Gas and oil are fundamentally different. Most individuals do not completely comprehend just how different they are and how gas projects (particularly with respect to LNG) are a completely different economic ball game.
1. Buyer Be There
When it comes to crude oil, you find it, produce it and sell it. Possibly the market price is lower than anticipated but finding crude buyers is not an issue, also crude oil is fairly cost effectively bunkered.
For LNG: sell first, produce it later.
A industry joke is there three LNG permits you must have: DOE, FERC and Adam Smith Permit. The first two are easy to get because they authorize your LNG project to lose money in a environmentally sanctioned manner.
Note that a FERC permit alone cost $100 million dollars and the US Government is happy to accept that check in the spirit of American laissez faire without inquiring to the interest of would-be buyers. You have to actually be able to sell the LNG to make money. Financiers, banks, venture capitalist and private investors will not lend money or put capitol into a LNG project without buyers.
For LNG: sell first, produce it later.
A industry joke is there three LNG permits you must have: DOE, FERC and Adam Smith Permit. The first two are easy to get because they authorize your LNG project to lose money in a environmentally sanctioned manner.
Note that a FERC permit alone cost $100 million dollars and the US Government is happy to accept that check in the spirit of American laissez faire without inquiring to the interest of would-be buyers. You have to actually be able to sell the LNG to make money. Financiers, banks, venture capitalist and private investors will not lend money or put capitol into a LNG project without buyers.
2. Oil is Global, Gas is Regional
Oil prices are standardized to global benchmarks (Brent, WTI etc.) worldwide and there is oil infrastructure (loading terminals, tanks, pipelines) EVERYWHERE in the world.
Gas and LNG prices are set regionally where the US Henry Hub Prices are less than Europe and Asia and the determination of the price is very much regionally calculated. The availability of LNG infrastructure is not nearly as prevalent either hence regionality.
Determining the economic viability of X oil project is simple* because economic projections against CAPEX, OPEX and transportation cost are calculated using the appropriate benchmark (as appropriate to the oil in question, Sweet, Light, Sour, Heavy) no matter the actual location.
*Not really.
LNG/natural gas projects are much much more complicated: there are a minimum of 3-4 global benchmarks to make projections on (LNG can be shipped long distances relatively cheaply), for example: Henry Hub (HH), UK (NBP) and Japan (JKM), where a wide range of disparity exists between these benchmarks.
Gas and LNG prices are set regionally where the US Henry Hub Prices are less than Europe and Asia and the determination of the price is very much regionally calculated. The availability of LNG infrastructure is not nearly as prevalent either hence regionality.
Determining the economic viability of X oil project is simple* because economic projections against CAPEX, OPEX and transportation cost are calculated using the appropriate benchmark (as appropriate to the oil in question, Sweet, Light, Sour, Heavy) no matter the actual location.
*Not really.
LNG/natural gas projects are much much more complicated: there are a minimum of 3-4 global benchmarks to make projections on (LNG can be shipped long distances relatively cheaply), for example: Henry Hub (HH), UK (NBP) and Japan (JKM), where a wide range of disparity exists between these benchmarks.
Henry Hub is priced in gas-on-gas terms where as the Asian and European markets tends toward being some version (depending on time datum) of half and half/not half and half mix of Oil Indexation pricing and gas-on-gas pricing. This mix makes pricing projections difficult and tending toward WAGs, as in Wild @ss Guesses.
This is extremely different from the oil market: the price for Brent Crude, be it spot or futures, is the same whether it is being traded/sold in New York, Tokyo or London. While futures for Brent Crude inherently have a range, that range rarely includes extreme outliers and tend to intersect with the spot price making projections relatively accurate* in comparison the natural gas trading.
*The only good indicator for following oil markets is comparative inventories, the relative strength of the dollar which broadly is the overall dynamic of currency markets, any other projections are gambles on Hurricane season and who/what/where in the middle east is at war: educated guesses at best.
3. Dating vs. Marriage
It is said that oil is like dating - if it is not going so well, it is relatively easy to end the relationship but LNG is like marriage because you commit for the foreseeable future (for most people, >20 years) and heavily invest in domestic infrastructure, also a divorce will be very expensive.
