LNG Marginal Supply Cost Curve Shipping HH/Asian LNG spread and The Politics of the Deadweight spread

The politics of the Deadweight spread. 

The U.S regulatory is behind the curve.  We are maybe 10-15 years before massive LNG exports from the U.S. mainly because politics and red-tape. There is even a lobby of companies against LNG exports, they think it is  bad for the Economy(I think it is the reverse) see http://beta.fool.com/erinannie/2013/01/15/argument-and-against-lng-exports/21631/

In-lieu of the markets, governments generally think they can control prices and quantity of resources and some companies think that they can use the government favorably to do so !

Nobody can enjoy to be the lowest marginal Gas producer in the World except the U.S. (or perhaps Qatar).

You see regularly a 10-15$/Btu price spread between HH and Asian markets and because of conflicting policies you need the FERC approval, the Departement of Energy approval and what else ? The presidential seal approbation !

It’s a deadweight spread !

It is true that the gas world is undergoing fundamental changes but the hype behind the Asian LNG/HH spread and U.S LNG export is dubious.

  • First you need an export licence, billions of pipes investments America, then wait 6-7 years to fix your first ship loaded of this gas to Asia.
  • Secondly, Gas infrastructure in Asia is still undeveloped (except for Japan).
  • In most Asian countries, gas markets prices aren’t deregulated and control by monopolists.
  • Benchmarking: Asian LNG is priced according to oil benchmark indexing thus inflating Asian LNG price versus the Henry Hub benchmark. It is very likely that if Asian Gas Markets use more Henry Hub Priced gas, the spread will be cut in 2 or 3. No Gas sales in Asia is based is HH Natural Gas but on Gas-to-Oil formula. What will happen when Asians will move away their benchmark from oil ?
  • The U.S demand is converting to natural gas and move away the dependency from oil to gas, thus increasing HH and reducing Asian LNG/HH spread.

The Atlantic Basin/Pacific Basin arbitrage gas trade will be still of relevance but the the fundamentals conditions that established the premise of the Asian/HH spread will be completely different.

Arbitrage will exist, but production cost is only one factor because of the nature of the market where terminal locations, local weather, large currencies swings, local power prices and price arbitrage trades are constant moving objects.

Sabine Project 

Sabine is Promoted Cheniere Energy Partners, L.P. and will no be ready for commercial operations until late 2015 (say 2016 for full-train capacity).

Cheniere had obtained its export approval but it is now required to get a new approval from the government only Because they have signed a new contract with a different company dealing with others countries. This an example of why U.S is just behind the market curve.

They will spend over 100 M$US in lawyers and bureaucracy to get this a new piece of paper required for LNG commercial operations see http://www.reuters.com/article/2012/11/13/lng-exports-approvals-idUSL1E8MD7NA20121113

 “The next door friendly option”

   “Who finds a faithful friend, finds a treasure.” -Jewish Proverb

They are many projects in the USGC with a proven economics benefit but just in case,  the next door friendly option is called Canada (or perhaps Mexico through Texas where a surplus could be export)

Canada is the next door friend of the U.S.

Bringing Marcellus, Utica production volumes into Canada is good for many reasons;Basis are favorable in the Eastern provinces and once gas is in Canada it could be processed into LNG exports in the West.

See Below https://jacquessimon506.files.wordpress.com/2013/04/lng-marginal-supply-cost-curve.png?w=560LNG

Marginal Supply Cost Curve and HH/Asian LNG spread to understand why Canada could be a Marketing option for U.S Gas and LNG exports.

I’m interested in knowing what is the short-term option with the least painful regulation. My conclusion is that markets will inevitably find their ways there.

These days, you see BG gas and many others in Canada… They are on the sidelines, one leg in Canada and the other in the USGC (Louisiana, Texas ). No rumors here, It’s public…

The pipelines already exist, the flow will have to be reversed.

LNG Marginal Supply Cost Curve and HH/Asian LNG spread.

LNG prices will be fluctuating around LNG processing  production cost+ pipeline tolls, shipping rate and LNG Demand.

A LNG producer/exporter will try to maximize his profits at his Marginal Cost, not more, not less.

LNG Marginal Supply cost curve

On Doshi’s Chart, you can see the LNG costs at three different stages for Canada and U.S. Project.

Gas prices;  gas ex-pipe,  bought at the processing plant.

