On the surface, LNG appears to represent a new opportunity where easy profits are for the taking. In reality, producing and delivering LNG is a difficult business, and that business will only get harder as time goes on.
Unlike natural gas, where prices are established regionally, LNG is becoming a global commodity. Market prices depend on global supplies and demand. It is expected supplies will remain constrained for the next three years.
The challenge for would-be suppliers is constructing new LNG export facilities. Each facility can cost more than a new nuclear power plant. But the suppliers’ challenge is not limited to constructing export facilities.
Suppliers must have access to special ships and customers with LNG import facilities. For US-based suppliers who are dependent on the Asian markets, their ships have another hurdle: The Panama Canal.
The Panama Canal is narrow and only small Panamax ships can traverse the isthmus. To accommodate the growing number of modern container ships, supertankers and LNG carriers, Panama is building new locks to open in 2015. Until then, it will be expensive and time consuming to transport LNG from Atlantic suppliers to Pacific consumers.
If Panama can deliver new locks on schedule, their timing may work. Today, no LNG export terminals exist in the lower 48 states. One company, Cheniere Energy Partners, a partially owned limited partnership of Cheniere Energy, plans to build the nation’s first export terminal in the Gulf of Mexico. Freeport LNG, a partially owned subsidiary of ConocoPhillips, plans to build an export terminal near Cheniere’s facilities. Dominion Resources wants to build another export facility in Maryland. If all goes as expected, it will take until 2015 before any of these facilities are in commercial operation.
The near-term challenge is to finance terminal construction and have enough money left over for shareholders. Between profits and shareholders are bankers, who provided debt financing and expect to be repaid.
Devil in the Details
Since bankers own the “I” in EBITDA, they want to be assured pro formas show healthy earnings for the life of their financing arrangements. So lenders insist suppliers have a bankable counterparties contract and firm offtake agreements at profitable prices. But bankers want to hedge their position and they have no interest in allowing their clients to speculate, particularly in the nascent LNG markets.
For new LNG export facility owners and shareholders, that is the rub. If owners depend on debt financing, they will not be allowed to speculate. Because they cannot speculate, they cannot take advantage of current market conditions.
That is what is going on with Cheniere. In order to secure financing, Cheniere had to lock in long-term contracts with predetermined margins. Most of their offtake agreements are indexed to Henry Hub.
Dominion has similar rules for different reasons. Unlike Cheniere, they have the financial capability to self-finance. But, to their core, Dominion is a utility and utilities are generally reluctant to speculate. Dominion is also securing long-term offtake agreements.
But there is something else going on. The motivation to build LNG export facilities is mostly about recovering losses from existing LNG import facilities.
With the exception of Boston, most US LNG import facilities have little business. The amount of capital tied up in these facilities includes LNG handling equipment, interstate pipeline connections, refrigerated storage tanks and special docking facilities. It also includes ongoing investments in operations and maintenance. Every day these facilities remain idle, investors lose real money.
One strategy to recoup loses is to reverse the flow of natural gas by converting existing import facilities to export facilities. The conversion will capture new revenues, stem operating losses and recover stranded assets.
Cheniere, Freeport and Dominion are using this strategy. They already own LNG receiving and regasification terminals. They plan to upgrade those terminals to become mostly export facilities.
Strong International Competition
Meanwhile, the rest of the world is not waiting. Australia has huge reserves of natural gas, they have close proximity to the Asian markets and they are developing world-class capacity to deliver low-cost LNG. With help from Royal Dutch Shell , ExxonMobil, ConocoPhillips and others, Australia is expected to surpass the world’s LNG leader, Qatar.
Canada, East Africa (Tanzania and Mozambique) and others are joining in. With huge volumes coming online soon, LNG’s high prices and tight supplies could soon be replaced by a glut and lower prices. Adding to the glut are anticipated incremental unconventional gas discoveries in Asia, Africa, South America and Europe.
For LNG markets, cost leadership will ultimately become the critical success factor. There is no assurance US LNG companies can sustain a cost leadership position, particularly in the Asian markets.