New Entrants Onto The World's LNG Stage

Introduction

Long before the International Energy Agency declared the world to be poised to enter the golden age of [natural] gas,¹ energy analysts were busily reviewing data and peering at maps of the planet. The world was indeed undergoing a dramatic paradigm shift with announcements of significant conventional and unconventional gas discoveries becoming a regular event. However, these discoveries have only served to underscore the fundamental commercial challenge of how best to monetize these resources in a timely fashion and on reasonable commercial terms.

Ever since the early design work of Godfrey Cabot and his 1915 patent for a river barge capable of transporting liquefied natural gas (LNG)² the ability to transport natural gas in liquid form has helped to unlock distant natural gas reserves previously considered stranded. Today, announcements about newly proposed LNG projects appear almost weekly in industry journals and newspapers as states and private industry scramble to realize the opportunities presented by newly unlocked gas reserves. There is no doubt that LNG will continue to play a pivotal role in the quest for monetizing these resources. But with so many projects to choose from industry watchers are understandably puzzled: which of these projects will succeed and which ones are likely to fade into oblivion?

This note examines recently proposed LNG export opportunities in East Africa, Western Canada, the U.S. Gulf of Mexico region and the most recent Australian ("Third Wave") projects and considers the advantages, and disadvantages, of each.

East Africa

As one starts to look around the globe a natural starting point is East Africa. Last year four of the world's five largest oil and gas discoveries were made off the coast of Mozambique with Eni and Anadarko now having identified 85 Tcf of recoverable gas reserves.³ When recent finds off the coast of Tanzania are factored in the East African reserve numbers quickly grow to more than 150 Tcf.⁴ The advantages of the East African LNG opportunity are significant. The gas fields are generally situated in shallower waters which are located close to shore, and the lands necessary for the development of a greenfield LNG facility are readily available. The presence of highly experienced players including Korea Gas, Anadarko and Eni also increase the likelihood of project success.

However this optimism is guarded as the challenges to the success of the East African LNG projects include the absence of a well developed oil and gas law, a lack of regulatory experience within government, an absence of energy infrastructure, and a scare trained labour force. In short, although gas resources are plentiful, accessible and affordable, the required expertise and infrastructure is lacking.

Western Canada

A very different demand presents in Western Canada. As U.S. demand for Canadian gas continues to decrease rapidly the focus for new market opportunities has shifted to Asia. Canada's reputation for technological oil and gas innovation, transparent regulatory regimes and plentiful gas reserves, make Canada an ideal new entrant onto the global LNG stage. Recent reports by the Ministry of Energy for the Province of British Columbia place BC's unconventional gas reserves at greater than 1,600 Tcf⁵. The province has recently announced that it is committed to the prompt and efficient monetization of these gas reserves though an aggressive LNG mandate, and has reported a plan to have three export projects operational by 2012.

Still, concerns circle around Canada's LNG initiative. Late last year the Fraser Institute released a report expressing reservations as to whether this goal was realistic.⁶ Reservations were expressed regarding unnecessary duplication between the federal and Provincial regulatory process, a lack of LNG regulatory experience within government, investment uncertainty in light of political musing over the introduction of new taxation policies⁷ and significant resistance from First Nations and other stakeholders regarding the necessary - and very expensive - pipeline expansion projects. In Western Canada, although the government has [publicly] expressed support for the proposed projects, uncertainties identified by commentators include the fact that the resources are a considerable distance from the coast, requiring a politically sensitive and expensive pipeline solution.

U.S. Gulf of Mexico

Today shale gas contributes slightly less than one-third of America's natural gas supplies but experts predict that by 2020 shale gas will account for more than one half of America's natural gas needs. With extensive pipeline infrastructure already in place, good access to capital, a robust domestic energy industry and more than a centaury of oil and gas regulatory experience, the US is well positioned to become a major player in the global LNG export market.

Still, the US does present a number of significant questions. First, under US law export approval from theDepartment of Energy ("DOE") is required in order to export gas to nations that do not have a Free Trade Agreement in place with the United States. Presently the Republic of Korea is the only Asian gas consumer with a free trade agreement with the US. Without such an agreement the DOE is required to conduct an assessment in order to determine whether the export of LNG is in the public interest.

This assessment process allows interested parties to express their views and participate in the proceedings. Earlier this year the Sierra Club, the American Public Gas Association and DOW Chemicals each filed materials urging against the export of LNG. Environmentalists expressed the concern that LNG exports would serve to increase drilling activities and that without a ready market for LNG exports, drilling activity will be dramatically reduced. US manufacturers also express concerns regarding export approvals; but for very different reasons. They argue that abundant domestic natural gas provides manufacturers with a competitive commercial advantage which needs to be protected. They seek to increase exports of manufactured products from the US rather than the export of gas as LNG.

