Global LNG

Will new demand and new

supply mean new pricing?
 Introduction and su

Contents
Introduction and summary 02

Global natural gas and LNG demand 04

LNG supply 08

The overarching economic issues — costs and pricing 12

Other risks and challenges 17

How can Ernst & Young help? 18

2 Global LNG: will new demand and new supply mean new pricing?
 Oal`l`]klYjl%mhg^l`]ogjd\ÌkÕjkl[gee]j[aYd%k[Yd]daim]Õ]\fYlmjYd
gas (LNG) plant at Arzew in Algeria in 1964, the modern global LNG
industry is approaching its 50th birthday in 2014.1 A massive amount of
new LNG capacity has been proposed — as much as 350 million (metric)
tonnes per year (mtpa) — which, if all were built, would more than double
current capacity (of less than 300 mtpa) by 2025. Even with reasonably
strong demand growth, this implies growing supply-side competition and
upward pressures on development costs and downward pressures on
natural gas prices. Nevertheless, the very positive longer-term outlook
for natural gas is driving investment decisions, both in terms of buyers’
willingness to sign long-term contracts and sellers’ willingness to commit
capital to develop the needed projects.
LNG demand growth is front-loaded, but in the wake of a capacity surge
over the last few years, capacity growth is now back-loaded. We are
k]]af_Yhgkl%>mcmk`aeYkim]]r]$Yko]ddYkYkdgo\gofaff]Yj%l]je
capacity additions, pointing to relatively
tight markets over the next few years. LNG

ummary
development costs have been rising at a
torrid pace, and with LNG demand shifting
to new, more price-sensitive customers just
as the supply side battles with rising costs
and increasing competition, sellers must
adapt.
The supply/demand magnitudes and
dynamics aside, the biggest potential
impacts are on LNG pricing: namely, will oil-price linkages continue
to dominate global LNG contract pricing, will there be room for spot
gas price linkages, and will divergent regional gas prices show signs of
convergence?
Going forward over the medium to longer term, there will most likely
be a gradual but partial migration away from oil-linked pricing to more
spot or hub-based pricing. LNG sellers are reluctantly facing the realities
of pricing and are offering concessions in order to remain competitive.
However, LNG pricing should not collapse, simply because the cost
to supply is high and incentives to develop new capacity must be
eYaflYaf]\&9kYfYdqklkYlEY[imYja]hgaflgml$DF?akYn]jq]ph]fkan]
_Ye]$Yf\hja[]kÈ`go]n]jl`]qYj]^gje]\Èemklj]Ö][ll`akj]Ydalq&2

)Daim]^Y[lagfg^fYlmjYd_YkoYkÕjklY[`a]n]\afl`]dYZgjYlgjq\mjaf_l`])1l`[]flmjq$Yf\fme]jgmkdg[Ydar]\keYdd%
k[Yd]h]Yc%k`Ynaf_DF?^Y[adala]ko]j]hmlaflgmk]afl`]]Yjdq)1((k&L`]ÕjklljYfkhgjlg^DF?g[[mjj]\af)1-1^jge
Louisiana to the UK, leading to the British Gas Council’s signing of a 15-year contract for import of LNG from a proposed
LNG plant in Algeria. The beginning of the modern LNG age is generally seen as the opening of that Algerian plant.
(Source: Deutsche Bank Markets Research, Global LNG, 17 September 2012)
*EY[imYja]=imalqJ]k]Yj[`$Global LNG Outlook, 10 September 2012

Global LNG: will new demand and new supply mean new pricing? 3
 Global natural gas
and LNG demand

Historic and projected demand

Total global natural gas demand is estimated to have grown by
about 2.7% per year since 2000; however, global LNG demand
has risen by an estimated 7.6% per year over the same period,
almost three times faster.1 The strong LNG demand growth has
been largely driven on a regional perspective by Asia, and from a
broader perspective, underpinned by what analysts at J.P. Morgan
termed “durable, investible and politically charged themes.”2
 National energy supply security — ensuring supply diversity and
Ö]paZadalq
 National energy infrastructure renewal to improve system
resilience to supply/demand shocks, stimulate investment and
reduce unemployment
 De-carbonization of economic growth as a social imperative,
continuing the displacement of coal by natural gas
 Rising popular opposition to nuclear power generation
Global gas demand is expected to continue to grow strongly. In
its most recent annual World Energy Outlook, the International
Energy Agency (IEA) forecast a growing role for natural gas in
the world’s energy mix, with the natural gas share growing from
21% in 2010 to 25% in 2035, with natural gas as the only fossil
fuel whose share was growing. The IEA sees global natural gas
demand growing at about 1.6% per year through 2035, more
than twice the expected growth rate for oil.3 Some other analysts/
forecasters put gas’s growth rate even higher.
LNG demand growth is, however, expected to be even stronger,
particularly through 2020. While a wide range of forecasts exists,
a broad consensus of industry analysts/observers sees average
annual growth of around 5% to 6% per year. After 2020, demand
growth is expected to continue, albeit at a slightly slower pace
(i.e., around 2% to 3% per year) as markets mature, demand
shifts to more price-sensitive buyers, and some price subsidies

1 Deutsche Bank Markets Research, Global LNG: Gorgon & the Global LNG
Monster, 17 September 2012
*B&H&Egj_Yf;Yr]fgn]?dgZYd=imalqJ]k]Yj[`$Global LNG, 13 January 2012
3 International Energy Agency, World Energy Outlook 2012, October 2012

