United States: LNG And Renewable Power - Risk And Opportunity In A Changing World

Last Updated: January 18 2016
Article by Jürgen Weiss, Steven H. Levine, Yingxia Yang and Anul Thapa

Executive Summary

Two important trends are transforming the energy industry across the globe. The production of relatively low-cost unconventional sources of natural gas—primarily in the United States and Canada, but potentially also in other parts of the world—has led to much heightened attention to the possibility of increased use of Liquefied Natural Gas ("LNG") in world markets and a large number of proposed LNG export projects in North America. Several LNG export projects are under construction in North America (and will begin exporting in the next few years), and many more are proposed with the hope of being part of a "second wave" of LNG projects to begin service in the post-2020 time frame. At the same time, both technological progress and concerns about climate change risks are stimulating the development and deployment of various types of renewable energy sources around the world.

While the natural gas industry has traditionally viewed LNG as a substitute for oil in many markets, this paper explores whether the evolution of renewable energy sources suggests that LNG may be competing less with oil and more with renewable energy sources in markets outside of North America in the coming years. Such competition is evident in electricity generation markets as natural gas combined-cycle units and renewable energy sources compete to serve future electricity demand. Competition between natural gas and efficient electric heating (using heat pumps, for example) is less prominent, but emerging in some countries (e.g., Germany). Thus, there are important and intensifying linkages between global natural gas and electricity markets that will impact developments in renewables markets and have feedback effects into the natural gas market.

This emphasis on LNG development takes place against a backdrop of several important market dynamics, including the recent collapse in world oil prices, a slow-down in China's economy and its demand for natural gas, the commissioning of new LNG export projects in Australia, and a reduced need for natural gas in Japan due to the re-start of some of the country's nuclear power plants. As a result of these factors, Asian LNG prices, which had risen to $15/MMBtu (or more) in recent years, have now collapsed to roughly $6-$7/MMBtu, and the significant price differential between world oil prices and North American natural gas prices (that gave rise to the North American LNG projects now in development) has now declined dramatically. The deterioration of this price differential is bad news for both the LNG export projects in development (but not under construction) in North America and the energy companies that signed up for long-term LNG export capacity from the new North American export projects (that are under construction and one of which will begin service in early 2016). These market suppliers need LNG delivered prices in Asia to be in the $10-$11 range in order to be profitable. With several more LNG export projects coming online in the 2015-2020 period and an expectation of continued low oil prices, global LNG markets are likely to be oversupplied for the next several years and the low LNG prices now observed seem likely to persist for some time. The fate of many of the proposed North American LNG export projects is increasingly uncertain in the new price environment (and some LNG export projects have already been delayed).

Thus, two important questions facing global LNG markets today are how quickly LNG supplies associated with the new LNG projects coming online over the next few years will be absorbed, and at what point in the future there might be a rebound in global LNG prices such that new LNG export terminals (beyond the terminals now under construction) are needed. The LNG export developers in North America (as well as buyers of LNG from the projects now under construction) are hoping that the worldwide LNG supply glut is temporary and that market conditions in the post-2020 time frame will improve.

The analysis in our paper suggests that market participants should be very cautious in thinking that the LNG supply glut is necessarily a temporary problem, because another important dynamic in world energy markets is the declining cost of renewable power and the prospect of increased penetration of renewables in the global power generation mix and thus competing with LNG as a "fuel source" for power generation. In fact, in some regions such as Germany and California, where renewable penetration has been high, gas demand growth has already been stunted by the penetration of renewables in the generation mix (causing a reduction in gas demand growth for power generation).

There is a real possibility of a significant shift towards more renewable power generation in some of the key Asian markets targeted by the LNG industry. While the current shares of wind, solar, and gas in China are each less than 5% of China's total electricity generation, all three sources of electricity generation are projected to increase substantially over the next 25 years as the share of coal generation as a percentage of total generation is projected to decline significantly from around 75% today to roughly 50% by 2040.1 Gas, wind, and solar (as well as nuclear) will therefore all be competing to serve China's growing electricity needs. The relative costs of LNG and renewables discussed in this paper will likely be a significant factor determining which technologies achieve the highest penetration levels. Of course, the uncertainties regarding the costs of both renewables and delivered LNG over the coming decades remain significant and other factors not discussed in this paper will influence China's future electricity generation mix. Nonetheless, the expectation of declining costs of renewables (discussed in this paper) relative to LNG is noteworthy and creates the possibility of a potential shift towards even more renewable generation than is currently forecast in key Asian markets.

