This is my last post for this year as I go into Christmas recess. I will be back on January 9th, 2017 with tons of fresh analysis poured onto the fabric of global energy. It’s going to be a fantastic year. But now – how about bringing balance to the force as my last act of 2016?
To many energy professionals, the LNG world would appear a bit like Black Magic. Those engaging in it sure must be snake charmers, black-hat wizards or even something alien featuring tentacles and five eyes.
But whatever unfounded myth surrounds LNG, nothing is more prevalent and less grounded than the belief that LNG must be some sort of horribly expensive super-gas that only rich and energy hungry Asians can afford. Spelling the word alone sure must bankrupt anyone immediately.
Even battle hardened energy experts fall for this gibberish so maybe it’s time someone tries to bring balance to the matter. In this article, I will, of course, run some numbers but it’s much more important to use common sense in order to balance the equation.
Because just as there is no such thing as two oilfields or two gas fields that can really be compared with each other, there are no two pipelines that can. However, we still are attempting to compare apples with some sort of other apples in this case. If already two pipelines cannot sensibly be compared with each other – how crazy must the calculation then become for any comparison between LNG and pipeline gas? However, let’s keep it real and simple. As a buyer of Natural Gas, you should ideally not have to care if your wares come from a Russian gas field in Siberia or from African flares. And I would agree to a point if the economic comparison would ever stand up to the test of common sense.
Unfortunately, there is little common sense in energy projects and particularly so in long-term Natural Gas supply.
As soon as people start to compare LNG and pipeline gas we are presented with some ballpark assumptions that are assumed to be true without any challenge. Anyone present at a meeting in the rooms of the Energy Union in Vienna on the subject of North Stream 2 could see this in full action. The OMV representative mindlessly repeated what he assumed to be true with not a shred of evidence at hand. It was clear to anyone from the LNG world that the man did not have a smidgen of a clue.
If one looks at the Russian pipeline system, one thing catches your attention. It’s old. Real old. So old in fact that at least parts of it need urgent rebuilding and all of it needs constant patching in order to keep it in working order.
Most of it was built by the Soviets and one of the younger pieces of the onshore system – the Druzba – counts almost 30 years. That’s pretty old – even for a pipeline. Some parts are the Methuselahs of the gas world as they have been operating since Stalin’s death.
When those pipelines were built, modern project economics were not very popular in this part of the world. Things were built for strategic reasons, not because they made economic sense. This was THE all-important reason why the Soviet system collapsed. No one cared about the money.
However, those pipelines have given the heirs easy clippings for decades as they are there and one just needs to keep the gas flowing. Little else to do.
If this system would have to be rebuilt today, this time with real project economics running the show, I strongly doubt that any of the Siberian gas would have made it to consumers. There are cheaper solutions for the consumers.
That said, now it’s there so why not use it as long as it does not fall apart? However, this is exactly what’s happening now which means that the times easy clippings are coming to a rapid end.
Let’s look at the challenge.
Russia urgently needs to replace its current gas fields producing for Europe as all the legacy fields have peaked and their production numbers go down. Much of the shortfall can be patched for a short time with stopgap measures such as bringing in gas from minor fields or better resource utilization but it is clear that in the mid- to long- run, Russia will have to develop new superfields.
Two of the most notorious are Yamal and Shtokman. Both of them are world class and would go far to ensure Russia’s position in the top league.
But both are also devilishly hard to develop. They are in the Arctic and the upstream developments have to be done in some of the most challenging circumstances. This won’t be cheap gas when it sees the light of day in the far north.
Then comes the transport challenge through a system that would have to be rebuilt from the scratch. Then whatever way one chooses for Europe. If we assume USD 3.- for the upstream development (I am guessing wildly here but you are free to put your own number) and I think I am going cheap here and another 3 USD for pipeline transport in Russia proper (again I feel really cheap here) then we have 6 USD at the Russian border or coast. Now comes the link to Europe which can be anything from little to way more than 3 USD such as Turkish Stream plus its extension to the middle of the continent would almost certainly be if we consider that a steel pipe alone wont suffice.
New Russian gas in Central Europe will probably cost something like USD 9 per MMBtu and this comes with very significant upward potential as things never are as easy as planned. Don’t agree with the numbers? Put your own in – I am waiting.
Now for LNG.
Let’s use Qatar as an example. Upstream cost is as little as 1 USD per MMBtu. Add 1,5 USD for liquefaction and another 1,5 USD for transport to North Western Europe plus a whopping 1 USD for regasification and entry into the system and voila, it’s on a North Western European hub. That adds up to USD 5.- per MMBtu with quite some downward potential.
LNG wins hands down.
How can that be? Europe still lives on the myth that LNG is always more expensive than pipeline gas and lots of executives from the gas industry will go to ridiculous lengths to support that claim.
One of the best-known graphs shows some lines where onshore pipelines are cheaper than LNG up to distances of 3500 to 4500 km depending on who did the numbers. Offshore pipelines are somewhere in the 700 to 900 km range when LNG beats them.
By that logic, virtually all Russian gas going to Central Europe is more expensive than LNG. The main Russian gas fields producing for Europe are located in Western Siberia, about 4000 km from the frontier to the European Union.
How convenient for those executives that the graphs seem to show that it’s better to buy from Russia than importing LNG. However, the above example shows that the logic is flawed.
All those graphs are grossly misleading. Putting a pipeline across uninhabited land is cheaper than putting it through densely populated areas. Crossing mountain ranges costs more than the flatlands and quite obviously, the tundra is way more challenging and hence more costly to cross than the Sahara desert. And it should be obvious that crossing squabbling transit countries will not come for free where a pipeline in one single country does not produce such hassle.
But even on the LNG side, there are not only apples to compare but rather apples, pears, strawberry and the odd watermelon. The chief distinguishing mark will be upstream cost (that’s a factor in pipeline gas as well) but also if channels or straits will have to be crossed or if there are exotic technologies that are necessary for liquefaction such as floaters.
The truth of the matter is that it’s simply impossible to honestly compare LNG and pipeline generically. What can be done is gauging the options when it comes to looking at a single scenario. Would it be cheaper to use LNG or pipelines to bring Iranian gas to Europe?
Or would LNG from West Africa be more expensive than pipeline gas from Shtokman or Yamal for Europe? Or should Japan consider a pipeline rather than LNG from Sakhalin? Or is it easier and cheaper to bring pipeline gas or LNG from the northern US to Southern Florida?
In all those scenarios, LNG will be hard to beat. The gas world and most of all LNG went through a time of monstrous cost inflation. This is over now and prices for liquefaction go down to the point where they can compete with almost anything.
There is still LNG crossing from Algeria to Italy and to Spain in spite of all the pipelines in place. And there is a lot of gas being flared in Sub-Sahara Africa that would make nice supply for Europe. This gas costs next to nothing to buy, liquefaction will run at USD 2.-, transport at USD 1.- and market access again at USD 1.-. With all the uncertainty hanging over Russian gas – maybe something to look at a bit closer.