Linda Cook, Executive Director Gas & Power with Royal Dutch Shell plc, explains why, over the coming years, LNG will be playing an ever-increasing role in the gas sector.
We in the natural gas business do not tend to dominate the headlines in the same way as our colleagues in the oil sector, but we are becoming just as vital in meeting the world's growing demand for energy.
The development of the gas business in the past 30 years has been dramatic. Global demand has tripled and the International Energy Agency (IEA) is predicting a further doubling in the next 30 years. That means gas will be supplying a quarter of our energy needs by 2030.
Within the gas sector, LNG is playing an ever-increasing role. Like all natural gas, LNG is cleaner than coal or oil, and it offers an opportunity to diversify energy supplies.
The decreasing cost of LNG is making it more competitive in more markets and, at a time of heightened concern about political instability, it can also be a more attractive option than international pipelines that cross multiple borders.
As a result, LNG demand is forecast to grow more quickly than for gas in general, at about 10 per cent a year over the next 10 years.
The LNG industry today
Today’s LNG industry is very different from that of the 1990s. In 1990, there were nine LNG production sites with just 13 trains. Eight countries imported 56 million tonnes of LNG, with Japan accounting for two thirds. Last year there were fifteen LNG production sites with 66 trains, supplying 14 importing countries with over 130 million tonnes. Japan was still the largest importer but its share of the market declined to about 40 per cent. And LNG accounted for seven per cent of the world’s natural gas demand.
But this is just the beginning. The IEA forecasts that liquefaction capacity will increase fivefold by 2030. That means about 100 new trains. Importing countries will need to build about 700 million tonnes per annum (mtpa) of regasification capacity. And the world’s LNG shipping fleet will need to increase from 179 operational ships to 600.
We can see those increases are already well underway. New liquefaction capacity to supply about 70 million tonnes a year is under construction; a record 69 ships were ordered last year; and many more potential projects have been identified.
I think all this activity underlines that investors and project developers have real confidence that the LNG market is going to continue to grow.
This increase in production has been enabled by a significant reduction in LNG unit costs. The IEA’s analysis shows that total capital costs for new LNG projects will decrease by about 40 per cent from the mid 1990s to 2010 – with the greatest cost reductions being seen in projects to expand existing facilities and to build larger trains.
While liquefaction costs have been systematically reduced over the past 20 years through the introduction of newer and more efficient trains, the more recent improvement has come through the increase in ship capacity – an increase of the order of 30 per cent when 200 000 cubic metre ships come into service.
Combined, these developments make LNG viable over longer distances than ever before. However, despite the reductions in costs LNG projects remain very capital intensive. While costs vary significantly between projects, Deutsche Bank suggest that total capital investment - including upstream, liquefaction, shipping and regas costs – for an integrated 5 mtpa LNG project is about US$3.7 billion. And the Qatargas II project, which includes two 8 mtpa trains, will cost in the order of US$13 billion. Due to the high upfront investment required, making new LNG project decisions is far from straightforward – even with the high price of natural gas in most markets today – because of the complexity of the value chain.
The discovery and development of the upstream resources may not be concurrent with target market development and customer demand, or with securing financing. That means, in order to move forward in this dynamic market, LNG developers need high-level strategic and commercial skills to manage and mitigate the inherent risks.
Meeting the challenges
The volume of projects being undertaken by Shell and others reflects confidence that these challenges can be overcome. Take Nigeria, for example.
The first three LNG trains in Nigeria started operation between 2000 and 2002 supplying European customers. Based upon the growing potential demand in North America – and facilitated by Shell import capacity – construction began on trains 4 and 5 in 2003. Then last year we began building a sixth train to supply the Altamira terminal in Mexico. And designs for trains 7 and 8 are maturing. This is a very rapid pace of development by any measure, in response to growing and changing market demand.
The project was also successful in attracting financing. Trains 4 and 5 were 50 per cent third party financed, which involved raising US$1 billion and is one of the biggest ever such finance deals in any industry in Africa.
Nigeria is but one example of the rapid growth in the world's LNG sector. Almost every existing project that can be expanded is being expanded and many greenfield projects are moving ahead – including in Egypt, Russia, and possibly someday in Iran.
The result of all this is clearly a globalising industry where a more diverse range of producers will supply a more diverse range of customers with more gas.
The impact of globalisation
So what are the implications of a globalising LNG sector on the global natural gas market?
We all know the ‘frequently asked questions’ in this respect. Will a material spot market for LNG develop? What impact will increasing amounts of LNG to North America have on the Asia Pacific market? Will we see the emergence of a global natural gas price like we have for oil?
Clearly we are seeing greater flexibility in the LNG market. In 1992, the LNG spot market was approximately one per cent of total sales. Last year that rose to just over 10 per cent. So, the logical question is whether this is a trend that will continue, with spot or short-term sales becoming the dominant form of trading. My answer is, ‘not so fast’.
Why not? Because new LNG projects continue to be very capital intensive, because they typically require third party financing, and because traditional customers continue to value long-term contracts for security of supply.
As a result, new LNG projects continue to move forward underpinned by a high proportion of their capacity committed under 15-25 year sales contracts to firm customers.
That’s not to say that the market is not changing. As international trade in LNG continues to increase dramatically over the coming years, we will undoubtedly see many new, creative and complex swaps to optimise shipping and meet changing needs. And we are already seeing a shift in the traditional Japanese customers as the Asian LNG market tightens and they recognise they now must compete with markets on the west coast of North America.
And so, while I do not believe we will see the emergence of a global gas price in the near future, there is already global competition for spot cargos - and no doubt increasing connectivity of prices between regions.
So, who are the winners in this exciting sector? Clearly, access to significant gas reserves is critical, ideally large deposits that can underpin major LNG plants that can be expanded over and over as demand grows. Obviously, the major natural gas resource holders such as Nigeria, Russia and Qatar have a lot to gain.
But reserves alone are not sufficient. Winners will be those who are not only able to develop the upstream gas and liquefaction capacity, but can also connect gas supplies to emerging and premium markets – markets such as the east and west coasts of North America as well as, in the longer term, China and India.
All of this takes capital, as well as a portfolio of global skills to pull it all together – technical skills, experience, a strong safety track record, shipping expertise, project management, marketing and project financing.
So, the global natural gas sector has a bright future in particular for those involved in LNG. Demand for our product is rising – and rising fast. And that growth – combined with the fact that our industry is still at a relatively early stage of development – means there are going to be many new business opportunities ahead.
The challenge for us is to make sure we have the skills and projects in place to seize those opportunities and respond flexibly to the rapid changes inherent in the transition to a global market. If we succeed in meeting those challenges then maybe one day soon it will be the global gas industry that dominates the headlines.