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The economics of LNG

In our series of background articles on IOC, we will analyse the LNG markets in general and the sitiation in Papua New Guinnea (PNG) in particular.

First, one has to understand a little about the economics of LNG production. Here is the whole article:

Worldwide natural gas proven reserves are estimated to be over 6000 TCF and worldwide production of natural gas is about 100 TCF per year. Some of the proven reserves may be overestimated especially in the Soviet Union which accounts for about 1/3 of estimated worldwide natural gas reserves.

Assuming that up to 30 percent of the worldwide proven reserves don’t really exist, there is still 40 years worth of proven reserves of natural gas at current production. It is likely that actual natural gas that will ultimately be produced going forward is much higher than current proven reserves. How much higher would be impossible to determine. But I believe that it is very unlikely that actual real producable natural gas in the ground will be less than 5X of proven reserves.

There are two ways for natural gas to be traded between countries that have a lot of natural gas to those that don’t. The first is building natural gas piplelines. The second is to build facilities to liquify natural gas or to make LNG.

LNG has some fixed costs above and beyond the cost of the raw natural gas. These costs are typically amortized over 20 years. The most significant of those fixed costs are:

1) Liquification plant $1.1 per Mcf +/- $0.20
2) Shipping costs (LNG tankers and operating costs) $0.70 per Mcf +/- $0.30 depending on distance.
3) Cost for regasification $0.35 per Mcf.

The costs come out to $2.15 per Mcf. This does not include the costs to develop the natural gas resource and get it to to the LNG facility.

For an LNG facility to be economical, the operator has to have a committed natural gas resource large enough that there will be sufficient natural gas to ship for 20 years. Otherwise, the costs per Mcf go up quickly because the capital costs of the facility would have to be amoritized over a shorter time period.

A conventional natural gas field located close to coastal area where a LNG facility might be built probably won’t have development costs (the cost for surface equipment and pipelines, drilling and completion costs) of less than $0.75 per Mcf. The costs will vary a lot based on the natural gas field.

If each well produces a large amount of natural gas, then the costs are lower. If each well produces less, then the costs are higher. Based on the costs of some of the conventional natural gas fields I’ve looked at, I think that the average cost will vary between $0.75 to $2.00 per mcf for most large conventional natural gas fields.

Note that the costs would be lower for oil and gas fields where the primary reason to drill the well was to produce the oil. Adding up everything, the cost to get LNG to market is in the range of around $2.90 to $4.15 per Mcf. This sets the “base price” under which LNG won’t be produced and exported.

What will ultimately set the price for LNG above the base price is supply and demand. The problem with LNG supply is that the facility to produce LNG requires a lot of time and capital to build. In addition, a LNG facility probably won’t be built until/unless there are enough proven reserves of natural gas to justify building the LNG facility.

Another major issue impacting the growth of LNG production is that much of the worlds natural gas is in areas where state oil companies control production or in areas with political unrest. Companies that would like to invest in natural gas production have to be careful that they don’t invest in areas where government may not honor contracts over the long period of time that it takes to amoritize the cost of the LNG facility.

The best current LNG production estimate that I’m able to make is roughly 8.2 TCF. Japan is the largest importer of LNG followed by Korea, the United States and Europe. LNG demand is growing in most of the current large importers of LNG but it is also growing quickly in India, China and South America.

The price of oil impacts the worldwide demand for natural gas. As the price of oil increases, countries that use oil for industrial purposes or electrical generation would like to purchase a lower cost alternative such as natural gas. If oil is $100 a barrel, even at $15.00 per Mcf, natural gas is competitive with oil.

The price of oil has increased recently therefore improving the economics of using natural gas. Since a LNG project takes several years to plan and build (usually three to five years), there is no possibility to rapidly increase LNG production to keep up with any increasing demand.

The cost of the terminal for handling, storing and converting the LNG back from the liquid to gas is only about $.35 per Mcf. Therefore, those countries that would like to use more natural gas instead of oil are likely to build terminals for LNG.

LNG terminals are also easier to plan and to build than are LNG production facilities and there is less political risk associated with building them. Therefore, for the foreseeable future, the number of LNG terminals are likely to be larger than is required on a one for one basis with the LNG production facilities.

Another driver of demand for LNG is that natural gas produces a lot less air polution than does burning coal or fuel oils. Therefore, large cities where there are air quality issues would prefer to use LNG instead of oil. Therefore, on a BTU basis, natural gas should be prefered over oil in those areas.

In Summary,

Considering all the relevant factors, unless there is a significant recession that reduces overall worldwide demand for oil and gas, demand for LNG should remain high and prices should continue to trend upwards year over year to get closer to the price of oil on a BTU basis.

If there are natural gas supply disruptions or if the winter of 2008/2009 is colder than expected, the price of LNG may for a time go higher than the price of oil on a BTU basis. The 2007/2008 winter demonstrated the potential for large weather related LNG demand spikes.

So far this article on the economics of LNG. Apart from rising prices, there is another factor impacting the LNG market, and that’s improved technology. In the words of Joseph Dancy, Adjunct Professor of Energy Law at Southern Methodist University and fund manager of the LSGI Technology Venture Fund L.P:

  • “The market for natural gas has changed. What was uneconomic to develop only a decade ago and ignored is now wildly profitable….
  • China and Japan are two prime markets with potentially severe fuel supply shortfalls. Technology has advanced, reducing the cost of LNG production and transport. As with the Barnett Shale play here in North Texas many are slow to realize the exponential increase in value this creates for players holding developmental rights….

Here are some more articles about increasing demand for LNG
Rising ING demand in Asia, declining export from Indonesia, the regions leading LNG supplier. One noteworthy quote:

  • “Indonesia has failed to meet LNG supply commitments to Asian customers since at least 2002 as reserves in several fields feeding its existing plants in Bontang and Arun in Aceh province declined faster than expected while domestic demand rose”

As energy demands rise and exports from Indonesia become problematic, LNG importers are looking for alternatives, PNG has excellent chance to fill the hole.

In fact, there are LNG shortages appearing world-wide:

  • “the market is in a flux, with severe downward pressure on available gas resources for export to consuming countries.”

The article discusses that Indonesia is not the only big producer with problems, Nigeria and other parts of Africa and the Middle East are struggling to meet rising demand too.

We conclude
Structural increases in demand for energy, especially relatively clean energy like LNG have increased prices to such an extent as to make erstwhile uneconomic fields economic. Technology has helped the cause of LNG production further.

4 Comments

4 responses so far ↓

  • 1 lulu // May 16, 2008 at 2:33 am

    Great summary. Thanks!
    I wonder how the political environment is in Papau New Guinea and how IOC has tackled that. The government has a number of very significant problems (HIV, a low educational level) that could bring political unrest….and development problems for IOC along with it. Anyone out there that was following IOC in the beginning that has any information to comfort a shareholder?

  • 2 A collection of our LNG articles // Aug 5, 2008 at 3:49 am

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  • 3 All you ever wanted to know about natural gas // Sep 1, 2008 at 10:16 pm

    […] The economics of LNG […]

  • 4 Quora // Nov 28, 2013 at 8:46 am

    What would be the most sensible energy source for Japan to solve its post-nuclear energy problem?

    That page says the marginal cost of diverting European LNG to Japan is $2-$4 per million BTU but that Qatar is equidistant from Europe and Japan. The Gulf has also always had a surplus of gas and I believe is still flaring. One barrel of oil is 5.8 mil…

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