4 Global LNG: will new demand and new supply mean new pricing?
are removed in non-OECD markets. Global LNG demand by 2030 Japan, South Korea and Taiwan (collectively, JKT) have been and
could, however, be almost double that of the estimated 2012 level are expected to remain the backbone of the global LNG market.
of about 250 million metric tonnes. Accounting for more than half of total global LNG demand in
2012, JKT are characterized as heavily industrialized countries
Measures and conversion factors with limited domestic energy options — i.e., they are seen as the
“premium” LNG markets. However, the newer and growing LNG
Natural gas is most typically measured in volumetric demand centers — China, India, the Middle East, Europe and
terms, either in cubic feet (cf) or cubic meters (cm). For South America — tend to have more available competitive energy
international consistency here, cubic meters are used with options, including coal and oil, as well as other sources of natural
l`]^gddgoaf_]imanYd]f[]2 gas — either from domestic production or pipeline imports. As a
result, these new markets will generally be less likely to willingly
1 cubic meter = 35.3 cubic feet
pay supply security premiums and will be more price-sensitive.
LNG, however, is typically measured in millions (metric)
More than 30 countries have proposed plans to build or add LNG
tonnes per year (mtpa — sometimes abbreviated as mmtpa).
aehgjl'j]%_YkaÕ[Ylagf[YhY[alq$oal`eYfqg^l`gk][gmflja]kf]o
For purposes of this report, the following conversions are
to the LNG market. By 2020, the number of countries with import
used:
capacity could double from the 25 countries at the end of 2011.
1 million tonnes of LNG = 1.36 billion cubic meters ;mjj]fl_dgZYdj]%_YkaÕ[Ylagf[YhY[alqg^Ydegkl.((elhY^Yj
(bcm) of natural gas, or about 48 billion cubic feet (bcf) exceeds current/projected supply or demand and yet could rise by
of natural gas as much as 200 mtpa by 2020.4
China and India are expected to be the biggest sources of
Figure 1. Global LNG demand additional LNG demand. The latest Five-Year Plan to “gasify” the
Chinese economy calls for the gas share of the energy mix to rise
600
Actual Projected from ~4% in 2010 to 8% by 2015, with a longer-term goal of a
500 10% share by 2020.5 Beyond 2020, China’s potential gas demand
Million tonnes per year

is huge, considering that China’s coal market is seven times

400 larger than the total global LNG market.6 China has considerable
300 development ambitions for its shale gas resources as well as for
aehgjlhah]daf]]phYfkagfk$Zmloaddkladdf]]\ka_faÕ[Yflngdme]k
200 of imported LNG to meet demand. Importantly, with multiple
100
supply options, China’s aggressive near-to-medium demand
forecasts are seemingly well-covered by increasing domestic
0 supply, increasing pipeline imports and signed LNG contracts.
2000
2005

2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020

2025
2030

JKT Other Asia Americas Europe Other

Source: Ernst & Young assessments of data from multiple sources

,B&H&Egj_Yf;Yr]fgn]?dgZYd=imalqJ]k]Yj[`$Global LNG, 13 January 2012

5 OilPrice.com, “China Turns to Natural Gas to Fuel their Economic Growth,” 19 June 2012
6 Deutsche Bank Markets Research, Global LNG: Gorgon & the Global LNG
Monster, 17 September 2012

Global LNG: will new demand and new supply mean new pricing? 5
 Natural gas in China: fueling the dragon
Driven by government policy and strategy, Chinese natural gas demand could more than double between
2012 and 2020. Planned aggressive expansion of domestic gas production, particularly from shale gas
development, will satisfy some of the demand increase, as will the expected import pipeline developments,
Zmll`]]ph][l]\aehgjlkg^DF?l`YloaddZ]f]]\]\lgZYdYf[]\]eYf\oaddegj]l`YfimY\jmhd]&K`gmd\
shale development disappoint or pipeline expansions be delayed, LNG imports will increase even further.

Table 1. Chinese natural gas supply/demand balance

(bcm) 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Demand 110 135 163 182 204 229 256 287 322 360 403
Supply
Domestic production
Conventional 92 100 117 119 129 138 144 147 151 155 159
Shale 1 2 5 6 10 20 30 45 68
Other 1 3 5 8 11 13 16 18 20 22 24
Subtotal 94 103 122 129 144 158 170 185 201 222 250
Pipeline imports
Turkmen 1 4 14 21 25 30 30 30 30 30 30 30
Myanmar 3 8 12 12 12 12 12 12
Turkmen 2 0 6 15 30 30 30
Subtotal 4 14 21 28 38 42 48 57 72 72 72
LNG imports to balance 13 17 20 25 22 29 39 45 49 67 81
LNG imports (mtpa) 9 12 15 18 16 21 28 33 36 49 60
LNG contracted (mtpa) 9 12 15 18 22 26 32 37 37 37 37
Regas capacity* (mtpa) 12 16 21 28 41 45 54 61 65 67 70

*Approved or proposed

Source: Deutsche Bank Markets Research, Gorgon & the Global LNG Monster, 17 September 2012

AfhYjla[mdYj$j]hda[Ylaf_l`]Fgjl`9e]ja[Yfk`Yd]km[[]kk]keYqZ]\a^Õ[mdl&;`af]k]k`Yd]ZYkafkYj]
generally smaller, deeper and more complex. They are also spread out across more than 150 separate basins
and generally are distant from demand centers. And with limited existing infrastructure in many areas, as
well as water supply issues, costs are expected to be substantially higher. Importantly, state regulation of
gas prices may defer risk-taking by non-NOCs, and more broadly, China generally lacks the community of
incentivized risk-taking independents that essentially pioneered the technological changes in horizontal
drilling and hydraulic fracturing. This may effectively slow down the pace of China’s shale evolution.

