Atlantic Basin is the Hottest Region of a Hot World Wide LNG Market

RelevanceWorldwide the LNG market is extremely tight, with supplies already contracted until the 2012-14 time frame. Rapidly increasing investment costs in LNG (steel prices high, fully booked EPC contractors and labor shortages) and political factors have caused many players to put back liquefaction projects (e.g. Sakhalin II, Tangguh and Gorgon). Meanwhile, demand for LNG shows no sign of abating, driven by resource hungry China and diversification of supply issues in Western countries.

In these circumstances holders of LNG assets are king and reluctant sellers. Even cash offers get little shrift – unless, of course, the price is extraordinarily high. That is why Woodside has set such high expectations for a possible disposal of a part of its interest in the Pluto project, Australia. One thing that would tempt Woodside is a deal that increased its exposure to the Atlantic Basin.

It’s no surprise that Woodside is interested in the Atlantic Basin. While LNG sales are expected to more than double over the next 7 – 8 years to 350-400MTPA, and all regions are experiencing tremendous growth, most commentators expect the Atlantic Basin to grow the fastest and to reach the same size as the Pacific Basin market by around 2015.

However, growth is not the only attraction for Woodside in the Atlantic Basin region.

AnalysisWorldwide growth in LNG is predicted to be strong through the medium term, and no region is expected to grow more quickly than the Atlantic Basin. For a company that has little exposure to the region it is natural that Woodside should show an interest. But such is the strength of the LNG market worldwide, Woodside is prepared to bide its time until the right deal materializes.

Woodside would undoubtedly be attracted by the Atlantic Basin growth story, but there are other attractions too. A summary of these would include:

Growth: Atlantic Basin growth in LNG demand is expected to be twice that of the Pacific Basin and some expect demand in the US to match that of Japan by the middle of the next decade (historically Japan is the major consumer of LNG and today still accounts for about 1/2 of all LNG production).

Pricing Formula: The LNG markets in the US and Europe are essentially pipeline markets, i.e. LNG is priced relative to pipeline gas. Asia (e.g. Korea and Japan) on the other hand has island LNG markets, i.e. all gas sold is LNG. Added to this, in the UK and US LNG is priced as gas, in Europe it is priced relative to gas oil and fuel oil, and in Asia relative to crude oil. The Atlantic Basin therefore offers diversification of pricing opportunity for Woodside.

Pricing Volatility: The US and UK offer well developed spot markets for gas generally, including LNG. The result has been an increase in volatility in gas price in recent years, offering potential for profitability through arbitrage for firms with LNG supply and shipping capacity. Support for LNG trading is provided by an excess of regasification capacity.

Regasification Capacity: 20-30 new terminals have been proposed in Europe and around 60 more in the US. Of course, many of these will never leave the drawing board, but there is consensus (backed by hard money) that local gas prices will support heavy investment in LNG imports. In the U.S. for example, incremental gas drilling projects in the Gulf of Mexico cost about $5/MMBtu, providing good support for LNG imports. Under this scenario Woodside and other suppliers will consider that they can dispose of all the LNG they can produce.

Market Drivers: The Atlantic Basin offers Woodside exposure to a new set of market drivers that are different individually and taken together to other regions. These drivers include: pricing mechanism (as discussed above); weather (e.g. hurricane season in the GOM); scheduling (e.g. ability to sell unplaced LNG cargoes into the spot market); shipping (e.g. cost and range of new build ships); home country diversity of supply issues (e.g. Spain diversifying gas supplies away from Algeria); and supplier country diversification of export destinations (e.g. Qatar supplying the US).

Portfolio Management: Woodside is a significant regional player in the LNG market. To become a leader it must emulate the Shells and BPs of the world by: finding the optimum balance of gas and LNG assets; securing access to transportation infrastructure; accessing end user markets; and increasing its activity over a greater number of regions. Increasing its exposure to the Atlantic Basin would help in this respect.

4 May 2007

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