There was good coverage this week of Chevron/Woodside’s new LNG expansion plan, but the most important takeaway seems to be overlooked – it points to LNG Canada Phase 2 FID in 2020 and a continuous BC LNG 2020’s runway of ~6 bcf/d. There were multiple positives formalized in Chevron/Woodside’s new Kitimat LNG expansion plan publicly posted by the NEB on July 11 – Kitimat LNG will be bigger at 2.4 bcf/d and cleaner with its all electric power for the LNG facility. Kitimat LNG started to emerge with big positive momentum in Q1/19, when these specific positives were indicated by Chevron and Woodside in March and why we wrote our April 5, 2019 blog “Big Positives For Kitimat LNG – May Get Some Brownfield Economics And Meet CleanBC Emissions” [LINK]. We thought the big positives would lead to FID in 2020, but the new expansion plan estimates a later FID timing in 2022 to 2023, construction start 2022/2023, and first LNG in 2028/2029. Why not an earlier FID? We believe there is only one reason – Chevron believes LNG Canada Phase 2 will go FID soon such that its construction cycle can lag in to immediately tie into the construction cycle for LNG Canada Phase 1, and therefore push Kitimat LNG’s construction cycle back to lag in to then tie into the construction cycle for LNG Canada Phase 2. We believe Chevron’s LNG capital cost lessons from its western Australia LNG and the existing demand for key LNG services led them to link to (instead of competing against) LNG Canada in a continuous BC LNG construction cycle to ensure continuous contractor services, quality and capital cost control. Its the same LNG construction cycle approach as Cheniere does in the Gulf Coast. It also means that Chevron must strongly believe LNG Canada Phase 2 will immediately follow LNG Canada Phase 1, which points to an LNG Canada Phase 2 FID in 2020. If not, Chevron’s FID and construction timing makes no sense and puts at risk contractor services availability, timing and cost control. It may take a few years, but a 2020’s runway from LNG Canada 1 and 2, and Kitimat LNG is ~6 bcf/d and that is huge relative to NGTL 2018 receipts of ~12 bcf/d. One last reminder, Kitimat LNG should be a big plus to western Canada natural gas producers it expects to be a disaggregated model and not the historical model where the LNG company also owned/controlled all of the gas supply to feed the LNG plant.
Two key positives – Kitimat LNG will be bigger and cleaner. On July 11, the National Energy Board posted the new Kitimat expansion plan [LINK] and opened it for public comments until July 31, 2019. There were two keys positive in the new expansion plan: (i) Its bigger at an expanded ~2.4 bcf/d LNG capacity – “as proposed, the Kitimat LNG Expansion Project would increase the facility’s LNG production capacity by more than 50%, to 18 million tonnes per year. The expansion would include the addition of a third LNG train, a LNG containment tank, marine berth infrastructure, and increased shipping”. This is an expansion to ~2.4 bcf/d LNG capacity. (ii) Its cleaner with less emissions. Kitimat proposes “to use a compact, all-electric drive design” to power the LNG instead of using natural gas. The plan said “In addition, the development concept includes an all-electric plant powered by clean, renewable hydroelectricity from BC Hydro, and will set the global standard for the lowest emissions intensity of any large-scale LNG facility.”
