Liquefied natural gas is the stand-out story of the post-Covid commodities boom. Asian spot prices are soaring amid firm demand in China and Europe, but marshalling investment into newbuild gas liquefaction projects is proving tough. US LNG developer Tellurian has all but abandoned a strategy to lure buyers into investing equity in its flagship project in Louisiana, and is now pre-selling the fuel to commodities traders instead. Taking the fuel is clearly seen as less risky than owning a big piece of new fossil infrastructure with a 20+ year lifespan.
LNG demand proved to be impervious to the coronavirus crisis that crashed the oil market in 2020. Global LNG trade rose modestly last year to 356 million tonnes (mt) despite Covid-19 lockdowns and travel bans, driving Asian spot prices as high as $20/MMBtu in January. China imported a record 7 mt in May amid strong domestic industrial demand, driving spot prices to a four-month high last week and prompting analysts to forecast robust prices for the rest of 2021.
Commodities traders that can exploit global arbitrage opportunities between supply basins and demand centres make good margins on LNG regardless of the prevailing macroeconomic environment. There is always a price differential to exploit somewhere, and gas is a mainstay fuel that heats homes and offices, powers electricity grids and drives industry the world over.
So it is was not entirely surprising that US LNG developer Tellurian last week broke its years-long sales dry spell with not one but two binding deals to pre-sell output from its flagship Driftwood LNG project in Louisiana to two of the world’s biggest commodities traders.
In two separate announcements (here and here), Tellurian hailed the conclusion of two ten-year sales and purchase agreements (SPAs) with Gunvor and Vitol. Each company will lift 3 million tonnes per annum from Driftwood for ten years, once the project enters commercial operations in the mid-2020s. The NASDAQ-listed company also signalled another delay in a final investment decision (FID) at Driftwood until Q1’22.
FID was expected this year, having been repeatedly pushed back due to a lack of customers. Tellurian’s business model is unique among North American liquefaction project developers in that it offers investors the opportunity to own a piece of the entire gas-to-LNG value chain, from upstream drilling and midstream pipelines to the liquefaction plant itself.
This business model has been rejigged several times in a bid to coax overseas LNG customers into investing in the means of production, rather than simply lifting volumes under long-term SPAs – which until recently has been industry convention. The trouble is, buyers don’t want to take onto their books risks that are now inherent in investing in fossil infrastructure.
India’s biggest LNG buyer Petronet LNG last year walked away from a proposed equity investment of $2.5 billion into Driftwood. That deal would have given Petronet the right to lift 5 mtpa of LNG from the facility for the duration of its economic life. With the world’s largest and most competitively priced LNG exporter Qatar on its doorstep, the Indian company baulked at committing to more costly sources from further afield for two decades or more.
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Tellurian is not yet in a position to proceed with Driftwood, which would have a nameplate liquefaction capacity of 16.5 mtpa in its first phase. Unless investors take equity in the plant, Tellurian will need to pre-sell around 80% of that output under binding SPAs with credit-worthy offtakers to leverage third party debt finance.
The Gunvor and Vitol deals total 6 mtpa in aggregate. Aside from these SPAs, French oil major TotalEnergies had already committed to lift 1.5 mtpa under its own SPA and intends to invest $500 million investment in Driftwood for a further 1 mtpa of LNG lifting rights. Those agreements cover off 8.5 mtpa, or just over half of Driftwood’s capacity – leaving a shortfall of around 4.7 mtpa to reach the 80% finance threshold.
Finding investors for Driftwood was already a tough task before Joe Biden entered the White House. With the US back in the Paris climate accord, the role of natural gas and LNG in the US energy transition is coming under greater scrutiny.
LNG exports confer geopolitical influence and commercial soft power to the US in overseas markets, but the methane footprint of North American gas production is already deterring European buyers.
French state-backed energy company Engie last year scrapped a plan to buy US LNG from NextDecade, another Gulf Coast project developer. The French government halted the deal over environmental concerns, citing the flaring and methane emissions footprint of shale wells in Texas that would feed NextDecade’s Rio Grande LNG project.
Being seen to be green
That ‘non’ from Paris sent US LNG developers scrambling to press their upstream gas producers to take action on their spiralling gas flaring and methane emissions problem, culminating in a slew of unconvincing announcements from fracking companies about their commitment to environmental, social and governance matters.
Tellurian is now also talking about ESG, saying its integration with upstream gas wells allows LNG greenhouse gas emissions to be tracked and certified. The company uses so-called “green completion” technology to “eliminate flaring and minimize methane leakage”, and is looking at certifying its molecules as “responsibly sourced gas”, or RSG – the latest acronym dreamt up by the industry to convince investors that American shale gas is green and not in conflict with ESG objectives.
Global gas demand is on an upward trajectory as markets in Asia and eastern and southern Europe wean themselves off coal. Double-digit Asian spot LNG prices are signalling for increased supply, but investment has not flowed into greenfield liquefaction capacity – raising the prospect of enduring spot price volatility and spikes whenever demand rises, sending buyers scrambling for cargoes.
These periodic spikes, in turn, drive European wholesale power prices upwards, which could push less efficient gas-fired power stations out of the money in some EU power markets. If global gas prices go stratospheric against a backdrop of a lacklustre EU carbon price, this could see mothballed coal plants brought back into service. And in Asia, where carbon pricing is not yet a dominant factor in determining power plant dispatch decisions, expensive gas simply means more coal burn.
None of this will perturb Gunvor or Vitol. Both trading houses agreed to buy LNG from Driftwood on a price that is indexed to the Japan Korea Marker (JKM) and the Dutch Title Transfer Facility (TTF), netted back for transportation charges. This means that if Driftwood is eventually built, those cargoes will be sold at a price that moves with the market in Asia and Europe.
If prices crash below the cost of production, it seems conceivable that Tellurian will be left carrying the can. Little wonder that nobody else wants a piece of that ‘action’.
Another key question is how Tellurian intends to finance Driftwood as banks typically dislike commodity price exposure which is the case here where they are selling TTF/JKM but buying HH / fixed price.