The puzzle is not an easy one to solve. A December 2012 report of the DOE suggested that there may be very little US LNG exported after all. Although the existing sites in the US (known as brown-field sites) provide the US with an advantage regarding project capital expenditures (cap.ex.) pricing still remains a concern. Exports from the US Gulf will not be able to access Asian markets without a voyage through the Panama Canal, and while steps are now underway to permit the transport of LNG through the canal, questions regarding canal charges, and passage logistics, have yet to be resolved by canal authorities. Moreover a recent report out of Rice University ran a number of market scenarios using the Rice World Trade Pricing Model and concluded that there were very few scenarios where US Gulf LNG exports would be internationally competitive. When seeking to better understand the risks associated with the proposed US projects, while all of the required elements for a series of successful export projects are present, the question receiving the most scrutiny from industry relates to the political approval process.

Australia

While Qatar maintains its reign as the world's undisputed LNG export champion, Australia continues to aggressively seek the crown. Last summer the EIA projected that if the construction of existing LNG projects continued as scheduled, Australia will overtake Qatar as the world's leading LNG supplier by as early as 2020. Here the key question continues to be the "if" as project delays, cost overruns and postponed FIDs (final investment decisions) continue to plague many of the Australian projects.

When examining the Australian LNG projects, the same set of issues regularly surfaces. First, project overruns -- particularly those associated with the "Third Wave" projects - have become legendary. In December of 2012 it was reported that the Gorgon LNG project (a 15 MMTPA facility) could cost as much as Aus$ 60 billion.⁹ A study commissioned by Santos earlier last year found that, on average, an LNG project being constructed in Australia was more than three times as expensive as similar project situated on the US Gulf Coast. The rapid strengthening of the Australian dollar, a shortage of skilled labour in Australia, and a shortage of skilled suppliers have all contributed to this cost escalation.

Second, a significant amount of gas for the new Australian projects is to be provided by coal seam gas ("CSG") reserves. Production requires water resources which are becoming increasingly scarce and recently enacted legislation in both New South Wales and Queensland evidences the difficultly in balancing existing agricultural and ranching needs with the water requirements of the growing CSG industry. Research by Berstein from spring 2013 indicates that the three major CSG LNG projects are more than 30% over budget.¹⁰ Finally, data from late 2012 suggests that the recovery rates for the CSG wells drilled to date are lower than expected, and that an additional 12,000 wells may be required in order to support the required production levels.

Conclusion

Each of East Africa, Western Canada, the US Gulf of Mexico and the Australian "Third Wave" projects present their own advantages in the quest to capture new LNG market share. Similarly, each presents its own unique project challenges. Still industry watchers continue to express enthusiasm regarding the Australian projects, cautious optimism regarding the Western Canadian projects and a "wait-and-see" approach for both the US Gulf and the East African projects. In the end however, only time will tell where success will be found, leaving the world's LNG industry watchers with a great deal to think about in the interim.

1. "Golden Rules for a Golden Age of Gas: World Energy Outlook Special Report on Unconventional Gas"; International Energy Agency, November 2012.
2. LNG: A Nontechnical Guide, Tusiani, D. and Shearer, G.; (Pennwell: 2007, page 138).
3. Banks, J.P, Brookings; "Could East African Gas Impact U.S. Liquefied Natural Gas Exports?"; February 15, 2013; citing Wood Mackenzie at page 2.
4. Wood Mackenzie; "East Africa Faces a Technical and Commercial Challenge to Bring its 100 tcf of Discovered Gas to Market"; 22 August 2012 and Reuters; "Analysis - East Africa Risks Missing the LNG Boom", (September 19, 2012).
5. BC Ministry of Energy, Mines and Petroleum Resources (2012) as reported in Fraser Institute "Laying the Groundwork for BC LNG Exports to Asia"; (October, 2012, page 5).
6. Fraser Institute, (Oct. 2012); Laying the Groundwork for BC LNG Exports to Asia.
7. Globe and Mail; (February 27, 2013).
8. Medlock Report; (August 2012); Political and Economic Influences on the Future of World Market for Natural Gas.
9. Reuters; (December 5, 2012); Chevron Adds $15 bln. to Gorgon LNG project Cost Estimate.
10. Bloomberg, (February 7, 2013); "Australia LNG Growth to Continue on Asia Demand, Bernstein Says".

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