The emergence of the United States (US) as a net exporter of LNG in 2016 upended the supply-demand balance in the sector, enabling importers to accelerate a transition away from fuels perceived to be more polluting, and the LNG shipping sector to adopt a more spot-driven model, underpinned by speculative orders for LNG tonnage. In 2019, final investment decisions were taken to proceed with a reported 71m tonnes of new production capacity, much of this capacity also uncontracted, with further liquefaction projects, with a capacity of circa 900m tonnes per year, on the table by the beginning of 2020.
While some of this supply growth was underpinned by demand from a "decarbonising" Europe, which increased imports by 74% as it shifted its focus away from coal and nuclear, Asia was expected to drive future demand, with China expected to more than double its gas consumption between 2019 and 2040.
However, the last two years have also underlined that LNG is as vulnerable as any other energy source to external pressures. The US/China "trade war" devastated the trade of LNG between the two countries, with the imposition of a 10% tariff on LNG imported from the US in September 2018 sufficient to reduce LNG cargoes from 35 to four in the September to April period, year-on-year. The subsequent tariff increase to 25% in June 2019, essentially stopped the trade altogether.
Such politically-inspired interruptions are hardly new. Europe's drive to decarbonise its energy mix has also seen the continent seek to reduce its historical reliance on Russian pipeline gas (which still stood at circa 40% of European gas supplies in 2019), following the Russia-Ukraine gas disputes of 2006 and 2009, and the perceived risk of Russia as a strategic supplier of energy. US/Russian politics have also intervened here, with the Nordstream 2 pipeline (already something of a political football in Europe) being sanctioned by the US since December 2019, with further potential sanctions being proposed in June 2020.
The world's second largest LNG supplier, Australia, also appears to be walking a fine line with its LNG exports to China. Having benefited from the aforementioned tariffs on US LNG, Australia's stance on COVID-19 investigations and Hong Kong have placed it on a collision course with Beijing. The country's LNG and iron ore sectors (both seen as critical to China's industrial restart, with Australia being the largest single supplier of both commodities to China) have avoided sanctions for the time being.
The impact of COVID-19 on the LNG market has been huge, with the markets mirroring the virus's spread around key LNG consuming economies. China, the world's second largest LNG importer, saw a 4.6% fall in LNG imports in 1Q 2020, with reports suggesting that imports of piped natural gas from Siberia and Central Asia also fell during this period (China’s imports of piped natural gas from Kazakhstan alone reportedly falling by around 25% in March 2020). Demand is understood to have rebounded following the easing of China's lockdown in April 2020, with this coinciding with the resumption of imports of LNG from the US following the waiving of the aforementioned tariffs for certain importers. The latter resumption owed much to the signing of the "Phase One" trade deal in January 2020, under which China was expected to increase its purchases of American energy exports by USD 52.4bn during 2020 and 2021, over and above volumes shipped in 2017. Doubts as to whether the Chinese can, even with the best will in the world, satisfy the conditions of the agreement, persist.
Japan, the world’s largest LNG importer, saw import volumes start to decline from March 2020, with imports reaching levels not seen since 2010 by May. South Korea’s KOGAS is reported to have sought to defer LNG cargoes due for delivery between May and October. India, by contrast, sharply increased its LNG imports in 1Q 2020, taking advantage of lower prices, with March 2020 seeing a 20% increase year-on-year. However, the subsequent lockdown sharply curtailed demand, with LNG imports falling by 40% in May 2020.
Europe’s gas storage assets have long supported the continent in being a regular importer of excess LNG, and Europe was expected to break LNG import records in 2020, potentially breaching 100m tonnes per year. However, the collapse in European industrial and commercial demand for LNG (estimated to have averaged almost 10% between January and May 2020, reaching 16% in April and May 2020), aided by a strong performance by renewables, and the resultant increase in gas storage utilisation, has seen LNG imports cancelled and a sharp reduction in pipeline flows.