If the oil market/geopolitical climate/regulatory environment has changed such that a crude oil development is no longer profitable, operators have options to adjust, depending on the situation. This may entail shutting in wells, cancelling frack jobs, freezing capitol expenditures, personnel lay-offs, or actually selling off the wells/leases. To be sure adverse financial implications are endured. The situation is the equivalent suffering the short-term effects of a break-up.
In the case of LNG, if the oil market/geopolitical climate/regulatory environment has changed such that a development is no longer profitable - there is simply no out due the scale of capitol invested. If a company is to get out of LNG project, the financial "divorce" will equivalent to an ex-spouse getting everything, garnishment of future salary and the kitchen sink. Think Rupert Murdoch and Wendi Deng. Hint: the company is Rupert Murdoch.
This "no-backsies" policy in LNG is due to the huge investments into pipelines, loading terminals, liquefaction plants. It's the infrastructure that is the knock out blow. Building a liquefaction plant is $10 - 15 billion dollar endeavor. To put that into perspective, $15 billion in 2016 is equivalent $3.77 billion in 1977 dollars. The Alyeska Pipeline cost $8 billion in 1977 dollars. A therefore liquefaction plant cost only slightly less than half the cost of the Alyeska Pipeline which is the largest privately financed project in US history. Though it seems between now and 1977 something should have beat that record? Any thoughts on that?
Consider that the price to build a land gas pipeline as of 2015 is $5.24 million/mile. A 2016 IHS report puts the cost of a crude oil pipeline at or above $2.5 million/mile (depending on location and pipe size). This cost differential is due the necessity of compressing natural gas to 6 atmospheres of pressure.
For all of these reasons approximately 2/3 of the price paid for LNG is due to the infrastructure. It can be said that LNG is a prisoner to the cost of infrastructure.
If the oil market/geopolitical climate/regulatory environment has changed such that a crude oil development is no longer profitable, operators have options to adjust, depending on the situation. This may entail shutting in wells, cancelling frack jobs, freezing capitol expenditures, personnel lay-offs, or actually selling off the wells/leases. To be sure adverse financial implications are endured. The situation is the equivalent suffering the short-term effects of a break-up.
In the case of LNG, if the oil market/geopolitical climate/regulatory environment has changed such that a development is no longer profitable - there is simply no out due the scale of capitol invested. If a company is to get out of LNG project, the financial "divorce" will equivalent to an ex-spouse getting everything, garnishment of future salary and the kitchen sink. Think Rupert Murdoch and Wendi Deng. Hint: the company is Rupert Murdoch.
This "no-backsies" policy in LNG is due to the huge investments into pipelines, loading terminals, liquefaction plants. It's the infrastructure that is the knock out blow. Building a liquefaction plant is $10 - 15 billion dollar endeavor. To put that into perspective, $15 billion in 2016 is equivalent $3.77 billion in 1977 dollars. The Alyeska Pipeline cost $8 billion in 1977 dollars. A therefore liquefaction plant cost only slightly less than half the cost of the Alyeska Pipeline which is the largest privately financed project in US history. Though it seems between now and 1977 something should have beat that record? Any thoughts on that?
Consider that the price to build a land gas pipeline as of 2015 is $5.24 million/mile. A 2016 IHS report puts the cost of a crude oil pipeline at or above $2.5 million/mile (depending on location and pipe size). This cost differential is due the necessity of compressing natural gas to 6 atmospheres of pressure.
For all of these reasons approximately 2/3 of the price paid for LNG is due to the infrastructure. It can be said that LNG is a prisoner to the cost of infrastructure.
4. TO MOVE OR NOT MOVE, THAT IS THE QUESTION
90% of natural gas goes to electrical plants, industrial usage and for residential/commercial.
Power generation by utilities, industrial uses include fertilizer, plastics and certain chemical manufacturing. Otherwise it is put into distribution networks to homes to power water heaters, dryers, gas stoves, heating/air conditioning et cetera.
Note that 0.1% of Natural Gas is consumed as vehicle fuel in the form of Compressed Natural Gas (CNG). CNG is very efficient and promising and has been implemented in several cities for buses used in public transportation.
Power generation by utilities, industrial uses include fertilizer, plastics and certain chemical manufacturing. Otherwise it is put into distribution networks to homes to power water heaters, dryers, gas stoves, heating/air conditioning et cetera.
