The global liquefied natural gas market without Russia

Sakhalin 2, Russia (Shell, CC BY-NC-ND)

From Algeria to Qatar

The market of LNG has now been operating for more than 50 years. LNG first appeared in commercial circulation in the late 1950s. It is assumed, however, that the international trade in LNG started with the launch of its production in Algeria in 1964 and the commencement of deliveries to the British market.

The 1960s and 1970s marked the beginning of a dynamic expansion of the gas pipeline network from North Africa to Europe and the commencement of exploitation of the gas fields in the North Sea. Then came the rapidly developed gas pipelines transporting conventional natural gas from then Soviet Union to the markets of Central and Southeast Europe (CSE), and then to Western Europe.

These processes hindered the development of the European LNG market. That is why the leading role on the emerging global market of LNG was taken by Asian countries, and in particular Japan and South Korea, which are still the largest importers of this fuel today.

A new phase in the development of that market began with the launch of LNG production in Qatar in 1996. That country quickly became a leading exporter of it. In 2017, it exported 77.5 million tons of LNG (26.7 per cent of global exports). The subsequent positions among the biggest exporters were taken by Australia — 55.5 million tons (19.2 per cent), Malaysia — 26.8 million tons (9.2 per cent), Nigeria — 25.7 million tons (8.9 per cent), Indonesia — 18.7 million tons (6.5 per cent), and the United States — 16.6 million tons (5.7 per cent). It’s especially worth noting the phenomenon of Australia, which doubled its export over the last two years: from 27.6 million tons in 2015 to 41.5 million tons in 2016 and 55.5 million tons in 2017.

According to the report entitled „LNG Trade & Transport 2018”, prepared by the British analytical center Clarksons Research, the demand for LNG accounts for 11 per cent of the global demand for gas, while back in 2000 its share was 6 per cent. However, LNG exports already account for 35 per cent of the global trade in gaseous fuels, compared with 26 per cent in 2000.

Europe is chasing after Asia

In 2017, the global exports of LNG reached the level of 289.8 million tons, growing by 9.9 per cent annually, which is the highest rate of growth in years. Almost 72.9 per cent of the demand came from the Asian market, which imported 211.2 million tons (an increase of 10.2 per cent). The highest volume of LNG was imported by Japan — 83.5 million tons, followed by China, which imported 39 million tons (an increase of 43.2 per cent), and South Korea (imports of 37.8 million tons).

There are over 100 LNG terminals in the world. In Europe alone, there are 24 such facilities, with a capacity exceeding 150 million tons. It’s worth noting their low levels of capacity utilization only approximately 25 per cent. In 2017, the LNG imports of European countries increased by about 7.5 million tons, i.e. by approximately 20 per cent. According to experts, the strong growth in demand for LNG on the European market will last for at least the next 10 years.

On the global fuel market, LNG is strengthening its positions at the expense of conventional gas. Over the last 10 years, global LNG exports have increased by 87 per cent, while exports of gas delivered via pipelines only rose by 6 per cent. According to widespread opinions, these trends will continue in the future, and the share of LNG in the global export of gaseous fuels will exceed 40 per cent by 2023.

The experts from the International Energy Agency (IEA) presented such predictions in a report published in June of 2018. They noted that in light of the dynamic increase in demand, an LNG supply shortage may appear on the market already in 2023. This is rather surprising, as in the recent years the possibility of an opposite scenario was discussed more.

The United States will increase its exports

By 2023, global LNG exports will increase by almost 30 per cent, reaching the level of 375 million tons (505 billion cubic meters, bcm). China will become the main importer. It will increase the imports of conventional gas by 60 per cent, to the level of 360 bcm, while its LNG imports will increase by 82 per cent, from the current level of 38 million tons (51 bcm) to 69 million tons (93 bcm) in 2023.

Investments that are have already been implemented and those planned for the next years can serve as a confirmation of the favorable trends in the LNG sales. According to the data from the late 2017, in the coming years they will increase the export capacities by 89 million tons, out of which 49 million tons will come from the Unites States and 17 million tons from Australia. In order to defend its market position, Qatar has commenced new investments, which will increase its export capacities to 100 million tons by 2024. This is a response to Australia’s plans, whose capacities will reach 75 million tons already in 2020.

However, experts emphasize that the United States may turn out to be a real black horse in this race. The six projects that have already been implemented will increase the LNG production capacity of that country to 78 million tons at the end of 2019, and if we were to include the facilities planned for completion in the following years, the production capacity of the United States would increase to 153 million tons. According to the American government agency EIA (Energy Information Administration), the United States will become the third biggest exporter of LNG after Australia and Qatar already in 2020.

Russia has missed its chance

According to popular assessments, LNG is the future of the gas market. In a report entitled „World Energy Outlook 2016”, the International Energy Agency interprets the dynamic growth of LNG production and exports as a symptom of the second gas revolution (the first one was related to the large-scale emergence of shale gas in the years 2010-2012). In an updated forecast published in November of 2018, the IEA predicts that LNG will account for 60 per cent of the global gas trade in 2040. Because of these processes, the gas market is becoming a global market, which could not be guaranteed by the traditional gas market, in which the exporter and the importer were inevitably dependent on each other and on connecting them pipelines, leading to the segmentation of the gas market into local markets.