Since many LNG forecasts suggesting that the LNG supply glut is temporary rely on the assumption that natural gas demand from China and other countries in Asia will more than double in the next 20 years (in part due to gas demand in the power sector), these forecasts should be seen as highly uncertain given the potential for a significant shift towards more renewable power in China and throughout Asia that could limit the growth in gas demand and the need for LNG. Likewise, in Europe, despite the fact that declines in domestic natural gas production (as well as the perpetual desire to diversify away from Russian-sourced natural gas) are leading many to look at LNG as a potential alternative, the on-going shift towards more renewables may reduce the incentive to import significantly larger amounts of LNG.

LNG infrastructure is very capital intensive across the entire LNG supply chain. As a result of the billions of dollars of fixed costs, LNG projects and associated financing arrangements usually require long-term contractual arrangements for the necessary infrastructure. These contractual arrangements allow the developers of the LNG infrastructure to pass the risk of their projects on to their counterparties. For example, the developers of LNG export projects may sell their export capacity to large energy companies (such as BP, BG, Total) who then assume the risk for selling LNG to overseas customers. In other cases, the developers may contract directly with overseas end-users. In either case, the risks can be substantial, especially because how much gas will be needed overseas is uncertain, e.g., for gas-fired electricity generation purposes future needs may not be known with any meaningful precision at the time long-term contracts are signed. LNG project developers will also not be completely shielded from risk for several reasons: the capital recovery period may extend beyond the term of their initial long-term contracts, the capacity of a given LNG project may not be fully subscribed, they will be subject to the ongoing creditworthiness of their counterparties, and they may face demands for contract price adjustments as market conditions and the competitive LNG landscape changes. Thus, market participants along the LNG supply chain need to understand how the development of renewable resources in overseas markets could impact the need for LNG imports in those markets.

Ultimately, investments in North American LNG terminals2 require that the prices paid for LNG in overseas markets are greater than or equal to the price of U.S. natural gas supplies (e.g., at Henry Hub) plus the cost of all infrastructure necessary to liquefy and deliver LNG to overseas markets (including a fair rate of return on that infrastructure). If the cost of renewable generation is low enough overseas (i.e., below the cost of new gas-fired generation burning LNG from North America), it could dampen the attractiveness of North American-sourced LNG as a fuel for electric generation and the willingness of market participants to continue to contract for LNG export infrastructure.

We find that the competition between renewable power and gas-fired generation using LNG delivered from North America is increasing in overseas markets. Our conclusion is based on an analysis of the costs of developing new gas-fired generation in Asian and European markets that use LNG from North America as a fuel source compared to the costs of developing new renewable generation in those markets. Our estimate of the delivered cost of LNG from North America includes both the forecasted commodity cost of North American gas supplies (from the U.S. Energy Information Administration) and the infrastructure costs of liquefaction, shipping, and regasification necessary for North American gas to be consumed in Asian and European markets.

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1 See, for example, World Energy Outlook 2015, p. 634, which forecasts the share of gas-fired generation (as a percent of total electricity generation) in the New Policies Scenario to grow from 2% in 2013 to 8% in 2040. WEO forecasts the share of wind generation to grow from 3% to 10%, and the share of solar PV to grow from 0 to 3% over this time period. Growth in generation from gas, wind, and solar PV over this time period is forecast to be 788 TWh, 886 TWh, and 353 TWh, respectively. Growth in installed capacity from gas, wind, and solar PV over this time period is forecast to be 160 GW, 321 GW, and 258 GW, respectively.

2 While this paper specifically discusses the risks posed by the declining cost of renewable energy to North American LNG developers and their customers, a similar dynamics between renewables and LNG could also broadly apply to other regions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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