6 Global LNG: will new demand and new supply mean new pricing?
European LNG demand is expected to grow as local production, technically recoverable unconventional gas resources, and the IEA
primarily from the North Sea, declines and total gas demand estimates that unconventional gas will increase to about 25% of
grows as a result of economic growth as well as environmental the world’s gas supply by 2035, as compared to about 8% today.8
preferences and Kyoto Protocol commitments. Forecasting LNG Generally, lower-cost unconventional gas is likely to capture some
kmhhdqYf\\]eYf\^gj=mjgh]akeY\]\a^Õ[mdl$`go]n]j$Zql`] of the demand that would have otherwise gone to LNG.
multiple domestic and regional supply options; multiple pipeline
Planned or proposed new/expanded gas pipelines from Russia,
import sources (Russia, North Africa and Norway); and, most
the Caspian and/or Central Asia into Europe or Asia (e.g., the
prominently, by the evolving price/volume strategies by the two
Nabucco or South Stream pipelines into southern/central Europe,
main regional suppliers, Russia and Norway.
the Turkmenistan-Afghanistan-Pakistan-India [TAPI] pipeline, an
Iran-Pakistan pipeline or the Russian Altai pipeline into China)
Demand-side risks for LNG could deteriorate potential LNG demand markets in Europe or
The principal risks for LNG demand growth come from Asia. Clearly, not all of these proposals will come to fruition, but
uncertainties around the global and regional economies and at least one of the lines into southern/central Europe is likely to be
from increasing gas-on-gas competition. Global economic Zmadl$Yf\YJmkkaY%;`afYdaf]akYdkgimal]dac]dq$_an]fl`]JmkkaYf
growth has been decelerating over the last few years, with the strategic gas marketing shift eastward.
j][gn]jq^jgel`]_dgZYdÕfYf[aYd[jakakg^*((0'*((1j]dYlan]dq
slow and uneven. The US recovery has been relatively anemic,
while the Eurozone crisis has hobbled the European continent.
The emerging markets, led by China, have seen their growth
restrained by the knock-on effects of the problems in their main
markets, the advanced economies. Conventional expectations
are for the global economy to stabilize and begin to grow more
strongly. However, downside risks remain relatively high, and
with those risks, uncertainties around energy demand growth will
continue.
Relatively new, “unconventional” supplies of natural gas —
including shale gas, tight gas and coalbed methane (CBM —
also known as coal seam gas or CSG) — could transform the
world’s energy markets. While global gas reserves have been
growing steadily for decades, over the last decade, the so-
called unconventional gas revolution has roughly tripled the
resource base that can be economically recovered. A decade
ago, the world was estimated to have only 50 to 60 years’ worth
of gas remaining; with the new unconventional supplies, the
estimated resource life has risen to more than 200 years.7 Of the
world’s estimated remaining technically recoverable natural gas
resources, unconventional gas accounts for more than 331 trillion
cubic meters (tcm) out of 752 tcm in total, or about 44% of the
total. Shale gas accounts for an estimated 63% of the world’s

7 The Economist, “Special Report: An Unconventional Bonanza,” 14 July 2012 8 International Energy Agency (IEA), Golden Rules for a Golden Age of Gas, June 2012

Global LNG: will new demand and new supply mean new pricing? 7
 LNG supply

DF?daim]^Y[lagf[YhY[alq
:]_affaf_oal`l`]Õjkl[gee]j[aYd%k[Yd]daim]^Y[lagfhdYflYl
9jr]oaf9d_]jaYaf)1.,$_dgZYddaim]^Y[lagf[YhY[alq_j]okdgodq
if not steadily, reaching about 100 mtpa in the early 1990s
and about 140 mtpa by 2000. But between 2000 and 2012,
daim]^Y[lagf[YhY[alqegj]l`Yf\gmZd]\$\jan]fhjaeYjadqZq
the series of massive LNG developments in Qatar and the early
Australian developments.1
Gn]jl`]af\mkljqÌkdYklÕn]\][Y\]k$o]`Yn]k]]fYhjg_j]kkan]
broadening of the LNG supply base, with three waves of suppliers.
L`]ÕjkloYn]oYk\geafYl]\Zq9d_]jaY$EYdYqkaYYf\Af\gf]kaY$
which still collectively accounted for more than 60% of total LNG
capacity as recently as 10 years ago, but which are expected to
drop to about 20% of total capacity by 2020. The second wave
has been dominated by Qatar and Australia, which have been
rising rapidly from about 20% of global LNG capacity in 2000 and
are expected to account for about 50% of total global capacity
by 2020.
A huge wave of Australian LNG projects are slated for the second
half of this decade. In the three years from late 2009, Australian
gh]jYlgjk`Yn]kYf[lagf]\egj]l`Yf.(elhYg^_j]]fÕ]d\DF?
hjgb][lkÈ]imanYd]fllgYZgml*-g^[mjj]fl_dgZYdDF?\]eYf\&
But the plethora of proposed but unsanctioned projects, are
unlikely to proceed without secure off-take commitments. There
are increasing development risks for operators, and even with oil
indexation, operators cannot assume that oil price increases will
outpace cost increases.
The third wave could come from as many as 25 other countries,
many of which currently have little or no capacity, but by 2020,
these countries could provide as much as 30% of the world’s LNG
capacity. Importantly, with the third wave, smaller operators are
becoming increasingly involved with what used to be the exclusive
domain of the major IOCs and NOCs. While there were 19 LNG
exporting countries in 2012, many of the new potential suppliers
have substantial resource bases and potentially generally lower
[gklk&:mll`]k[Yd]g^afn]kle]flj]imaj]\Yf\l`]gf_gaf_

