Go with the flow: LNG sales remain strong, although the market may be set for a shake-up

Since the inception of Brunei LNG in 1972, a joint venture between the government (50%), Shell International (25%) and Mitsubishi Corporation (25%), Brunei Darussalam has developed an extensive and integrated liquefied natural gas (LNG) supply chain geared towards serving the export markets of Japan and South Korea. However, with these contracts up for renegotiation in 2012 and 2013 and the LNG market set to undergo a dramatic shift in the next 10 years, the Sultanate may need to reassess its natural gas strategy.

PRODUCTION: Natural gas production in Brunei Darussalam increased by 3.9% to 1256 mmscf per day in 2011, according to the Department of Economic Planning and Development (JPKE). The majority of this production, which is liquefied, is designated for the export market. The country currently has five LNG trains operated by Brunei LNG with a total plant capacity exceeding 7.2m tonnes per year. Some 97% of LNG produced in 2011 was exported. Exports increased by 5.3% in 2011, an illustration of the strong demand for gas in Brunei Darussalam’s two export markets, Japan and South Korea. In 2010, the last year for which statistics were available, Japan accounted for 88.7% of total LNG exports by value (BN$4.8bn, or $3.74bn), while South Korea accounted for 11.3% (BN$611.7m, or $476.4m).

As Brunei Darussalam’s long-term sales purchase agreements (SPAs) with Japanese utilities firms come up for renewal at the beginning of 2013, Brunei LNG and the government have had to make crucial decisions on how to position themselves in a fluctuating global market. Indeed, the global situation for LNG is currently in a period of uncertainty. Although natural gas prices over the past several years have begun to decouple from the oil price, there is still disquiet about the impact of crude prices on the market from LNG buyers. Moreover, in 2011, as prices on the Henry Hub market in the US effectively collapsed, global spot prices remained strong and, in some circumstances, increased.

RECENT EVENTS: The LNG market was dramatically affected by the nuclear shutdown in Japan, resulting from the earthquake and Pacific tsunami in March 2011. The natural disaster had a substantial impact on global LNG trade. As a result of the event, Japan closed all but one of its 54 nuclear reactors, which have a combined generation capacity of 48.96 GW, or 21% of the country’s total installed capacity, according to Platts.

To mitigate these losses, the Japanese government has been relying more heavily on gas-fired generation, which has led to a substantial jump in LNG imports. In the second half of 2011, LNG consumption among Japan’s top 10 power utilities companies was up 18.7% to 26.7m metric tonnes, according to the Federation of Electric Power Companies. According to estimates, Japan required 53.4m metric tonnes of LNG in 2012.

SIGNIFICANT SPIKES: Combined with additional demand from fast-growing economies such as China and India, this rapid spike in Japanese LNG consumption has led to a significant increase in prices on the spot market. The Japanese crisis, as well as high oil prices on which Asian spot LNG prices are based, saw spot prices in the second half of the year grow to an average of $15 to $16 per million British thermal units (mmbtu) from $10, with prices hitting $20 in some cases, according to an October 2011 statement by IHS Cambridge Energy Research Associates analyst Rafael McDonald, speaking to US-based publication The Street.

In the shorter term, Brunei Darussalam could potentially benefit from retaining some capacity to sell on short-term contracts or in the spot market. Despite the fact that all its LNG has been tied into long-term contracts, the country did benefit from price volatility in 2011. According to the JPKE, the Sultanate achieved an average weighted LNG price of $16.49 per mmbtu in 2011, an increase of 41.6% on 2010 and considerably higher than the $12.92 per mmbtu of 2008 when the oil price reached record levels. This was a result of the price mechanism built into long-term contracts.

However, while Brunei Darussalam did well out of the uncertainty of 2011, it might have done better if its gas was not tied up in long-term contracts. For example, Qatar was able to achieve a price of $17.12 per mmbtu in Japan in January 2012, according to a Bloomberg report citing data from the shipbroker Poten & Partners. Qatar, the world’s leading LNG supplier, has built diversion clauses into its contracts allowing it to funnel additional supply to places with the highest prices, such as Japan in 2011. While Brunei Darussalam’s 2011 average price of $16.49 per mmbtu was impressive, it was still significantly below the highest spot prices, which reached the $20 mark.

LONG LASTING: Nonetheless, the Bruneian government has built strong and lasting relationships with Japan and South Korea in LNG supply and are unlikely to forego these easily. The Energy Department at the Prime Minister’s Office stressed to OBG that the country is still pursuing its long-term contracts, a move which should ensure, in the medium term at least, the country is able to insulate itself, to some extent, from additional global supply and any potential softening of the international spot price.

However, in March 2012 Reuters reported that Tokyo Electric Power, Tokyo Gas Company and Osaka Gas Company have extended their contracts with Brunei LNG, but for less gas. According to the report, the Japanese utilities will take 3.4m tonnes per year (compared to 6.01m tonnes under the current contract) from April 2013. LNG World Shipping also reports that the contract will be shorter, at 10 years compared to 20 years under the existing deal (the second such one).

In the short to medium term, this contract could be good news. An April 2011 report by the LNG trader Vitol estimated there will be a shortfall in supply of 11bn cu metres in 2013, rising to 23bn cu metres by 2015. With such a market, Brunei Darussalam may well be able to price its additional supply strongly on short-term contracts or in the spot market. China and India will be power-hungry and looking for a regional supply of LNG over the coming years. According to an October 2012 report by Upstream, a trade magazine, Indian demand for LNG is set to double over the next five years. Meanwhile, an October 2011 report by Reuters suggested that Chinese demand for LNG is likely to increase fivefold to 44m tonnes per year by 2020.

This suggests that in the medium term Brunei Darussalam will be well placed to command strong prices for its excess LNG supply that is not locked into long-term contracts. However, in the longer term, the current tight market is unlikely to persist. Dramatic export capacity expansions in Australia and the US will dramatically alter the supply landscape over the coming decade. The former is likely to be particularly crucial for the Sultanate, as Australia will be able to directly compete in the regional market (although transport costs are likely to be more expensive). Australia is currently the fourth largest LNG exporter, with annual exports of approximately 20m tonnes a year. However, if all plans come to fruition, Australian exports could reach 80m tonnes by 2020, according to The Australian.

Beyond the region, the US could categorically change the natural gas landscape, and indeed the entire energy game, over the next decade. The development of better technology and techniques for extracting shale gas should lead the country beyond self-sufficiency to a major exporter of LNG in the coming years.

Such external factors could have a significant impact on Brunei Darussalam’s revenues from natural gas exports. Long-term contracts could insulate the country from a precipitous fall in LNG prices to some extent. However, in the longer run, the government may begin to look towards the local market and downstream petrochemicals projects in order to monetise its reserves.