Competing in the global LNG market: Evolving Canada's opportunity into reality
The capital agenda continues to dominate discussion at the C-Suite and boardroom table of the world’s leading oil and gas companies. Important strategic decisions around where, when and how to raise, invest, preserve and optimize capital have become increasingly challenging as companies struggle to achieve satisfactory returns and effectively manage risk.
Portfolio optimization has been the primary focus for global players as they seek to improve margins and generate adequate returns in a period of flat commodity prices and rising costs. That focus on cost and capital availability will continue to rule business decisions going forward.
Canadian LNG projects will have to compete globally for capital against projects in many jurisdictions. For example, the significant capital requirements for pipelines, infrastructure, liquefaction facilities and development of the required natural gas reserves for Canadian projects will have to compete with brownfield projects in the US where a far more developed infrastructure capable of supporting LNG exports already exists.
For participants looking to grab some share of the multi-billion dollar spend that will be needed to advance the BC LNG projects, the dynamics of this capital allocation process and the global organizations that are behind the projects add to the complexity. Where are the decisions being made? To secure a contract, do sales calls get made in Canada, Houston or somewhere in Asia? What is the timing of the spend? Will global procurement practices and world-class best practices in areas such as “modularization” leave room for BC content? And, will wage inflation zap profit margins both for the project owners and contractors?
Another challenge to those assessing an investment in a Canadian LNG project is the ongoing chess game around how LNG cargos will be priced. Our recent report, Competing for LNG demand: the pricing structure debate, digs into this challenge. LNG buyers are holding out for supply contracts that break — or at least modify — the traditional oil-indexed linked contracts. Sellers (the project developers) argue that their projects simply are not economically viable unless they earn sufficient premium over simple Henry Hub pricing models. Buyers are proceeding cautiously, pointing to the large number of announced “new build LNG projects” globally and assert that there will be plenty of LNG supply (given if all announced projects were to proceed there would be a significant oversupply based on current demand forecasts).
There is considerable risk to LNG buyers, however, that they will find themselves short of LNG. Given the structural challenges to achieving adequate returns that many of the global oil and gas companies are facing, and the cost blow-outs on many of the recent LNG projects, it seems unlikely that projects will proceed, in Canada or elsewhere, unless acceptable pricing arrangements are achieved. And, no new LNG facilities, means no downward pressure on LNG prices.
Another dynamic affecting Canadian LNG projects is the structuring required to accommodate the multi-faceted nature of the projects. Upstream spending decisions, the need for significant investments in pipeline and midstream facilities, the multi-billion dollar investment in liquefaction facilities, ports, logistics, and the need for sophisticated marketing operations to manage complex processes leads to complex business structures. Add to the mix the need for project structuring to achieve desired risk management and mitigation objectives. All projects will also require very sophisticated financing structures to support the required project returns. The good news for Canadian projects is that the financiers will see relatively little geopolitical risk. The more challenging news is that many perceive relatively higher project cost risks, given the Australian LNG experience and Canada’s cost history in the oilsands.
Many wonder why decisions appear to be developing slowly in a world where there exists a significant arbitrage opportunity between North American natural gas prices and the value of those molecules sold as LNG into Asian markets. The complexity of the capital allocation process provides some insight.