The US has significant reserves of natural gas, an expandable upstream and midstream infrastructure and pro-business, pro-energy stakeholder support. Regardless, US-based project development is challenged by development business models that do not adequately address investor and customer risk.
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In reality, construction costs associated with these mega-projects are expensive. In addition, securing large scale, reliable quantities of natural gas for feedstock and then transporting it to liquefaction facilities can be a costly, risky proposal.
Consider the two primary business models for liquefaction development in place today: the tolling model where the customer is responsible for buying gas and ensuring its delivery; and the sales and purchase agreement model where the developer is responsible for gas supply and transportation.
Under the tolling model, customers are at risk when gas prices in production basins move in a direction that is unfavourable to the contracted price (often benchmarked to Henry Hub). This requires a deep understanding of the resource and valuations. Competition for pipeline access exists among LNG customers and other industrial users; this demands a high level of expertise on the part of the customer to avoid hidden costs.
The second model shifts risks from the customer to the developer and its investors. This forces the developer to be a ‘price taker’ for gas transportation services due to contracts that limit transportation to only 5% of Henry Hub. Few follow this model, largely due to the inherent transportation risk.
A compounding factor for liquefaction development is that projects require significant amounts of feed gas over a very long-term. One 10 million tpy plant with a 1.5 billion ft3/d feed gas requirement would currently tap almost 20% of the current daily dry gas production in the Permian Basin of Texas and New Mexico. While US production is expected to continue to expand to keep pace with demand, customers and developers must ask whether feed gas and transportation resources continue to be adequate, reliable and affordable over the 40-year life of the liquefaction facility.
Tellurian has developed a third approach that addresses customer risk and development risk, while ensuring long-term supply and transportation capacity. It differs from other models by offering customers equity in the interconnected components of the LNG development chain – an upstream position in the Haynesville, pipeline investments in Texas and Louisiana and the 27.6 million tpy Driftwood liquefaction facility near Lake Charles, Louisiana. This approach reduces construction risk, basin risk and basis risk to help achieve the goal of producing LNG delivered FOB on the US Gulf Coast at US$3/million Btu.
Based on market fundamentals, there has never been a better time to enter the LNG market. Global LNG demand is up at a rate of almost 9% year-over-year. To a large extent, this demand is inelastic, particularly among Asian customers that are turning to natural gas due to its low-emission characteristics. Prices have increased, with the Japan/Korea Marker (JKM) up 32% since November 2017.
This trend is expected to continue. By 2020, LNG demand and supply are expected to be at equilibrium. With demand growth of 4.5% per year post 2020, we expect a 107 million tpy shortfall in supply by 2025. And liquidity is increasing – in the next two years, Tellurian expects that on any given day there will be up to 17 new cargoes loaded and nearly 600 LNG vessels on the water.
These factors signal great opportunities for US liquefaction development and the US remains uniquely qualified to meet global needs for low cost, reliable LNG. In this evolving environment, the winners will be those projects that successfully mitigate a range of risk factors to provide investors and customers alike with true transparency and control of costs.