Why US LNG Matters
When Cheniere Energy first proposed, in June 2010, to export LNG from the Lower 48, it was greeted with a mixture of mockery and disbelief. Many analysts doubted that the US government would allow exports, and the economics were both compelling (cheap) but also complicated (volatile). It was only in October 2011, when BG Group announced it would buy 3.5 mmtpa from Sabine Pass, that the mood changed. A top LNG player was betting on the Lower 48, and within a few months, Sabine Pass T1-4 was sold out. From the start, US LNG felt like a big deal, something qualitatively different than Qatari or Australian or any other LNG. So as Sabine Pass readies its first cargo, here are some thoughts on why US LNG matters.
Big (and could grow)
By year-end 2015, there were 62 mmtpa of LNG capacity under construction in the Lower 48, which would make the United States the world's third largest LNG exporter by 2020. These volumes will push down prices, increase flows to "sink" markets, and create a surplus of LNG that can be used to create new demand. More importantly, additional LNG could be available: this is not like Qatar, which has a moratorium on new projects, nor is it like Australia, where costs have stopped new developments since 2012. In the United States, there is a long list of projects that could easily be sanctioned in the next two years if they can secure a buyer or two. Even if no other project is sanctioned in the Lower 48, the belief that more could come is enough to put pressure on any other project developer worldwide.
Cheaper (sort of)
From the start, US LNG stood out due to cost; as oil prices rose, and as Japan took in additional LNG after Fukushima, the spread between Henry Hub-based LNG into Japan and Japanese LNG import prices widened to around 35%. Of course, the market understood that this spread might not last, yet the temptation for buyers was too great to ignore. In early 2016, of course, US LNG is out of the money in most European markets; in Asia, US LNG is on par with existing contracts, but lower oil prices will soon make US LNG among the pricier options. Even so, US LNG has put downward pressure on new contracts, and it will put downward pressure on spot prices. In the longer term, however, it is too soon to know how US LNG will play out. After all, almost all long-term bets involving LNG in the United States have been proven completely wrong so far.
Not linked to oil
Besides being possibly cheaper, buyers appreciate US LNG because it is not linked to oil. At a minimum, this means the introduction of a new pricing regime in LNG markets; at a maximum, it further undermines oil indexation, which has already been dethroned in NW Europe. Of course, as oil prices have tumbled, buyers and sellers view oil indexation differently than they did in 2011-2013 when all the contracts for US were being signed. Nor is it clear that US LNG will be sold in prices linked to Henry Hub: LNG might leave the United States under one pricing system and arrive under another (linked to NBP, for example, or oil, or spot prices). And while there is some effort to incorporate Henry Hub pricing in non-US contracts, those efforts have been limited so far. In other words, Henry Hub-linked LNG matters; but we don't know how much yet.
US LNG is sold FOB without territorial restrictions, which means that the supply of destination-flexible LNG will grow substantially. The short-term / spot market is about 65 to 70 mmtons, depending on who is counting, so the addition of another 60 mmtons of LNG that is contractually free to be sold on the spot market is a big deal. In a tight market, more flexible LNG should mean closer prices between spot and long-term LNG, since the divergence often reflects the limited availability of truly flexible LNG. In a loose market, the main impact should be to allow price-sensitive importers to boost their purchases. Of course, we still need to see how this theoretically flexible will actually be marketed—after all, it might prove sticky, especially for Asian buyers who are not used to actively trading their long-term SPAs. But the theoretical potential is significant.
Perhaps the biggest unknown is whether US LNG volumes will fluctuate based on market conditions: will facilities run at close to 100% or will buyers reduce purchases when the arbitrage is small or negative? Will buyers look at full-cycle or just variable costs, which treat the liquefaction charges as sunk? How will US LNG interact with Henry Hub prices? One can hypothesize about these issues but we will only know when we see exports in practice. If US LNG is adjustable, the impact will be huge: until now, the LNG market has always adjusted through prices, with supply being price-insensitive. If US LNG proves price sensitive, that would present the biggest structural change that the global LNG market has experienced since the introduction and spread of destination-flexible LNG.
Nikos Tsafos is President & Chief Analyst at enalytica. Republished with permission.