)B&H&Egj_Yf;Yr]fgn]?dgZYd=imalqJ]k]Yj[`$Global LNG, 13 January 2012

8 Global LNG: will new demand and new supply mean new pricing?
economic uncertainty may mean that many of these proposed
hjgb][lkYj]mfdac]dqlgegn]lgÕfYdafn]kle]fl\][akagf >A<!&
The new exporters — North
DF?kmhhdqk[`]e]kafAjYf$N]f]rm]dY Õjklkm__]kl]\afl`] America and East Africa
early 1970s) and Nigeria will struggle with geopolitical and
;mjj]flMKdYoj]imaj]kYf]phgjlda[]fk]^jgel`]MK
ÕfYf[af_akkm]k&Hjghgk]\]phYfkagfkaf[gmflja]kl`YlYj]
Department of Energy (DOE) in order to export LNG. In general,
increasingly short of gas for domestic markets (e.g., Trinidad and
export of LNG to a nation that has a free trade agreement (FTA)
Egypt) are also unlikely to proceed. The Eastern Mediterranean
with the US is considered in the public interest and is typically
and East Africa are important new gas provinces and should
Yhhjgn]\oal`gmleg\aÕ[Ylagfgj\]dYq&L`]<G=`Ykegj]
support world-class LNG projects. Notably, the proposed US
latitude in modifying the terms and/or stipulating conditions
and Canadian LNG export projects will counter Australia’s long-
in considering applications for export to non-FTA countries.
standing position as a politically stable major LNG supplier.
9lhj]k]fl$l`]MK`Yk>L9koal`)1[gmflja]k$Õn]g^o`a[`
Dggeaf_la_`l]jeYjc]lkgn]jl`]f]pll`j]]lgÕn]q]Yjkgjkg currently import LNG (Canada, Mexico, the Dominican Republic,
km__]klkÕjeaf_[gfljY[lhja[]k$Yld]Yklmfladegj]f]ohjgb][lk Chile and South Korea), with a sixth country, Singapore, set to
move to FID and production. By 2025, the global LNG market have import capacity in 2013. Of the current FTA countries, only
should have room for all of the projects that are currently seen as Kgml`Cgj]YYf\hgl]flaYddqKaf_Yhgj]j]hj]k]flka_faÕ[YflYf\
“possible.” However, unless there is substantially higher growth in economically viable markets.
DF?\]eYf\$Zmad\af_Yka_faÕ[YflfmeZ]jg^l`]Ékh][mdYlan]Ê
As of late January 2013, 20 companies have submitted
projects implies increasing supply-side competition.
applications for US LNG export; 16 of these have been approved
Figure 2. Global LNG capacity and demand for FTA countries, but only one application, from Cheniere’s
KYZaf]HYkkDaim]^Y[lagfDD;$`Ykj][]an]\YhhjgnYd^gj]phgjl
700
to non-FTA countries. The proposed projects are predominately
600 located on the Gulf Coast, but also include proposed facilities on
Million tonnes per year

500 the East and West Coasts. Importantly, nine of the applications,
400 af[dm\af_;`]fa]j]Ìk$ogmd\ZYk]]phgjlk^jgeeg\aÕ]\$]paklaf_
DF?aehgjl^Y[adala]k&L`]k]ÉZjgofÕ]d\Ê]phgjlhjgb][lkogmd\
300
dac]dq]fbgqka_faÕ[Yfl[gklY\nYflY_]k^jgel`]]paklaf_af%hdY[]
200
infrastructure (particularly utilities, storage and port facilities),
100 af[gehYjakgfoal`gl`]jÉ_j]]fÕ]d\Êhjgb][lk$oal`gmlkm[`
0 af^jYkljm[lmj]Ydj]Y\qafhdY[]&;YhalYd[gklk^gjMKZjgofÕ]d\
LNG projects are broadly estimated to be between US$550 million
2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

and US$650 million per mtpa of capacity, substantially less than

Existing Construction Possible Speculative Demand lqha[Yd_j]]fÕ]d\hjgb][lk&2
Source: Ernst & Young assessments of data from multiple sources More than 200 mtpa of US LNG export capacity has been
proposed, which could translate into more than 28 bcf/d of gas
exports. However, the market is unlikely to need anywhere near
that amount, with global LNG demand in 2012 at just over

*EY[imYja]=imalqJ]k]Yj[`$Global LNG Outlook, 10 September 2012

Global LNG: will new demand and new supply mean new pricing? 9
250 mtpa, growing potentially to 400 mtpa by 2020 and to northeastern British Columbia (BC) — the Montney, Horn River and
-((elhYZq*(+(&;d]Yjdq$Õjeg^^%lYc]Y_j]]e]flkoaddZ] Liard basins in particular — to the export facilities. Such pipeline
critical for US projects to go forward. capital costs are estimated to add about US$150 million to
US$200 million/mpta to total projected costs.
Notably, Cheniere’s Sabine Pass project is essentially sold out
going forward; it has four proposed trains, totaling about 18 mtpa Of the four Canadian projects, the Shell-led LNG Canada project
with four anchor buyers, along with some gas reserved for spot at Kitimat is the largest, at 24 mtpa, or about 3.2 bcf/d. Shell’s
sales. General contract terms are based on Henry Hub spot partners in LNG Canada include the Asian NOCs PetroChina and
prices, plus a 15% uplift for fuel use/shrinkage, along with a Kogas, along with the Japanese conglomerate, Mitsubishi. The
Õp]\daim]^Y[lagf[`Yj_]g^MK*&*-lgMK+'e[^&3 Particularly Apache-led Kitimat LNG project, producing roughly 10 mtpa
important for proposed exports to Asia from the Gulf Coast will (about 1.4 bcf/d), is the furthest along in terms of regulatory
be the opening of the expanded Panama Canal in late 2014. approvals. The Kitimat LNG project originally included two other
(Most LNG tankers currently in use cannot use the existing canal. large North American E&P partners, EOG Resources and EnCana,
However, tolls will counter much of the distance/time advantages but in late 2012, Chevron announced that it would buyout the
of the new canal.) interests of EOG and EnCana. Chevron will bring to the project
extensive LNG experience and, importantly, existing relationships
In Western Canada, four LNG export projects have been proposed,
with potential Asian LNG buyers.
collectively with almost 50 mtpa of capacity, or about 7 bcf/d.
As in the case of the US, not all projects are expected to go ahead. 9l`aj\;YfY\aYfDF?]phgjlhjgb][l$l`]HY[aÕ[Fgjl`o]klDF?
The proposed projects are underpinned by a large resource base project at Lelu Island near Prince Rupert, BC, has been proposed
in Western Canada, supportive government policy and a generally by Petronas/Progress Energy, with planned capacity of 11 mtpa
welcoming environment for foreign investment. The projects will (about 1.5 bcf/d). The Canadian government recently approved
however, be disadvantaged in comparison to their US competitors l`]H]ljgfYkY[imakalagfg^Hjg_j]kk=f]j_q$Yf\af]Yjdq
in that each of the Canadian projects will likely be an integrated January 2013, TransCanada announced that it would develop
_j]]fÕ]d\hjgb][l&Fglgfdqoaddl`]hjgb][l\]n]dgh]jk[gfkljm[l a natural gas pipeline from the Montney production region in
l`]daim]^Y[lagf']phgjl^Y[adala]k^jgek[jYl[`$l`]qoaddYdkggof northeastern BC to the LNG facility.
Yf\\]n]dghl`]_Ykj]kgmj[]k&L`]hjgb][lkoaddYdkgj]imaj]
In offshore East Africa, the recent tremendously successful
additional capital investment, likely from third parties, in the form
discoveries of natural gas are, in the words of the analysts at
of pipeline infrastructure from the gas source — presumably in
EY[imYja]$kaehdqlggZa_lggn]jdggc&4 The discovered resource

