Next wave of LNG capex to fall short of recent highs

November 2016 | Pietro Dalpane

As we exit a boom period for liquefaction capex that peaked between 2013 and 2015, some very quiet years are expected before a renewed phase of investment begins in the early 2020s. Due to fewer projects that require construction in the near term and a drive toward a reduction in development costs, we may see the next wave of LNG capex peaking at less than half that of this decade, posing a variety of challenges for LNG stakeholders.

Between 2010 and 2014, the oil and LNG market experienced buoyant commodity prices which supported a high level of investment in new oil and gas facilities, including LNG liquefaction capacity. However, due to this significant capacity build-out and the considerable demand growth slowdown from emerging economies in 2014—alongside low crude oil prices in 2015-16—the market has entered a period of oversupply and LNG prices have fallen. This situation is now expected to persist for several years and that has led to a sharp reduction in new LNG investment announcements (see Figure 1).

As demand steadily eats into the supply glut over the next few years, the market will eventually revert to balance, but more moderate demand growth forecasts beyond 2020 and increasingly cautious investors mean the next wave of LNG capex is expected to be just a fraction of this decade’s spend.

Exhibit 1

SOURCE: McKinsey, Energy Insights, Global Gas Model, Press, Cedigaz, Rystad

Two main drivers lie behind the fall in LNG capex spend in the second wave:

  1. Fewer LNG projects will be built to rebalance the market in 2030
  2. Most future development will be in the US, where far lower construction costs are anticipated, compared to Australia (which is dominating current expansion)

1. Fewer LNG projects

The reduction in additional supply is mainly caused by the LNG oversupply that the market is now experiencing, which is expected to continue until early 2020. The supply overhang has come about due to two major factors.

First, project developers expected that demand growth would continue at the rapid rates (about 7% per year) of the first half of this decade—which had been propelled by China’s stellar GDP growth and greater demand from Japan’s power sector following the Fukushima nuclear disaster in March 2011. However, these factors proved more transitory than anticipated, with global GDP growth rates and energy consumption growth now projected at well below the levels of earlier in the decade.

Second, the linkage of LNG contracts to oil prices—especially in dominant LNG importers such as Korea, China, and Japan—facilitated the process of raising the minimum capital required to build new plants. This was made possible thanks to high oil prices, which also led to high slope-to-crude correlation between oil and gas prices, giving the certainty that no matter how inflated breakeven prices might have ended up, the full-cost breakeven prices would be entirely covered.

2. Composition of new suppliers

With numerous export projects on the go, North America is expected to replace Australia at the forefront of new LNG liquefaction development, thanks to an abundant gas supply and low construction costs. Beyond high labor force productivity and the ample availability of materials, the US boasts highly competitive costs for the expansion and development of brownfield projects (i.e. Lake Charles).

When combined with the region’s proximity to LNG importers such as South America and Europe—where breakeven prices for most of the North American plants are currently below USD7-8/mmbtu—US and Canadian LNG project economics are expected to be highly competitive compared to those elsewhere. We, therefore, expect Canada and the US to bring online a total of 50 trains—which is more than three quarters of the total expected number of new trains up to 2026—accounting for 55% of global LNG capex spend in the next 10 years.

The lower capital intensity combined with the predominance of US plants is expected to drastically lower the average cost per tonne of new developments in the period 2018 to 2026 to roughly USD700/tpa—more than USD1000/tpa lower than in 2010-2018 (see Figure 2).

Exhibit 2

SOURCE: McKinsey, Energy Insights, Global Gas Model, Press, Cedigaz, Rystad

Furthermore, the LNG market will no longer support development costs as high as USD2,800/tonne, which were typical for about three quarters of total Australian capacity in 2010-2016. In fact, given the current low price environment and the abundance of LNG supply from competitive plants, costs above USD1,500-2000/tonne have become prohibitive, even for the most coveted assets. At this level, and with a relative scarcity of feed-gas supply, it is not surprising that Australian plants are not expected to be developed in the next 5-7 years, leaving room for new terminals in the Middle East and West Africa, alongside the dominant US LNG penetration.

The sharp decline expected in LNG capex spend raises the following questions for LNG stakeholders:

  1. Will EPC companies be able to meet the expectations of project developers for less capital-intensive LNG projects?
  2. Will this reduction in liquefaction capex be sufficiently robust to improve project economics and lead to FID? If so, could sufficient cost compression drive production costs low enough to displace more expensive projects developed in the recent boom period?
  3. How efficiently can labor be relocated across regions, especially from countries that boasted high investment levels –which are not expected to be replicated in the next wave (i.e., Australia) – to those that will be at the forefront of new LNG developments?
  4. What role will governments play in stimulating multi-billion dollar liquefaction investments?

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About the author

Pietro Dalpane is an analyst with Energy Insights in McKinsey's London office.

The author would like to thank Jeremy Bowden for his contribution to this article.

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