Wednesday, February 26, 2014

Factors to consider in LNG plant development viability

For an LNG facility to make an sense there are a number of factors to be considered and each one of them spells the end of the project if they can not be dealt with.  I am writing out this list of issues so that in future posts you can see how I decide if a project is likely or not.

The list of issues:

  • Access to natural gas
  • Access to a safe deep water port
  • An export licence
  • Environmental regulatory approval
  • Secure land tenure
  • Capital
  • The price of natural gas in BC
  • Buyers for the LNG
  • The medium and long term market for LNG

Access to natural gas
This is an issue in BC as opposed to many other LNG locations around the world especially the United States.   It is not that BC does not have natural gas, what it lacks is the pipeline infrastructure to bring the natural gas to the north coast.

From the 2013 IGU World LNG Report:

7.4.3 CANADA COMMERCIAL RISKS: PROJECT COST (CAPEX). The commercial position of liquefaction proposals in Western Canada is weakened by the need for greenfield facilities, as well as the early stage of development of the shale gas resource play in Western Canada. Based on announced costs, projects in Western Canada face inexpensive liquefaction costs (~$1,000 /ton) relative to greenfield projects in Australia. However, a major factor affecting Western Canadian projects is the need for a long, expensive pipeline to bring gas from eastern British Columbia to the Coast. Currently, pipeline infrastructure in British Columbia is limited, with one major north-south trunkline and a smaller pipeline running west to the coast. As of may 2013, four projects have proposed building ~500 mile pipelines with costs of between $1,000/mmcf/d - $3,000/mmcf/d, which will significantly increase total project costs.

This means that any project that can not point to their source of natural gas is unlikely to be a serious project at this time.  

It is important to understand that the five proposed pipelines are not enough to supply all the LNG projects currently listed by the BC government.   If someone were to propose a new pipeline now, it is going to be eight to ten years before it is built.   This means that any project without a clear source of natural gas is nothing much more than a drawing board idea and is on the order of a decade away.

The total capital investment in the proposed pipelines is large and may make some of the proposed pipelines financially nonviable.  The loss of any one pipeline project will make some LNG plant proposals nonviable.

Access to a safe deep water port
This does not seem to be a problem in BC with numerous locations available.

An export licence
This does not seem to be an issue in Canada

Environmental regulatory approval
The process takes time and add costs to any project but is likely to be a barrier.  The various environmental regulatory requirements are a two to five year process to get through.

Until a company has started down this process, it is hard to consider their project as a serious one.

Secure land tenure
This is an issue in BC much more so than most locations around the world because of the lack of a settlement with First Nations.   As long as BC does not settle treaties with the First Nations, all tenures for the plants and pipelines are not 100% secure.

All I can say about the First Nations issues is that they are not as bad as they could be.

This is an issue on two levels, the first is finding the money to build and the second is how to fund cost overruns

Can the companies get the capital needed to build the plant?   For the large international oil and gas firms this should not be an issue, but some of the projects are being proposed by companies not on that scale and the money they need to raise is in the billions.   Without everything looking just right, these projects are unlikely to go forward.

For the global oil and gas companies with the deep pockets the BC projects have to offer a good enough return that it is better than other projects they could invest in.  Companies like Chevron and Shell have a whole planet to choose from.

The second issue is cost over runs.  The track record for LNG projects over the last several years has been to have significant cost over runs.  Cost over runs elsewhere are going to make companies wary of committing to BC projects given their need to ensure the capital is available to complete the projects already under construction.  All the major players in BC currently have LNG projects under construction somewhere else in the world.

Price of Natural Gas in BC
BC natural gas is not the cheapest to produce and this will matter if the end buyers want a price tied to the Henry Hub price.   As more and more shale gas close to infrastructure comes online around the world, the remote gas in places like BC's Horn Basin may have trouble competing in the market.

Buyers for the LNG
Normally in the LNG market there is a contract between the LNG supplier and an end client.   To date none of the BC based projects have contracts for their LNG.  This is where the American projects have a significant advantage over the BC projects.  Many of the American projects have buyers contractually committed already to their LNG.

There is an ever increasing spot market for LNG but this is risky for any project because the spot price can go well below the cost of production.  If spot prices start to offer LNG buyers on going cheaper prices, companies may become unwilling to sign long term contracts to buy LNG.

Medium and Long Term Demand for LNG
The capital investment to build an LNG plant and a pipeline is huge and requires a pay back period long enough to justify the initial capital.

At the moment there are 100 mtpa of LNG plant capacity.   This is a 27% increase in global LNG production capacity over the next four years.   That is a much faster rise in LNG capacity than demand for LNG.   By 2017 there should be about 366 mtpa of LNG capacity but likely only a demand of 280 to 290 mtpa.   There is going to be an issue with more capacity being available than demand by 2018.  Does it make sense to build 30 to 60 mtpa of LNG capacity in BC when there will be so much more capacity than demand?

LNG demand is also impacted by a host of other energy decisions.   As an example, if Japan were to ramp up nuclear power again that would remove the most significant increase in LNG demand seen in recent years.

To finish, there are many different barriers to LNG development and an executive with any of the companies proposing LNG plants in BC has to justify that the investment of billions of dollars   Much of what the companies could be doing in BC is keeping their options open.   The large cost of the projects means spending 1% of the value exploring an idea is a drop in the bucket.   For a $15,000,000,000 project that would be $150,000,000 which is a lot of money but still so small in the overall project that they can walk away from it without it financially impacting them.

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