Note that 0.1% of Natural Gas is consumed as vehicle fuel in the form of Compressed Natural Gas (CNG). CNG is very efficient and promising and has been implemented in several cities for buses used in public transportation.
It has not been implemented at any considerable scale (as in freight trucking) because CNG requires special compressors in addition to the specialized engines (both dedicated CNG and dual fuel engines exist). Beginning in 2009, Texas and California have invested aggressively in CNG transportation technology. It is hoped that CNG transportation usage grows but for the meantime electricity generation, hot showers, lighting and fertilizer are the main applications for natural gas.
Electricity is the largest end usage of natural gas, short term fluctuation in prices do not generally effect large power utilities as they purchase LNG at a fixed price contract with those contracts having terms between 5 and 20 years. This becomes an issue when natural gas prices drop dramatically and the utility is stuck paying far above the market rate. Utilities in Japan fell into this situation and Japan's trade commission aggressively re-negotiated contracts.
So 0.1% of natural gas is used for transportation, and while there is strong growth potential, compare that to 75% of crude oil is made into transportation fuel: gasoline, diesel and jet fuel respectively.
Oil is often over-priced/valued because a certain vega exist in the market due to fear of wanting for oil - what is referred to as in-elastic demand. Goods, services or people cannot be moved without oil - it literally moves the global economy. It is for this reason that even minor geopolitical events have the effect of causing oil prices skyrocket regardless of the supply and very small supply differentials can exponentially spike the price.
A shortfall in natural gas supplies will give the CEO of fertilizer company a migraine but aside from increased gas/electric bills for those on natural gas distribution/power grids, the greatest impact to most everyone is their Dad angrily cranking down the thermostat and grunting about how he's not paying to heat the house like Tahiti.
Electricity is the largest end usage of natural gas, short term fluctuation in prices do not generally effect large power utilities as they purchase LNG at a fixed price contract with those contracts having terms between 5 and 20 years. This becomes an issue when natural gas prices drop dramatically and the utility is stuck paying far above the market rate. Utilities in Japan fell into this situation and Japan's trade commission aggressively re-negotiated contracts.
So 0.1% of natural gas is used for transportation, and while there is strong growth potential, compare that to 75% of crude oil is made into transportation fuel: gasoline, diesel and jet fuel respectively.
Oil is often over-priced/valued because a certain vega exist in the market due to fear of wanting for oil - what is referred to as in-elastic demand. Goods, services or people cannot be moved without oil - it literally moves the global economy. It is for this reason that even minor geopolitical events have the effect of causing oil prices skyrocket regardless of the supply and very small supply differentials can exponentially spike the price.
A shortfall in natural gas supplies will give the CEO of fertilizer company a migraine but aside from increased gas/electric bills for those on natural gas distribution/power grids, the greatest impact to most everyone is their Dad angrily cranking down the thermostat and grunting about how he's not paying to heat the house like Tahiti.
Natural Gas is not as vital a commodity as oil due to it not being heavily utilized in transportation. If and when natural gas becomes a major transportation fuel, will natural gas considered a more valuable and critical energy resource.
Should electric vehicles become more dominant in the future, the current existing power grid capacity will have to be upgraded considerably. Only natural gas turbines (or nuclear, but that probably isn't going to happen) would provide the necessary installed capacity should everyone in Seattle plan on plugging in their Tesla. This would fundamentally change the market and make the economics of natural gas and LNG much more competitive.
Should electric vehicles become more dominant in the future, the current existing power grid capacity will have to be upgraded considerably. Only natural gas turbines (or nuclear, but that probably isn't going to happen) would provide the necessary installed capacity should everyone in Seattle plan on plugging in their Tesla. This would fundamentally change the market and make the economics of natural gas and LNG much more competitive.
5. Market Size Matters
In LNG, the number of players able to shift the market by dumping volume at rock bottom prices is critical to market volatility and potential investment return by would-be players. Crude oil is a market of legendary volatility yet it is one upped by the international LNG market. Kindly allow me to elaborate.
In Oil, the top players are Saudi Arabia, the United States and Russia. The holder of the #1 Crude Oil Producer is matter of the historical datum taken. The latter are the global heavy weights of the oil market. Despite the number of other oil producing countries, No one else comes even close.