Liquefaction; Removing impurities + Chilling it and liquefies it, making it suitable for transport by ocean-going tankers.

Shipping; CLNG carrier rate DES delivered

The costs form a marginal cost supply curve. I have plotted the spreads with the Argus Daily Settlement price for this day.

Shipping Economics 

Canadian LNG DES* ASIA looks better than U.S LNG FOB so this is a compensation for higher pipeline costs.

The main reason is that current Panamax vessel size excludes 93 % of LNG vessels from using the Canal.

At present only 7% of the LNG carrier global fleet can transit the canal due to size restrictions in the canal locks.

This physical limitation for LNG carriers not creates an economic incentive for Canadian west coast LNG project over USGC projects but also a niche for the 3 shipowners in the shipping market.

  • GasLog has panamax carriers at a 155,000 cbm maximal capacity.
  • Golar Lng with 160,000 cbm capacity panamax carriers .
  • Teekay will receive two 173,000 cbm in 2016. They will be the biggest LNG carriers transiting through the new Panama canal.

Indeed, after the end of the Canal expansion in 2016, post-panamax Q-Flex (210,000 – 217,000 cbm) and Q-Max LNG  vessels (263,000 to 266,000 cbm) owned by Qatargas (the largest LNG producer in the world, with an annual LNG production capacity of 42 MTPA) will remain too large to pass through the Panama Canal.

Q-Max Q-flex lng vessel and Panana Canal

Shipping Rates are correlated with ARBs, sometimes forcing exporters to quote lower prices FOB prices because of higher freight rates with whom they have no or little control.

In the Real World, gas carriers’ rates will eat the arb, forcing down the Asian-US Lng spread.  Swings in Freight Rates and foreign currency exchange can also open/close arbitrage windows for Exports. 

Sempra/TEPCO LNG Deal

If a Gas deal is brokered with terms; Monthly HH+690 FOB ( Monthly Henry Hub Gas Price settlement plus 690 cents Free on Board), it means that the settlement will purely depend on the S/D of the U.S Gas Market. (because of the low correlation between HH price and Asian Lng Prices)

This contract has been drafted recently. It is a 20 years contract between the Japanese utility TEPCO Tokyo Electric Power Company and Sempra which is awaiting to the approval to convert a Lousiana LNG Import terminal into an Export terminal.

The contract will start in 2017. Of course the HH is cheap now and can be hedged in the future by Tepco. However what will be the outcome if NG prices double or triple ? The risk is unlimited for Tepco. (You may also say about Sempra, that they will have to buy LNG and delivered it to Tepco in case they do not get the export permit from the U.S government.)

Two different mentalities:

You can see that Sempra has really a trading mentality, they are seeking a trade difficult to enter and easy to quit. The Floor they received is HH+690 and the payoff is unlimited.

You see that Tepco doesn’t have a risk management mentality; it is the perfect example of a company where the culture allows taking unlimited risks for a short-term benefit. They have accepted unlimited price risk thinking that HH+690 is a good deal.
Conclusion:

LNG technology is reshaping markets but when you heard that U.S natural gas prices is reshaping the global markets, think about it twice.

  • We are still waiting for Gas Free-Market because in Asia Gas Markets are controlled by monopolists and gas prices are regulated.
  • The U.S is not better; because of the red-tape and political issues we are still a decade before massive LNG exports from the U.S. 
  • In the future, new market structures will emerge with exports but this DeadWeight spread may still be in the cards for a while.
  • Where is it written that a lower  HH/ASIA LNG spread is an inevitable outcome with LNG exports ?
  • The LNG Marginal Supply Cost Curve explains why Canada/Mexico will be a good option for Natural Gas Marketers.
  • LNG sales and purchase agreements**, Gas sales agreements, transportation will become more and more complex (not the reverse) but Gas Producers will get an access to more net-back marketing options and well capitalized Gas Structurers will have a plethora of new marketing tools to offer.

My scenario is

1. U.S shale gas (Marcellus and Utica) flowing to Eastern Canada to catch a favorable basis (actually the basis is flat in the us) http://wp.me/p3k7lL-fi,

2. You will see gas going west to catch the export basis.

The remaining question is where the demand curve will be plotted when projects will bring LNG exports on the markets ?

-The Trade Finance and Shipping Wizard

* Delivered Ex-Ship

** ** See Natgas.info for an extensive discussion about LNG sales and purchase agreements and Gas sales agreements.

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