Oil plunge dims outlook for LNG projects

11 December 2014

By Ross Kelly

SYDNEY--Investors in giant gas-export terminals from Australia to Canada are facing the prospect of losing billions of dollars plowed into the projects as plunging oil prices darken the outlook for the industry.

Unless they recover, weaker oil prices could wipe out returns for companies such as Chevron Corp. and Royal Dutch Shell PLC, which have committed nearly $250 billion combined in liquefied-natural-gas projects over the past seven years to meet rising Asian demand for the cleaner-burning fuel. LNG is natural gas compressed into liquid form inside huge refrigeration units, enabling it to be shipped on tankers to places unconnected by pipeline.

To fund their expensive build-out plans, the companies have typically agreed to sell most of the gas upfront ahead of the completion of their projects at rates linked to oil prices. But the oil-linked pricing means LNG producers stand to get much less revenue on delivery of their first shipments than if crude had remained nearer its peak of $116 as recently as six months ago.

Already, the tumbling price of Brent crude, the global oil-price benchmark, to around $64 a barrel has claimed a casualty in Canada, where developers led by Malaysia'sPetroliam Nasional Bhd., or Petronas, last week indefinitely delayed starting construction of a $32 billion LNG plant on Canada's Pacific coast.

At the same time, oil prices have fallen so low that U.S. shale-gas producers with plans to export the usually cheaper commodity into Asia in LNG form suddenly find themselves facing a much tougher competitive environment.

Crude futures started weakening once again last month following the decision by OPEC to shrug off oversupply fears and maintain current production targets. To break even, most Australian LNG projects would need to sell the commodity for at least $12-to-$14 per million British thermal units, according to estimates from Credit Suisse and Wood Mackenzie, a resource-industry consultancy. The price would need to be even higher for some of the more expensive developments.

LNG prices in Asia have sunk below $10 per million British thermal units, meaning many of the projects may struggle to turn a profit. "OPEC's come along and burst the bubble," said Mark Samter, a Sydney-based analyst at the brokerage. " Project returns are awful at these prices."

To be sure, most experts believe demand for LNG will soar over the coming decades as Asian economies such as China attempt to drive their rapid modernization using fuel that burns more cleanly than coal, which scientists says contributes to global warming. Demand for LNG will also likely remain high in more-developed Asian economies, such as South Korea and Japan, which lack their own fossil-fuel reserves. Japan has added more LNG to its energy mix since the 2011 Fukushima nuclear disaster.

Typically, LNG is sold through contracts spanning up to 30 years, and so a swift recovery in the oil price may allow projects eventually to make money--if stretched company balance sheets can withstand the pressure long enough. Santos Ltd., a big investor in Australian LNG, has been forced to cut spending across its business after a failed attempt to strengthen its balance sheet through a hybrid debt issue.

Adding to their woes, Australian LNG projects have suffered from a spate of cost blowouts caused by everything from unfavorable currency swings to labor shortages, leaving them far more exposed to the oil-price plunge. The challenges are different for producers in Middle Eastern countries such as Qatar, which uses a lot of cheap foreign labor.

On the east coast of Australia, U.K. oil and gas company BG Group PLC is running last-minute checks before switching on a vast new facility that cost more than $20 billion to build, having overcome budget overruns of more than a third of the original price tag. The project--clustered on an island alongside two other giant plants owned by rivals including Santos, Total SA and ConocoPhillips--is due to ship its first LNG cargoes to Asia this month.

BG said it remained optimistic about the prospects for its Queensland Curtis LNG project, which counts China's Cnooc Ltd. as a minority investor and a key customer. "The economics for QCLNG are sound and competitive across a wide range of oil prices," a Brisbane-based BG spokesman said. The company also bolstered its balance sheet this week by selling the project's main pipeline to Australia'sAPA Group Ltd. for $5 billion.

On the country's west coast, the cost of building the Gorgon LNG project, operated by Chevron with backing from Shell and Exxon Mobil Corp., has already swelled by around 45% to $54 billion since building started in 2009. The work is expected to be completed sometime next year, when the project is also supposed to come online. A California-based spokesman for Chevron declined to comment on the weakening oil price, but Chief Financial Officer Pat Yarrington said in October that four major projects it is building, including Gorgon, would rapidly turn from being "cash consumers" to " cash generators."

Australia has found itself at the sharpest end of oil's fall with the construction of seven export terminals across the country that have cost more than $160 billion to build--a sum close to the gross domestic product of Vietnam. It is on course to overtake Qatar as the world's biggest LNG exporter before the end of the decade, made attractive by its proximity to Asia and stable political environment.

"Clearly, many Australian projects are at risk of delivering inadequate returns," said Ian Ashcroft, a U.K.-based gas analyst at Wood Mackenzie. "Some are already suffering due to cost overruns, but the impact of the oil price on early cash flow is also critical to project economics."

Elsewhere, companies that haven't yet started building dozens more planned LNG terminals in Canada and East African countries such as Tanzania and Mozambique will likely be questioning the timing of hundreds of billions of dollars in proposed new investments.

U.S. shale-gas producers looking to export their product are affected less by the multimonth drop in crude oil because they typically signed contracts overseas linked to U.S. domestic-gas prices, which are low due to the boom in the local production of shale gas. But on the flip side, thanks to crude oil's fall, LNG producers offering oil-linked contracts will be able to compete better in the international market against their U.S. shale-gas rivals.

Currently, there are two LNG terminals under construction in the U.S., alongside several more that have received the go-ahead from regulators. Construction of the Sabine Pass project in Louisiana, operated by Houston-based Cheniere Energy Inc., began two years ago and is expected to be completed late next year. Freeport LNG Development LP last month began building a project in Texas that it expects to ship cargoes from by 2018.

Both projects involve converting previous LNG import terminals into export facilities, making them cheaper to build than the Australian ones, since a lot of the infrastructure such as pipelines and storage tanks is already in place. Cheniere declined to comment, while a spokeswoman for Freeport said it had already signed contracts that would absorb its plant's projected output for decades.

Daniel Gilbert in Houston and Mari Iwata in Tokyo contributed to this article.

Write to Ross Kelly at ross.kelly@wsj.com

Source: Nasdaq.com