How US LNG may create new pricing fundamentals over the coming 5 years
February 2018 | Renjun Chong, Dumitru Dediu, and Gillian Boccara
Since the startup of the first US gas liquefaction and export plant, Sabine Pass, in 2016, 15.5 million tons of US LNG were produced and shipped overseas. As much more US LNG is scheduled to come online in the coming 5 years, the US may reshape global LNG flows and price dynamics for the foreseeable future.
2017 LNG trade and flow pattern
In 2017, the US exported 12.4 million tons of LNG, a significant increase from the 3.1 million tons of LNG export in 2016. According to the McKinsey Energy Insights LNGFlow model that tracks daily shipping patterns, this rise in US exports has already begun to change the global LNG flow patterns: US LNG has reached European markets where it has displaced Middle Eastern supplies, and some volumes have already reached Asian markets.
Exhibit 1: 2017 vs 2016 LNG flows differential
SOURCE: McKinsey Energy Insights LNGFlow
Strong LNG demand in Asia has attracted LNG flows from the Atlantic basin. The flows from Atlantic to Pacific basin increased from 15 million tons in 2016 to 23 million tons in 2017. As a result, in 2017 the Atlantic basin became self-supplied with net imports of 2 million tons only (down from net 11 million tons imports in 2016). In 2018, the Atlantic basin is expected to flip into a sustained export mode to the Pacific basin as more LNG plants come online in the US.
Exhibit 2: Cross-basin trade in 2017
SOURCE: McKinsey Energy Insights
LNG demand growth driven by Pacific buyers
Looking forward to 2022, global LNG demand is expected to reach 318 mtpa, up by 41 mtpa or +15% from 277 mtpa in 2017. Of the 41 mtpa demand growth, 40 mtpa is driven by buyers in the Pacific basin, of which China will take the lion’s share with 18 mtpa of LNG demand growth over the next 5 years.
In their 13th Five Year Plan (2016), the Chinese government has set a target to reduce the share of coal consumption in the total energy mix from 63% to 55% by 2020. The focus on gas across the residential, power, and industrial sectors was one of the main agenda items outlined in the plan with a target to increase the gas share to 10.5% of the domestic energy mix by 2020.
The impact of this policy was clearly felt in the winter of 2017. The residential sector started switching to gas boilers or electric heaters, gas-to-power consumption rose at the expense of coal, and the industrial sector also followed suit. As a result, gas demand in China grew by 17% YoY in 2017, double the growth rate in 2016, and China imported 37 million tons of LNG in 2017 (+39% versus 2016).
Exhibit 3: China domestic gas demand and imported LNG volume
SOURCE: McKinsey Energy Insights LNGFlow, Cedigaz, BP statistical review data
In Europe, LNG competes with piped gas in meeting European gas demand to offset declining domestic gas production which limits its growth rate. Further, the overall Atlantic basin LNG demand is anticipated to be flat because of reduced LNG import needs in several regions:
- Egypt: new domestic gas production, primarily from the Zohr field
- Mexico: increased pipeline gas imports from the US
- South America: the growth of renewables (e.g., hydro in Brazil)
How will Pacific demand be met?
In 2022, LNG Pacific supply will add up to 222 million tons, well short of the 252 million tons of the Pacific LNG demand, creating a 30 million tons net import need.
Exhibit 4: Pacific LNG supply and demand breakdown in 2022
SOURCE: McKinsey Energy Insights Gas Intelligent Model, McKinsey Energy Insights LNGFlow
Moreover, from the 222 million tons LNG supply in the Pacific, a total of 40 million tons is expected to be shipped to the Atlantic basin due to contractual agreements. The total import deficit in the Pacific, therefore, will amount to 70 million in the Pacific basin.
Exhibit 5: Pacific LNG supply shortfall in 2022
SOURCE: McKinsey Energy Insights Gas Intelligent Model, McKinsey Energy Insights LNGFlow
This 70 million tons LNG supply shortfall in the Pacific basin will be fulfilled by incremental LNG supply from the Atlantic basin - thus opening the space for the US to play a greater supply role.