3 Deutsche Bank Markets Research, Global LNG, 17 September 2012 ,EY[imYja]=imalqJ]k]Yj[`$?dgZYdDF?Gmldggc$)(K]hl]eZ]j*()*

10 Global LNG: will new demand and new supply mean new pricing?
base could theoretically support exports of up to 70 mtpa, but
since the exploration phase is far from over, that estimate could
easily rise to 100 mtpa. More than 110 tcf of gas in place has
Z]]fa\]flaÕ]\afg^^k`gj]EgrYeZaim]$hjaf[ahYddqZqk]hYjYl]
consortiums led by Anadarko Petroleum (Rovuma Area 1) and Eni
JgnmeY9j]Y,!&?an]fl`][dgk]hjgpaealqg^l`]EgrYeZaim]
discoveries, the export project economics will be strongly
dependent upon the clustering of development and the extent
of cooperation between operators. In late December 2012,
Anadarko and Eni agreed to a cooperative development program
for their adjoining offshore areas, and will together plan and
[gfkljm[lY[geegfgfk`gj]DF?daim]^Y[lagf']phgjl^Y[adalq&
The agreement should facilitate government approval of the
developments.5
Particularly interesting to watch in early 2012 was the
competition between Shell and the Thai NOC, PTT Exploration
and Production (PTTEP), for the 8.5% Cove Energy interest in
9fY\YjcgÌkJgnmeY9j]Y)\]n]dghe]flafg^^k`gj]EgrYeZaim]&
After multiple bids and counterbids, Shell withdrew from further
bidding. However, Shell is expected to continue to explore other
options in the East African gas plays, with Shell’s deep experience
in LNG development and marketing expected to be particularly
attractive to potential partners.
Neighboring offshore Tanzania has seen somewhat similar
exploration success. But while some progress has been made in
\]n]dghaf_l`]Õk[Yd^jYe]ogjcYf\l`]_Yk[gee]j[aYdarYlagf
agreements, more formal cooperation between the partnerships
oadddac]dqZ]j]imaj]\$YkYj]kmdlg^l`]\aklYf[]kZ]lo]]f
discoveries.

-A@K?dgZYdAfka_`l$É9fY\YjcgYf\=faka_f_Yk\]Ydoal`EgrYeZaim]_gn]jfe]fl$
awards FEED contracts,” 21 December 2012

Global LNG: will new demand and new supply mean new pricing? 11
 The overarching
economic issues —
costs and pricing

Sticker shock — the capex

challenge
The early wave of LNG projects were largely developed for capital
costs of less than US$200 million/mtpa of capacity, and with a few
notable exceptions (e.g., Norway’s Snøhvit and Russia’s Sakhalin),
the second wave of capacity was generally developed for costs in
the US$500 million to US$1,500 million/mtpa range. The third
wave of capacity is now challenged by what can only be described
as a “step-change” in capital costs. Deutsche Bank estimates
that the currently operating LNG projects were developed at an
average cost of approximately $1,200 million/mtpa, whereas the
average cost for the recently sanctioned and proposed projects is
more than US$2,600 million/mtpa, more than double the historic
average.1
LNG project proposals are growing faster than the industry’s
capabilities to develop them. Generally at the high end of the cost
curve, with development bottlenecks and spiraling construction
costs, Australian projects are typically suffering the most
hjgZd]ek&KYf[lagf]\hjgb][lkYj]_]f]jYddqd]kkka_faÕ[Yfldq
impacted (unless contracts are reopened or renegotiated), but
projects still seeking contracted off-take are at substantial risk.
Af[gfljYkl$ZjgofÕ]d\hjgb][lkl`Ylaf[dm\]]phYfkagfklg
existing operations and those that will build on existing LNG
import infrastructure, such as in the US, will have distinct cost
advantages. Similarly, merchant LNG projects that do not include
the upstream costs of gas supply development, which again is the
case for most of the US LNG export projects, will enjoy distinct
cost advantages over the integrated projects.
According to analysts at Credit Suisse, the proposed
North American and East African export projects are seen as
hYjla[mdYjdqo]ddhgkalagf]\Y_Yafkll`]_j]]fÕ]d\9mkljYdaYf
hjgb][lk$oal`mfal[gklk afl]jekg^lglYd[gklklgÕjklDF?
supply) averaging less than US$2,000 per tonne, as opposed to
the Australian average of more than US$3,000 per tonne.2

1 Deutsche Bank Global Market Research, The Australian LNG Handbook, 6 September 2011
*;j]\alKmakk]?dgZYd=imalqJ]k]Yj[`$Global LNG Sector Update, 7 June 2012

12 Global LNG: will new demand and new supply mean new pricing?
Figure 3. Total capital costs to supply: selected LNG projects
lglYd[Yh]plgÕjklDF?kmhhdq!
Indexing and convergence
The last few years have seen a record divergence in regional gas
Darwin
NW Shelf prices, driven by both supply and demand factors, e.g., the US
Sabine Pass k`Yd]_YkZgge$l`]=mjgh]YfÕfYf[aYd[jakakYf\l`]>mcmk`aeY
Yamal nuclear crisis.
Tanzania
Mozambique The advent of diverse new supply sources is challenging the LNG
Kitimat klYlmkimg$oal`9kaYfZmq]jkhj]kmeYZdqdggcaf_lgeg\a^qgj
AP LNG
PNG LNG
possibly replace their long-standing and relatively expensive
Sunrise pricing model of gas prices tied explicitly to oil prices.
Gladstone
QC LNG Figure 4. Global natural gas prices (monthly averages)
Gorgon
Tangguh $24
Abadi
$21
Browse
US$ per million BTUs

Pluto $18
Shtokman $15
Wheatstone
Prelude $12
Ichthys $9
Arrow
$6
$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$3
$0
US$ million/mtpa
2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Pre-FID Post-FID Online

