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Global LNG overhang is not done yet

Gas prices may struggle to move significantly higher in 2020, despite a recent bounce

Rising gas prices and surging freight encouraged predictions that LNG’s bear run is over in the latter months of 2019. Even long-dormant US Henry Hub prices sprung to life on forecasts of colder-than-normal November weather.

However, while seasonal gas demand recovery is likely, there is little sign short-term demand growth can fully absorb substantial new LNG supply due from the ramp-up of 2019 start-ups and new projects due in 2020. Moreover, weak year-to-date demand in 2019 has allowed consumer market inventory to build ahead of peak winter demand. So, while gas prices may strengthen seasonally, a step-change higher currently looks unlikely. 

Freight jump 

LNG freight rates have also surged since September, amid US sanctions affecting the CLNG subsidiary of Chinese shipping company Cosco. The US penalised Cosco for alleged breach of Iran sanctions, effectively removing up to 12 CLNG vessels from the market. However, a subsequent transfer of COSCO’s 50pc stake in CLNG to its parent company has removed the vessels from sanction and should ultimately ease demand for alternative spot charters.

Notwithstanding, the issue strained tanker availability already hampered by both long-haul demand—as new US LNG capacity enters service—and LNG price contango since August, resulting in floating storage. Analysis by bank Goldman Sachs suggests 25 LNG vessels (5pc of the fleet) were unavailable in October, due to floating storage and sanctions combined.

Argus assessments suggest a start-of-November cost for the USGC-NE Asia round voyage of $2.32/mn Btu, up from $1/mn Btu in mid-August. Laden charter rates doubled over the period, and shipowners began to claim back more of the costs of ship repositioning as the market tightened, increasing round voyage costs further.  

While ongoing US liquefaction expansion may support rates by tying up vessels in longer-haul voyages over the next 15-18 months, supporting rates, this may dissipate as new-build tonnage enters the market from mid-2020. Shipowner Teekay Shipping sees 50 new LNG carriers entering service in 2020, with similar additions for the ensuing three years. Allied to a slowing in new US liquefaction supply, this could see winter 2020-21 freight rates markedly lower than today’s levels. 

Supply wave continues 

A burgeoning LNG supply ‘wave’, allied to slower demand growth, will likely limit short-term gas price upside until this phase of supply expansion slows after 2020. Around 20min t of nameplate liquefaction capacity arrived in 2018, but additions may double that this year, with a further 30mn t expected in 2020. The US, Australia and Russia underpin supply growth. By the end of 2020, the US will become the world’s largest LNG supplier, with around 100mn t/yr of liquefaction capacity, ahead of Australia and Qatar, and potentially doubling capacity again longer-term if all slated projects proceed. Russia, too, has ambitious longer-term expansion plans.

Construction and start-up delays can occur, with the inauguration of new capacity at the Australian Ichthys, US Cameron, Elba Island and Corpus Christi and Russian Portovaya and Yamal projects all slipping from 2019 to 2020. Nonetheless, a potential 25pc rise in global LNG capacity versus end-2017 levels clearly limits short-term price upside. 

Anaemic demand 

Asian LNG import demand has also slowed from double-digit growth in 2017 and 2018. Asia’s ‘big five’ importers (Japan, China, Korea, India and Taiwan–collectively 70pc of global demand) saw combined imports 3pc below 2018 levels in January-September 2019. A mild north Asian 2018-19 winter, economic slowdown, the US-China tariff war and ample nuclear and hydro generation have curbed regional LNG appetite, even despite low prices.

Prospects for the coming six months are mixed. Taiwan, Japan and Korea could see incremental winter demand if temperatures normalise, while Japanese nuclear maintenance and Korean coal-fired capacity closures during December-March to alleviate particulate emissions both look supportive. But milder weather and macro slowdown could counteract LNG upside.  New import terminals, weaker domestic production and tax changes favouring LNG generation in India should aid demand recovery there—albeit pipeline capacity remains a constraint.

China is the exception to weaker 2019 LNG demand, with January-September imports up by 16pc. This remains, though, much lower than average 2015-18 import growth of 40pc pa.

With Chinese manufacturing contracting since April, exacerbated by the tariff war—plus higher domestic gas production—import growth has slowed. The coal-to-gas initiative for domestic heating, which underpinned 2017/2018 LNG demand, has also faded, and boiler replacement plans are lower this year and next.

China’s Electricity Council reported new gas-fired capacity additions in 2019 around half those for new coal-fired plant. Coal and solar generation costs are also half those for gas, rendering both more attractive as the economy slows. Factor in a program to retrofit existing coal-fired capacity with ultra-low emission technology, as well as ongoing nuclear expansion, and the likelihood of an imminent Chinese power sector demand surge seems remote. China’s LNG demand will expand, but 10-15pc annual growth now looks more the new normal. 

Europe the beneficiary 

Absent another warm European winter, prices may not fall to levels that threaten US supply shut-ins, but nor should higher freight rates prompt stronger Asian prices, as regional demand there remains muted. Rather, tighter LNG tanker availability between now and mid-2020 may keep new US supply within the Atlantic Basin. Europe will likely, once again, absorb surplus supply this winter, given sufficient storage capacity, also capping hub prices despite the now almost habitual winter threat of disrupted Russian gas supplies via Ukraine.

David Fyfe, Chief economist, Argus Media

Keep up-to-date with how the predictions in Outlook 2020 are playing out and get a first look at the themes that will shape Outlook 2021, as well as with relevant events such as the Outlook launch party and publishing schedules, by subscribing to Petroleum Economist’s bi-monthly Outlook newsletter.

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