Narrowing Oil-Gas Price Ratio Challenges US LNG

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The plunging price for global benchmark Brent crude might have an outsized impact on North America's gas sector by delaying final investment decisions (FIDs) for US LNG export and petrochemical projects. The prices of oil and gas have diverged sharply in recent months, plunging the ratio of Brent to Henry Hub to its lowest level since 2009, according to Barclays analyst Sam Phillips. For example, when Brent was reaching its 2018 highs around $85 per barrel in early October, Henry Hub cash prices were averaging in the $3-teens, a 26-to-1 ratio. Late last month, with Brent falling into the low $50s/bbl and Henry Hub cash prices averaging closer to $3.25 per million Btu, the ratio was closer to 15-to-1. The oil-gas ratio was even lower for US West Texas Intermediate (WTI) at roughly 14-to-1. This fast-narrowing relationship delivers two blows to US LNG development. First, elevated winter gas prices raise the cost for US LNG based on a tolling model calculated using the Henry Hub price plus a set percentage. And second, a lower price for Brent drops contracted prices paid for LNG linked to oil, which includes most of the LNG bought in Asia. "The fact the oil-gas ratio has plunged so fast is likely to make developers and offtakers alike pause to reaccess their long-term forecasts at a minimum and could lead to some delays on pulling the trigger on a 20-year deal," Phillips told Energy Intelligence. LNG FIDs slowed dramatically following the oil price crash in 2014, and while gas prices have recently declined with early January warmth, "any sign of a return of real cold could easily push the contract back to $5 per million Btu," he added. "This would squash the oil-gas ratio even more, as there's little reason for Brent or WTI oil to rise appreciably in the near future. Although Barclays does not believe in "the staying power of either the natural gas rally or the decline in oil, current Nymex futures have led to a significant revaluation of the comparative value of oil versus natural gas," Phillips wrote in a report. What it does do is demonstrate how mercurial gas prices can be vis-à-vis oil prices. And that is not a welcome lesson for US second-wave LNG developers, he said. "With US natural gas prices up by about 50% in the past few months, the net result is that US export arbs have shrunk by more than two-thirds from recent highs. Recent history suggests that the contraction in the oil-gas ratio could lead to project delays, particularly for those projects that are further behind in the process. The ongoing US-China trade war and macro slowdown create additional uncertainty for LNG exporters." For instance, Phillips notes, the recent rally had a huge effect on US LNG costs. Excluding sunk costs for liquefaction, the variable cost to ship gas from the Gulf of Mexico to Asia and Europe rose to about $8/MMBtu and $6/MMBtu, respectively. These higher costs have chipped away at potential export arbitrage opportunities, which, while still positive, are down more than two-thirds from recent highs. The Barclays analysis has history on its side. A steady rise in the oil-gas ratio in 2010-15 was accompanied by global LNG FIDs of 25.8 million tons per year. But when crude fell, FIDs also ground to a halt, averaging just 5.9 million tons/yr (0.78 billion cubic feet per day) in 2016-17. And when oil prices began recovering last year, FIDs jumped by 18.5 million tons/yr (2.4 Bcf/d). Nonetheless, five-year dated futures paint a rosy picture for LNG exports, as the oil-gas ratio remains above historical trends, which leads Barclays analysts to conclude that several more US LNG export projects will ultimately move forward. Timing is the unknown, Phillips said. "Recent history suggests that the falloff in the oil-gas ratio might make offtakers more hesitant to sign 20-plus year deals," he said. "Moreover, this winter represents a litmus test for how US LNG exports will respond when domestic prices rise and the export arb shrinks. Given these headwinds, we believe that delays to FIDs is a possibility." * * * The Natural Gas Week composite spot wellhead price this week is $2.31/MMBtu, 15¢ less than last week and $1.61 less than the Jan. 8, 2018, average. The spot delivered-to-pipeline price this week is $3.26/MMBtu, 21¢ less than last week and $3.99 less than last year's corresponding average. Tom Haywood, Houston

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