Author: Ross McCracken, Natural Gas World | 24 February, 2023
Spot LNG prices were extremely high throughout 2022. Their retreat in the face of a mild European winter still leaves them at historically elevated levels. With the Russia-Europe energy relationship irretrievably broken, LNG imports into Europe are expected to remain strong for the next few years as countries seek to replace the loss of Russian pipeline imports.
In this situation, investment in new LNG capacity could be expected to boom – prices have never looked better. It is not as if there is a dearth of potential projects – the pipeline is huge. Yet the response looks lacklustre. By the end of Q3 2022, 28mn mt/yr of new LNG capacity had reached an FID, a substantial increase yes, but no boom. Of this, 26mn mt/yr was in the US – a localised rather than global response. Reaching FID for large, long-life, capital-intensive projects is not easy and does not happen simply on the basis of an apparently bright market outlook.
Mozambique’s prospective large-scale LNG plants remain hostage to the onshore security situation. Timor Leste’s Greater Sunrise has for years been unable to find a development concept acceptable to all parties, although the situation at the end of 2022 looked positive. LNG development in Tanzania, now also making progress, has equally been a painfully slow affair.
By the end of 2022, no other major LNG projects had passed an FID, although some smaller-scale floating projects were announced in Malaysia and elsewhere. This is in stark contrast to the demand side of the market. Import projects in Europe have received unstinting state backing and been delivered at extraordinary pace. No equivalent support has been forthcoming on the supply side. Nonetheless, up to 100mn mt/yr of new capacity could see FIDs in 2023, again mainly concentrated in North America. However, developers face an uncertain financial environment, as inflationary pressures push interest rates higher, and they need to consider the LNG market post-2026, when the worst of the European energy crisis should be waning.
Climate policies and the impact of the European energy crisis on Asian gas plans are other key factors which developers, and their financiers, need to assess with some caution.
The USSR and Europe established gas trade despite ideological differences, and that trade survived the former’s collapse. But last year, the Russia-Europe energy relationship collapsed seemingly irrevocably.
Europe is now adding regasification capacity at breakneck speed. The US Energy Information Administration estimates EU and UK regasification capacity will expand by 34% between 2021 and 2024. Germany, the world’s fourth largest economy, in the space of a year, is emerging as a major LNG importer, having previously been absent from the market. This sudden creation of demand is wholly unprecedented and far too rapid for an adequate supply-side response.
Before Russia’s invasion of Ukraine, the LNG market’s expansion plans were stalling. From a boom in investment in 2019, 2020 saw only one new LNG project sanctioned. This reflected in large part Qatar’s plans for its giant North Field and the rapid expansion of the US LNG industry.
Qatar’s expected expansion of LNG output from 77mn mt/y to 126mn mt/yr by 2026/27 – in many senses a now-or-never decision – would suck up a huge proportion of forecast LNG demand, pushing back an expected market deficit into the late 2020s.
A large expansion in Russian LNG output was also on the cards, driven by Novatek, a private Russian company with strong state support that had attracted western partners. In contrast to Gazprom’s apparent lack of enthusiasm for non-pipeline gas exports, Novatek demonstrated in no uncertain terms, with Yamal LNG, that it had the capacity to get major LNG projects up and running. The long-term increase in Russian LNG now has to be discounted because of sanctions. Even in the US, FIDs for the vast bulk of new LNG – the capacity which will help rebalance the current inflated market in 2025-2027 – were taken before Russia’s invasion of Ukraine.
Demand Curtailment and Destruction
The sudden boom in LNG demand in Europe has resulted in a massive redirection of LNG flows. Europe could only absorb more LNG because of the fortuitous existence of spare regasification capacity and a fleet of around 20 floating, storage and regasification units (FSRUs) globally, which were being used as LNG carriers, owing to a lack of demand for their regasification services.
No such flexibility exists in the supply side. As a result, Asian LNG imports have plummeted, particularly in the more price-sensitive markets of South Asia, and FSRUs have been relocated from Asia to Europe. Europe’s crisis has set back Asian gasification plans – largely predicated on the need to reduce coal use – by years.
Climate Change and the Demand Balloon
Based on stated policy and those in development, Europe’s trajectory is clear. By 2050, it intends to achieve a net zero carbon economy. This means hugely reduced fossil fuel use. In fact, the EU’s REPowerEU plan is designed to eradicate gas use faster than previously anticipated even at the cost of extended coal consumption.
Carbon capture utilisation and storage (CCUS) may provide some longer-term gas use, but abatement is not 100%. This may change in the next decade, but Europe’s preference, with some exceptions, is mainly for non-CCUS pathways. The concern for LNG developers is that given net zero, Europe’s sudden thirst for gas is like a massive demand balloon which looks likely to deflate almost as quickly as it arose.
This uncertainty is an everyday reality for Europe’s utilities. They do not want to commit to the long-term off-take contracts LNG developers need to gain finance because they are not certain of gas demand 10 to 20 years down the line.
Asian LNG Demand Arrested
Moreover, owing to high prices and the loss of FSRUs, Asian LNG demand growth is no longer as certain as it was. The prospect of market entry and then steeply rising LNG imports for countries like Vietnam, for example, now look far less certain because LNG has become expensive.
India has lost two FSRUs this year, truncating the expansion of its LNG regasification capacity amid a 14% drop in LNG imports. The country has ambitious gasification plans, targeting an increase in gas use as a share of primary energy consumption of 15% by 2025, up from just over 6%, but this target, ambitious before the Ukraine crisis, now appears wholly unrealistic.
With its major construction programme of new onshore regasification terminals, China’s LNG demand looks certain to revive. However, weaker economic growth means that even Chinese LNG demand carries its uncertainties. It will also take advantage of Russia’s need for new customers and willingness to build major export pipelines, offsetting its need for LNG.
Coal Use Locked-In
Europe’s demand bubble creates a period of dislocation in the LNG market, which creates an opportunity not just for LNG developers, but for other technologies to fill the gap. And the high price of LNG makes those alternatives much more attractive.
Developing economies, to the extent that they can, will pursue renewables and electrification as both the lowest cost and most sustainable solution. At its current cost, gas will find it hard to compete. But those economies will also extend the use of domestic coal, while they develop their renewables sectors, losing the early and large emissions reductions afforded by coal-to-gas switching.
As such, amid the uncertainty, there is some clarity.
Global coal-fired power generation is estimated by the International Energy Agency (IEA) to have reached a record high in 2022. The agency estimates that global coal use will plateau at some 8bn mt/yr through 2025. While Chinese coal demand is expected to stabilise, India’s coal demand will emerge as the engine of consumption growth, the IEA says.
Fast forward to 2030 and not only will the opportunity for coal-to-gas switching remain huge, it will be all the more urgent.
The case for LNG FIDs today is therefore less to do with European energy – new liquefaction capacity will only come on stream at the tail end of the crisis. FIDs are needed now to address the problem of massive global coal use, which will be extended by the current limited supply of LNG caused by Europe’s sudden demand surge for the fuel. China and India account for almost 80% of global coal consumption, and their net zero targets are understandably set later than those of the developed world, at 2060 and 2070, respectively.