Three and a half years ago I wrote about the Black Mamba. That’s a phenomenon under which a project has overspent in order to get itself built and suddenly that market does not provide the kind of returns needed to allow for the project to generate enough revenues for repaying investments made – with a profit on top.
Australia is an especially appalling case as it’s here where a slew of brand-new LNG projects make the country the number one exporter worldwide. At the same time, those plants were built so extensively that under current LNG sales prices (and even higher ones) it’s hard to see how any of those plants could ever generate any positive cash flow.
Some floating LNG production schemes will join this club of toxic LNG projects that might even drag some of their sponsor companies to the grave.
However, how on earth have we gone from relative financial sanity to absolute cost madness on Oil and Gas and especially LNG projects?
When I started to take an interest in LNG more than 10 years ago it was conventional wisdom that liquefaction would cost about 1,5 USD for every MM Btu that was to be liquefied. This number was always a bit hard to gauge accurately as what went into this number was widely different from project to project. Some projects had access to nice, clean, stabilized streams of feed-gas – no further refining necessary. On the other extreme where those with extensive upstream works to be factored in.
However, whatever the variance in liquefaction cost was – it was pretty sure that the cost stack for FOB LNG would not be more than USD 2 per MM Btu. And there were plenty of LNG projects that were built in this price range.
With the Egyptian plants, the low point for CAPEX cost of an LNG plant seemed to be reached and the industry speculated if and how far below the USD 400 per ton of installed capacity CAPEX would still drop.
And suddenly the world went on a hyperbole and as if there was no technological progress for decades, costs spiraled out of control way beyond the USD 2000 per ton of installed capacity mark. That’s 5 times the cost of projects that were built just before. Australian projects plus the floating schemes represent the tip of the iceberg and it looks unlikely that those monsters would ever recoup their investment as long as market prices for LNG don’t rise up to way above USD 10 per MM Btu. We are a long way from that in the current market.
A look at any other industry would suffice to say that there is something that went horribly wrong. We are used to ever dropping prices resulting from technological advancement and the economies of mass production. The same device that yesterday was still 4 digits of USD today is 3 digits and next year will be in the lower 3 digits.
The latest tech always commands a premium but it usually also gives you the best bang for the green buck you fork out.
In LNG however, the contrary seems to hold true. The newer the plants are, the more expensive they get and there is usually not an appreciably positive effect on efficiency. Those plants are technologically very similar to their 10 years older brethren but as already said – they are much, much more expensive. It’s a bit like you are buying the first model of the iPhone today and you would have to fork out almost USD 3000 for it.
OK, let’s end the rant here and see where the journey is likely to go.
Unhinged spending is over now. In fact, the lower but still insanely expensive price tags of those newer lower 48 US LNG liquefaction plants are a first clue when you compare them to the Aussie plants. You will say, the US is not Australia, and we should not forget that those US plants don’t have to factor in upstream cost. That’s true and I am still a bit concerned about those variable gas purchase prices the US plants have to watch out for. The world has gotten used to the notion that USD 2.- is cheap for feed-gas. I beg to remember that not very long ago, 0,6 USD/MM Btu was considered not bad for feed-gas. That’s an almost 4 fold price rise. Nothing to sneeze at.
But the real fun will play out somewhere else. It’s the EPC part of the LNG terminal piece (both ends of the chain) as well as transport that will see the most radical innovation and subsequent cost drop.
EPC players are under duress. New big ticket projects seem to be hard to get now and order books will start to wear thin with ever more of the newer plants starting up. There will be some activity on the regas side but that’s not exactly the same glossy ticket that liquefaction is and much of the new regas will be the floating – at least in the shorter run until those operators start to find out the real cost of those floaters like it’s happening now in Kuwait.
This means that the building boys will have to drop the pants a little lower for less available work to be done and as I know them, they won’t enjoy this. Some of them have already gone innovative as they have smelled the roast for a little while but when the good times roll, you know the mantra.
Now this latent innovation gets some “out of cage” time and starts to bite hefty chunks away from the cost stack. Besides, project sponsors must be cost conscious in the new oil price environment and just won’t underwrite those monster projects anymore. Small, quick, nimble and cheap is the word of the day and now it’s interesting.
I predict that cost for building will rapidly fall below USD 600 per ton installed capacity and the journey won’t end there as the former low marks are already some years old and can sure be beaten. Similar to what happens in the shale world where some players suddenly cut a profit with 50 and even lower sometimes. Where will it lead?
Let’s come back to our USD 1,50 for liquefaction. Take gas production out of the picture and I think we will go way below USD 1 pretty quick. I am not an engineer but I have an unshakable belief in human ingenuity and the effects of price pressure and the battle for survival.
Just imagine liquefaction goes down to USD 0,5 per MM Btu (just kidding – not really) and shipping goes real robotic (has anyone seen the Lloyds video on the future of unmanned shipping?) and crossing the Atlantic can hence be done for 0,5 USD or less plus regasification for much less than USD 0,5. Apply that to HH at USD 2 and you have LNG from the US in Europe on a full USD 3,5 cost stack.
Apply that to current prices in Europe and at what Gazprom needs in order to not belly up.
There is going to be much more LNG from the US in the future and also from other places that do shale and I am not talking about those plants under construction right now but rather of totally new projects we don’t know yet.
Oh, you think I am crazy? Pull a number and get in line.