 20 tcf. Even the low end of this is a sizeable gas discovery, and it is located relatively close to the European market. So how did the market react? Well, a nice 10% spike on the announcement followed by a decline to pre-discovery levels within a couple of weeks. A huge shrug and a sigh. Ho Hum, more gas.
So some pretty conflicting messages then.
The origin of the market apathy is actually quite easy to see; just as with oil, it looks like over-supply coupled with a stagnation in demand.
Supply-Side
On the supply side, there is a huge amount of LNG coming into the market, initially with the big Australian projects, which will be followed in quite quick succession by the US starting its LNG exports. Exploration for oil (outside of unconventionals) has been underwhelming for many years, gas however has seen considerable success, notably in East Africa and the Eastern Mediterranean. Prior to the US unconvenionals being all about oil, it was a gas story – and one that has not gone away. Unconventional gas in the US has been so successful, that prices have been depressed for years due to local over supply. As with oil, innovation has been pushing the boundaries – a recent well in the Utica did some 72 mmscf/d, which is a respectable rate for a conventional well, let alone one drilled in tight formations.
That ‘local’ over supply is about to hit the world market as the US starts to export LNG.
So there is a huge pipeline (if you’ll excuse the term) of gas that is coming to market. And the rise in supply (in the above graph) is far more certain than the rise in demand – as most of the near and mid term LNG coming onto the market has FID already.
Demand-Side
One of the key drivers on the demand-side for the resurgence of gas is the perception that it is the “cleanest” source of fuel, outside of renewables. So as a ‘least bad’ option, it is preferred to coal, to oil or to nuclear in providing base-line power. Just how much cleaner is another question. Gas is generally seen as the acceptable face of fossil fuels in the absence of a solution that is 100% renewable.
Gas demand has stagnated with the global economic slowdown, and indeed, a major importer of LNG, Japan, is starting up its nuclear reactors again. Post Fukishima, Japan was mopping up any and all spare cargos of LNG at prices close to $20/mmbtu; this demand is now ebbing as nuclear comes back on stream. Woodmac recently reported that “China’s LNG imports fell by almost 4% yoy in the first half of 2015, as a consequence of subdued industrial output and fuel competition, which was driven by relatively low priced oil.”
Getting Gas to Market
Gas has always been tricky due to the difficulties in transportation. If you happen to have a massive pipeline complex leading to big markets, like the FSU into Europe, you clearly have an advantage. If you have a big gas discovery in the middle of nowhere, you were stranded. The advent of LNG has to a large extent changed this dynamic, especially for any gas deposits in or near coastal areas. However, LNG has always been seen as a Big Boys game, with huge barriers to entry in terms of technology, cost, financing and time-frame. Projects can cost multi-billions of USD and have 10 year lead-times. Only giant gas deposits need apply. To finance these mega-projects, the LNG supplier needed to have long-term off-take contracts. Equally, anyone receiving LNG wanted security of supply to justify the infrastructure at the receiving end. To keep life simple, long-term LNG contract prices are generally bench-marked to oil, and almost all LNG is contracted. Or at least, that was the case.
Technology has advanced very fast in the LNG space – not with any major leaps, but lots of incremental steps, that add up to big changes. This is most obvious in the Floating LNG (“FLNG”) and Floating ReGas (“FSRU”), where the land based projects are being scaled down into ship-sized entities, and indeed the early FLNG was predicated on ‘mega’ projects like Prelude. Whilst this is a small part of the overall market (<10% as of Q2 2015) it has numerous consequences:
- Smaller, to-date “stranded” gas assets can become candidates for development (clearly not all, as FLNG requires fairly benign sea conditions),
- Smaller gas-markets can consider bringing in LNG for power – this is very early stage, but Pakistan, Egypt and Jordan have FRGUs, and Uruguay and Chilie have projects, and Dominican Republic, Colombia and the Philipines are in the planning stages (source EIA)
The over-supply is having important consequences in the “balance of power” of where margins are made in the LNG chain. Beyond the scope of this article, but one clear take-away is that the spot LNG market will become a more and more significant part of the overall supply offering.
source – GoldmanSachs
This should in turn encourage greater demand – with lower prices, flexibility of supply and the ability to supply into smaller, and some cases temporary markets via FSRUs – which can be sailed-away as and when local/alternate supply can be sourced.
As this develops – I believe that we will see a “4G” effect. With the introduction of high bandwidth 4G, the ability of app developers and users to adopt band-width hogging new uses (streaming) quickly made even 4G look like a bottleneck. Likewise, when new motorways are build (e.g. the M25 London orbital) actual usage always surpasses forecasts, because people use it because it is there…
LNG is likely to benefit from the same effect – Supply-Driven Demand – if it is available and cheap, people will find ways to use it. Markets we have not thought of today will be created.
I guess we’ll know that LNG has become mainstream when we start to see RBL style financings based on LNG being sold onto the spot market.
Conclusion
So in what is becoming something of a suicidal tradition, I’ll make a forecast. We will see global oversupply in the short/medium term (not much risk in that statement). With more granularity, I’d also expect to see lumpy local markets – where there are opportunities to match cheap local LNG supply to local power-starved markets.
However, this bearish view should be coupled with a medium-to-long-term bullish view predicated on a (supply-driven) rise in demand that is not factored into current forecasts.
Oh and all those lovely new Teslas are going to need electricity – and that is unlikely to come from coal.