Its all about OPEC and oil this week, but this meant that the most bullish we have heard on the LNG market rebalancing sooner than expected from Woodside’s May 23rd investor briefing in Australia have been overlooked. Woodside is another in a growing group to forecast LNG markets get rebalanced much earlier than expected. But they are the firmest in their views, saying it multiple times in the investor briefing, and they see this happening “around 2020”. As their Executive VP Marketing, Trading and Shipping said “I am a bit more bullish than our economists, I actually talk to customers out there”. At the end of 2016, the more common view was LNG rebalancing in 2023 to 2025. That view still seems reflected in the forward strips, which are well below current prices (ie. Henry Hub HH in 2020 is $2.84 vs $3.10 today). A LNG rebalanced market in 2020 should lift mid term Henry Hub (HH), which will in turn help drag up mid term AECO prices. This means that LNG rebalancing could well be the major factor that will set the tone and valuations for Cdn natural gas in 2018 and 2019. The Woodside presentation is at [LINK], and the webcast replay is at [LINK].
New LNG buyers are the big surprise and could hit 25% of the market by 2020. FSRUs (Floating Storage Regasification Units) have been our highlighted game changer to LNG demand markets, and FSRUs were prominently featured by Woodside. Woodside noted that the “advent of FSRU technology has opened new markets. 15 countries now import thru FSRUs. There is a current fleet of 25 vessels out there, 10 are on order, they already makes up about 10% of the market. FSRUs are cheaper, they are faster to install, they provide accelerated access to new markets that would otherwise have to wait”. But then Woodside gave their view on how these New Buyers will drive the market to 2020. Woodside said “First. New buyers accounted for approx. half of new LNG contracts signed over the last two years. Even though the volumes they currently take only represent about 4% of the market, as new contracts kick in over the next few years, that share will grow, and it could get to 25% of the market by 2020”. In the below graph, it looks like the uncontracted LNG demand increases by about 25 million tonnes of LNG per annum, which would be about 3.3 bcf/d.
Uncontracted LNG Demand
Source: Woodside
There are other demand factors leading to stronger demand growth. Woodside highlighted the role of FSRUs in opening new markets, but also noted other emerging trends. For China, they noted that China’s current 5 year plan calls for natural gas to provide 10% of primary energy needs by 2020, up from 6% today. And that a 1% change in China’s energy mix represents about 25 million tonnes of LNG equivalent. This would represent ~3.3 bcf/d. Woodside also used the example of LNG as “a natural replacement for declining domestic natural gas in some countries” using Pakistan as an example. It is being facilitated by FSRUs. Woodside said that Pakistan has already installed 2 FSRUs, and has two more planned with more growth to come. Woodside says “So in the space of 4 to 5 years you will see Pakistan grow from a new entrant to maybe the 5th or 6th biggest importing nation.” Woodside also sees LNG being “positioned to capture a significant portion of the bunkering market”, when the new low sulphur bunker rules come into effect in 2020.
“I will repeat that, we think the market will rebalance earlier than we previously thought. Woodside was clear and made sure they emphasized that they see LNG markets rebalancing earlier than they previously thought. They are like everyone else on today’s LNG market – it is currently over supplied. But their changing view of demand sees the demand growth absorbing all the supply from “projects that are currently under construction or undergoing commissioning”. A key point was their comment that “for the most part buyers have committed to take that new supply under new long term contracts”. And they see excess LNG supply gone around 2020. Woodside said “this short term supply will satisfy market demand for a number of years thru to around 2020. Beyond 2020, the market will require additional new sources of supply for sources or projects that have yet to take FID. To keep pace with demand, approx. 20 million tonnes of new FID will be required every year. In 2016, we only had 2 projects take FID and the total capacity was only 6 million tonnes per annum. This year there have been none. So we are falling behind. Therefore we anticipate the market will rebalance earlier than we thought before. I will repeat that, we think the market will rebalance earlier than we previously thought”. Note that 20 million tonnes of LNG per year is ~2.6 bcf/d.
There is a “new” equation driving HH and AECO gas prices – more HH gas driven by international gas and LNG prices. US gas storage entered the winter at record levels (4.0 tcf on Nov 13, 2016), it was the 6th warmest winter in the last 122 years, US gas storage ended the winter only 429 bcf lower YoY vs the April 1, 2016 record storage of 2,480 bcf, but HH gas prices were $3.13 vs $1.88 the prior year. HH gas prices are way stronger than expected, especially with a warm winter. But this winter proved there is a new way of looking at HH and AECO gas prices. The increasing US natural gas exports via LNG and via pipeline to Mexico are “structural” changes to the key factors driving HH gas prices. And with exports increasing in both factors, they should have an an increasing impact thru 2022. This will mean there is an increasing amount of US natural gas that will be impacted by global LNG and natural gas prices.
Why? US natural gas exports are high enough to offset the impact of a warm winter. Prior to this year, a very warm winter inevitably led to very low natural gas prices. Our March 13, 2017 blog “Under Construction US LNG Export Projects To Add >2 Tcf Of Incremental Demand In 2017 Thru 2019” noted how under construction LNG projects would add incremental send out capacity of 255 bcf in 2016 vs 2015, 430 bcf in 2017 vs 2016, 650 bcf in 2018 vs 2017, and 1,039 bcf in 2019 vs 2018. Looking at 2016 and 2017 only, this is incremental 685 bcf of annual send out capacity, or ~615 bcf assuming a 90% utilization. This is before looking at increasing pipeline exports to Mexico, which over the same two year period add ~500 bcf of incremental demand. The below table shows the variation in natural gas demand to residential customers for the last 6 winters. The takeaway is that the incremental demand of >1,100 bcf per year provides more than enough cushion for the variance in a warm winter. It is why HH was $3.13 to end the winter after the 6th warmest winter on record.
We can’t wait to see how HH gets impacted as LNG markets become rebalanced or move to under supply. We continue to be surprised by mid term HH strip prices that are below $3 in 2019, 2020, 2021, and 2022. US natural gas exports are going into a global over supplied LNG market, but even still, the impact of the increasing US exports is having a material impact on HH prices. US natural gas exports are only increasing and we see the impact to be even more significant as global LNG markets move out of over supply to a balance or under supply. Cheniere Energy made an interesting point at its recent analyst day, when they said “long lead time to new supply means once the market is tight it will take 4+ years for supply to adjust”. It is why we continue to believe HH will outperform the strips in 2019 thru 2022 and is more likely a $3.25 to $3.50 than below $3.
Woodside’s bullish view on LNG rebalancing around 2020 would be positive to AECO and the tone to Canadian natural gas. We recognize that Woodside is speaking from a LNG producer perspective, but they also have the advantage of real marketing discussions with customers. Woodside was very strong in their view that the LNG over supply will be gone around 2020. “I will repeat that, we think the market will rebalance earlier than we previously thought”. We continue to highlight this 2020 view as it will impact the tone and valuations for natural gas (US and Canada) before 2020. LNG oversupply being fixed closer to 2020 than 2023 may not impact spot HH and AECO gas prices, but should lead to an increase in the out years (2019 thru 2022) of HH strips. And a move up in the 2019 thru 2022 strips should lead to a stronger investor tone and ultimately valuations for natural gas, including Cdn natural gas. Lastly, we believe it is timely to look at this now ahead of the normal cycle for analysts to take a new look at their 2018 and 2019 natural gas thesis in Q3/17, ahead of going into the winter.