September 8, 2022 - Nom Geo
Best Fix for the Modern Energy Crisis: part one LNG
This is the first of a series of articles in which I hope to outline the case for a new perspective on energy, and energy economics. In this instalment, we look at the role of LNG (liquefied natural gas). Because no analysis is complete without considering historical events, I will attempt to shape the paradigm as fully as I can. This may be challenging because the story of energy is ever-changing, dynamic, but a snapshot may be all we need to see.
A lot of the information used here is based on reported, measurable indicators. The qualitative side of the discussion will be based on my exposure to global and holistic analysis of projects, companies, government regimes, financiers and to the limits of my personal involvement and training in the coal and gas sector, and on my reading of thought leaders from all sides.
I have no conflicts of interest or financial involvement with the energy industry to declare. I do, somewhat reluctantly declare some of my own prejudice, based on personal experience against dogmatists whose claims are not accountable.I do strive to make myself accountable in terms of rational discourse.
There will be several articles on LNG. Let’s begin with recent and current events in global gas markets and the energy crisis and a brief mention of the factors leading to it.
LNG or liquefied natural gas, is a product composed mostly of methane (natural gas), that often (but not always) contains very small (0.1 to 5%) fractions of ethane and propane that are added at the request of buyers, and which besides energy, are useful molecules for chemical industries.
LNG suppliers and import terminal operators are in pole position to rescue energy consumers hit by a combination of faltering pipeline gas supply and record-high prices. These price and supply gaps extend from Australia and across Asia to Europe, the UK, and the Americas; all global markets that have been hit by high energy prices, reduced reliability of supply, confusion regarding issues of sustainability. For industrial users in particular, difficulty in negotiating long-term supply commitments from gas suppliers is not confined to the current crisis, in many places it is a chronic problem.
Starting with Europe, the 2022 northern summer is one that will be remembered for supply chain problems, the Dutch farmer protests and worst of all, a price, supply crunch for users of natural gas. To provide some context, among European nations, the UK, Italy, the Netherlands, Spain and also Turkey have the highest natural gas usage as a proportion of their energy mix. These nations have some flexibility of supply from a combination of pipelines, their own production, and seaborne LNG. Germany has a lesser reliance on gas but a higher reliance on Russia for its gas supply, around 55-60%, for what gas it does need is Russian sourced. Overall, natural gas accounts for around 25% of Europe’s energy mix.
While the Netherlands and the UK have a high percentage of their own production, and Norway is self-sufficient, around 70% of Europe’s gas is imported. Russia is Europe’s largest supplier, representing almost 40% (pre-invasion of Ukraine) of European supply. It supplies, mainly via pipeline but to a lesser extent seaborne LNG to almost every major European market. Additionally, Finland, and central European economies such as Austria and Hungary rely 100% on Russia for their natural gas supply.
Factors that contributed to the recent crisis include the reduction of flows of natural gas to Germany by main supplier Gazprom of Russia and a (predictable) curtailment of flows via Ukraine’s Naftogaz pipeline, which has also impacted supplies into Poland. There was also unseasonably high demand over the spring and summer of 2022, driven in part by lower-than-expected hydroelectric generation in Spain. Spain uses gas from LNG or imported via sub-sea pipeline from Algeria as its the main swing commodity used to make up any energy shortfall.
As of September 2022, Russia is resuming flows via Nordstream, reportedly at just 20% of its pre-war volumes, while Spain has had to resort to higher imports of natural gas to offset the 49.5% year-on-year reduction (compared to 2021) in hydroelectric generation over January-July. National dam capacity in Spain is still under 38% (at time of writing), representing a 30 year low. The UK has also experienced a severe dry period. Drought in both countries have driven up gas demand.
Elsewhere, Poland and Ukraine enjoy some local production, but have traditionally received gas from Russia using Soviet era pipelines. This reliance has proved increasingly fickle since Vladimir Putin’s rise to power and as such this is not a new problem. Relations between the Ukraine and Russia have been worsening for a least a decade and Poland, ever distrustful of Russia, has in particular has taken steps to diversify its supply to the extent that it is economic.
