US LNG building boom to lead to overcapacity : Datamonitor

In fact, demand for LNG is so great that shipments at sea have been diverted from their original destination to take advantage of arbitrage opportunities elsewhere. It has also sparked considerable investment in LNG infrastructure and the market is poised to get bigger, according to a new report from London-based independent market analyst Datamonitor, in a new report, Atlantic Basin LNG US Market Dynamics, which focuses on the LNG markets in the US and Europe.

LNG is an increasingly important alternative energy source in both the US and European energy landscape. By analysing the largest LNG market in the Atlantic Basin, it is possible to understand the long term development of the Atlantic Basin market.

Lots of gas but no market
The LNG market is fuelled by countries with abundant gas resources, but with little domestic demand and the inability to export gas via traditional pipelines. LNG gives suppliers the opportunity to monetise this stranded gas by liquefying and shipping it to countries with insufficient or irregular gas supplies, and it is fast becoming a competitive alternative in the energy mix of gas consuming markets.

LNG is traded globally in two major markets; the Atlantic Basin and the Pacific Basin. The Atlantic Basin encompasses all LNG producers and consumers physically located west of the Suez Canal, which includes Europe and North America.

Algeria, Nigeria, and Trinidad and Tobago are the major Atlantic Basin LNG producers, whilst on the demand side the market is segmented by the Europeans on one side and the American continent on the other.

Belgium, France and Spain are the major European consumers, while the US is the primary LNG market in the Americas, says Datamonitor energy analyst David Niles. "The UK was actually the first user of LNG in Europe, but because of then-abundant North Sea supplies, importing LNG was discontinued. However, with North Sea supplies diminishing, LNG has a renewed role in the UK energy agenda.

"Already there are two import terminals in the UK, and two more are being constructed in Wales," he says.

The US is a LNG consumer in the Atlantic Basin, whilst in the Pacific Basin it is both a producer (Alaska to Japan) and consumer (California).

Interestingly, North America is an anomaly, in that it belongs to both LNG world markets — the East Coast belongs to the Atlantic Basin whilst the West Coast belongs to the Pacific Basin.

LNG in the US is fuelled mainly by declining indigenous natural gas supplies and its widespread use as a power generation source. The US accounts for 95 per cent of the North American LNG market, where consumption grew over 1000 per cent in the ten years from 1996. Yet despite this phenomenal growth, LNG remains a niche within the US gas market accounting for just three percent of total gas consumption, Niles says.

High consumption fuelling high investment and over capacity
Despite its niche position, market players are wagering that LNG will eventually become a major fuel for primary energy consumption. This means that present volumes will have to significantly increase, at a far greater rate than its already robust growth rate. With this in mind, there is currently a construction boom in LNG terminals.

Presently, the US Atlantic Basin has five LNG terminals with a combined annual capacity of 60.3 bcm. However, in 2006 these were vastly under-utilised with only 17.5 bcm of LNG being imported. Imports are expected to grow at an annualised rate of six percent by 2020, when total US LNG consumption is expected to reach 46 bcm. Despite this, 22 terminals have been approved for construction, with a total annual capacity of 349 bcm.

A further 118 bcm is proposed for consideration, Niles says. "Given the forecasted growth in LNG, even if 10 per cent (3.4 bcm) of the terminals that have been approved for construction are actually built, there would still be a glaring under-utilisation of capacity."

The construction and under-utilisation of so many terminals can potentially increase the risk of volatility in the industry if its growth rates are not maintained or increased. Yet the US government is trying to spur investment in LNG projects to increase its penetration in the energy landscape as an alternative energy supply.

Since 2002, two major US regulatory rulings were passed to spur investment and effectively deregulate the US LNG industry. As such, LNG import terminals are now considered supply sources, similar to a gas production field. Previously, LNG terminals were seen as links in the gas transportation network, placing them under the same regulatory guidelines as the interstate gas transportation pipelines.

Owners of offshore terminals were also previously allowed sole access to their entire capacity rather than being obliged to offer third party access. Terminals are also no longer subject to regulatory pricing and conditions, Niles says. "The rulings essentially allow LNG terminals to charge for services based on current market conditions rather than based solely on the terminals'' cost for providing services, as was previously required."

Atlantic LNG market will become more competitive
Because LNG projects demand high capital investments, producers have traditionally secured long term contracts to mitigate their exposure to price risk. However, short term contracts are becoming increasingly common worldwide, and as competition and energy market liberalisation increases on both sides of the Atlantic, long term contracts will be ceded in favour of the greater flexibility afforded by short term contracts.

In the Atlantic Basin short-term contracts will become the norm. In 2004, short-term contracts and spot market deliveries represented more than 70 per cent of all US LNG imports, compared to just 25 per cent in 1988. This can be attributed to the Atlantic LNG market becoming more liquid, as prices on both sides of the Atlantic are based on transparent gas indices, such as the Henry Hub and Zeebrugge.

As competition between North America, Europe and the Pacific Basin heats up, it is becoming increasingly common for suppliers to take advantage of arbitrage opportunities between importers, Niles says. "Suppliers with flexible delivery terms have diverted shipments to other markets despite higher transportation costs, to gain the highest netbacks or revenues.