Global LNG Supply Shifts: An Interview With McKinsey’s Dumitru Dediu

Dimitru Dediu is an Associate Partner at McKinsey, an international management consultancy firm, and the co-author of McKinsey’s Global Gas Perspective paper. We caught up with him at Flame to discuss the prospects for the LNG market, including the challenges and opportunities involved with a supply shortage in the next decade, the impact of the Panama Canal’s expansion on LNG shipping, and the available options for an Asian LNG trading hub.
“It has to be innovation, it has to be keeping costs down, it has to be new commercial structures, it has to be working closer and better with suppliers to actually deliver the project. And projects which can simply not meet the bar – they will not be delivered.”
Shell have been talking about an impending LNG shortage, maybe in the mid 2020’s. What are your views on that – do you think it’s a real risk?
Well it’s a risk and it’s an opportunity. So we do see, because of a growth in demand that will continue to be particularly driven by the Asia-Pacific region, China and many other South East Asian economies, we see demand growing from 300 today to 400 [million tonnes per annum] going forward. Given the capacity there is today, we’ll see a supply gap of around about one hundred million tonnes per annum, all settling out by around the end of the next decade.
So who’s going to be able to actually capture that supply and make use of that then?
It’s going to be a mix of conventional projects – that is to say projects in the Middle East, maybe Russia, and some projects in East Africa – but also it’s going to be projects in the U.S. We’ll see the U.S. playing a bigger role in supplying to Asia Pacific.
What’s the balance between all of that? Will it be mainly the U.S., or closer – what do you think?
So we’ll see from this for instance 100 mmtpa (million tonnes per annum) – we’ll see about 20, 25 mmpta from Qatar alone, and then the rest will be projects in East Africa, maybe Russia, maybe some other conventional projects around the world, and possibly the gap will be filled in by projects from the U.S.
And do you think those projects are going to be new projects coming on, or ones that are maybe just increasing exports?
So it’s going to be a combination of expanding the existing plans, but it’s also going to be new projects that are sort of brownfield projects – that is to say regas terminals, traditionally import terminals, will be retrofitted into export terminals in the U.S.
Obviously everybody on the supply side wants to keep the prices down, so are we going to see more competition do you think within those existing projects as well?
That’s right. And here we talk quite a bit about cost innovation in the U.S., and how all the projects also around the world are trying to compete with each other, and to keep the costs of LNG down. And we see in the U.S. many of the projects are competitive and economic – round about seven to seven and a half dollars per mmbtu delivered LNG into Asia. And that will set quite a material marker for global LNG projects, and all projects will have to beat this price level.
So how are they going to keep those prices down though? Is this new innovation, or cost cutting… how is it going to be done?
It has to be innovation, it has to be keeping costs down, it has to be new commercial structures, it has to be working closer and better with suppliers to actually deliver the project. And projects which can simply not meet the bar – they will not be delivered.
And do you think that’s the case, that actually there are projects which are now coming online which we won’t even be talking about in a few years time.
So the projects that are now being constructed most likely will be delivered. These are already launched, and we will see that once the project is post FID they will be completed. Now what we do see is around about 1100 million tonnes of capacity announced pre-FID (so pre-investment decision). And from this 1100 mmpa of capacity we will see around only about 100 mmpa actually sanctioned to be built. So there will be around 10% of those that have been announced that will actually make it. So there will be massive competition going forward.
How difficult then is it to get investment into projects at the moment if such a low percentage will actually be going forward?
Well we’ll see that some are privileged – like the ones that have privileged upstream gas resources, like the ones in Qatar, or some parts around the world. But some will have to work very closely with suppliers to keep the cost down and actually deliver the project at the lowest cost possible. So there will be quite a bit of innovation that will be needed on all levels.
Talk to me about contract lengths. Because it sounds like when you talk about innovation, keeping costs down, all the rest of it – that sounds to me like very short contracts. Is that always now going to be the way forward?
Well, we do see a preference among LNG buyers for shorter-term contracts, and the definition for longer term-contracts has actually shortened from 20 – 25 years to 15 – 20 years. And we do see a lot of projects in the U.S. that actually need long-term contracts to secure funding from banks for the project. Now the big question is how these contracts will be made, and whether buyers are willing to accept Henry Hub pricing for these contracts, or whether they will push for oil-linked or European hub pricing, that will be preferred for many European buyers.
But do you think though that actually those prices are stable enough, that the projections are stable enough, to allow people to do that?
Right. So we see Henry Hub actually being relatively stable over the last years, and there is an enormous resource base that can supply gas from about 3 dollars per mmbtu or even less. Today Henry Hub is at 2.8 dollars per mmbtu. And we see going forward with the competition with renewables, and actually gas supplies in the U.S. keeping costs down, and figuring a way to produce gas at relatively low prices, we’ll see Henry Hub actually being rather stable at least for the coming decade.
What about an Asian trading hub – what are your views there?
So there are multiple elements that need to come into play for an Asian hub to happen. And there are many contenders for this one hub. Very likely it is just going to be one hub, because of liquidity, because of the scale that is needed to have one hub. And we see Japan, China, Singapore and many other places competing for this one position. At the moment there is no one clear winner, because, for one, you need to have well developed infrastructure, you need to have a big market, you have to also have standardised products and enough liquidity and depth in the market to enable such a hub. Now we see all of these places like Japan, China, Singapore, India, Indonesia – all having some limitations, to some extent, to establish this hub. And we’re working with some of our clients to see how we can contribute to overcoming some of these hurdles, and develop the right infrastructure – regas infrastructure, thinking about the contracting, thinking about how to bring both buyers and suppliers in the same marketplace to look at creating such a hub.
What’s your gut reaction, though? What do you think, if we were standing here in five years – five years actually sounds like a very long time now – would we see an Asian hub and where would it be?
I would say – I don’t know one, specifically – but I would say it’s most likely to be China, Singapore or Japan. If I were to bet [laughs].
That’s spread betting [laughs]. What about the Panama Canal – what are your thoughts on that?
So the Panama Canal has expanded recently, and that has enabled LNG cargoes to go through the Panama Canal to land in Asia. And this new route has enabled U.S. LNG exporters to supply Asia at a much lower cost. Now what we see is that currently there are one or two slots per day – out of twelve, that is – supplied for LNG. Going forward, given the increasing U.S. supply, we could see this going up to three or four slots. Now there are a number of things that could happen – either congestion, or the fees for Panama canal potentially coming under pressure, competing with cargo vessels or container vessels for the passage.
Let’s look ahead. I said five years, earlier – shall I just say two years now. Let’s say we were here not next year, but the year after. What sort of conversations would we be having? I think it’s fair to say that have been a few surprises in the marketplace, so two years from now what will we be talking about?
So we will probably see much more of a focus on contracting, and on contract renegotiations, given that many U.S. contracts or U.S. exports are competing with oil-linked contracts in Asia. We see quite a gap between the cost at which the U.S. can land, and the oil linked contracts in Asia – especially at higher oil prices. So we’ll see much more discussion around gas contracting, gas contract arbitration, renegotiations going forward, as well as talking about how the gap will be filled. So now we’re just starting the discussions, and we see some of the projects actually competing. But by then we’ll see even more competition over how this gap will be supplied.
I tell you what – as Flame goes on over the next few days, there will be a lot of people who are trying to position themselves to be the ones to supply it.
Absolutely.
It will be interesting to see who takes you aside for a chat as well.