LNG Shipping Market Supply Side Macro Outlook – April 2016
By James Catlin
Liquid Natural Gas – LNG – maritime trade is a crucial link in the natural gas supply chain for many nations where domestic demand outstrips available supply. These vessels transport natural gas, which has been reduced to a liquid state by cooling it to minus 162°C, achieving a volume reduction of approximately 600 to one. Upon delivery, this LNG can be stored in a liquid state until the market demands, whereupon it enters a regasification process.
Companies that engage in LNG transport include, but are not limited to, Dynagas LNG Partners LP (NYSE:DLNG), Golar LNG Limited (NASDAQ:GLNG), Golar LNG Partners LP (NASDAQ:GMLP), GasLog Ltd (NYSE:GLOG), GasLog Partners LP (NYSE:GLOP), Tsakos Energy Navigation Ltd. (NYSE:TNP), and Teekay LNG Partners L.P. (NYSE:
Here we will examine several key trends on the supply side to determine the outlook for this maritime segment. For a complete picture of the overall market, please see my LNG Shipping Market Demand Side Macro Outlook – April 2016. This combination should provide a fundamental understanding of factors that will determine the charter rate structure for these vessels going forward.
There are two distinct vessels that will be brought up over the course of this article. They are Liquid Natural Gas vessels – LNG – and Floating Storage & Regasification Units – FSRUs. The former provides the transport while the latter actually stores and converts LNG to usable form as demand dictates. FSRUs can be thought of as a substitute to land based regasification units. Obviously, both vessels occupy different parts in the supply chain and therefore have different factors that govern their respective markets. We will try to touch on both throughout this article.
During the course of my research, I noticed two factors that will play an increasing role in the supply side going forward. One has been widely discussed; an influx of vessels set to distort the current market and therefore depress rates. I will only briefly touch on that here with my own personal predictions.
However, the second and far more important could be the availability of cheap supply that could inspire a shift in the global energy landscape.
Let’s start from the beginning. For a long time, the LNG shipping industry has faced what I believe to be a sort of Chicken/Egg problem. Developing a long-term viable market requires significant investment in infrastructure such as ports, liquefaction and/or regasification facilities, transportation, natural gas power plants, perhaps fueling stations, etc. However, the lack of infrastructure creates risk for the end users subsidizing this shift in the beginning due to the uncertainty of long term and/or widespread adoption. However, I believe this may be coming to an end with major supply coming online as well as increasing availability of FSRUs and planning/construction of land based regasification terminals.
Therefore, the first part of the puzzle would be reassuring the market that the long-term supply of natural gas would be cheap and stable. Recent supply increases (with growth projected among major producers) coupled with price declines have created a fundamental shift in market perception regarding the long-term outlook of natural gas. Australia is projected to approximately double capacity by 2020. Additionally, places like Malaysia and the USA are set to become significant net exporters. This can be illustrated by a shift in plants under consideration or construction in the USA.
As of April 2016, according to Global LNG Info, the USA had officially cancelled or suspended 13 regasification units, representing almost all new capacity for imports. The ability to recover natural gas from domestic shale deposits has drastically altered the energy landscape and even made it possible for the USA to become a net exporter. Therefore, we now find 10 LNG plants proposed/under study, four plants in the planning phase, and five currently under construction. In fact, oilprice.com reports that “by 2020, when liquefaction projects are completed, the United States will have the third largest LNG export capacity in the world, behind Qatar and Australia.”
Let’s not forget that natural gas in the USA is dramatically cheaper than many other parts of the world. A simple look at LNG landed prices tells that story.
For those unfamiliar, ‘landed price’ is just a fancy way of saying price received at the terminal.
But here’s the bonus. Notice the distance between those all important Asian markets, which represent 72% of all LNG trade, and the USA? Well, that distance is about to get a whole lot shorter for about 80% of the fleet. The Panama Canal expansion will be able accommodate over 88 percent of the world’s LNG fleet, up from just 8.6 percent today. Vessels representing more attractive economies of scale will be able to cross this distance in far less time and cost.
