April 01, 2020

The impact of the COVID-19 virus on the LNG business

The impact of the COVID-19

The COVID-19 outbreak has put huge unprecedented stress on society and economies. Its impact will be severe and, whilst its duration is uncertain, it is too early to assess what the outcomes will be.  

The LNG business will be affected in a number of ways, with several challenges but some opportunities are also likely to be created.  Potentially the LNG business may emerge from this crisis in a healthier state than it was in at the start of this year.

The first issue to impact the LNG market has been the fall in crude oil prices. Brent crude oil has fallen from US$70/bbl in January to US$24.88/bbl in mid-March.  The March average is likely to be around US$34/Bbl compared with US$64/bbl for January. 

Figure 1: Brent Crude Oil                                                             Figure 2 North-East Asia Spot

The fall in crude prices will trigger a fall in term LNG contract prices - but due to the time lag built into many contracts this might not work through to invoices until mid-year.

Lower prices will finally get through to markets. Lower spot prices last year did not benefit many markets as the bulk of LNG was imported under term contracts. The average price of LNG imported into Japan in December 2019 was US$9.24/MMBtu.  By mid-2020, the average landed price could be half that.  

Lower prices is likely to stimulate demand as Asian markets emerge from the current coronavirus crisis.  In Japan and Korea, we could see gas/LNG replacing coal from power generation but the demand response could be greater in South Asia.

We are unlikely to see a positive demand response in Europe.  Prices there have been low for some time as traded LNG is linked to gas hub prices rather than oil.  Shut downs have led to lower gas consumption and this is expected to fall further in Q2 when Europe moves out of the heating season.  LNG imports into Italy in March are likely to be only about a third of the volume supplied in March last year.

Europe can no longer act as an “LNG sink” and we are already seeing cargoes destined for Europe being redirected to Asia.  Cargoes backed out of China have been diverted, often to India.  India imported a record 2.54 million tonnes of LNG in February, 68% more than the same month last year. However, as India moved into a shutdown in late March major buyers issued force majeure notices to their main suppliers and several cargoes are floating offshore awaiting opportunities to berth. India is unlikely to be able to act as an ”LNG sink” in the immediate future.

Supply has not yet been significantly impacted by the coronavirus outbreak.  Lower prices has led to increased pressure on US producers to reduce production but it can only be a matter of time before a producer has to suspend production due to a shutdown order or due to key staff being unavailable.  Already, some Australian staff at Gorgon LNG and Ichthys LNG have been quarantined due to the discovery of a coronavirus case. At some supply locations production is going straight into floating storage. We must now be very close to a shut in of some production capacity.

Shipments have been impacted by vessels being placed into quarantine but this has delayed supply rather than reducing supply.

A reduction in supply is unlikely to have any immediate impact on the market due to high inventories and the amount of LNG currently in floating storage. Eventually it will have an impact and lower supply could mean the market comes back into balance earlier than previously expected - and prices recover earlier than expected.

Lower term prices will not lead to an easing off of pressure from Asian buyers to secure a price review.  Instead events have galvanised buyers to be even more aggressive about securing a price review.  Negotiating them has become much more difficult as it less clear to the parties what would be a desirable outcome. 

The "slopes" in new (oil linked) term LNG contracts - which represent the linkage between oil and gas prices - have been falling in recent years from 14%+ to about 11%.  The decline may now cease as in the current low oil price environment, 11% may start to look "too cheap"

The greatest effect of the coronavirus outbreak so far has been on the project pipeline.  The risk of long term over capacity now appears to have reduced.

125 million tons of new liquefaction capacity is currently under construction at 18 projects.  So far, these have not been impacted by the coronavirus outbreak but they inevitably will be. LNG Canada, a huge 14 mtpa project, recently made the decision to gradually and methodically draw down by half the number of people working at the construction site in Kitimat, B.C.  Only personnel involved with essential activities are now working at site. 

Meanwhile, an unprecedented 18 projects had lined up to take FID in 2020 potentially adding almost 200 million tonnes of new liquefaction capacity.  These included some of the 14 US projects that have received FERC approval but not yet moved to construction and behind all of these there was an even longer tail.  At the start of the year 59 new liquefaction plants had been proposed offering almost 600[1] million tonnes of new liquefaction capacity!  Nexant, through its World Gas Model (WGM) reviews global LNG and pipeline capacity and is able to run sensitivities around these projects under various oil price and other scenarios

[1] To put this in perspective, current available global liquefaction capacity is 410 million tonnes

Recent events have meant that FID's have been postponed, projects rescheduled and capacity reduced.  Some are on hold and it appears possible that some projects may be cancelled.  Our analysis suggests that it is increasingly unlikely that any new liquefaction projects will be sanctioned this year.

Going forward, investors and Lenders are expected to be more wary of these projects and financing will become more difficult in a lower pricing environment. Successful project development and investment in the LNG sector is likely to become much more challenging in the current environment requiring deeper consideration of strategic advantages and competitive positioning of individual projects before making firm commitments.

So as we look at the impacts of the coronavirus crisis on LNG markets to date:

  • A dramatic reduction in Asian term LNG prices (some may halve)
  • No significant impact yet on supply – but it is coming
  • Fairly modest impact on demand – Europe/China down 5%-10% rather than 50%
  • Demand reductions in some locations could be offset by demand increases in others, particularly S. Asia.
  • The project pipeline bubble has burst.
  • Price reviews and new contract negotiations have become much more difficult as desirable outcomes less clear.

We are at a relatively early stage of a pandemic that is going to do massive social and economic damage. The LNG business has got off relatively lightly so far. This may not be the case in a few weeks’ time.

Nexant remains available to assist clients in evaluating sector investments as a well-respected independent consultancy with no conflicts of interest (we are not Licensors/technology providers and do not offer EPC services);

Nexant’s Natural Gas Team extensively tracks global gas developments and stays abreast of E&P activity, infrastructure projects, contracts and pricing movements, and volumetric flows to consumers; in essence the entire value chain.  Using our proprietary World Gas Model (WGM) simulator we forecast gas market dynamics and pricing out to 2050.  Including but not limited to: country level supply-demand balances, trade flows by source (pipe or LNG), contract and spot prices for all consumer markets etc.  Furthermore the WGM was built for maximum flexibility and as such it is a powerful tool in developing bespoke scenarios allowing us to investigate all pertinent variables and assist clients in making investment decisions and to deepen their understanding of natural gas markets.

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Tony Regan – Lead Gas & LNG, Asia Pacific, Nexant

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