Global LNG flows will be dictated by pricing which has diverged globally since 2008 with Asia, Europe and the US all following different paths. Asia remains the a premium pricing market and therefore the market of choice for all those stranded gas resource holders including East Africa.
LNG market fundamentals are attractive with demand set to grow at 6% per year to 2020 after rising by such levels over the last decade. Asia is the largest source of demand led by Japan and South Korea and imports to both nations continue to remain robust and rose strongly in 2011-2012 due to the tsunami. However demand in Asia is set to rise further from new countries. China will have 11 LNG imports terminals by 2015 and imports will double to 30MT annually we estimate. Furthermore, India's LNG imports will increase to 23MT by 2015 from 11MT in 2011 as eight new imports terminals are commissioned. LNG supply comes in waves and the growth of circa 20% witnessed from late 2009 to early 2011 from the Middle East has now slowed. New material LNG supply won't enter the mart until 2016. Consequently LNG market dynamics are positive for the medium term as spare capacity will continue to fall unless new developments are sanctioned.
This creates the space for East African LNG but in the way is cheaper North American LNG. Twenty projects are vying for export approval from governments in 2013 and the market will have to wait and see how much is approved. The magnitude and production cost of the this gas leaves it at the low end of the LNG cost curve and hence puts pressure on competing internal LNG projects of which there are many. Indeed, over the last 3 years, 60% of our conventional new discoveries have been natural gas in all terrains and water depths and most prevalent in East Africa where almost 17Bn boe has been discovered.
Having analyzed the quality of this resource base, we believe it makes sense to monetize it through LNG and that it remains more viable than competing projects in Russia, Australia, Alaska etc. However, market expectations for East African LNG exports by 2018 are widely optimistic. LNG projects used to take 3-4 years from FID to first LNG. More recently, that has changed to 6-7 years. In particular, Mozambique which is planning 10 LNG trains of 5MT each would leave it double the size of Nigerian LNG which took 12 years to reach 25MT per annum of LNG output. Additionally, cost pressures and inflation are most evident in the LNG sector where everyone single project in Australia has seen 15-40% cost inflation in recent years destroying project returns and investor enthusiasm for such ventures. It will not be plain sailing for East African LNG.
Global LNG demand has been weak this year on gas to coal switching in Europe, lower global economic growth and shale. Asian demand continues to be robust, although growth has stalled as high prices have impacted consumption in China and India. In Europe however, LNG demand has declined dramatically as high LNG prices have resulted in power companies switching from gas to coal. In North America, LNG imports have almost been fully eliminated by shale.
- While demand has stalled, supply growth has also been extremely weak with disruption to Middle East supply, maintenance in Indonesia and Trinidad and limited new liquefaction capacity additions. With Angola start-up delayed into 2013, Pluto will be the only LNG project to start up this year. Elsewhere, supply has dropped sharply from Yemen, Egypt, Trinidad and Indonesia on maintenance and terrorism.
- Demand is starting to come back however and signs are of a market tightening as we head into winter which should support gas prices. We expect that North Asia and European demand should start to pick up over the coming months on seasonal winter demand. The shut-down of two nuclear power plants in Korea and continued problems with the Oi reactor in Japan should mean higher demand this winter. Weak supply from Nigeria and Trinidad could compound these problems driving winter gas prices higher after weakness over the summer months.
- With limited new capacity additions, the LNG market continues to look structurally tight through to 2014. Over the next 2 years the LNG market is likely to remain structurally tight. Less than 10 mmtpa of new liquefaction capacity is due to start up in 2013 and Australian projects (PNG LNG and QCLNG) due to start up in 2014 could be delayed. As such we expect global LNG spare capacity to remain low and spot LNG prices to remain high in the near term.
- Competition for market is increasing however, with over 100 mmtpa of projects vying for approval next year. Australia, Russia, West Africa, and North America have a significant number of projects targeting final investment decision next year. Strong competition from these projects will put pressure on long-term LNG contract prices, in our view.
- US LNG exports remain the largest source of supply uncertainty, although we think the export volumes approved could be higher than current consensus estimates. The US has the largest number of LNG projects under proposal globally, although it is unclear how much capacity will be approved. Current estimates for US LNG exports approved by 2020 range from 40-50 mmtpa (consensus) to a high side of 100 mmtpa (5-12 bcf/d). The US DOE report on LNG exports which is scheduled for release in December will provide the first insights into the volumes of LNG that will be approved.
- Increased exports from North America would be negative for Australian, Russian and Canadian LNG; conversely any decision to limit exports from the US would be positive for LNG exporters in these countries. North America LNG will be more cost competitive than any other country in terms of LNG supply. Greater than expected US LNG exports will displace marginal LNG projects in Australia and the Arctic. Conversely, any decision by the US to limit exports will be a positive for the more marginal LNG projects.
The biggest question for investors in global LNG markets is how much LNG capacity will the US approve for export? The world needs an additional 80 mmtpa of LNG to be approved over the next 3 years and while the US could supply this alone, there remains political uncertainty on export approval. In December the DOE will release its much awaited report on US LNG exports. If adopted, the conclusions of this report will have global significance for the LNG industry. If the US approves a large export quota (12 bcf/d or more) this will be negative for marginal LNG projects, especially those in Australia and the Arctic which are at the top of the cost curve. If on the other hand the US restricts exports to a low export quota (5 bcf/d or less) then this will be a positive for the Canadian, Australian and Russian LNG projects. While consensus estimates for the US are currently around 40-50 mmtpa of export approval by 2020, we think the number could be larger than this, which poses a risk to Australian LNG.
While some of our favorite LNG names have taken a step backward over recent weeks on deferred production and higher costs we still think there is significant upside ahead given the growth in this industry. In the Asia-Pacific region, our top pick is Oil Search which continues to have the best long term organic LNG growth in the region and in Europe our top picks in LNG are TOTAL and BG.