These positives are not new, just formalized in this expansion plan filed with the NEB. There is no question being bigger and cleaner is a big positive to the momentum of Kitimat LNG and the fact they are formalized in this revised plan is a reinforcement of Chevron and Woodside’s positive comments/indications in March and April. (i) Our March 10, 2019 Energy Tidbits memo [LINK] asked “Chevron Pointing To A Potential FID of Kitimat LNG in 2020/2021?” based on the annual investor day Q&A and Kitimat being one of their 12 major projects from the March 5 analyst day.(ii) April 5, 2019 blog “Big Positives For Kitimat LNG – May Get Some Brownfield Economics And Meet CleanBC Emissions” [LINK] wrote “In exactly one month, the Chevron/Woodside ~2.4 bcf/d Kitimat LNG project has jumped from a hint that a FID could be coming in 2020/2021 to an LNG project that is pointing to being able to solve all the major issues that would hold back a FID in 2020 – size, capital cost and meeting Clean BC emissions levels. At its March 5 analyst day, Chevron’s Q&A comments provided us with the view that that Chevron might be pointing to a FID in 2020/2021. It was far from a direct comment, but their comments and slides clearly pointed to a probable FID. This week, the comments from Chevron and Woodside were direct and positive to pointing to FID – Chevron is moving to double the size of Kitimat LNG to ~2.4 bc/d, piggy back on LNG Canada to effectively get some “brownfield” cost advantages to a “greenfield” project, and moving to use hydroelectric power instead of natural gas to power the LNG plant so it can meet CleanBC emissions limits. There was also big disclosure this week that is good news for a number of western Canada natural gas producers, Woodside says they will have a “different” natural gas supply model and will be contracting natural gas supply from a number of natural gas producers. If 50% of the Kitimat LNG gas supply goes to this “different” model, there will be ~1.2 bcf/d of gas supply up for grabs from western Canada natural gas producers, which is about 20% of current Canada’s net natural gas exports to the US. Chevron and Woodside haven said when FID is coming. In fact, Woodside CEO said this week FID was not expected in 2019. But when we think about the last month, it reminds us of how we wrote in the several months leading up to LNG Canada’s FID – there were multiple clear signs and comments that they are ticking all the boxes of the items need to make a FID. In this Kitimat LNG case, they ticked perhaps the biggest boxes this week, which is why we think they are pointing to a FID in early 2020”
Being cleaner was needed to fit with CleanBC emissions standards. Our primary reason for previously doubting Kitimat LNG was that we didn’t see how it would fit under the CleanBC emissions limits. But our April 5 blog noted that was resolved and we wrote “One other hugely significant disclosure this week came in the Business in Vancouver Wed story “Kitimat LNG commits to electrification” [LINK]. BIV wrote “A promise made in Kitimat today that the Chevron-Woodside Kitimat LNG project would use electric drive would be a game-changer, if fulfilled, not just for the LNG industry in B.C., but for independent power producers. At a conference on LNG hosted by the Haisla First Nation in Kitimat today, April 3, Rod Maier, vice president of public affairs for Chevron Canada, said the Kitimat LNG project would use e-drive, according to the First Nation LNG Alliance. He was quoted as saying it would be “the Tesla of LNG plants.” That is no mean pledge, as it would significantly lower the project’s greenhouse gas emissions profile, and significantly increase the demand for power. It would also meet the strict new best-in-class emissions benchmarks set out in the CleanBC plan.” Kitimat LNG would take advantage of the massive being built Site C hydroelectric power generation to use electricity instead of using natural gas to power the LNG plants as is the norm. BC Hydro [LINK] states “The Site C Clean Energy Project (Site C) will be a third dam and hydroelectric generating station on the Peace River in northeast B.C. Site C will provide 1,100 megawatts (MW) of capacity, and produce about 5,100 gigawatt hours (GWh) of electricity each year – enough energy to power the equivalent of about 450,000 homes per year in B.C”. We agree with BIV that this is a game changer as it would allow for Kitimat to get under the CleanBC emissions limits. If so, then it becomes an economic question – how much more does electricity cost relative to burning natural gas. But at least it means that it isn’t a non starter because of emissions. Prior to this announcement, we were firmly on the record that CleanBC emissions limits would mean there couldn’t’ be another major BC LNG project (after LNG Canada) that could be built and fit under the CleanBC emissions limits.”