Politically, the United States and Saudi Arabia are allied against Russia/Former USSR. Economically, it is every man for himself - Saudi Arabia has no warm feelings whatsoever for American Shale Producers. Saudi Arabia heads OPEC which has historically been capable of ganging up and turning the market to support or drop the price as it sees as fit.
In Oil, the top players are Saudi Arabia, the United States and Russia. The holder of the #1 Crude Oil Producer is matter of the historical datum taken. The latter are the global heavy weights of the oil market. Despite the number of other oil producing countries, No one else comes even close.
Politically, the United States and Saudi Arabia are allied against Russia/Former USSR. Economically, it is every man for himself - Saudi Arabia has no warm feelings whatsoever for American Shale Producers. Saudi Arabia heads OPEC which has historically been capable of ganging up and turning the market to support or drop the price as it sees as fit.
The next chart shows World Oil production from the last 34 years and the fact that there are only 3 heavy weight oil producers is readily apparent. Oil production has grown steadily over the past three decades but year to year - the production rate varies by less than 5%.
While OPEC is powerful, not one single oil producer has the power to double/triple their production as to flood the market and create chaos.
While OPEC is powerful, not one single oil producer has the power to double/triple their production as to flood the market and create chaos.
That statement is "true" with the sole exception Saudi Arabia. Saudi Arabia has served as swing producer to bring spare capacity online to either prevent oil prices from spiking precipitously, which they did at Carter's bequest from 8.5 mmbpd to 10.5 mmbpd in 1979 and historically have willingly made +/- adjustments to balance the oil market. Saudi Arabia is the most power swing oil producer however in real terms the capacity it has to manipulate the actual oil market is less than +/-6%.
During any oil crisis - be it the 1973 embargo, the 1979 Iranian Revolution shortage - fears of a shortage and anticipation of oil prices rising fuels speculation which in turn causes market wide anxiety and panic feed even more speculation in a giant negative feedback loop that cause prices to skyrocket seemingly overnight. Many have the idea that the actual oil supply has drastically contracted. In fact if you examine the % change year-to-year from 1960 - 2004 data, the change in the annual average daily oil production rarely breaks +/-8% whereas the % change in the actual oil price has broken +/- 50% more than twice. Admittedly, using annualized pricing and production data takes away from proper numeral resolution. Be that as it may, the take-away about oil is that the actual year-to-year production levels change by less than 10% (the % change of price is another story). Surpluses that drive down the price of oil exist, but they tend to very small in comparison to the shear mass of the market.
.....So how does this tie into the LNG market?
The size issue for LNG projects is very different (see figure below). Let's start with Producers. There is one mega exporting LNG producer: Qatar with a trailing second that is Australia. In comparison, the crude oil market's cliometric production division seems quite equitable.
The disturbance in the oil market that OPEC has the power to make in comparison to the power that Qatar has in the LNG market is like comparing the destructive power of 3-year old with fingerpaints to a hurricane.
The size issue for LNG projects is very different (see figure below). Let's start with Producers. There is one mega exporting LNG producer: Qatar with a trailing second that is Australia. In comparison, the crude oil market's cliometric production division seems quite equitable.
The disturbance in the oil market that OPEC has the power to make in comparison to the power that Qatar has in the LNG market is like comparing the destructive power of 3-year old with fingerpaints to a hurricane.
LNG Export Volume by Country, 2015. Source: EIA
For non-E&P people, this is completely nuts - Qatar is a tiny country that 9 out of 10 Americans would be unable to locate on the world map. And they absolutely dominate the LNG market?? Not Russia, not Iran, not Australia - tiny freaking Qatar.
Yes.
Qatar is a massive natural gas well that is also doubles as a country. Furthermore, it's coastal location in the Persian gulf is ideal for shipping LNG worldwide. Because of it's LNG capacity, Qatar makes OPEC look wimpy. Because natural gas (and a little bit of oil and Al Jazeera) is all Qatar has, it was aggressively investing in LNG infrastructure decades ahead of anyone else hence it has paid off it's initial infrastructure investment and has since been raking in cash. Qatar can dramatically increase production and flood the market. Qatar is a very small rich country hence it can withstand years of depressed gas prices without breaking a sweat.
Yes.
