14
LNG
INDUSTRY
MARCH
2016
In Queensland, three coal bedmethane (CBM) projects
(Queensland Curtis LNG –QGC/BGGroup; Gladstone LNG –
Santos; and Australia Pacific LNG –Origin, ConocoPhilips,
Sinopec) extract dry methane from shallow coal measures, and
transport the gas to the coast for treatment and liquefaction.
These projects are great examples of Australian innovation, as the
gas value chains have limited storage and are the first of their kind.
In addition, the industry is pioneering two hybridmodels. The
Ichthys (Inpex) project will also tap into offshore gas fields, but will
separate liquids at a floating production vessel, with the residual
methane treated and liquefied in Darwin. The
Prelude
project
(Shell) is another example of innovation, as it is the world’s first
purely floating LNG (FLNG) facility that will treat gas and
manufacture LNG entirely at sea.
Commercially, Australia’s LNG projects have strong
underpinnings. All have largely sold gas forward on long offtake
agreements to large credit worthy customers on terms based on
oil indexed pricing. Those same customers are frequently
investors in the projects to help align interests.
The country’s growth as an LNG exporting nation was based
on expected rising demand for gas in Asia – a physically close
market with which Australia shares close exporting ties (based on
its coal and iron ore industries) – and, at the time, falling gas
supplies in the US. The sector received a significant boost in the
aftermath of the global financial crisis, which had the effect of
constricting capital availability for rival nations, leaving only the
Australian projects to capture growthmarkets.
The demand outlook for gas remains promising, with growth
rates expected to be above global GDP growth rates. However,
Australia no longer has themarket to itself, with US supplies,
unlocked by technology innovations, such as horizontal drilling
andmulti-stage fracture stimulation, to bemore than abundant via
five large projects under construction, and new trade agreements
that allowUS gas to be freely exported to some of the world’s
largest gas consumers, such as Japan.
Critical challenges
It goes without saying that, in an eternally challenging sector,
Australia’s LNG industry has encountered a number of challenges,
including some of the highest costs in the world, low productivity
and significant social license concerns.
Studies show that Australia leads the world in capital costs,
driven by a small available working population, remote project
sites far from settlements, long transportation supply routes, and
a demanding regulatory burden. Hand-in-hand with high costs is
the low productivity of the workforce, which is tied to strong
organised labour, restrictive work practices and high levels of
compliance-related activity.
It is also proving difficult for the industry to earn andmaintain
a high social license to operate. The political environment
translates to an unstable regulatory environment, with frequent
rule changes for gas projects. High levels of social activism also
block project approvals, drilling activity and other legitimate gas
industry business. The export oriented LNG trade has exposed the
domestic market to the global price of gas, leading to frequent
calls for gas reservation as a protectivemeasure for domestic
manufacturers ill-prepared for shifting energy costs.
As the projects transition to operations, operators are taking a
firmhand to their cost structures and are working hard to improve
their economics by rightsizing staffing, reshaping contracts, and
collaborating to share costs. Suppliers are also acutely aware of
the need to rethink their own cost structures (under no small
pressure from the operators), and costs are at last coming down in
the sector.
Coincident with the drop in oil prices, which has caused a fall
in eventual LNG revenues, the Australian dollar has also fallen
relative to the US dollar. This has helped lower the cost of inputs,
such as labour and logistics, and has helped offset these
challenges.
Structural shifts
A small set of structural shifts underway in global gas markets
may have some eventual commercial impacts on the Australian
LNG players.
Destination flexibility
The looming US LNG supply will feature less restrictive destination
flexibility than other supply arrangements. This is an attractive
contracting arrangement, particularly for Japanese buyers who
face an uncertain and possibly shrinkingmarket, and need the
ability to redirect LNG cargoes away from Japanese shores.
Oil pricing delinking
Another USmarket innovation, export LNG contracts may be
priced, in part, on North American domestic gas prices, which
were at historic lows at the time of writing. Japan joined the
Trans Pacific Partnership, in part, because of tariff-free access to
US gas that would help delink LNG fromoil pricing.
Infrastructure expansion
The widening of the Panama Canal will allow the vast majority of
LNG carriers to transit, which will further enable trade flow and
make Asianmarkets more accessible to planned US Gulf Coast
LNG plants.
Market deregulation
Japan and China have announced energy market deregulation,
which will have an eventual impact on spot markets, competition
for customers and cargo destinations. In tandem, there will be
a rise in LNG trading activity as the flood of LNG comes to an
already oversuppliedmarket.
Contract renegotiation
India andQatar havemade headlines recently through the
renegotiation of their supply contracts now that LNGmarkets are
inmedium-termoversupply. Australia’s LNG contracts feature
some of the highest pricingmodels, which were established
whenmarkets were short, and gas buyers may be tempted to
renegotiate the Australian supply contracts.
The immediate agenda
In themidst of somany global and local forces, challenges, and
opportunities, the agenda for the Australian industry over the next
24months is largely set.
Complete construction
There is still considerable build activity inWA and the NT that
must come to a successful conclusion, while under ongoing
threats of labour activism. Projects in build will increase their focus
on cost of construction.
Transition to operations
Confidence in the CBMprojects is growing, with the successful
launch of the QGC project and its transition to operations. The
