LNG Projects Are Progressing, and the Payoffs Should Be Worth the Trouble

ExxonMobil, Chevron, ConocoPhillips, and Royal Dutch Shell all have expensive LNG mega-projects coming on stream in the near future.

Apr 16, 2014 at 3:45PM

The rise of LNG, or liquefied natural gas, has sparked somewhat of a revolution in the energy industry. Indeed, all of the industry's main players, including ExxonMobil (NYSE:XOM), Chevron (NYSE:CVX), ConocoPhillips (NYSE:COP), and Royal Dutch Shell (NYSE:RDS-B) are falling over each other to get a piece of the action.

However, producing LNG is not as simple as the production of traditional natural gas. For example, the facilities required to produce the supercooled natural gas, on any reasonable scale, are so expensive they are out of reach for many companies.

What's more, many LNG projects have run into trouble, and rapidly rising costs have sent budgets skyrocketing. Chevron's Gorgon project is a great example of the problems currently hampering this LNG gold rush. 

Eye-watering numbers
The Gorgon and Wheatstone Australian LNG projects are the cornerstones of Chevron's LNG strategy. These assets are a collaboration between Chevron -- which holds the majority stake -- Exxon, and Shell.

Unfortunately, the cost of getting Gorgon into production has spiraled out of control, from an initial estimate of $37 billion, projected back in September 2009, to a current figure of $52 billion. This extra $15 billion is not small change, even for Chevron and Shell.

These high costs, according to some, are due to the high cost of labor within Australia along with a strong Aussie dollar. Poor rates of productivity have also seen the first expected date of export from the site pushed back to the first quarter of 2015 instead of late 2014.

Meanwhile, Shell has made the decision to sell its holding in the Wheatstone development as part of the company's $15 billion asset divestment program. Shell has also postponed the development of its proposed $20 billion-plus Arrow LNG venture with PetroChina in Queensland.

Nevertheless, Shell has plenty of other LNG ventures in the process of development.

Specifically, Shell still owns a majority of the Prelude floating LNG venture under development in the Browse Basin and 25% of Gorgon, as mentioned. Additionally, the company owns one-sixth of the North West Shelf LNG venture.

But while costs spiral out of control across the LNG industry, forcing companies to divest assets, there is some hope for select projects, which are progressing to plan.

Ahead of plan
Exxon recently announced that the company's Papua New Guinea LNG project is slated to begin exporting LNG by the middle of 2014, ahead of schedule and below budget.

That said, when Exxon says "below budget," it means below a revised budget that is actually 25% above initial estimates. Initially the project was slated to cost $15 billion, but the new budget was revised up to $19 billion. Costs are expected to come in below $19 billion.

Still, the very fact that Exxon will finally bring one of these mega-projects on stream and on time is a relief for the industry.

Engineering challenge
The Papua New Guinea project is a good example of the challenges facing the engineers who are responsible for these LNG projects.

LNG plants have to be built near the shore, so the liquefied gas can be put onto tankers and taken to its destination. However, it is often the case that the gas reserves are located inland, meaning that gas has to be transported from the drilling site and wells, to the LNG facilities. With regard to Exxon's project, Decie Autin, manager of the PNG LNG project, explains:

The toughest part of the project I would tell you was the onshore pipeline ... We had to go from 9,000 feet, up and down a tortuous path down to the shore ... The pipeline was built above ground then had to be covered with 1 metre [3 feet] of dirt to bury it for safety and security ... This is high pressure gas pipe. You don't want anyone messing with it, because it would be dangerous.

In the end it should pay off
For the most part, however, these projects should pay off. Current predictions forecast that the price of LNG per mmBtu, or million British thermal units, will average $14 for shipments to Asia and in excess of $12 for shipments to Europe from now until 2035.

Fortunately, even though LNG projects have seen multibillion-dollar cost blowouts, the estimated final cost of production per mmbtu at the majority of these projects remains at a level that will allow oil and gas majors to turn a decent profit.

In particular, expectations are that the Gorgon projects will produce at around $12 per mmbtu and Prelude will produce for $8 per mmbtu. Remember, these projects will ship to Asia, where expectations call for LNG prices to average $15 per mmbtu during the next few decades.

That said, in comparison with ConocoPhillips' Darwin project, Gorgon and Prelude appear to be poor investments. Current numbers suggest that the Darwin project will be able to produce LNG for only $3 per mmbtu, which implies a profit margin of 400% if it ships its output to Asia.

Foolish summary
In all, it's been tough, expensive work getting LNG projects into production, but now as they come on stream, developers should be able to start reaping the benefits.

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Rupert Hargreaves owns shares of Chevron. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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