As European energy prices skyrocketed, the UK, who derives 50% of its gas needs from sea-to-shore pipelines directly fed by North Sea gas fields, suffered prices over 650 pence per therm (GBP/thm) in August, an all-time record high. Considering that UK market gas prices since the late 1990s up to the first half of 2021 hovered around GBP50/thm, this translates into an energy cost jump of 10x, battering the economy. It currently sits at just over GBP450/thm, levels that most consumers and also that industry cannot support for any length of time.
Across the channel, Euro markets are seeing TTF futures (the Dutch TTF is regarded and the default index in the European energy market) of over Eu270/MWh at the TTF. Again, as in the UK, the relationship to long term prices is more than 10x the long-term average of around Eu20/MWh, placing a crippling impact on markets, consumers, on industry and governments.
Europe is not alone in its crisis; in the US, natural gas represents 32% (E.I.A. 2022) of the national energy mix, second only to petroleum, Henry Hub gas prices exceeded US9.30/mmBtu this summer, a historical high point. At the time of writing (Sep 22) prices were around US$8.60/mmBtu, still close to all-time highs.
But for the US, gas prices are being driven up by infrastructure shortfall, mostly delays of new pipeline projects. In addition, there has been increased drawdown of gas from onshore networks to feed growth of LNG exports through Louisianna, Maryland, Georgia and Texas based LNG export terminals. To round out the situation, there has been deferral or cancellation of new pipelines connecting various markets in the USA, this last factor possibly the largest contributor to the price inflation.
To help us compare prices globally here are the dollarized regional prices. The August 2022 USA gas price hit a peak of US$8.8/mmBtu, a level that in most years was reserved for winter spikes and restricted to north-eastern states. For most of the preceding five years prices seldom exceeded US$3.2/mmBtu. In Europe, the equivalent price converted into $ per mmBtu was US$68 at the TTF in Europe. In emerging South-Asia economies of India, Pakistan and Bangladesh, the price soared to US$31/mmBtu, too high for consumers to accommodate. US$52/mmBtu was reached in the key LNG import markets of Japan and South Korea; all are historical record highs for a summer price when demand is lowest.
Even in Australia, prices for locally produced natural gas were more than double their long-term average in the equivalent range of over US$13/mmBtu. Australia is a relatively open market, and gas prices at these levels make it difficult for industry to absorb without also passing the cost increase onto their customers.
Admittedly, most gas around the world is delivered under contracted terms, meaning that in normal times users are not being subjected to the full brunt of price increases because local distribution is in-part protected by fixed longer-term arrangements. But in 2022 the perfect storm we are experiencing means that most, if not all of the supply shortfalls were filled using inflated spot pricing terms.
To the casual observer it might seem that the problem here is in part due to the price volatility invoked by the LNG trading model itself, however one needs to consider that the actual crisis stems from vulnerabilities inherent to pipeline gas, obstacles to new pipelines, unpredictable rates of renewables generation, especially in Europe. In 2022, these is the additional challenge of post-pandemic supply chain issues, although this is likely to be short-lived.
As I write this, there are early signs that the situation may normalize, with prices now below August peaks in almost every market. But it can and will happen again, possibly by the 2022-23 Northern winter when demand is expected to peak seasonally. It is expected that terminal operators will be working harder than normal to ensure tanks are filled to capacity in time for winter,
For reasons I will outline below, LNG appears to offer an almost perfect solution to prevent this type of crisis due to its mobility and LNG’s decentralized supply model. As a globalized power source delivering watts (or joules) to any location that has an offloading terminal, LNG can be rapidly deployed to any currently existing gas market, and to new markets with less up-front cost than almost any other commodity (more on this later).
The current energy crisis is in part, but not completely, due to the vulnerability of pipeline gas to geopolitical pressures, as exemplified by the Russian influence in the current crisis. LNG suppliers and import terminal operators are thus more likely to be playing an increasingly essential role in gas markets everywhere, as governments shift policy towards a more strategic setting.
I have long advocated that LNG overcomes the strategic disadvantage of continental pipeline gas. Pipelines bring with them a heavy reliance on diplomacy with nations through which a pipeline must pass. Is this then, only about Russian gas? No, because the same principle is applicable to other parts of the world.