Kgmj[]2;j]\alKmakk]?dgZYd=imalqJ]k]Yj[`$?dgZYdDF?K][lgjMh\Yl]$/Bmf]*()* US-Henry Hub UK-NBP Asia-JCC

Source: US Department of Energy and Thomson/Reuters

;gklkaf9mkljYdaY`Yn]Z]]f\jan]fmhZqafÖYlagfYf\[mjj]f[q
shifts, as well as by local challenges of developments in remote @a_`DF?\]n]dghe]fl[gklkoaddj]imaj]ajgf[dY\dgf_%l]je
areas with limited existing infrastructure and constrained access off-take agreements. But more recently, the market is witnessing
lg]imahe]flYf\kcadd]\h]jkgff]d&9[[gj\af_lgl`]Afl]jfYlagfYd l`]af`]j]fl[gfÖa[lg^af[j]Ykaf_dqegj]]ph]fkan]hjgb][lk
Egf]lYjq>mf\$gn]jl`]dYkl)(q]Yjk$afÖYlagfaf9mkljYdaY`Yk trying to sell to increasingly more price sensitive buyers. From the
averaged more than 1% higher than the collective average for supply side, oil is becoming somewhat scarcer while gas is more
all of the advanced or developed economies.3 Adding to the cost hd]fla^md&9kYj]kmdl$l`]j]akl`]af`]j]fl[gfÖa[lg^h]jkakl]fldq
pressures, particularly in the last few years, the Australian dollar high oil prices and a growing surplus of natural gas, with strict oil
`Ykka_faÕ[YfldqYhhj][aYl]\Y_Yafkll`]Z]f[`eYjcMK\gddYj3 indexation becoming less tenable.
since early 2009, the Australian dollar has strengthened by more
than 65%.4

3 International Monetary Fund, World Economic Outlook database,

accessed 12 December 2012
4 Dow Jones Factiva, accessed 12 December 2012

Global LNG: will new demand and new supply mean new pricing? 13
 Understanding Asian LNG pricing
Long-term LNG contracts in Asia have historically been linked to prevailing crude oil prices, and while the
concept is relatively simple, the actual derivation of the LNG price can be somewhat confusing. There are
typically three pieces to the contract calculation: the oil price, the slope and the constant.
The calculation starts with an oil price reference benchmark; the one most commonly used is known as the
Japan customs-cleared crude (JCC) price (also known as the Japanese Crude Cocktail). The JCC represents
the average monthly price of a basket of various crude oils imported into Japan. The JCC typically moves in
line with other global crude benchmarks.
The second contractual piece in the LNG price derivation is the negotiated factor, which is known as the
Éhja[]kdgh]&ÊKdgh]]kk]flaYddq\]Õf]kl`]j]dYlagfk`ahZ]lo]]fgadYf\_Ykhja[]k$Yf\akl`]femdlahda]\
by the JCC. On average, one million BTUs of gas has about 16.67% of the energy content of a barrel of oil
a&]&$l`].%lg%)`]Yl%]imanYd]flhYjalq!&;gfljY[lkdgh]aklqha[Yddq]phj]kk]\afh]j[]flY_]l]jek3l`mk$a^l`]
`]Yl%]imanYd]flhYjalqo]j]mk]\$l`]kdgh]ogmd\Z]).&./&;gfljY[lkdgh]kYj]lqha[Yddqkda_`ldqd]kkl`Yf
16.67%, usually around 14% to 15%, but they could be higher if the buyer were willing to pay a premium over
l`]`]Yl%]imanYd]flgadhja[]&9kkdgh]\][j]Yk]k$l`]j]kmdlaf_DF?hja[]^gjY_an]fgadhja[]oaddZ]dgo]j&
To further add complexity, some contracts will have varying slope percentages used at different oil price
levels. Broadly speaking, there can be four basic forms: the simplest is a straight-line constant slope that
exposes both the buyer and seller to adverse price movements. A second type is the so-called “S-curve,”
o`a[`oadd`Yn]YÖYll]jkdgh]Yldgogadhja[]klghjgl][lk]dd]jkYf\YÖYll]jkdgh]Yl`a_`gadhja[]klghjgl][l
buyers. The other two types are variations on the S-curve, where either only the seller has some protection
Yfgad%dafc]\[gfljY[loal`YÖggj!gjgfdql`]Zmq]j`Ykhjgl][lagf Yfgad%dafc]\[gfljY[loal`Y[]adaf_!&

Figure 5. Notional LNG contract slopes

$18

$16

$14

$12 Straight-line contract

Gas price (US$/million BTUs)

$10
Higher prices

$8

$6
S-curve contract
$4

$2
Higher prices
$0
$6 $12 $18 $24 $30 $36 $42 $48 $54 $60 $66 $72 $78 $84 $90 $96
Oil price (US$/barrel)
Source: Ernst & Young adapted from Deutsche Bank Markets Research, The Australian LNG Handbook, 6 September 2011

L`]ÕfYdha][]akl`][gfklYfll]je$o`a[`_]f]jYddqj]hj]k]flkYÕp]\hja[]]d]e]fll`Ylakaf\]h]f\]flg^
oil price movements. Most LNG contracts will include a modest constant, typically less than US$1 per million
BTUs, which generally bears some implicit relationship to shipping costs.

