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China puts a prop under LNG market

Asian demand is supporting the LNG business despite low prices and the recession, reports Conal Walsh from Perth

IN PERTH, everybody is talking about the Gorgon deal. Australia's resources capital recovered its economic optimism in August, as the project's partners agreed to supply $41bn-worth of liquefied natural gas (LNG) to China over the next 20 years (see p27).

The deal promises billions of dollars for the state and thousands of jobs. But it is about much more than Australia's growing status as one of the world's most attractive resource economies; it also reflects a shift in global gas demand towards China and its fast-growing neighbours.

At the end of 2008, Nobuo Tanaka, director-general of the International Energy Agency (IEA), said "investment uncertainties, cost increases and delays remain a significant problem in most gas markets."

In the US, gas prices have fallen to a seven-year low in recent months and the outlook for LNG demand in the next two to three years is poor because of oversupply. However, that imbalance will prove temporary. Indeed, heavy investments are still being made: contracts covering nearly 12m tonnes a year of Australian LNG have been signed since the start of 2009. And, as they emerge from recession, demand from Japan and South Korea, traditional big buyers of LNG, should accelerate.

The continued industrialisation of China and India will add to demand – especially given China's growing desire to switch from coal to cleaner-burning gas for power generation for environmental reasons (see p17). Combined-cycle gas-turbine power stations are among the cheapest forms of electricity generation to run, and the quickest to build, and the IEA projects Chinese gas demand will rise by 6.5% a year between 2005 and 2030. As a result, a long-term shortage of supply in Asia seems more likely than a prolonged demand shortage.

Qatar, the world's leading LNG producer, should boost exports to 77m tonnes next year (see p15). The extra production is bound for Spain, the UK and the US, as well as for Asia. Other gas producers are aiming to capitalise on the eventual upturn in demand.

Russia, whose gas pipeline network caters solely to European customers, has made inroads into the global gas market with the launch of its Sakhalin-2 LNG project, although other LNG ventures, notably its Shtokman project, are struggling. Even Trinidad and Tobago, traditionally an LNG supplier to the US, is sending its tankers on a 13,000 nautical-mile path to Asia, enticed by the prices China, Japan and South Korea are willing to pay.

In Australia, there is significant investment in converting coal-seam gas (CSG) – natural gas produced from coal deposits – into LNG, packaged for Asian clients. The technology, which requires once-prohibitive economies of scale to gather highly dispersed CSG into volumes that are large enough to be commercial, is still in its infancy and unlikely to produce any shipments for several years. But BG, which has agreed supply deals with Singapore, Chile and China, has spent $5.3bn strengthening its holdings in Queensland; Petronas and ConocoPhillips are also active in the region.

And then there is Gorgon, owned by Chevron, ExxonMobil and Shell. The west Australian field was already earmarked to supply China through Shell's 25% concession, even before last month's $41bn deal with PetroChina. ExxonMobil also recently signed a $20.5bn agreement to supply India with Gorgon gas.

LNG's strong prospects as a market segment are an important growth area for international oil companies (IOCs) that have had royalties and access to resources in other areas, especially oil, squeezed by petro-nationalism. The complex and costly liquefaction process requires their engineering expertise and typically obliges customers to sign long-term contracts. This type of arrangement also suits many buyers, including China, for which long-term security of supply is equally important.

August's Gorgon deal implies an oil price as high as $104/b, according to analysts at Baring Asset Management – an encouraging sign for upstream developers if it can be taken as a price that China and India will generally be prepared to pay for gas under long-term deals. Given that consumers are unable to meet these prices, that remains an uncertain prospect.

A new phase in China's development

Nonetheless, that China in particular is willing to make such a financial commitment may mark a new phase in its development as a geopolitical player. The deal strongly suggests the country is serious about constraining its carbon emissions. China has abundant coal supplies, but has declared its intention to increase its use of gas, a cleaner fuel, to 10% of total energy consumption by 2020, from about 3% today. It is also investing in nuclear power and funding research in new areas such as clean-coal technology.

By agreeing to pay a generous price for LNG from Gorgon, China has also noticeably refrained from bargaining with the aggression that has sometimes characterised its negotiations for other raw materials.

In addition, the deal does not involve equity ownership. By contrast, in the oil sector, Chinese companies have systematically sought to become owners as well as customers. In gas, however – where China is buying from wealthy or Western countries, where it needs the help of IOCs, and where above all it needs security of supply – the country appears no longer to entertain hopes of becoming a price-setter. Gas may be trading at historic lows, but if even China acknowledges and accepts that gas will be expensive and valuable in future, investors might be advised to believe it too.

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