Linking Kitimat LNG construction cycle to LNG Canada was why we thought FID in 2020 and not the estimated Kitimat FID timing in 2022 to 2023. The new Kitimat LNG expansion plan has an estimated timing of FID in 2022 to 2023, construction start 2022/2023, and first LNG in 2028/2029, whereas our April 5 blog estimated FID timing in 2020. The key reason for our timing were the Woodside CEO comments on April 4. Bloomberg terminal had an excellent story on Thurs “Chevron Partner Pleased Shell Moving First on Canadian LNG” that reminded us that Kitimat LNG will actually have some “brownfield” cost benefits even though it is a “greenfield” project. Bloomberg wrote “* Shell’s LNG Canada will lay the groundwork for working in the area, Coleman said in a Bloomberg TV interview. “The two plants are only about 10 kilometers apart, so we’ll be using essentially the same infrastructure” * “We’re working hard now with our partners to ensure that we are decision ready, really at the back end of the construction period for LNG Canada so that we can pick up that work force and take advantage of the work that’s already been done”. One of the reasons we bought into this concept of linking the Kitimat construction cycle to the LNG Canada construction cycle was so Chevron would avoid a competition for Asian fabricators and local service contractors with LNG Canada Phase 2 so they could avoid massive cost escalation and timing delays as seen in the NW Australia LNG buildout and oil sands build out. Chevron is well aware of these cycles and we believe this is why they are linking the Kitimat construction cycle to link into the LNG Canada construction cycle. This linking of the construction cycle is why we previously expected FID in early 2020.
Linking Kitimat LNG construction cycle to LNG Canada is even more critical with increasing global LNG contractor capacity risk. We believe that Chevron also sees the same risk to shortage of global LNG contractor capacity and this only reinforces their plan to link the Kitimat LNG construction cycle to LNG Canada to provide a continuous contractor services process. (i) Our June 23, 2019 Energy Tidbits memo [LINK] noted two items. A Bloomberg @TheTerminal story “PNG LNG Expansion Delay Would Risk Higher Costs, Chiyoda Says” warned that contractor books are getting full, and therefore any significant timing delays for PNG LNG’s expansion would likely result in cost overruns. Exxon’s comments at a US sellside conference and in the Q&A, Exxon noted the problem with LNG contractor capacity. In the Q&A, mgmt. was asked “We had dinner last night with Andy and we’re also talking a bit about contractor availability, things like that on, especially on the LNG side. So I’m curious if you take all of these pieces of activity based on acceleration or inflation risk and then maybe labor inflation and other factors that could drive a higher spending budget. How comfortable are you from an upstream side around the budgets?” Mgmt. replied “But the other piece of it that Andy mentioned is very valid is, to many degrees, it’s set by capacity as well. How much work can you do? Whether it’s the industry contractors and what we’ve seen is a pretty dramatic consolidation of those over the last several years, particularly the LNG business. The numbers I think went from 11 or 12 major LNG contractors 10 years ago to six today. And they have lots of work, right? Lots of work in the Gulf. Lots of work in other parts of the world. So, I would tell you as much as anything, what limits our ability to do things is actually the capacity that’s available in the contracting industry and internally. But we don’t let a number limit the opportunity space that’s available to us, if it’s the right thing to do”. (ii) Hellenic Shipping News June 24 story “Global LNG producers see cost risks looming over next wave of projects” “Construction delays and cost blowouts could hit the next wave of liquefied natural gas (LNG) projects as there are a limited number of contractors able to handle the huge projects, three developers said. Around $200 billion in projects across the globe from Australia to the United States are racing to be approved over the next two years, vying to provide around 65 million tonnes of new annual supplies that are needed by 2025, according to estimates by consultants Wood Mackenzie. The race is not just to make final investment decisions (FIDs) on projects, but to enter front end engineering and design (FEED) work to lock in contractors before others snap them up, the three developers said at Credit Suisse’s Australian Energy Conference. “Unless you’re in FEED in the next six to nine months, unless you’re in FID in the next two years, there’s going to be no one to build your project,” Oil Search Executive General Manager Ian Munro told the conference.”
We believe capital cost control is even more critical under an extended period of Asian LNG prices below $10. There is capital and the ongoing supply cost for LNG projects. Capital costs out of control make it difficult (impossible) for mega projects to make acceptable returns. Its why we believe linking of Kitimat LNG construction cycle to LNG Canada to effectively get brownfield economics and better cost control/certainty is the determining factor for the Kitimat LNG timing. For LNG Canada, Shell’s Oct 2018 “LNG Canada Final Investment Decision” [LINK] “estimated integrated project IRR ~13%” “at LNG price of $8.5/mmbtu (Tokyo DES, real terms 2018)”. Shell didn’t provide LNG Canada capital costs for the IRR or sensitivities to the ~13% IRR, but a capital cost escalation would hurt this IRR.