Qatar is a massive natural gas well that is also doubles as a country. Furthermore, it's coastal location in the Persian gulf is ideal for shipping LNG worldwide. Because of it's LNG capacity, Qatar makes OPEC look wimpy. Because natural gas (and a little bit of oil and Al Jazeera) is all Qatar has, it was aggressively investing in LNG infrastructure decades ahead of anyone else hence it has paid off it's initial infrastructure investment and has since been raking in cash. Qatar can dramatically increase production and flood the market. Qatar is a very small rich country hence it can withstand years of depressed gas prices without breaking a sweat.
Then there is the issue of the distribution of large volume importers that makes LNG projects difficult (see figure below). Ideally, there would about 2-3 huge markets and then everyone else. In LNG, there is only one actual BIG market - Japan. South Korea and China trail somewhere behind with China's LNG import growth potential likely retarded due access to Russian gas and the government's regulation on LNG prices.
This negates producers from being able to negotiate large-scale "Costco" type contracts with any large customer and requires they negotiate a number of lower volume contracts with a variety of buyers. The economies of scale principle applies here and further impacts the economics of LNG projects.
This negates producers from being able to negotiate large-scale "Costco" type contracts with any large customer and requires they negotiate a number of lower volume contracts with a variety of buyers. The economies of scale principle applies here and further impacts the economics of LNG projects.
LNG Importers by Market Share 2016. Source: IGU
6. Thermal Content
Volumetric calculations are somewhat deceptive in the ongoing discussion of energy resources [specifically Alaska's] when trillion cubic feet terminology is thrown about like opinions on global warming on Fox News. Here's the math:
The thermal content of crude oil: $${\left( {5,800,000{{BTU} \over {bbl}}} \right)_{oil}}$$ The thermal content of natural gas: $${\left( {1,032{{BTU} \over {f{t^3}}}} \right)_{natura\lg as}}$$ Converted to barrel equivalent $${\left( {1,032{{BTU} \over {f{t^3}}}} \right)_{natura\lg as}} * \left( {5.615{{f{t^3}} \over {bbl}}} \right) = 5,795{{BTU} \over {bb{l_{equivalent}}}}$$ Therefore the thermal ratio of oil to natural gas is: $${{{{{\left( {5,800,000{{BTU} \over {bbl}}} \right)}_{oil}}} \over {\left( {5,795{{BTU} \over {bbl}}} \right)}}_{natural\_gas}} = 1,000$$ That is oil is 1,000 times more energy rich than an comparable volume of natural gas.
This simple exercises is illustrative as to why oil is such a dominant fuel and why the infrastructure and transporation cost are merited to ship it via tankers and pipelines such long distance - there is a very high energy yield.
However, to understand why despite complicating economics, LNG has so much potential, let's look at the Btu content of LNG.
(1 Gallon LNG = 82,644 Btu. 1 bbl = 42 gallons. )
However, to understand why despite complicating economics, LNG has so much potential, let's look at the Btu content of LNG.
(1 Gallon LNG = 82,644 Btu. 1 bbl = 42 gallons. )
The thermal content of LNG converted to barrel equivalent: $${\left( {3,471,000{{BTU} \over {bbl}}} \right)_{LNG}}$$ Therefore the thermal ratio of oil to LNG is: $${{{{{\left( {5,800,000{{BTU} \over {bbl}}} \right)}_{oil}}} \over {\left( {3,471,000{{BTU} \over {bbl}}} \right)}}_{LNG}} = 1.67$$ That is oil is only 1.67 more thermal energy per volume hence LNG gives crude oil a run for it's money in terms of thermal content.
So far, this post has been 5 reasons why LNG projects suck*, but I'm going to end it on why LNG is really awesome. Maybe, thermally, we are winning with LNG but there are actual economic advantages.
*I genuinely dig LNG projects, the "nuanced" point I'm trying to explain is why they are so economically difficult.
If the literal energy "bang" for buck is considered, natural gas - even at prices on parity with oil ($/mmbtu)- is a very good deal and therefore the upside to natural gas and LNG projects should be considered.
*I genuinely dig LNG projects, the "nuanced" point I'm trying to explain is why they are so economically difficult.
If the literal energy "bang" for buck is considered, natural gas - even at prices on parity with oil ($/mmbtu)- is a very good deal and therefore the upside to natural gas and LNG projects should be considered.
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