Is the price gap between Asian and Canadian natural gas prices on the verge of softening? It's already shed 20 per cent since its peak. Will the tightening trend diminish the incentive to build liquefied natural gas export projects off the B.C. coast?
Japanese benchmark prices for LNG in Asia have been exceptionally high since the Fukushima nuclear disaster, almost exactly three years ago. Concurrently, domestic Canadian natural gas prices have been anomalously low. The resulting "differential" between the two was $15.70 (U.S.) for one million British thermal units (MMBtu) at its widest in July, 2012. It's been that massive price gap, or arbitrage, that triggered the buy-low-sell-high opportunity to build LNG export facilities in North America, including 14 projects off the west coast of B.C.
Since July, 2012, the Asia-Canada natural gas price differential has narrowed by more than $3 MMBtu from the peak (see Figure 1). This downtrend, if it continues, is a progressive threat to the viability of proposed LNG export facilities. And the risk to further narrowing comes from the Asian side of the difference formula.
In spring 2011, soon after the Fukushima disaster, Japan began shutting down its fleet of almost 50 nuclear reactors. For the third-largest economy in the world, that meant quickly firing up new primary fuel sources to offset the loss of 13 per cent of its total energy needs (30 per cent of its electricity needs). In shunning uranium, Japan backfilled its power generation shortfall by burning more oil (240,000 barrels a day), natural gas (two billion cubic feet a day [Bcf/d]) and coal (650,000 tonnes of oil equivalent per day). More conservation of electricity – in a country that is already one of the stingiest energy users in the world – contributed to the displacement of nuclear power too (see Figure 2).
Migration back to fossil fuels was expensive for Japan. For LNG, the surge in demand caused the price per MMBtu to shoot up to $17 in 2011 from $11. Consumers not only endured shortages of electricity, but also felt the pain in their accounts.
Heavy industries like the automotive sector can't compete globally with expensive energy costs and intermittent supplies. That's one reason why the Japanese government's Basic Energy Plan is now calling for the restart of the nuclear power fleet, pending safety checks. Putting the nukes back to work is potentially radioactive for 11.3 Bcf/d of natural gas demand, and therefore prices. If (when) Japan goes nuclear again, the natural gas price differential to Canada could easily thin out a few more dollars. (Side note: Uranium stocks appear to be rebounding on the expectation of the Basic Energy Plan; natural gas has yet to respond.)
On this side of the Pacific, the coldest winter in a decade combined with moderating production growth has jacked up continental natural gas prices by a couple of dollars, thinning out the differential from the bottom up. The weather will warm up (we hope!) and the rebuilding of storage levels through the summer will moderate prices again. But Canadian natural gas is unlikely to fall back to $2 (U.S.) for 1,000 cubic feet, a price that made the cross-Pacific price arbitrage truly sweet. Long-term price expectations of around $3.50 to $4, as expressed in today's futures markets, is a more realistic assumption.
Each of the 14 Canadian LNG consortia members has complicated economic models. Each has a risk-adjusted threshold for what a sustained Asia-Canada price differential is needed to go ahead with their multibillion-dollar LNG project. Most, if not all of them, will have to contract their shipments at a lower price than what is quoted in the Asian market, so the differential in Figure 1 is most optimistic.
At a $15.70 MMBtu differential, everyone has a hat (or tanker) to throw in the LNG ring. At less than $10, only the most disciplined projects will survive the circus of dealing with all the uncertain technical, fiscal and social issues; the buffer for inevitable cost overruns would be pretty skinny.
Today, the estimated market differential is $11.50 MMBtu. Further weakness will force some of B.C.'s LNG players to go back into the ring, pick up their hat, and go home. Consternation will ensue, but that's fine. There are already too many hats in the ring.
Peter Tertzakian is chief energy economist at ARC Financial Corp. in Calgary and the author of two best-selling books, A Thousand Barrels a Second and The End of Energy Obesity.