U.S. LNG Accelerates Shifts in the Global Marketplace
Posted April 26, 2019
Over the past few weeks, we’ve published a series of posts on the United States’ emergence as a major global natural gas exporter, including discussion of the benefits both at home and abroad (see here and here).
In this post, we’ll look at how the business of liquefied natural gas (LNG) is changing in exciting ways—ways that give customers around the world unprecedented flexibility and access to clean and reliable natural gas.
We’ll see that while some of these trends have been in motion for years, it’s been the introduction of U.S. LNG into the market that has really accelerated this shift. With multiple project developers pursuing a wide range of structures and technologies, it’s clear that the U.S. is once again at the forefront of innovation in this critical part of the world’s energy sector.
The Old Way of Doing LNG Business
The first global LNG export projects date as far back as the 1960s, but for decades the industry remained decidedly niche. Projects were expensive, and difficult to pull off. Finding buyers was a challenge, because only a few countries needed LNG, and fewer still could afford it. As a result, LNG remained a small and rather opaque part of the energy sector, limited to few large exporters (Indonesia, Algeria, Malaysia) selling to a few large importers (Japan, South Korea).
Beyond the LNG industry’s focus on stranded reserves in remote regions, a big part of the status quo surrounded the contracts signed between buyers and sellers. These contracts (often called “offtake contracts”) were, by necessity, long-term, with 20 years being the most common duration. Further, the LNG contracts were almost always linked to global oil prices.
Both requisites were in response to the considerable risk associated with the nascent LNG industry. Given the limited number of buyers, project developers were understandably unwilling to construct these multi-billion-dollar liquefaction projects without a firm guarantee that there would be a multi-decade buyer on the other end.
Similarly, buyers needed the oil linkage to ensure a relation to a competing fuel that offered a widely reported price benchmark. No such benchmark existed for LNG, or for coal for that matter—oil was the best option, since the natural gas was largely being used to replace oil in electricity generation.
Finally, to ensure the offtake contracts served their intended purposes for the duration, neither buyer nor seller were permitted to redirect cargoes to other markets, unless both parties agreed in advance. The contracts were point-to-point, with volumes flowing from a specific project to a specific importer—in other words, the destination was “fixed.”
First Wave of U.S. LNG Proves a New Concept
The global LNG industry remained largely locked in this status quo for many years. To be sure, there were exceptions here and there, but the pace of change was incremental at best. As recently as the late-2000s, most LNG projects were being commercialized the same way they had been since the beginning—through long-term, fixed destination, oil-linked contracts signed with large Asian buyers.
This status quo was disrupted in the early-2010s, when rapidly surging production of unconventional gas suddenly pushed the United States into a new era, with the focus shifting from LNG imports to exports. Within a quick few years, more than 250 million metric tons per annum (MMTPA) of LNG export capacity had been proposed in the U.S.—an amount that exceeded the total size of the global market at that time.
The projects in the U.S. didn’t merely represent a new source of LNG supply, they signaled an entirely new approach to LNG project development.
To begin with, offtake contracts were not linked to oil, but to natural gas prices—specifically, U.S. Henry Hub natural gas prices. While this may seem obvious—LNG is after all, natural gas—it hadn’t really been possible in the past because most of the traditional LNG exporting countries do not have transparent and highly traded natural gas “prices” in the sense that we have them here in the U.S. (few LNG importing countries do either for that matter).
The option to contract LNG linked to U.S. natural gas prices proved very attractive to a wide assortment of global LNG buyers, especially given the high oil prices—and exceptionally low Henry Hub prices—in the early-2010s. The arbitrage opportunity, as seen below, was simply hard to resist and was instrumental to ensuring the sanctioning, construction and completion of the massive first wave of U.S. LNG capacity.
But the linkage to U.S. natural gas prices wasn't the only innovative component of U.S. LNG projects. Most of the first wave were “brownfield” sites—meaning they had originally been developed as LNG import terminals, left mostly unutilized as a result of the shale revolution, and converting them to exporting terminals was less costly than building a greenfield liquefaction plant. This fact had several important implications for structuring the export projects.
First, the existing on-site infrastructure allowed for greatly expedited construction timelines. Compared to LNG export projects elsewhere in the world—which often take at least five years and suffer significant delays—most U.S. LNG capacity to date has come online in four years or less.