14 Global LNG: will new demand and new supply mean new pricing?
Gadaf\]pYlagfg^_Yk[gfljY[lkoaddZ][ge]egj]\a^Õ[mdloal` The Deutsche Bank analysis suggests that the supply side of the
greater competition between sellers; more price-sensitive buyers; LNG business needs to be assured that it will be able to achieve
increasing energy deregulation; increasing gas-on-gas competition a netback (i.e., after shipping costs) of about US$10 to US$11
^jgef]ohah]daf]af^jYkljm[lmj]3af[j]Ykaf_khgleYjc]ldaima\alq3 per million BTUs, or about US$12 to US$13 per million BTUs
and, most important, increasing availability of spot-price-based delivered. Given a broad assumption that long-term oil prices
DF?]phgjlk&<]n]dgh]jkg^`a_`%[gklhjgb][lkoaddÕf\al`Yj\]jlg average between US$80 to US$90 per barrel, this would imply
Õf\k`]dl]jafZadYl]jYd[gfljY[lkYf\`a_`%[gklk]dd]jkoaddkljm__d] that sellers would seek oil-linked contracts with slopes in the range
to preserve pricing power. of 14% to 16%, approximately where they currently are.5

Analysts at Deutsche Bank similarly see challenges for many But the possibility of spot gas-linked contracts for North American
of the proposed Australian LNG projects, looking at estimated LNG could upset the traditional pricing structure. Using the terms
nominal break-even costs, including an assumed 12% internal rate of the Cheniere Sabine Pass contracts, the attractiveness of
of return, and an assumed delivery into Tokyo Bay. In Deutsche “Henry Hub plus” pricing becomes apparent, both to buyers and
Bank’s view, the proposed North American LNG export projects sellers: buyers accessing supply not linked to high and presumably
are particularly well-positioned, even though the US Gulf Coast increasing oil prices, and sellers opening margin opportunities. As
projects will give up some of their FOB cost advantage with higher shown in the table below, the “plus” component or “uplift” over
shipping costs. the spot price needs to be about US$6 per million BTUs. Thus,
US LNG will be particularly attractive if spot prices stay under
Figure 6. Nominal new-build LNG costs: selected LNG projects or around the long-term US spot gas price assumption of about
(assumes delivery to Tokyo Bay) US$5 to US$6 per million BTUs.

Brass LNG Table 2. US Gulf Coast LNG to Japan

LNG Canada
Kitimat LNG
(US$ per million BTUs)
Henry Hub spot $2.00 $3.00 $4.00 $5.00 $6.00 $7.00
Sabine Pass*
Energy cost (15%) $0.30 $0.45 $0.60 $0.75 $0.90 $1.05
Mozambique
Capacity charge $3.00 $3.00 $3.00 $3.00 $3.00 $3.00
Tanzania
FOB cost $5.30 $6.45 $7.60 $8.75 $9.90 $11.05
Pluto Shipping $2.50 $2.50 $2.50 $2.50 $2.50 $2.50
Gorgon CIF cost $7.80 $8.95 $10.10 $11.25 $12.40 $13.55
Ichthys
Source: Deutsche Bank Markets Research, Global LNG, 17 September 2012
Prelude FLNG
Wheatstone Notional FOB costs for proposed Western Canada LNG exports
QC LNG are assumed to be slightly higher than those for US Gulf Coast
Browse exports, largely due to the pipeline supply component (moving the
Shtokman gas from northeastern BC to the coast), but shipping costs to Asia
are substantially lower. Total CIF costs of Canadian LNG to Asia are
$0 $2 $4 $6 $8 $10 $12 $14 $16
estimated to be US$0.50 to US$1.00 less per million BTUs than
US$ per million BTUs
LNG from the US Gulf Coast.6
FOB cost (break-even) Shipping cost

*Assumes US$4 Henry Hub spot gas

Source: US Department of Energy and Thomson/Reuters

5 Deutsche Bank Markets Research, Global LNG, 17 September 2012

.EY[imYja]=imalqJ]k]Yj[`$Global LNG Outlook, 10 September 2012

Global LNG: will new demand and new supply mean new pricing? 15
As substantial volumes of lower-cost LNG move into Asian
markets, projects at the high end of the supply curve — namely,
many of the Australian projects — will become increasingly
vulnerable.
Going forward over the medium to longer term, we expect to see a
gradual but partial migration away from oil-linked pricing to more
spot or hub-based pricing. Alternatively, we are also likely to see
some lowering of contract “slopes” (again, see the sidebar), which
has the same effect. LNG sellers are reluctantly facing realities
and are offering concessions in order to remain competitive.
However, LNG prices are unlikely to collapse, simply because the
cost to supply is high and incentives to develop new capacity must
Z]eYaflYaf]\&9kYfYdqklkYlEY[imYja]hgaflgml$DF?akYn]jq
expensive game, and prices — however they are formed — must
j]Ö][ll`akj]Ydalq&7
Khglhja[af_af[j]Yk]kZmq]jkÌ[`ga[]k$Y\\kdaima\alqlgeYjc]lk$
Yf\YddgokZmq]jklg`]\_]ÕfYf[aYddqYf\h`qka[Yddq&L`]`aklgja[
bmklaÕ[Ylagfg^gaddafcY_]koYkl`]k][mjalqg^kmhhdq$Zmloal`
af[j]Ykaf_daima\alqafl`]eYjc]l$l`]k][mjalqÉhj]eamekÊ
Z][ge]`Yj\]jlgbmkla^q&?jgoaf_daima\alqYdkg_an]kkmhhda]jk
[gfÕ\]f[]lgkYf[lagfhjgb][lkZ]^gj]dg[caf_afg^^%lYc]
agreements — hence, the emergence of major portfolio LNG
players. The opening of the Singapore LNG terminal in 2013
oaddhj]kmeYZdqhjgna\]l`]ZYkak'f]pmk^gjYkm^Õ[a]fldqdaima\
regional exchange on which to base pricing. Additionally, some
Asian buyers have already begun to sign contracts for future
US-based cargos at Henry Hub-linked prices.
However, hub-based exports may not always be cheaper — e.g.,
US gas prices can be extremely volatile — and while greater
[gfljY[lÖ]paZadalqakYZa_YlljY[lagf$khglhja[af_[gmd\bmkl
interject more volatility for buyers and cause projects to have
higher internal return thresholds to account for that volatility risk.
O]Yj]Ydkg]ph][laf_lgk]]af[j]Ykaf_\]klafYlagfÖ]paZadalqaf
LNG contracts, increased “diversions” of cargos between markets
Yf\af[j]Yk]\j]%]phgjlaf_g^[Yj_gk$Yddg^o`a[`af[j]Yk]daima\alq
and contribute to greater linkages between/among regions and
markets. These increasing linkages between markets and the
growing supply-side competition for premium Asian customers
will provide some convergence of regional prices: namely, Asian
prices are pushed down, while North American prices are lifted
somewhat, generally narrowing, but not eliminating, the regional
differentials.

