The LNG world is abuzz with speculation about the precipitous fall in crude oil prices over the past half-year. After all, liquefaction plants are essentially bets in arbitrage—very long-term, capital-intensive bets.

Analysts take on the roles of divining signs from tea leaves left at the bottom of a cup of experience, but in an emerging market that is exploring new ground, there’s not much experience to draw from. But the premier question many analysts are asking themselves at the moment is, what effect will this drop in oil prices have on LNG pricing throughout the world?

Already a few major developments have grabbed optics over the past couple of months. Perhaps the most striking of these is Petroliam Nasional Berhad’s (Petronas) decision last December to delay a final investment decision for its CA$36 billion (US$28.7 billion) Pacific NorthWest project in British Columbia. After haggling with the local legislature over a tax scheme for several months, the two-train, 12 million tonnes per annum (mtpa) project received what many analysts in the LNG world saw as a favorable scheme, where the second tier ended up being half of what was originally proposed by the government of British Columbia.

The Malaysian company had also just acquired environmental assessment approvals, and Japan Petroleum Exploration Co., which owns a 10% interest in the project, had just begun to construct a new LNG import terminal in Japan, presumably to import some of its invested capacity.

The stars were aligning, yet Petronas delayed. Why?

Seeking ‘clarity’

According to Petronas, “challenging” pipeline and liquefaction facility costs were important, but they also desired “further clarity on substantive items of importance to ensure that critical project components align with economic viability of the project and competition from other LNG producing countries.”

Excelerate Energy LP was even more direct when it released a statement placing its Lavaca Bay LNG proposal on the Texas coast in abeyance until at least April, if not longer. In the filing, Excelerate wrote that “recent global economic conditions,” including “a steep decrease in the price of oil,” have “created uncertainty regarding the economics of the project.”

Since the price of LNG often remains tied to the price of oil, what happens to the price of oil affects the economics of LNG contracts. And for some projects, operators are considering shifting assets to projects with more certain futures.

In late January, Sanford C. Bernstein & Co. released a report detailing how lower oil prices will affect the global LNG industry for years to come. It characterized the industry as going through a temporary “anxiety attack” over falling oil prices and uncertain global growth. The basic conclusion was that this would lead to temporary suspension of investment plans, despite an acceleration of LNG demand by 9.8% this year, but that the industry demand would grow from 268 mtpa this year to 355 mtpa by 2020 and 440 mtpa by 2025.

Not necessarily bad

Alex Munton, an analyst at Wood MacKenzie, acknowledges that the oil price has certainly caused some LNG developers to rethink, but he thinks it may be ultimately too soon to gauge the full impact of the dip. There are more fundamental aspects at play in these recent pauses, he said. To him, the oil price dip may be a convenient way to announce a change in their plans.

“Essentially what we were looking at prior to the oil price change was an oversupply situation in the market within the next few years,” he told Midstream Business. “This meant that it was already becoming difficult for new LNG projects to secure buyers because of the growth in supply.”

Several projects in Australia are slated to start up this year, and shortly after, Sabine Pass LNG in Louisiana, followed by another wave of about 60 mtpa of U.S. LNG projects that will begin in the 2018 to 2020 time period, he said.

“It was already becoming difficult for buyers and sellers to agree to contracts, because from the buyer’s standpoint, there was no incentive to lock themselves in when they could see lots of supply coming into the market,” he added.

However, this drop in oil prices may not be all unhelpful, he said. With much of the world tying LNG sales prices to about 14% of the price of oil, with the expectation that prices would remain around $100 per barrel, some buyers swallowed their anxiety out of necessity. These lower prices may lead to a greater understanding between buyers and sellers.

“If there is greater alignment between buyers and sellers as to what the long-term oil price might be, perhaps in the context of lower oil indexation, then that may allow deals to be done,” he said.

On the other hand, however, Munton acknowledged that oil-indexed sellers may have difficulty continuing to develop their projects at such low prices, especially given the uncertainty of the wave of U.S. projects coming online and offering a tolling model for pricing.

A strong dollar

One thing that many analysts are ignoring, said Dr. Peter Hartley, George and Cynthia Mitchell chair and professor of economics at Rice University and BHP Billiton professor of economics at the University of Western Australia, is the U.S. dollar’s role in these price fluctuations.

When the U.S. dollar depreciates relative to other currencies, the price of oil goes up measured in dollar terms since much of the demand is facing lower prices measured in domestic currencies. Conversely, when the U.S. currency appreciates, the price of oil measured in dollar terms will come down. To Hartley, that’s part of the story in oil prices.

He acknowledged that the focus on supply and demand is justified, given the lack of demand in Europe and Japan and slower-than-expected growth in China. Decreased demand met an expansion of supply from U.S. shale and Canadian oil sands and that put downward pressure on prices.

“But the other factor is the rise in the value of the U.S. dollar, which has primarily been driven by monetary policy,” Hartley told Midstream Business. “So the U.S. is ahead of Europe and Japan in the cycle now. Everyone’s expecting the Federal Reserve to start to tighten, expecting interest rates in the U.S. to go up. Europe has just announced another big monetary expansion, so interest rates are down. People are going to want to invest in dollar-denominated assets because of the higher interest rates, so that drives up the value of the dollar. If you drive up the value of the dollar, the price of oil measured in dollar terms is going to fall.”

Before this current rise in the dollar, there was a fundamental disconnect between domestic production and consumption of natural gas in the U.S. and the international crude oil market. The fact that the domestic market set the gas prices at the key Henry Hub made it look attractive to buyers in an internationally traded, oil-pegged LNG market, especially since strong Chinese economic growth, Middle East disturbances, North American shale trying to find its footing and a low dollar all led to high oil prices. That, in turn, led to high international buying prices for LNG in Asia. The arbitrage opportunities were significant.

“The supply of natural gas in North America is set by domestic supply and demand; it’s not a function of the dollar. The point is, the other thing that moves the relative price between gas and oil in North America is the changes in value of the dollar,” he added.

Supply and demand

U.S. LNG exports will, Hartley believes, link the U.S. natural gas market with the rest of the world. He likened the connection to putting a tube between two pitchers of water, one filled higher than the other. The water, in this case the supply and demand markets for natural gas, will eventually equal one another.

Moreover, because of the scalability of shale gas, not as many LNG projects will be built as world prices slowly take away the price premium that once existed between North American and international markets. Asian demand will be relatively inelastic, while North American shale makes supply elastic.

“With a fairly flat supply curve here and a fairly steep demand curve in Asia, a small amount of export will bring prices off there pretty swiftly without raising prices here very much. And so the biggest impact, once you’re getting exports from here to Asia, is you’ll kill all of that price premium,” Hartley said.

That’s not great news for LNG projects that haven’t gotten off the ground.

“What it also means is that a lot of the projects down the line aren’t going to look very economic once the first ones get going. The markets will work, and if you didn’t get in early on, the opportunity’s not going to be there,” he added.

Both Munton and Hartley agree, though, that there will be future opportunities for LNG trade. Munton sees an opportunity for projects after 2022, as the supply and demand interchange tightens once again, and possibly projects in Canada or East Africa will be able to take advantage of it.

Hartley sees India and other parts of Asia, particularly Association of Southeast Asian Nations, that will need to import natural gas in order to grow. It’s also possible, he said, that buyers and sellers will come to rely more on the spot market as the overall state of the LNG market becomes more liquid.

Energy is a cyclical industry, and while LNG may suffer a temporary setback, it will be back.

Brian Mothersole is associate editor for LNG products at Hart Energy. He can be contacted at bmothersole@hartenergy.com or 713-260-4652.

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