Second, because the projects were already connected to the highly liquid U.S. natural gas grid, they avoided the upstream and infrastructure costs and complications that have plagued so many LNG projects elsewhere. Similarly, the projects could rely on the United States’ world-class workforce, especially on the energy-intensive Gulf Coast, as well as competitive upstream and capital markets and a regulatory structure that was well known. This, too, allowed the U.S. projects to escape some of the challenges common to project development in other parts of the world.
Combined, these attributes meant that U.S. LNG projects could be built cheaper and quicker than projects anywhere else in the world. Among other things, this allowed for a new type of developer to emerge, focused on employing some version of a “tolling model” for their projects, where a tolling company provides liquefaction services to the upstream owners of natural gas for a fee.
Long-term contracts remained necessary for these first wave projects, but the developers (including Cheniere, Dominion, Sempra and Freeport) offered the cargoes without overly burdensome destination clauses. In other words, buyers could direct their cargoes wherever they wanted.
Beyond linking LNG to domestic U.S. natural gas prices, this destination flexibility is the second major disruption spurred by U.S. LNG. Granted, a few other projects in the past had offered some degree of flexibility, but no supply region has ever embraced it as thoroughly and transparently as the U.S.
Offtakers from the U.S. have benefited enormously from this unprecedented flexibility, as it allows them to adapt their LNG procurement strategies to changing market conditions.
To see this in practice, one only need observe the tremendous diversity of markets that have imported U.S. LNG since exports began in 2016. Already, 34 of the 42 LNG importing countries have imported at least one U.S. cargo. Even regionally, the diversity is impressive—East Asia is the largest (driven by Japan, China and South Korea—the world’s three largest importers) but significant cargoes have also been directed to Europe, South America (including Mexico) and beyond.
Thus, the unique attributes of U.S. LNG not only offer LNG buyers access to some of the world’s lowest natural gas prices, but also provides unprecedented flexibility. Asian buyers are free to send cargoes to Europe, while European buyers routinely place cargoes in South America.
If a particular buyer determines it’s overcontracted, it’s free to re-contract some or all of its U.S. offtake to another buyer on whatever terms mutually agreed to. Other types of buyers, from portfolio players (such as Shell and TOTAL) to pure traders (such as Trafigura and Vitol) have also been highly active in signing a variety of contracts with U.S. LNG.
This adds significant liquidity to the market—as evidenced by the growing number of short-term and spot transactions. In turn, this produces more efficient price signals, gradually improving the interconnectedness of global natural gas markets. Perhaps most importantly, it also gives buyers the confidence to make long-term investments in gas infrastructure in their own domestic markets and around the world.
Second Wave of U.S. LNG Set to Push New Boundaries
With the first wave of U.S. LNG now entering the market, the market has already experienced significant changes, with consumers around the world being the primary beneficiary. But the game-changing role of U.S. LNG is only in the early innings, especially given the promising prospects for a second wave of U.S. LNG projects to be sanctioned over the next few years.
Several of the second-wave U.S. LNG projects are exploring highly innovative approaches to everything from project development to contracting and even technology. Some are offering shorter contract durations (10 years), others are exploring smaller, modular liquefaction technology. Several contracts have been signed that incorporate not just Henry Hub prices, but Northwest European gas prices (such as NBP, TTF), global LNG spot prices (JKM) and even Brent crude prices.
Some approaches will certainly be successful; others perhaps not. But the strategies aren’t better or worse, they’re just different. It’s this great diversity of options—largely unique to U.S. LNG—that continues to prove attractive to a diverse set of LNG buyers around the world.
By being able to adapt and respond to changing market conditions and buyer demands, U.S. LNG developers are leading the world in establishing a larger, more transparent and more efficient global LNG market. In doing so, they’re expanding access to clean and reliable natural to countries and consumers worldwide.
Next: U.S. LNG exports and Europe as business leaders convene in Brussels next week.
About The Author
Dustin Meyer is a Policy Advisor at API, serving as a subject matter expert on Global Gas & LNG. His efforts are focused on establishing the United States as a leading supplier of reliable and affordable LNG for the rapidly expanding global gas market. Dustin has a Masters in Energy Policy & Economics from Yale University and a B.A. from Princeton University. He lives in Washington, D.C. with his wife Tess and dog Mabel.