Exhibit 6: Pacific LNG supply breakdown in 2022
SOURCE: Cedigaz data, McKinsey Energy Insights LNGFlow
The US becoming a critical balancing LNG supplier
Our models highlight that the US is not only is becoming a major LNG producer but may have a critical role to balance LNG supplies and influence pricing dynamics.
Three important factors contribute to this change in commercial dynamics:
- The current technical recoverable resources in North America (the US and Canada) are capable of supplying more than 860 Tcf of gas at less than $3/MMbtu, equivalent to more than 30 years of North American demand, based on the McKinsey Energy Insights North American Supply Model. This continues to provide highly competitive feed gas for liquefaction plants in the US for at least the next decade to compete globally.
- The availability of natural gas to feed liquefaction projects from a deep and liquid market to any credible investor has made the US a distinct and attractive location. Access to this gas comes at a considerably lower cost compared to the other liquid market in Europe. Moreover, the US offers the opportunity to buyers and investors to decouple investments in liquefaction plants from the upstream, thus reducing investment costs compared to traditional integrated projects where upstream costs are a considerable part of the overall investment. These factors have encouraged investments in US-based LNG plants. In the coming years, LNG plants currently under construction are expected to add 52 mtpa of LNG volume to the market
- In 2022, LNG volumes from the US are expected to offer a high degree of flexibility in terms of destination, as 96% of the volumes have flexible destinations. This will provide the flexibility for primary offtakers to direct the volumes to the most attractively priced region and benefit from basin arbitrage. This is expected to initially drive volumes to Asia and shape the US supplies into marginal LNG supplies changing destination when arbitrage opportunities arise.
Exhibit 7: New LNG volume expected to be added by the US from 2017 to 2022
SOURCE: Cedigaz data, Press Search, McKinsey Energy Insights
Exhibit 8: US LNG volume contract breakdown in 2022
SOURCE: Cedigaz, McKinsey Energy Insights
The emergence of flexible LNG supplies at scale from the US may shift how the market price will evolve over the next 5 years and have an impact on LNG global pricing and trade patterns in the future.
- US projects, unlike many conventional integrated LNG projects, have a relatively high cash cost for feed gas and liquefaction charge, which may place them as the marginal supplier shaping global LNG pricing
- The spread between Europe and Asia may be based on the differential in shipping costs from the US FOB LNG cargoes, as these volumes have significant flexibility to be directed to supply either Europe or Asia
- Middle Eastern volumes are increasingly expected to stay within the Pacific region to maximize profit due to lower shipping costs
Beyond 2024 when market supply and demand are in balance, the long-term LNG market may continue to stay linked to the US market: pre-FID US liquefaction projects will continue to compete with each other to enter the market to meet further growing LNG demand.
Our LNG Cost Curve identifies US LNG projects as the marginal projects balancing supply in the market. It is becoming apparent that buyers and suppliers need to adapt to some fundamental new investment and commercial dynamics in the market.
We have increasingly been working with clients to assess relevant changes for them and formulate responses. What will it take for projects elsewhere to take FIDs? What commercial and contract structures are emerging? How can they bring the delivered cost of LNG below the bar set by US LNG projects? What preferences do new LNG Buyers bring that are different from or similar to traditional JKT buyers?
Such client questions are addressed through a suite of distinctive, state-of-the-art tools, insights, and methodologies, including our proprietary LNG buyers survey that identifies buyer needs, our Cost Curve to benchmark projects, and our contract and commercial perspectives to detail pricing implications. Where current positions need to be renegotiated, clients seek expert support for arbitration.
The stakes are high due to existing contracts, contracts under re-contracting, and new positions buyers and sellers should fully embrace the future pricing logic to enable them to make informed decisions.
About the authors
Renjun Chong and Gillian Boccara are both Specialists in McKinsey's London office. Dumitru Dediu is an Associate Partner in Mckinsey's Amsterdam office.