This demand destruction has direct impacts on producers and traders. China National Offshore Oil Corp reportedly declared force majeure on cargoes expected to be shipped during February and March 2020, with this quickly followed by India’s GSPC, GAIL and Petronet LNG. European buyers are understood to be among a number of global buyers cancelling purchases from the US’s leading LNG exporter, Cheniere Energy Inc. Reports suggest that the pandemic has prompted 130 cancellations of LNG export cargoes from the US alone. While there is some confidence that cancellations will reduce from August 2020, it remains unclear if suppliers, particularly those who link their contracts to gas prices, rather than crude, will now resort to locking in production until conditions improve; Egypt, for example has ceased exports from the Idku LNG terminal altogether, with Petronas bringing forward planned maintenance activity.
Impact on the LNG tanker market
As might be expected, this significant change in market conditions has directly impacted rates in the LNG tanker spot market, where even storage, slow steaming and discharge delays haven't prevented high specification tankers experiencing a collapse in day-rates. These have fallen from over USD 100,000 per day in October 2019 to circa USD 30,000 per day, far below estimated OPEX, by June 2020. While there is hope for increased demand, and therefore higher rates, towards the end of 2020, there remains much uncertainty in the global LNG market for tanker operators.
The approval of the US’s USD 10bn Jordan Cove LNG export terminal, for example, may have negative consequences for the LNG spot freight market, as it opens up the US West Coast export market, and reduces tonne miles to key Asian receivers. In the longer term, new supplies of piped gas from Russia will increase the options of both China and Europe (Gazprom’s two “Power of Siberia” pipelines are expected to deliver almost 90bn cbm of gas to China alone, once they come onstream in 2025/2030s). This comes against a background of 42 newbuilding deliveries in 2019, and circa 120 LNG tankers on order as of May 2020, a figure almost doubled by a reported 100+ units ordered by Qatar Petroleum in June 2020. Investors in this market were clearly confident that demand will show similar growth – it remains to be seen if they will be proved right.
LNG projects are notoriously expensive. We’ve covered the risk of “mega projects” in our earlier blog, but the days when LNG production assets and LNG tankers were only constructed against specific, and long-term, offtake agreements are long gone. Each project now represents a significant up-front cost, with timescales, and eventual returns, increasingly unpredictable, with cascades of delays or cancellations upsetting the already delicate (and seemingly in the LNG tanker sector, overheated) balance of demand and supply.
Even assuming there is no “second wave” of COVID-19, can those LNG producers and ship owners who have borrowed heavily to cover the construction phases of these assets still be confident of a worthwhile return over the life of the asset? Will banks be as prepared to underwrite the cost of the 60 proposed liquefaction projects and 200+ LNG tanker newbuildings discussed earlier, or are we entering stranded asset territory?
There remains significant optimism for the medium-term prospects for LNG. While the EU's 2030 Climate and Energy Framework is expected to have a significant impact on the demand for LNG imports on the continent, few analysts seem to be predicting a significant near-term reduction in global LNG demand (China perhaps growing more slowly that expected, and Japan/South Korea flatlining). Again, much depends on external influences, but given the investments to date, and those predicted, it seems impossible to put the genie of flexible LNG production back in the bottle.
One of the reasons that the US was so successful in getting exports off the ground was its flexibility. If you asked established LNG suppliers back in 2016 for a contract only two years in duration or a price clause not marked to crude oil, they would probably have declined, unless you were a strategically important buyer. US producers came in with much greater flexibility and gained a significant market share practically overnight, with a very diversified customer base. Arguably, when the recovery comes, and if the producers are still trading, these more flexible market participants are well-placed to stage a strong recovery, too.
The LNG tanker market may face significantly greater challenges, as owners seek profitable employment for those ships exposed to a spot market undermined by a supply/demand imbalance that shows no signs of correcting itself in the near/medium-term.
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