For years, Russia has been passively observing the changes taking place in the global gas market. The Russian gas company Gazprom — oftentimes in denial of reality — failed to notice the genuine competition and threat posed by LNG to its traditional gas supplies. There are many analyses and studies confirming that Russia — seeing itself as a gas empire — identified the limits of its influence with the spread of Russian gas and the length of its gas pipelines: the further the reach of its pipelines the broader its influence. This thinking was at the heart of the official energy strategy pursued by Russia for many years, in particular in the part concerning foreign expansion.

During this time on the global gas market, new gas liquefaction and gas regasification plants have been built, and producers such as Qatar, Australia, the United States have been competing for the leading positions on the LNG market. Meanwhile, Russia has been implementing and continues to implement its costly infrastructure projects, which are often driven by its political ambitions and are frequently detached from the economic reality. These projects include, among others, Nord Stream 2, Turkish Stream, or the Power of Siberia, and before that the South Stream project, blocked by the European Union in 2014.

The first Russian LNG production terminal — Sakhalin 2, with a production capacity of 9.6-10.6 million tons — was launched in 2009. It would be difficult to call it a purely Russian project, however. The terminal, developed since the early 1990s, belonged to Shell (55 per cent), Mitsui (25 per cent), and Mitsubishi (20 per cent) until 2007. Only then, as a result of actions bearing the marks of a forced takeover, Gazprom acquired a 50 per cent stake, reducing the shares of the other participants (Shell’s stake was lowered to 27.5 per cent, Mitsiu’s to 12.5 per cent, and Mitsubishi’s to 10 per cent).

High hopes for the Arctic

In order to make up for the significant delays in relation to the trends on the global market, in October of 2010 the Russian government approved a comprehensive plan for the production of LNG on the Yamal Peninsula — the Yamal LNG. The project provided for the development of gas deposits, as well as the construction of a gas liquefaction plant with a capacity of 16.5 million tons and the necessary transport infrastructure (a sea port and an airport). Russia’s first initiative in the production of LNG has been implemented by the company Novatek. It was treated as a matter of prestige, receiving significant backing from the authorities and financial support from the state budget. The state budget covered the costs of building the Sabetta port on the Yamal Peninsula, and the nearby airport. The Yamal LNG company was granted many exemptions and privileges, especially relating to taxation.

Yamal LNG’s initial shareholders were Novatek (60 per cent stake), the French company Total (20 per cent), and the Chinese oil and gas company CNPC (20 per cent). In December of 2015, 9.9 per cent of the shares were sold to the Chinese Silk Road Fund (SRF). The current ownership structure in Yamal LNG is the following: Novatek has a 50.1 per cent stake, Total holds a 20 per cent stake, CNPC also has a 20 per cent stake, and SRF’s share is 9.9 per cent.

The first line of the Yamal LNG facility, with a capacity of 5.5 million tons, launched production at the end of 2017. The second line, with the same capacity, was launched in August of 2018, and the third line went into operation at the turn of 2018.

Forced by the competition on the international LNG market, the project’s shareholders assumed the main burden associated with purchasing and distributing the gas from the Yamal LNG facility. More than 85 per cent of the Yamal LNG production is supposed to be sold on Asian markets, and primarily on the Japanese, Chinese, and Indian markets. However, it seems that it will be very difficult to compete with the local suppliers from Malaysia, Indonesia, Australia, as well as those from Qatar, Oman, and the United States.

Due to the region’s geographical remoteness from the main sales markets and the permafrost conditions, the Yamal LNG faced serious transport and logistics challenges. It was assumed that during the 5 summer months the gas produced at the Yamal facility would be transported directly to the Asian markets, along the northern sea route through the Bering Strait. In the remaining months of the year, the gas would be transported along the western route, to the Zeebrugge LNG terminal in Belgium. A contract for the transport and storage of 8 million tons of LNG was signed with the operator of that terminal.

Due to local climatic conditions and the thick ice cover, the Yamal LNG will be serviced by a special series of fifteen ARC7 class (capable of operating at temperatures up to -52°C (-61.6°F) and navigating through an ice cover of up to 2.1 meters) increased-durability gas tankers, which have been ordered at the Korean Daewoo shipyard.

The construction of 3 new nuclear-powered icebreakers was also planned in order to secure the transport of the LNG from Yamal. In the case of the first Arktika icebreaker, which was supposed to be put into operation in December of 2017, a delay of at least two years is now signaled.

A long way to Belgium

At present, there are significant disparities between the dates of production launch (2017) and the achievement of full production capacity by the Yamal LNG project (2018/2019), and the deadlines for the construction of the necessary fleet of tankers (2018-2021) and icebreakers (2019 and subsequent years). This is starting to cause problems with the exports of the extracted raw material.