So with all this supply coming online, I’m sure the more astute LNG aficionado will counter with the undeniable fact that much of the proposed regasification capacity has been scrapped lately, painting a gloomy picture for any positive long-run LNG demand outlook. Well, allow me to counter your counter. Yes, much of that capacity has been scrapped. But, as noted earlier, the USA has been a big part. In addition, Canada, benefiting from cheap USA natural gas pipeline connections (as has Mexico), also scrapped some capacity. Also, much of this can also be attributed to Malaysia which has experienced a dramatic shift in available supply as they transition into becoming a major exporter. Left over are a few plants that from what I can tell were not needed or actually replaced with FSRUs. Additionally, in a graph presented later on (LNG Trade Volumes 1990-2015), please note the ample regasification capacity already in the market.
My point is that there has been a dramatic shift in the LNG landscape, but global demand, which grew last year at 2.5%, remains a long-term probability, especially given these market shifts which should promote ease of access and greater competition.
As noted, FSRUs are part of that shift, so let’s take a moment to discuss their increasing role.
Increasing availability of FSRUs makes it possible to supply regions without fixed regasification units. In 2015, the largest increase in LNG imports went to Egypt and could continue in 2016 with the addition of a FSRU coming online in late 2015. So why a FSRU? In short, I think they present many advantages over a land based operation. The first is that the design already exists. This allows the terminal to focus on connecting infrastructure. Additionally, FSRUs are able to adapt to a variety of scale. They are offshore and don’t take up expensive real estate while allowing for enhanced public safety. This often requires less permitting, studies, and bureaucratic shenanigans (depending on the country, of course). All of this means they can come online years sooner than fixed regasification units and at a much lower cost. Estimates range from about 1-3 years to connect a FSRU vs. 4-6 years for a land based operation.
Additionally, FSRUs can act as a hub for small-scale LNG deliveries. Small-scale LNG provides an entry point into burgeoning/emerging markets and is an effective solution for delivering natural gas to consumers who, due to either geographic conditions or small demand, do not have access to major networks.
FSRUs are a relatively new market but should play an increasing role going forward. The could contribute to more widespread adoption of LNG from areas lacking land based regasification infrastructure, smaller population centers, smaller budgets, and/or new markets wishing to dabble in natural gas to determine the adoption potential.
Increasing adoption of FSRUs should provide a bit of a tailwind in the medium to long term going forward. Additionally, the conversion of existing LNG vessels to FSRUs as demand dictates could provide a bit of a relief valve for a developing oversupply problem on the LNG vessel front.
I believe FSRU capacity demand will increase over the coming years as some importers find FSRUs more attractive than land based facilities due to the reasons described above. While still facing an oversupply issue, the number of ships is small and a few significant charters could radically change the outlook.
Which brings us to the order book, an issue that has seen much discussion lately. Many readers already know that an influx of LNG vessels is set to hit the water in 2016 and 2017. This should further push fleet growth well ahead of demand growth, thus creating a headwind for rates further exacerbating an ongoing problem.
But how bad is the problem and how long will it persist?
According to GIIGNL, at the start of 2016, the total LNG tanker fleet totaled 449, including 23 FSRUs and 28 vessels of less than 50,000 cubic meters. At the end of 2015, the order book stood at 158 vessels, 144 of which were above 50,000 cubic meters. 52 of these vessels were set for 2016 delivery, including three of the eight FSRUs on order. Further compounding the oversupply issue is the lack of demolitions in 2015, numbering just three.
The problem facing LNG vessels is pretty obvious. We are looking at an order book exceeding 30% with over 10% fleet growth in 2016. Remember, 2015 saw just a 2.5% demand increase. Obviously, this condition contributes to disequilibrium and puts pressure on rates. Additionally, as noted in my demand side outlook, ton miles will be decreasing and could free up tonnage further compounding the oversupply issue.
The only good news is that orders have been waning since 2014. Over the course of 2015, 33 new orders were placed compared with 77 new orders in 2014. Furthermore, four LNG carriers were laid up and awaiting conversion to FSRU’s. Finally, 62 vessels are 20 years or over with 36 of those being 30 years plus.
