Fading taboos: accelerating the evolution of LNG towards a modern commodity

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LNG stakeholders face an acute need to reposition themselves, as competitive threats from all directions set to accelerate the evolution of LNG towards a modern commodity.

Breaking taboos in the LNG industry is a time-honored tradition. The guardians of the status quo have long heaped scorn on agents of change. Sometimes they succeeded, sometimes they failed, but the commercial arc of the LNG universe is unquestionably bending toward change.

These changes are happening out of necessity and not out of choice, and what previously seemed to be formidable obstacles are rapidly deteriorating into historical footnotes.

Remember how LNG projects could not move forward without destination clauses, long-term contracts or oil- indexed pricing? What about how it was impossible to make a final investment decision unless 50% of the capacity was signed up to long-term deals? How could a pricing slope go below 14% and still cover long-run marginal costs?

LNG markets in the next decade will be breaking all of these taboos and several more sacred edicts.

Entrenched players will continue to squeeze every last dollar, yen, and riyal out of what was once a paragon of high- margin business in the energy sector.

But they also now face highly commercial market realities that will severely limit the relevance of the traditional project model. LNG industry mainstays, like long-term contracts and oil indexation, are morphing into something resembling a modern, fundamentals-driven commodity market.

Setting the scene

Investors in the LNG sector, once the most staid of businesses, are probing new facets of the energy space in order to create higher demand.

In any form, the cost of moving gas from point A to point B remains relatively high and problematic, while the number of competitive fuel options are rising within key use sectors for gas. Taking the most expensive form of gas supply (imported LNG) and placing it into the most competitive sector for gas use (power) will be the defining story for gas demand growth in the next decade.

It may require a severe curtailment or complete elimination of oil indexation as the driving force in LNG pricing, and recognition that pricing gas at a competitive level with coal and battery storage is the absolute least that needs to transpire.

Of course, the ability to price LNG against oil to compete with coal and battery storage is possible, but why would it hold on to this legacy when commercially viable alternatives are readily available?

Oil issues

The supply push coming from oil-centric upstream developments, combined with a narrowing of traditional downstream opportunities, is forcing LNG developers to rethink their strategy for marketing volumes. The problem of how to market LNG is so acute that it is now threatening to curb upstream development for oil. The price of oil and gas has moved on from an era when the two commodities competed downstream in the home or industrial park to one in which gas must compete with coal and battery storage in power generation.

As a result, price movements for oil and gas have become largely inverted and therefore pricing the latter off of the former has become highly problematic. In the extreme, higher oil prices in the US have led directly to negative gas prices in regions such as the Permian Basin. While these price inversions are eventually solved by additional midstream and downstream buildouts, the problem is a chronic one that is forcing change.

The move further downstream by LNG sellers into import terminals, power generation, and transportation fuels (bunkering and trucking, primarily) comes from increasing pressure tied to the upstream realities. Creating more gas demand has become an existential threat to higher oil and liquids production.

Almost every cubic meter of LNG produced over the next two decades in the US will be sourced from wet gas production, where the considerably higher price of oil, NGLs and condensates will dictate the economics of drilling, completions and output. As a result, incremental gas is being produced without a corresponding strategy for how it will be consumed.

The assumption of a wellhead price for gas at close to zero will help with the marketing of the LNG, but also shines a light on the reality that gas and LNG specifically are moving from a downstream, high-margin business to an upstream cost-of- production one.

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