A new report released by Ernst & Young, Global LNG
reportWill new demand and new supply mean new
pricing, examines the evolving market dynamics for global
liquefied natural gas (LNG).
The report indicates the near-consensus view of strong LNG
demand growth over the next 10 to 20 years, but with a growing
role for more price-sensitive buyers who are likely to be less
willing to pay supply security premiums.
Supply development is in progress. On the
supply side, a massive amount of new LNG capacity has been
proposed. If all of these plants are built, it would more than
double present LNG capacity by 2025.
Even with reasonably strong demand growth, this implies
growing supply-side competition, upward pressure on development
costs and downward pressure on natural
Nevertheless, the 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.
Over the industry's last 50 years, there has been a
progressive broadening of the LNG
supply base, with three waves of suppliers. The first wave was
dominated by Algeria, Malaysia and Indonesia, while the second
wave has been dominated by Qatar and Australia.
The third wave could come from as many as 25 other
countries, many of which have little or no capacity at present.
By 2020, however, these countries could provide as much as 30%
of the world's LNG capacity.
LNG project proposals are growing faster than the industry's
capability to develop them. Generally at the high end of the
cost curve, with development bottlenecks and spiraling construction costs, Australian
projects are under the most pressure.
Sanctioned projects are less significantly impacted, but
projects still seeking contracted offtake are at substantial
risk. In contrast, "brownfield" projects, which include expansions to existing operations
and those that will build on existing LNG import
infrastructure, will have distinct cost advantages.
Similarly, merchant LNG projects that do not include the
upstream costs of gas supply development (as is the case for
most of the proposed US LNG
export projects), will enjoy distinct cost advantages over the
Possible pricing changes loom.
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? Will divergent
regional gas prices show signs of convergence?
The advent of diverse new supply sources is challenging the
LNG status quo, with Asian buyers presumably looking to modify
or possibly replace their long-standing and relatively
expensive pricing model of gas prices tied explicitly to oil
High LNG development costs will require solid, long-term
offtake agreements. However, more recently, the market is
witnessing the inherent conflict of increasingly expensive
projects trying to sell to increasingly price-sensitive
From the global supply side, oil is becoming somewhat
scarcer while gas is more plentiful. As a result, there is an
inherent conflict of persistently high oil prices and a growing
surplus of natural
gas, with strict oil indexation becoming less tenable.
Oil indexation of gas contracts will become more difficult
with greater competition between sellers, more price-sensitive
buyers, increasing energy deregulation, increasing gas-on-gas
competition from new pipeline infrastructure, rising spot
market liquidity, and, most importantly, increasing
availability of spot price-based LNG exports.
In short, high-cost projects will find it harder to find
shelter in bilateral contracts, and high-cost sellers will
struggle to preserve pricing power.
North American pricing is critical. Among
the new wave of potential LNG exporters, most important to the
issue of pricing are those in the US and Western Canada, where
the source gas is likely to be priced on a spot basis, unlike
gas elsewhere in the world, which is generally priced on an
Critically, the possibility of spot gas-linked contracts for
North American LNG could upset the traditional LNG pricing
The proposed North American LNG export projects are
particularly well-positioned, even though the US Gulf Coast
projects will give up some of their free-on-board (FOB) cost
advantage with higher shipping costs.
As substantial volumes of lower-cost LNG move into Asian
markets, projects at the high end of the supply
curvenamely, many of the Australian projectswill become
Over the medium to longer term, Ernst & Young expects to
see a gradual but partial migration away from oil-linked
pricing to more spot price-based or hub-based pricing. LNG
sellers are reluctantly facing realities and are offering
concessions to remain competitive.