If FID isn’t until 2022 to 2023, it has to imply linking Kitimat construction cycle to LNG Canada Phase 2, not Phase 1. We believe the reason for Chevron’s estimated FID and construction dates must be to link into LNG Canada Phase 2 construction cycle and not Phase 1. The Woodside CEO April comments told us to think about Kitimat LNG’s construction process differently – its really a LNG phase linking in to LNG Canada’s construction cycles. Conceptually, much like what Cheniere does in the Gulf Coast with the multiple phases of its LNG projects – the cycles of each phase are linked so that services at a certain part of the construction cycle move are continuously used moving from one LNG phase to the next. This continuous FID/construction cycle fits with the FID/construction cycle of a new project starting up every 2 years or so. LNG Canada Phase 1 went FID in Oct 2018 and, if Kitimat LNG FID is 2022 to 2023, it leaves a gap for the LNG construction cycle in BC that must be assumed to be filled by LNG Canada Phase 2 ie. a FID in late 2020. If not, Chevron’s FID and construction timing makes no sense, it would leave a 2 to 3 year gap in overseas and BC contractor usage, and put at risk contractor availability, timing and cost control. It is why we believe Chevron’s Kitimat LNG timing is pointing to LNG Canada Phase 2 in 2020.
A continuous BC LNG 2020’s runway of LNG Canada and Kitimat LNG can add ~6 bcf/d and is a game changer to western Canada natural gas. No question western Canada natural gas continues to be in the tank and its all because of lack of access to markets for existing natural gas production. Western Canada natural gas continues to get backed up by the growth of US gas production reducing the need for Cdn imports and also taking market share in eastern Canada markets. Chevron’s expansion plan is significant as it points to a continuous BC LNG runway of LNG Canada Phase 1, Phase 2 and then Kitimat LNG. This is a 2020’s runway of ~6 bcf/d, which is huge relative to Canada natural gas production of ~16.6 bcf/d. But perhaps the best way to think about it is to think about it relative to TC Energy (new name of TransCanada) Canadian Natural Gas Pipeline Volumes picture, in particular, the NGTL system receipts that were up to ~12 bcf/d in 2018. Supplying this new natural gas supply will require new development drilling (there is lots of potential development) on plays that flow into NGTL, but will also redirect some existing production from going into NGTL instead going to the west. TCs investor day is held in the fall, the last one was Nov 13, 2018 and included the below graph.
Canadian Natural Gas Pipeline Volumes
Source: TC Energy
Reminder, Kitimat LNG’s “different” natural gas supply model is a big plus to western Canada natural gas outlook. LNG Canada hasn’t disclosed their natural gas supply model, but we still expect to see benefits to third party natural gas supply therein. However, Woodside has indicated that Kitimat LNG will have a different model for gas supply. Bloomberg TV’s April 4 interview with Woodside CEO [LINK], where he said there will be a different LNG business model to secure natural gas for Kitimat LNG. He said this different model would be a disaggregated model and not the historical model where the LNG company also owned/controlled gas supply to feed the LNG plant. Rather they will tie up gas supply much like a natural gas aggregator by going to a number of natural gas producers and contracting the gas. This is a major switch in business models and is only possible because there is ample natural gas supply. It may not lead to M&A, but this “different” natural gas supply model is a big plus to western Canada natural gas outlook. If we assume that 50% of the total required ~2.4 bcf/d gas supply is ultimately done under this “different” model, that sets up a market for ~1.2 bcf/d of natural gas supply from western Canada natural gas producers. This is equal to ~20% of current Canada natural gas net exports to the US. The EIA estimates Canada net natural gas exports were 6.21 bcf/d in Jan. The National Energy Board estimates Alberta/BC marketable natural gas in Jan was 15.84 bcf/d.