Now, I have seen projections, from companies mostly, indicating that the oversupply issue could clear up by 2017. For instance, in GLNG’s Q4 2015presentation states that “based on current trading patterns, the order book of approximately 130 vessels will be insufficient to carry new LNG production from plants currently under construction. This deficit of LNG carriers is expected to manifest itself in the form of substantially improved utilisation and rates from 2017.”
So I did some basic math for just the LNG trade, taking into account an expected increase in demolitions and/or conversions as well as the anticipated supply coming into the market (at 84% utilization, the 2015 average) coupled with expected increases in exporting capacity from key nations.
Now, I did assume a lot and averaged quite a bit, but long story short, my math indicated the oversupply issue could clear up as soon as mid-2018 if the new LNG capacity coming online is able to find customers abroad.
Of course, the largest assumption here is that new LNG capacity coming online will do so in the expected time frame and find customers. The finding of customers is largely dependent on further development of the energy and retail market for the LNG trade.
Here is where things get less clear, so please stay with me.
As noted below, growth hasn’t been wonderful over the past five years.
Dynagas, in its Q4 2015 report, stated that the reason “LNG trade has remained relatively flat, ~240 mt, since 2011 (is) due to constrained supply.”
It projects that with new supply coming online, low prices, and the ample regasification capacity, we will see more use.
These increases represent 57% growth through 2020 and many of these destination have high ton miles associated with their routes. A dramatic reversal from the past five years. These demand projections are largely what make a forecast of a 2017 or even 2018 recovery possible, but are they reliable?
Personally, I don’t believe the customers will materialize as quickly as capacity over the coming few years so I can’t get behind a 2018 prediction of equilibrium. Probably because I don’t view it as solely a supply constraint problem.
In fact, the International Gas Union points out that “while global LNG trade reached a historic high in 2015, global nominal liquefaction capacity outstripped demand by 50 mtpa.” Global liquefaction nameplate capacity in 2015 reached 301.5 mtpa.
This makes it hard for me to believe this is simply a supply side issue that can be solved through more liquefaction capacity. Additionally, waning demand from the two largest importers (Japan and S. Korea), composing almost 50% of the market, look to free up supply. Additionally, if supply was really constrained, LNG would probably be seeing price movement to the upside reflecting the disequilibrium, which hasn’t happened.
I am therefore skeptical of a 2017 or even 2018 rebalancing unless we begin to see a significant growth on the demand front that confirms the belief that this was largely a supply constraint issue. Personally, I find predictions like the IGU’s 2021 recovery timeline far more realistic with their estimated growth at 46% over that period.
Increasing and sustainable global supply at very competitive prices appears to be a significant catalyst toward resolving the chicken/egg problem cited in the beginning. But infrastructure, ports, connections, utilities, consumers, etc., all need time to adjust. This is a process that will take years and could move much slower than those involved in the industry would like. But nevertheless a transformation appears to be underway which is the good news.
If the latest stagnant demand is a result of supply constraints, as some maintain, this issue will be resolved shortly through increasing LNG supply and the Panama Canal expansion. In fact, this scenario and solution would be very bullish for the segment since the IGU estimates that 2020’s LNG capacity could be as much as four times larger than 2015 demand.
However, if it is a combination, with less emphasis on the supply side (as I suspect), we will most likely see demand increases set the tone rather than output increases.
While watching the order book will be key to the oversupply issue, the area I will watch the most will be construction and utilization of new LNG plants coupled with increases in market demand. Obviously, if things progress slower than anticipated on this front the oversupply issue will continue longer keeping rates low. However, the opposite is also true.
In short, I believe given the current fleet profile, extensive investment in these vessels, and order book, we will need to side a demand side solution to this supply side problem as owners will be unwilling to scrap relatively new and costly ships that take years to get on the water. However, as noted in my demand side outlook, that could be a few years off given the developments on that front. Therefore, rates should continue to see pressure in the short-run. A mid-term recovery rests mostly on the shoulders of the demand side. Finally, the long-term outlook seems bullish beyond 2020 if we can keep tonnage under control and markets for LNG continue to grow or materialize at a relatively conservative pace.