Lennart Luten, Director, Galway Group, Dubai
The predicted LNG supply overhang over the coming years is starting to show its effects as the beginning of 2017 witnessed a sharp drop in LNG spot prices. This encourages aspiring LNG buyers in emerging markets to consider LNG import projects. LNG suppliers and portfolio companies are keen to catalyse the development of such markets as a sustained imbalance in supply and demand does not bode well for their shareholder value. Emerging markets can thus expect an overwhelming interest from parties to develop LNG value chains aimed at unlocking these new demand centres. However, this can be a risky endeavour with many hurdles to be overcome and the prospect of capital destruction always present.
Notwithstanding each country’s individual characteristics, emerging markets tend to share a number of traits that make the development of LNG infrastructure projects high-risk in nature. Once successfully completed however, the risk profile should dictate that expected returns can be above-average as well, especially as these new projects are typically supposed to drive economic growth spurts. Drawing on our experience with recently proposed LNG import projects in both Asia and Africa, we can say that off-taker creditworthiness, the fledgling state of the domestic gas market and an opaque or underdeveloped regulatory environment are amongst the top concerns for project sponsors. Political dynamics and noise from potentially competing projects are likely to add to the insecurity. Lastly, and certainly if we look at the tenders recently published or expected to be published in countries like Indonesia, Pakistan and South-Africa, bidders tend to be invited to propose integrated value chain solutions, bundling molecule supply, import infrastructure, connecting gas pipeline and sometimes gas-fired power generating capacity. This can load significant development risk on the solution providers, whilst sovereign or corporate guarantees in return are by no means a given.
Parties with deep pockets and established partnerships to deliver the separate value chain components are clearly at an advantage to consider taking on these projects. They will seek out those project opportunities with the best credentials, and preferably with World Bank support. Asian export credit agencies seem to be especially keen to provide secondary funding as well. Provided that the project sponsors and financiers can rely on take-or-pay contracts with the key off-takers, emerging markets may see the realization of fast-track, fit-for-purpose but scalable LNG import terminals without having to sink a dime in the upfront capital outlay themselves: the ideal scenario.
In our view, this will be the model that will bear fruit over the coming decade. Portfolio companies, large trading firms and cash-rich private parties are already starting to implement this strategy, not seldom leveraging existing relationships built over past decades, notably on the back of other commodity trading or infrastructure development credentials.
The term emerging LNG market is however not reserved only for new import centres. Rather, it also applies to those regions that seem to be well-positioned to export LNG at some point, or indeed potentially do both (import and export). Notable examples include Mauritania and Senegal on Africa’s west coast, the Mediterranean, specifically off the Egyptian coast, and Tanzania and Mozambique on Africa’s east coast. Collectively the fields in these regions are estimated to hold around 300 trillion cubic feet of recoverable gas. Indeed, upstream parties with a long-term view on the market are actively positioning themselves to secure stakes in these fields for future development. It may be true that the LNG market will be oversupplied up until the second quarter of the next decade, but inevitably new LNG export facilities need to be built to satisfy the growing global demand for gas. These reserves could contribute to the next wave of export projects, provided they can be developed in low-cost fashion.
Field development for export is however only part of the story. The mentioned countries are projected to experience significant demographic and economic growth. This growth needs to be facilitated by increasing levels of electrification, preferably on the back of low-cost and clean power generation capacity. Gas has an important role to play in this respect and so it would make sense to earmark part of the gas reserves found offshore in notably east and west Africa for domestic and regional consumption. At the same time, we observe that the legal and fiscal frameworks to guide the development of such fields may still have some ways to go in terms of development, although Tanzania and Mozambique are reportedly making good progress here. Another important element in catalysing the development of domestic gas resources and creating sustainable wealth for the national economies is inter-state cooperation. Mauritania and Senegal need to work together to accommodate the monetization of the offshore gas finds as well as to address the associated environmental, social and political challenges that typically accompany large-scale infrastructure projects.
World Bank-funded domestic programs are already in swing to successfully bring online the first gas-to-power projects in Mauritania. In addition, other facilitators, such as consultants, lawyers and investors, have an important role to play in rolling out the right type of frameworks and structures to help un-lock the gas resources and build a constructive investment climate which will also ensure long-term economic benefit to the domestic economies.
From a more generic perspective, we believe that proposed LNG export projects in emerging markets that want to successfully take FID in the period leading up to 2025 would have to focus notably on the following criteria: sticking to a very low-cost development philosophy; designing fit-for-purpose, scalable facilities; enhancing/building relationships with (new) off-takers; possibly allowing for more flexible off-take and pricing arrangements; leveraging G-to-G relationships to catalyse projects; securing access to low-cost sources of finance; potentially partnering with other proposed projects; and seeking collaboration with long-term buyers & trading houses. Diversification of supply and securing access to lowest-cost sources of gas will always remain top-of-mind items with buyers as the supply landscape continuous to change and fragment; we are now starting to see the signs of buyer collaboration to optimize bargaining leverage as well strategic positioning to take maximum advantage of current market dynamics. The CNOOC-KOGAS-JERA cooperation is perhaps the clearest example of this. It is very conceivable that such consortia will also take an active role in new upstream investments and export projects to prepare for the future.
The theme that both early-stage import and export projects in emerging LNG markets have in common is an increased focus on risk management, aimed at ensuring minimal risk of potential capital destruction and ensuring maximum exposure to reward upside. Even as we are entering a period in which LNG buyers have a distinct bargaining advantage, we advocate that parties continue to seek win-win solutions with their sell-side counterparts. Opportunistic buying behaviour will likely ensure more competitive pricing and flexibility terms in sale and purchase agreements. However, and notwithstanding that the LNG market is in fact commoditising, the nature of the industry is still such that short-term gains can easily be undone by long-term short-sightedness.