The LNG industry was already oversupplied before it entered the pandemic crisis. This will not change
By Charles Ellinas
The first quarter of 2020 has proved to be very challenging for natural gas and liquefied natural gas (LNG) producers. The increase in LNG capacity and exports in 2019, combined with a mild winter, impacting demand growth, led to an LNG oversupply and unprecedentedly low gas prices. This has been exacerbated by the impact of the Covid-19 pandemic on the global economy, reducing gas demand and prices further.
Throughout most of its history LNG trade has been driven more by supply than demand. Producers output as much as they can and the market somehow balances, as any ‘surplus’ cargoes find a home in a market of last resort. This year is becoming the year when this assumption ceases to apply.
Too much LNG
By December 2019, 123.3million tonnes/year (mtpa) of new liquefaction capacity was under construction or sanctioned for development. This will be adding to the LNG glut for years to come. About 40 per cent of this is in the US, where excessive supply of shale gas is doing to the LNG industry what shale oil has done to the oil industry.
According to the International Gas Union’s latest report, 24.3mtpa new liquefaction capacity additions are expected in 2020. These will increase global liquefaction capacity to 454.8mtpa by end of the year. This is well in excess of demand, expected to remain around 2019 levels, about 355mtpa. But that was before the impact of the Covid-19 pandemic.
As a result of reduced industrial and commercial activity, LNG buyers have been scaling down orders and in cases refusing cargoes invoking force majeure. Buyers in Asia and Europe have cancelled about 20 US LNG cargoes for June loading. Prices are now at a level that threatens the economics of not just new projects, but also existing gas production, with some liquefaction plants having to shut-in production – especially in the US.
Prices are now so low, around $2/mmbtu, that US LNG exporters are trading at less than half breakeven levels, weakening their position. With oil prices staying low, oil-indexed LNG prices will also stay low. And with new, and already sanctioned, liquefaction projects continuing to come into the market until 2027, the pressure on prices is expected to continue.
Demand for LNG may remain more or less flat, but it is very difficult to forecast. The International Energy Agency (IEA) estimates that there will be a 5 per cent drop in gas demand in 2020. The biggest problem, though, is increasing LNG production and oversupply – it may take years before this problem fully dissipates.
The oversupplied LNG market, exacerbated by the impact of the pandemic, is deterring many project developers and project financiers. There are more than a dozen liquefaction plants scheduled for final investment decision (FID) in 2020 and if buyers remain hesitant to sign long-term agreements, most of these may be deferred and some will be cancelled. With most majors announcing significant spending cuts this year and next, investment decisions will be delayed.
For example, ExxonMobil has already announced it would not go ahead with FID on its Rovuma LNG plan in Mozambique this year. Even more drastic, Shell has withdrawn from the Lake Charles II LNG project in the US.
But some projects, especially those that are low-cost, are still progressing. Qatar LNG has reconfirmed its plans to expand its liquefaction capacity by 30mtpa by 2025, with another 19mtpa to be added by 2027. This is the world’s cheapest source of LNG.
New LNG export projects, and developers, need to brace themselves for a continued glut as further production is added, outpacing global demand, contributing to prolongation of depressed prices.
Once the threat from the pandemic is over and the global economy starts picking up, LNG demand will improve and gas prices are expected to see some improvement. But the LNG industry was already oversupplied before it entered the pandemic crisis. This will not change. It will still be on a shaky footing. Weak Asian demand and increasingly saturated European gas markets mean that the LNG oversupply problem and low prices will persist for some time to come.
With global prices very low, exports become more challenging, favouring local and regional markets.
Impact on East Med
Asia might no longer be a market for East Med gas. With the application of the Green Deal, the EU is becoming even more challenging for gas.
In the East Med, projects and drilling are struggling faced with the impact of the pandemic, an over-supplied gas market and much reduced oil company spending. Egypt’s Idku LNG plant has been unable to sell LNG since March because of low prices and Zohr production is down one-third.
Commenting on this recently, Jonathan Stern, founder of Oxford Institute for Energy Studies, and with good knowledge of East Med, was blunt. He said “I was very dubious about East Med gas even at pre-2019 prices. Now forget it.” He added that that by the time any new East Med gas would theoretically be ready to export to Europe, possibly only by the late 2020s, EU CO2 constraints would add further costs and complexity. He advised “East Med resource holders need to concentrate on supplying to the region.”
Wise advice with which I fully concur. I have been saying as much in my articles, but it reassuring to see this reconfirmed by such a renowned expert.
Also recently, S&P Global commented about Cyprus’ enigma as one of the last remaining EU countries to still burn diesel in power generation despite having made three significant gas discoveries over the past decade. Commenting on the LNG import project, it said “instead of leasing the FSRU, Cyprus will own it, which is questionable from an economic perspective as it limits the country’s ability to offload the vessel if it no longer needs it. It is also planning to lock-down a 10-year LNG supply deal for its terminal, so at a time when the majority of the world is opening up to gas and LNG competition, Cyprus is doing the opposite.” It is difficult to understand the “rationale behind the country’s LNG import strategy.”
I do not need to add more other than at such difficult times we must review our energy strategy to reflect these unprecedented developments. We must avoid locking ourselves into expensive ventures and outdated plans for the next ten years.
Dr Charles Ellinas is senior fellow at the Global Energy Centre of the Atlantic Council @CharlesEllinas