In an incredibly rapid yet somewhat overlooked shift, global trade volumes of liquefied natural gas (LNG) have doubled since 2005 -- and they're not done growing yet. Demand will continue to rise, and the countries lucky enough to be flush with natural gas reserves are racing to keep up with it.
The United States will boast 9.5 billion cubic feet per day (Bcf/d) of LNG export capacity by the end of 2019. That will make it the third-largest LNG exporter on the planet, right behind Australia and Qatar. While that alone is amazing, the U.S.'s overnight ascension up the global rankings is even more incredible: America had just 0.8 Bcf/d of export capacity at the start of 2016.
Judging by the supply growth in the U.S. and elsewhere, it seems the market will have plenty of LNG to go around. But an astonishing industry outlook published by Royal Dutch Shell (NYSE:RDS-A)(NYSE:RDS-B) sounded the alarm bells, concluding that the world soon won't have enough LNG production to meet demand. That flies in the face of what investors have been told over the years.
Is the world really headed for an LNG crunch?
Why Shell thinks an LNG shortage is possible
Countries around the globe have turned to LNG imports for various reasons -- sometimes to displace dirtier coal-fired power generation, sometimes to replace falling domestic production of natural gas, sometimes to lower geopolitical risk, and sometimes for all those reasons. Cheap and abundant natural gas reserves in Australia and the U.S. have made the global LNG boom possible, as have billions in investments planned years ago.
Royal Dutch Shell is a majority owner in a floating LNG (FLNG) facility hovering over the massive Prelude field in Australia, which is nearly 300 miles offshore. Meanwhile, Cheniere Energy (NYSEMKT:LNG), America's top LNG exporter, employs more traditional land-based liquefaction facilities along the Gulf Coast. The company actually embodies the national and global trends in the industry quite well.
Cheniere made huge bets a decade ago on the potential opportunity in LNG exports. It will see most of its production capacity (nearly half of America's total) come online between 2017 and 2019, and then it plans to kick back and let cash flows accumulate. According to Shell, that last part is the problem facing the global industry.
The awesome growth in global LNG trade, which reached 293 million metric tons in 2017, has been made possible by hundreds of billions of dollars invested in supply expansion. From 2015 to 2019, the world will add roughly 150 million tons per year of production capacity, including over 40 million tons of annual capacity expansion both this year and next. But a strange thing happens after that: Planned capacity expansions fall to virtually zero in 2020 and beyond.
What's the reason? Well, it's not because LNG consumption growth stops. To the contrary, Royal Dutch Shell expects global LNG demand to nearly double again by 2035. Instead, the global energy leader points to a stalemate between the needs of producers and buyers.
Buyers are increasingly seeking smaller and more flexible volumes in order to make LNG more competitive for an expanding list of downstream applications, ranging from industrial use to vehicle fuels. From 2011 to 2014, the average LNG supply contract had a length of over 12 years and volume of over 1.3 million tons per year. From 2015 to 2017, those metrics slipped to just seven years and 0.7 million metric tons per year.
The problem is that producers have come to rely on signing massive long-term contracts up front in order to secure the financing needed to construct export terminals. That's because export terminals are incredibly expensive to build, and financiers want revenue certainty before handing over money. Case in point: Cheniere Energy may be barreling its way toward 4.5 Bcf/d of export capacity, but it had $25.3 billion (and counting) in long-term debt at the end of 2017.
Luckily, the stalemate doesn't appear to be bad news for investors. In fact, investors stand to win almost no matter what.
A boon for business?
While investors have become accustomed to seeing Cheniere Energy announce supply agreements lasting 15 years or longer, that will become increasingly rare going forward. The good news: America's largest LNG exporter will be largely unaffected by the shifting market dynamics for the foreseeable future. That's because 85% of the company's capacity -- including most of the expansions coming online between now and the end of the decade -- is entered into long-term contracts.
Things could get interesting as existing contracts begin to expire closer to 2030, but that's a pretty long time away. The supply crunch Royal Dutch Shell is warning against is expected to become a problem in the early 2020s.
In fact, given the mismatch between supply and demand, it may make sense for Cheniere Energy to reserve a certain portion of its production capacity for spot markets, where prices have periodically tripled those in long-term contracts. And the company seems to have left that door open, as the liquefaction trains at its Corpus Christi expansion project are smaller than those at its flagship Sabine Pass facility. That would be a win for investors, perhaps providing lucrative incremental income under the right market conditions.
Royal Dutch Shell's Prelude FLNG project should be able to fly above market turbulence, too, as it's smaller and close to the world's fastest-growing LNG markets in Asia. There's almost no set of market conditions under which it couldn't thrive.
Long story short, the changing dynamics in global LNG trade appear to have caused a dramatic underinvestment in new liquefaction capacity. That could create problems for supply sold on the spot market -- especially if prices skyrocket as product becomes scarce -- and affect planning and investment in new production facilities. But Cheniere Energy and Royal Dutch Shell should avoid the worst of the fallout. In fact, it could even be a boon for business.