/EY[imYja]=imalqJ]k]Yj[`$Global LNG Outlook, 10 September 2012

16 Global LNG: will new demand and new supply mean new pricing?
Other risks and challenges
Beyond the cost and pricing issues, there are a number of other expected to remain extremely high through the end of the
risks and challenges that companies have to consider and address: decade. In Canada, where skilled labor markets are already
tightly stretched with oil sands construction activity, the knock-
 Hja[]ngdYladalqÈYkfgl]\]Yjda]j$khglhja[]k$km[`Ykl`gk]
on effects of aggressive LNG development could substantially
in the US, can be very volatile, often affected by local supply/
Y__jYnYl]l`]hjgZd]ekYf\j]kmdlafka_faÕ[Yfl[gklaf[j]Yk]k&
demand factors, abnormal weather or accidents.
 Kmhhdql][`fgdg_qÈlogYj]YkafhYjla[mdYj[gmd\aehY[ll`]
 Hgdala[Ydjakc ]phgjlk!ÈhYjla[mdYjdqafl`]MK$l`]j]eYqZ]
future of LNG: methane hydrates and Floating LNG (FLNG).
domestic energy cost implications as a result of LNG exports.
Over the long term, methane hydrates could potentially double
Gas-intensive industries that have recently gained competitive
the world’s natural gas resources. With a disproportionately
international advantage with low US gas prices are adamantly
large volume of methane hydrates located near Japan and
opposed to LNG exports. The recent study by NERA Economic
Korea, both countries are ramping up R&D activities. Successful
Consultants for the US Department of Energy found that LNG
\]n]dghe]fl[gmd\ka_faÕ[Yfldqj]\m[]\]eYf\^gjDF?&
]phgjlkogmd\hjg\m[]f]l][gfgea[Z]f]Õlk^gjl`][gmfljq
FLNG may in some cases be an attractive, cost-effective
despite somewhat higher domestic gas prices, and that these
Ydl]jfYlan]lgdYf\%ZYk]\daim]^Y[lagf$oal`hgl]flaYddqdgo]j
Z]f]Õlkogmd\af[j]Yk]oal`]phgjlngdme]k&1 While the
development costs, lower environmental impacts and the ability
Õf\af_kg^l`]j]hgjlo]j]o]d[ge]\Zql`]DF?[geemfalq$
lgegf]lar]j]egl]gjkeYdd]j_YkÕ]d\k&9lhj]k]fl$l`]j]Yj]
the report itself does not settle the politically charged issue.
no operational FLNG facilities — Shell’s Prelude FLNG project,
The US government always retains the right not to issue and/
currently being developed in Australia, is slated to come online
or to revoke export licenses. In addition, there simply are some
in 2017–2018.
concerns about the political “optics” of selling large amounts of
gas to China.  AeeYlmj]Õk[Yd'd]_Ydj]_ae]kaf]e]j_af__YkeYjc]lkÈ
with East Africa emerging as one of the most promising new
 Hgdala[Ydjakc ]fnajgfe]flYd!Èaf;YfY\Y$l`]k]jakck[]fl]j
gas provinces, governments will be pressed to establish fair,
around rising environmental opposition, particularly with regard
ljYfkhYj]fl$Yf\]^^][lan]Õk[YdYf\d]_Ydkqkl]ek&>Yadmj]lg\g
to potential pipeline and/or shipping spills, and around First
so will likely slow LNG development.
Nations’ land issues with the export facilities and the associated
pipeline infrastructure.  Hgl]flaYdDF?lYfc]j[YhY[alqakkm]kÈaf\mkljqoaddf]]\gf]
additional LNG tanker for ~1.5 to 2 mtpa of new capacity; this
 ;YdgjaÕ[[gf[]jfkoal`Éd]YfÊgj\jq_Ykkm[`Yk^jgel`]
will depend on tanker size, with the biggest new tankers (Q-max
US — Asian customers typically prefer “richer” gas. Technical
tankers) holding up to 260,000 cubic meters, with the typical
workarounds may be effective, e.g., “spiking” dry cargos with
tanker size ~175,000 cubic meters. Tanker tightness could slow
fYlmjYd_Ykdaima\k F?Dk!&
khgleYjc]ldaima\alq_jgol`&
 LjYfk^]jhja[af_Èhja[af_ak[gehda[Yl]\Zqj]dYlan]dqaddaima\
 ;`][c]j]\af\mkljqj][gj\afl]jekg^k[`]\md]\]dYqkYf\[gkl
markets with few participants and a paucity of comparable data.
overruns — Deutsche Bank notes that only 2 of the last 12 LNG
There are challenges in allocating or apportioning value and risk
projects have been delivered on time and budget, and it appears
to the various functions along the supply chain in a long-dated
lgZ]egj]\a^Õ[mdllg\gkg&Hjgb][lkYj][`Ydd]f_]\Zqk`]]j
[gfljY[l&L`]k]akkm]k[YfZ]eY_faÕ]\afl`][Yk]kg^[Yj_g
train sizes, increasing technological complexity, labor issues
“diversion.”
and environmental issues, while upstream supply regions have
 Kcadd]\dYZgjk`gjlY_]kÈdYZgj\]eYf\k^gjl`]kmj_]g^ also become more complex.2 Analysts at J.P. Morgan similarly
Australian LNG projects have been a major factor in the cost estimate that, since 2000, about one-third of all LNG projects
afÖYlagfl`]af\mkljq`Ykkm^^]j]\&=n]foal`em[`g^l`] have been delayed or over budget, or both.3
fabrication work done outside of Australia, labor demand is

2 Deutsche Bank Global Market Research, The Australian LNG Handbook,

1 NERA Economic Consulting, Macroeconomic Impacts of LNG Exports from the United 6 September 2011
States, a report prepared for the US Department of Energy, 3 December 2012 +B&H&Egj_Yf;Yr]fgn]?dgZYd=imalqJ]k]Yj[`$Global LNG, 13 January 2012

Global LNG: will new demand and new supply mean new pricing? 17
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