SINGAPORE--The world's two biggest producers of liquefied
natural gas-- Royal Dutch Shell PLC and BG Group PLC--are planning
a tie-up worth nearly $70 billion just as conditions for the fuel
in Asia, the region that consumes more LNG than any other, are at
their worst in years.
Until recently, prices for LNG--supercooled so it can be
liquefied for export--have been much higher in Asia than in either
the U.S. or Europe. In part that is because demand for gas has been
growing in countries like China and Japan. Three-quarters of the
world's LNG demand comes from the Asia region, according to the
International Group of Liquefied Natural Gas Importers.
But LNG prices have tumbled in recent months in tandem with the
slide in global oil prices. Sales of LNG in Asia are often based on
long-term contracts, often around 20 years in duration, with prices
linked to oil. About 25% of sales are made on a shorter-term basis,
with spot prices pressured by both cheaper oil and new
supplies.
Spot Asian LNG prices have now fallen to levels last seen before
the 2011 Fukushima nuclear accident led to an increase in Japanese
gas demand. They have dropped from a peak of around $20 a mmBtu in
February last year to less than $7 a mmBtu, roughly in line with
gas prices in Europe though still higher than prices in the
U.S.
Shell and BG didn't respond to questions Friday, but their
executives dismissed any concerns about falling LNG and oil prices
at a news conference on Wednesday. BG Chairman Andrew Gould echoed
the opinion of some analysts who say an LNG behemoth could
withstand the industry's problems.
"In the lower price oil environment that this industry is
facing, there will be strength in scale," Mr. Gould said.
Shell's acquisition of BG would create the world's dominant
producer and supplier of LNG and is a bet that countries like China
and India will eventually use less coal and more cleaner-burning
natural gas. Together, the two companies produced 45 million tons
of LNG last year, nearly 20% of the total global output.
But the company's strategy is linked heavily to energy prices
and doesn't produce significant profits until oil prices recover to
about $90 a barrel, from about $58 on Friday.
The merger also comes as demand for LNG in Europe has been
declining since 2011 due to recession. In 2014, European
consumption fell to a 10-year low, according to recent figures from
BG. Last year, European demand was about 14% of the global market,
BG said.
BG said last month it expects LNG prices to become more volatile
over the next few years, even as a wave of new supplies begins
reaching Asia and new markets in Egypt, Jordan, Pakistan, the
Philippines and Poland.
The weakness in Asia's LNG market is expected to reverse in the
longer term, but the price drop has, for now, put the economics of
some major global LNG projects in question--including those owned
by Shell and BG.
In December, BG reached a milestone when it shipped the first
LNG cargo from its Queensland Curtis facility in Australia, in
which it had invested $20.4 billion. But the company had to take a
$4.1 billion write-down on the project this year, driven mainly by
a reduction in the company's assumptions about future energy
prices.
"When you get married you don't choose all of the relations.
They just come as a set," said David James Hewitt, head of Asian
oil and gas research at Credit Suisse. "I don't think anyone would
pretend that the [QCLNG] asset is attractive from an
economic-return perspective."
BG's QCLNG plant had already been bedeviled by cost overruns.
Australia remains one of the world's most expensive places for gas
projects, with the cost of projects rising fourfold in the past
decade. Currency fluctuations, high commodity prices and a shortage
of labor at a time of high demand contributed to the steep rise in
costs.
BG is also feeling the effect of lower LNG prices in Asia in its
trading business. Like other oil and gas producers, BG makes money
not just from producing gas, but also by contracting LNG supplies
from other producers and selling them into higher-priced
markets.
BG's revenue and other operating income fell 32% in the fourth
quarter in its LNG shipping and marketing business. In the quarter,
BG supplied 30 cargoes into Asia, compared with 37 in the
corresponding period a year earlier.
With Asia no longer commanding premium prices, BG may also have
trouble finding a market for the first LNG exports from the U.S.
later this year.
"The portfolio players were betting on an expensive [Asian]
market, to buy low and sell high. Now they have to buy high and
sell low," said Vivek Chandra, CEO of Texas LNG, a project lining
up to export LNG from the U.S. "There are simply lesser margins for
them to play with."
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