LNG: Churning it out
Producers face a further period of low prices as more production comes online
The liquefied natural gas market of 2018 will bear many similarities to the present one. The market in 2017 remained in a period of LNG oversupply that began in 2016. Although the year opened with strong demand, due to low winter temperatures and nuclear outages, forcing Asian spot prices to near $10 per million British thermal units, we saw prices return to pre-winter levels in all major regions in March. As warmer weather returned and the seasonal demand fell, it became evident that the favourable market for LNG suppliers of the early 2000s had led supply to catch up and overtake demand. Even though the winter temperatures have brought back high demand, the supply glut is expected to return in 2018.
In 2017, Rystad Energy recorded added liquefaction capacity of 37m tonnes a year, a rising trend that will continue through 2018. The additions will not reach full production this year, but continue to increase through next year. This is due to late start-ups in 2017 for a large part of the capacity additions, coupled with the fact that liquefaction plants generally require one or two years to reach full production. Overall, we see increased global production of around 16m t/y in 2018, from plants commissioned in 2017. However, potential outages, export curbs in Australia and teething problems with the new floating LNG units in Malaysia and Cameroon could negatively affect this production.
On top of production ramp-ups, the emerging export majors will continue their capacity expansion efforts through 2018. Although the market is already saturated, we see additions coming on stream in 2018, having received the go-ahead at a time of more favourable market terms around half a decade ago. We forecast added global capacity to reach 29m t/y, with 58% and 22% coming from Australia and the US, respectively. As a result, Australia's capacity will reach 87m t/y at the end of 2018, placing it ahead of Qatar (77m t/y) as the world's largest LNG exporter in terms of capacity. The production from additions in 2018 will ramp up through 2018 and 2019.
Up to 41m t/y of new regasification capacity is scheduled to come onstream during 2018: 17m t/y from onshore plants and a potential 24m t/y from floating storage and regasification units (FSRUs). The latter either under construction or waiting to be sanctioned. While the onshore units were approved back in 2013 and 2014, when global LNG prices were peaking, the plummeting prices through 2015 and 2016 triggered new LNG demand and hence an increased interest in FSRUs because of their short lead-time.
New onshore regasification capacity of 17m t/y is under construction and scheduled to start operations during 2018 in China, India, Japan, Singapore and Greece. The additions in China and India are mainly to supply gas to the two countries' power and industrial sectors, whereas Singapore and Greece want to establish LNG-distribution hubs. The new terminal in Japan was scheduled to take LNG from the recently cancelled Pacific NorthWest liquefaction project in Canada, and is likely to experience low utilisation due to this and uncertainty in LNG demand.
China will lead the growth in LNG demand in Asia in 2018
During the past years, several countries have entered the LNG market with FSRUs because of declining domestic gas production and increasing demand. FSRUs are a flexible and low-cost solution, and are, therefore, a good fit for emerging buyers of LNG. The potential capacity additions of 24m t/y from FSRUs in 2018 is spread among India, Pakistan, the Ivory Coast and Russia, and will provide quick access to LNG for countries with large appetites for gas like Pakistan and India. The floating units require little capex and can thus provide new sources of supply for emerging markets like the Ivory Coast. They're also a temporary and flexible solution, which fits projects such as Gazprom's LNG terminal in Kaliningrad that will eventually be replaced by the Baltic LNG project.
The added regasification capacity of up to 41m t/y won't, however, be the main driver of LNG-demand growth in 2018, as the projects require time to ramp up and the average utilisation rate of global regasification terminals is only around 30-40%. We estimate the increase from new capacity to be between 5m and 10m t/y. The main contributor to the growth will be the increase in demand from established markets with sufficient capacity. Large buyers in Asia and Europe will drive most of this, with additional support from emerging LNG markets in Latin America and Asia.
China leads the way
China will lead the growth in LNG demand in Asia in 2018, since the rise in domestic natural gas demand in China has outpaced supply growth in recent years. Complex shale formations have created headaches for China's oil companies, and LNG has been the natural choice for coping with increasing demand before new pipelines from Russia start operations.
Japan, on the other hand, is facing declining LNG demand due to nuclear's gradual comeback in the power mix. The country is the world's largest importer of LNG and will have new contracts amounting to 7m t/y beginning in 2018, compared with expiring contract volumes of 3.6m. Re-exports of LNG cargoes from Japan will likely increase, given the oversupply of long-term contracts.
We see Europe facing declining domestic production of natural gas, which will be replaced by both Russian pipeline gas and LNG. Europe has a utilisation rate below 35% and will likely take a significant amount of the excess volumes in an oversupplied market due to the market structure and available import capacity.
We see no end to the supply surplus in 2018 as additions outpace the increased demand for LNG. As this builds on the existing glut from 2016 and 2017, and there's low production flexibility and storage capacity for LNG, the prices will have to fall to attract enough demand outside the seasonal peak periods—for example, to replace coal or oil in Asia or coal for power generation in Europe.
Furthermore, continuing the trend of recent years, the geographic price differentials are expected to contract during 2018 due to fewer destination restrictions. Destination clauses have been standard in supply contracts until now, leading to the separation of markets. But as American producers operate without these barriers, flexibility will increase with larger US export volumes. In addition, Japan ruled destination clauses anti-competitive in June 2017, and we've already seen other Asian countries beginning to follow suit, which will affect future contracts with the major importers.
On the other hand, we see increased spreads between spot and long-term contract prices. While spot prices will fall through 2018 due to market saturation, long-term contracts will remain stable or follow the upward trend, which isn't increasing the appetite of potential long-term buyers. Still, we see some buyers opting for the longer contracts to ensure supply security.
In the long term, a hard-bargaining strategy could backfire on buyers, of which we can see evidence already in the planned sanctioning of activity for 2018. Buyers are using their power to renegotiate deals to achieve shorter contract terms and better prices. But several large-scale projects are stalled, as contracts of only five-to-15 years aren't sufficient to secure approval for new LNG plants. Coral FLNG in Mozambique was the only project sanctioned in 2017, and we expect activity to be slow through 2018. The next project we see being approved is the Fortuna LNG plant in Equatorial Guinea. At this rate, the market could turn on the buyers as early as the opening years of the 2020s, and we'll see LNG prices rising again. For the time being, we'll have to settle for a flooded market.
Sindre Knutsson is Senior Analyst at Gas Markets. Iben Frimann-Dahl is an Analyst at Rystad Energy
This article is part of Outlook 2018, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here