Rising costs and reputational damage limit prospects for new LNG

Costs for new LNG projects are soaring at a time when the industry is also facing market upheaval, demand destruction and the risk of permanent reputational damage after cargoes from the Middle East go undelivered.

The Strait of Hormuz has been blocked for nearly three months, keeping 20 percent of the world’s LNG capacity offline. The disruptions have major LNG-consuming countries, such as those in Southeast Asia, rethinking their dependence on imported gas.

Gas executives are enjoying enormous profits from war-time prices, but have also begun to recognize the danger to their industry from a shattered reputation.

“It’s quite clear, for our customers in Asia, a crisis in 2022, another one in 2026, reliability from an affordability point of view of the LNG will be questioned,” Patrick Pouyanné, CEO of TotalEnergies, told investors on an earnings call.

“Electrification will be also a global answer, because you can produce electricity from various means and not only from hydrocarbons. So that will be the other big trend, that we will see, because security of supply, because again affordability of energy is of essence.”

“It’s not very good news, I agree, for the LNG markets,” Pouyanné added.

There is now “clear differentiation across markets in Asia to cope with the supply shock,” Anatol Feygin, Chief Commercial Officer, Cheniere Energy said on an earnings call.

“China has again demonstrated system flexibility, halting spot purchases and redirecting cargos to markets of higher need. Price-sensitive Qatari-dependent markets such as Pakistan, India, and Bangladesh have taken measures to reduce demand and seek alternate fuel sources.”

He sought to reassure investors that today’s disruption will “become relatively small inflections in a much broader, longer-term growth trajectory.”

But he added that he was “astounded” that global gas prices hadn’t yet gone even higher.

JKM prices — the main reference price for LNG delivered to Northeast Asia — have consistently traded above $19/MMBtu, nearly double pre-war levels. But given the scale of the outage, many analysts argue prices could easily be much higher.

Venture Global’s CEO Mike Sabel said prices are lower than might be expected because buyers are hesitating and holding off on making purchases. “That means you’re not getting the purchasing activity that could drive prices up. The psychology is the customer hoping that suddenly it will end and prices will drop and so they don’t wanna precipitously, in their opinion, move to make purchases,” Sabel said on an earnings call. He added that there is “pent-up buying that has to happen” that will put upward pressure on prices through next year.

However, it’s not clear when “normal” ship traffic will resume. Markets have arguably been rather complacent given the scale of the outage.

“I don’t think markets and consumers and society are yet fully appreciating it, and there’s a belief that things will return to normal at some soon point,” Liz Westcott, chief executive officer at Woodside Energy Group Ltd., said at an industry conference in Australia.

High prices, volatility, and ongoing physical risks to supply could turbocharge the energy transition. At least some of the demand that is currently being destroyed may not bounce back even when the war is over.

The anticipated glut of LNG markets prior to the war is now significantly delayed. A scenario in which the Strait of Hormuz remains shut for an extended period of time, perhaps extending through 2026, would result in higher sustained prices for the next few years, according to Wood Mackenzie. That, in turn, would lower the long-term outlook for demand.

“Persistent supply uncertainty would accelerate efforts to diversify away from imported LNG, supporting coal resilience and faster growth in renewables and electrification across Asia and Europe” said Massimo Di Odoardo, vice president of gas and LNG research at Wood Mackenzie. “LNG prices would remain elevated through to 2030 supporting investments in new LNG outside the Gulf, but lower long-term demand would risk undermining the industry’s future perspectives.”

Higher costs

LNG developers that are located outside of the Middle East are trying to market their projects as having a security advantage over gas from the Persian Gulf. While the war may catalyze a faster shift to renewables, the sudden loss of Middle East LNG could provide a short-term jolt to projects that are currently on the drawing board.

In mid-May, Commonwealth LNG announced a final investment decision on its 9.5-mtpa project in southwest Louisiana.

However, the competitiveness of new LNG is very much in doubt. Costs are spiralling upwards, according to the industry’s own experts.

“The global LNG market is entering a structurally different phase defined not by resource scarcity, but by rising marginal costs and increasing capital constraints,” concludes a new report from the Gas Exporting Countries Forum (GECF).

Existing LNG projects and those already under construction have signed deals that include liquefaction costs below USD$3 per MMBtu. But new projects are running above USD$4/MMBtu, or a 45-55 percent increase, according to GECF.

The factors driving up costs include “the depletion of lower-cost opportunities, rising project complexity, increasing engineering and construction costs, and expansion into more challenging environments, including remote, offshore, and high-risk regions.”

As a result, the LNG industry is in the midst of a “deeper structural transformation rather than a cyclical cost increase.” Future LNG supply will “increasingly depend on higher-cost projects that require stronger price signals.”

That could be a problem for developers of new LNG because it’s not clear that Asian buyers have any appetite to swallow higher costs.

In what could be a worrying sign for the industry, Woodside Energy is struggling to find buyers for its Louisiana LNG project, which is under construction, because it is asking for liquefaction fees slightly above typical U.S. market rates, according to Reuters. Woodside was asking $2.80/MMBtu, but hasn’t found customers willing to pay that much.

That doesn’t bode well if future projects require liquefaction fees over $4/MMBtu.