One example is the long delayed, and problematic proposal to build the Iran to Pakistan pipeline. As Pakistan has discovered, a direct pipeline would be subject to any US sanctions against Iran, an unsavory prospect for project backers. Project funding from the Pakistani side has been problematic, due to geopolitical risks. As well as the high upfront capital cost of building any pipeline, the potential price premium for gas could be US$6/mmBtu based on initial discussions – the resultant price level is on a par with LNG.
Contrasting the continental pipeline trade throughout Eurasia, in the far East Japan’s economy has thrived for many decades under gas imports that are exclusively seaborne LNG, a product of its island-bound geography. Apart from the high cost for any deep-water pipeline, for Japan, any sub-sea gas conduit would necessarily require access to either China or Russia, an unacceptable position as this would surely place it at the mercy of geo-political caprice by those nations.
The same goes for South Korea, and Taiwan, countries whose energy independence rely on LNG imports, as they are effectively sea locked. Even paying cost-premiums and seasonal price spikes for LNG, these nations have thrived under their exclusively seaborne LNG supply conditions.
While in recent times the Japanese, the Koreans and the Taiwanese can count themselves lucky to have dodged the prospect of having to rely on pipeline gas passing through either China or Russia, the Germans continued to expand their reliance on Russian gas. It is astonishing how the German government, for all of its apparent sophistication, let itself become solely reliant on Russia for its gas.
Even more startling is that despite that the implications of this approach in the context of Russian-NATO tension are obvious to all observers, no matter whether the observer is a college student, drives a cab, washes dishes at the back of a restaurant, or is in Moscow formulating policy, the implications against a backdrop NATO-Russian tension are evident. The mere fact that Germany nevertheless continued on that path may be signs of a policy-snooker engineered by Russia and from within Germany itself, leaving its decision makers no way out.
One possible rationalization for this oversight might be that Germany was betting on its conversion to renewables, a move that in hindsight, appears fantastical; renewables have proven to be of little use in an energy crisis and have so far failed to deliver the much-promised energy independence, at any cost; Germany currently continues to depend on coal.
But the Germans are not alone in their policy miscalculations. For example, the government of the state of NSW (New South Wales), Australia, banned new onshore gas exploration some years ago, condemning the state to record gas pipeline prices in 2021-22, with a large proportion of the delivered cost attributed to the pipeline transport. Most of the state’s gas comes via the Moomba pipeline from South-Australia or from gas fields in the state of Queensland, with its single active coal seam gas (coal bed methane or CBM) project in Camden, southwest of Sydney, currently under abandonment.
To the South of NSW, the equally myopic policy makers in the State of Victoria also banned all onshore gas exploration. The bans in both states were in spite of high compliance rates amongst operators, mostly comprised of well-run engineering outfits, a move apparently made solely in the name of politically driven optics.
Luckily for the people of NSW and Victoria, the neighboring Australian states of Queensland and South Australia continued to develop new gas fields, ironically with no reports of significant environmental damage. Thus, NSW and Victorian gas users, whilst becoming increasingly nervous, are managing to fill the gas-supply gap, albeit at inflated prices. Worthy to note here is that Australia’s legacy power coal projects are also being menaced by these same politically driven optics that killed gas exploration. Like Germany, Australians will continue depend on coal power stations that actually deliver energy as well today as they did for the more competent generation that built them decades ago.
In the USA, gas (and oil) producers are being constrained not by a lack of field capacity, but by limited “take-away” capacity, with activism blocking, or delaying additional pipeline capacity. These projects are needed to boost delivery between fields, particularly in western Texas, Dakota and the tri-state area in the country’s North-East to main markets in areas of high gas usages. This issue affects both oil and gas producers, in equal measure.
In Canada and Alaska, super-sized LNG producing facilities are being planned, or are underway, aimed at resolving the political, legal and pseudo-cultural obstacles to new pipeline projects. Delays to those projects, as ever, center on the regulatory and legal obstacles for the local pipelines that connect the gas fields to the liquefaction facility and the port.
In the next article, I will focus on what LNG is, how it is made, how it is stored, transported and delivered, and how LNG contrasts with traditional natural gas distribution networks. The article will also delve into the global growth and capacity of LNG, its economics and also technical challenges. Finally, this series will focus on the future of energy markets and the currents trends for the LNG sector as a globalized solution.