Analysts have had some doubts regarding the efficiency of the Yamal LNG project since the beginning of its implementation. The authorities exempted the facility from the export tax (30 per cent) and the tax on the extraction of raw materials in order to increase its attractiveness. Significant tax breaks were also applied at the local level. All the technological imports implemented for the purposes of the Yamal project were exempted from customs duties. The construction of the Sabetta port and the airport involved significant financial support from the budget.

Despite the strong support for the Yamal LNG project from the government, analysts indicate that its efficiency is negatively affected by the transport factor. The transportation of LNG from the Yamal facility using special tankers (according to estimates, they are twice as expensive as regular tankers) additionally accompanied by icebreakers, raises the costs up to USD2-2.5 per MBtu (which is twice as much as in the case of American LNG).

Considering that the largest part of the LNG exports will be directed to the Asian markets, including in particular the Far East, the facility’s efficiency will be negatively affected by the costs of transshipment and storage of that part of the Yamal LNG exports (8 million tons) at the Belgian Zeebrugge terminal.

According to experts, the problems with the efficiency of the Yamal LNG project  result from the divergence between the current oil prices (and, consequently, gas prices) at the level of USD50-70/barrel and the prices at the level of USD100/barrel that were used for the calculations during the design stage of the Yamal LNG facility in the years 2011-2013.

Moscow wants more investment

LNG accounts for approximately 2.4 per cent of Russian production and just over 7 per cent of its exports of natural gas. All experts agree that Russia should significantly increase its activity on the LNG market in order to defend its position on the broader energy market. Among other things, that was the basic conclusion from the discussions held during Energy Week in Moscow in 2018. In light of the threat of losing market share, it seems that this conclusion is accepted both by Russia’s government and by Gazprom, a mainstay and the entity implementing the state’s official energy doctrine, which assigns the leading role to the network of gas pipelines and further development of infrastructure in this area.

According to the plans of the Ministry of Energy, Russia should significantly strengthen its position on the global LNG market by 2035, increasing its share in the global exports from the current level of 4-5 per cent up to 15-20 per cent. In order to achieve this, however, it would be necessary to expand the production capacity from the current level of 21 million tons to 100 million tons. Novatek’s investments on the Yamal Peninsula — Arctic LNG — are supposed to make up the fundamental part of these new capacities.

The expenses associated with these plans are estimated at more than RUB10 trillion (USD165bn). In light of the existing restrictions on access to international capital markets faced by Russia and Russian entities, the financial barrier may prove to be a significant obstacle to the implementation of these plans, but it is not seen as the most important problem. It seems that the main obstacle lies in the technology. This is associated with the fact that Russia is almost completely dependent on imports, which are subject to the sanctions imposed by the United States and the European Union. And the leading suppliers of machinery and equipment for the production of LNG are western companies.

The Russian Ministry of Energy declares that Russia will be able to start its own production of up to 80 per cent of the necessary devices within the next few years, and will be able to manufacture the remaining equipment after 5-7 more years. However, many experts do not share this official optimism. They point out that Russia will not be able to become completely independent from imports also in the long term. Even the Russian Ministry of Industry and Trade is pessimistic in this regard and plans to fully base the production of LNG on domestic technology in 2035 at the earliest.

The Russian dilemma remains

According to analysts, continued attachment to traditional gas delivered through pipelines threatens Russia’s strategic interests in the global gas market. This is illustrated by the deteriorating situation of Gazprom. The fact that LNG was ignored for the last 20 years is now seen as a significant strategic error, resulting in the loss of the company’s market position. In 2008, Gazprom was a leading global company with a market capitalization of USD365bn, and its president announced that the company’s capitalization would reach USD1 trillion within the next 7-8 years. Instead Gazprom has transformed into a medium-sized company with a current capitalization of USD54bn.

Gazprom’s position on the Russian market has also weakened. It has lost its position as the most important Russian company and the „flagship” of the Russian economy, and fell to the 4^th place in terms of market capitalization. This decline became particularly visible in September of 2018, when Gazprom’s competitor on the gas market Novatek — a company that has been created from scratch and that has an incomparably lower potential — achieved a higher market capitalization. These trends are interpreted as an expression of disapproval of Gazprom’s strategy and the lack of confidence among investors in the effectiveness of its infrastructural investments. Meanwhile, Novatek’s strategy based on investing in LNG development is met with a positive reception.

Regardless of the aforementioned limitations, it will be difficult for Russia to implement its ambitious plans. Due to the dynamic development of LNG production, primarily in Australia, Qatar, United States, and Malaysia, and the proximity of the Asian market, it will be extremely difficult for Russian producers to compete on market conditions with the LNG exports sourced from deposits located in the Arctic regions. Even direct and indirect (through tax exemptions) state support will be insufficient.

Many analysts question whether it makes any sense to support the production and exports of LNG at the expense of lost tax revenues. Especially considering that sooner or later the Russian LNG exported by Novatek will start competing on the market with the Russian pipeline gas exported by Gazprom. Meanwhile, the latter constitutes an important source of Russia’s budget revenues, derived, among other things, from the 30 per cent tax on gas exports.

Sakhalin 2, Russia (Shell, CC BY-NC-ND)

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