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(EnergyAsia, June 8 2012, Friday) — In this inaugural OxfordPrinceton Series, EnergyAsia interviewed energy industry veteran Malcolm Johnson on the state of the global natural gas and LNG markets.

natural gas oxfordprinceton series interview with industry veteran malcolm johnson
After more than 30 years with Shell in the natural gas/LNG sector, Mr Johnson now provides private consulting services as well as teaches energy professionals attending OxfordPrinceton Programme courses. Today, he is a director of eMJay LNG Limited providing expert advice and consulting services to the natural gas/LNG industries.

His time at Shell included a stint as Strategy and Planning Manager in the UK and Germany during the period of gas liberalisation in Europe.

He helped developed a number of LNG projects including over 13 years on the Sakhalin LNG project from inception to final investment decision involving the full range of commercial activities covering governance, marketing, contract negotiations and technical-commercial interface management. He has also provided commercial advice on the Elba LNG receiving terminal expansion, floating LNG, LNG contracts and project development assurance.

Today, we publish the first part of the interview. The second part will appear on Monday, June 11.

1. We have a very interesting / unprecedented global natural gas market today.  Asian LNG prices are holding well above US$17 per million BTU, while Henry Hub gas prices are struggling to stay above US$2. What are the reasons for such an astonishing price gap for the same commodity, and for how long do you think this gap will hold?

MJ: The fundamental drivers and the structure of the Asian and US markets are different.  Given the lack of indigenous gas supply, particularly in key markets, particularly Japan, South Korea and Taiwan, the priority in Asia is security of supply and diversification of supply sources, in contrast to the US which is  a liquid market with significant supplies of  indigenous gas.
 
The Asian LNG prices are based largely on long-term contracts based on oil, whereas the US gas market  is based on gas to gas competition driven by the short term supply demand balance.

It is difficult to put a timeframe on how long such a differential is maintained.  Clearly the short term situation in Japan following the Fukushima incident has put considerable pressure on supplies as Japan comes to terms with the limited options to replace its nuclear supplies.
  
The long term nature of new LNG project development   limits the way that new supplies can be brought to market in response to short term changes in market demand.  Diversions of supplies on existing  long term contracts enable suppliers to respond to the short term demand.
  
In the longer term there are several factors that are likely to affect the price gap including but not limited to:

– Potential and timing of LNG export availability from the US
– The growth of gas consumption in the US market in response to the low prices
– On the demand side the extent and timing that nuclear capacity can be restored in Japan
– The extent to which countries like China can develop coal seam gas/shale gas to reduce their import  dependency on LNG.
– Oil price developments

2. Do you see this Asia-US price gap widening further, or is the current gap as big as it gets?

MJ: The key driver  is the alternative market price in the main LNG consuming markets. High oil prices sustain the LNG price in Asia due to the oil price linkage in long term contracts while in the US the price is driven by gas to gas competition.

Given that the short term prices in Asia are approaching oil parity and US prices are extremely low, it is difficult to see the gap widening significantly.

A key question is how long the current prices in the US are sustainable, or whether the cost of developing shale gas will rise in response to possible environmental concerns combined with the growth in US gas demand due to low prices.

3. Do you think this huge price gap is a blip, and how soon will traders be able to take advantage of this enormous arbitrage opportunity?

MJ: A price gap has existed for several years that has increased recently because of the impact of the tsunami/earthquake in Japan and the Fukushima incident and the outages in Japan’s nuclear capacity. This is likely to be maintained in the short term.  In the medium term the start up of several Australian LNG projects is likely to provide additional volumes for Asia and this coupled with additional volumes from the US could reduce the price gap.
  
Although the market differentials are smaller, the arbitrage opportunities in Europe should not be underestimated. The European market, which is closer to the US Gulf, has increasing market opportunities and a more liquid market than most importers in Asia.

4. US gas consumers (like power and petrochemical companies), supported by some politicians, absolutely love this low natgas price environment, and want to stop all plans to develop the infrastructure to export US LNG to Asia. This group faces off against the oil and gas lobby, which counts ExxonMobil and Chevron among its members? Who do you think they will succeed?

MJ: This is a classic dilemma between commercial market drivers and National Energy Policy.

From a purely commercial viewpoint the pressure to realise the arbitrage value of LNG is clear. Over the past five years the US has gone from a perceived shortage with high gas prices to a  glut of natural gas.

A significant amount of import capacity was built that now appears to be redundant and as a result the owners of these facilities are keen to build LNG plants for export capacity.  In order to build the facilities the operators will seek capacity arrangements to ensure that they have income whether the export facilities are used or not.
  
A concern for the US government must be that given the huge US demand the situation can shift very quickly from feast to famine as far as natural gas supply is concerned, particularly if gas is used in the transport sector either directly as CNG or LNG, or indirectly by liquefying gas to take advantage of the huge price differential between gas and crude prices.

5. On balance, do you think it is in the US interest to keep its growing natgas production for domestic use, or will the US be better off becoming a major LNG exporter? The anti-export group argues that cheap natgas gives US manufacturers a fighting chance to compete against Asian companies, which operate on lower labour and environmental costs. Can the US have it both ways: cheap natgas for domestic consumers and growing LNG exports?

MJ: The commercial reality is that the large price differentials between the markets will inevitably provide opportunities to LNG exporters and unless there is a national policy to restrict exports this will eventually drive up domestic gas prices. 
  
Indications by the Federal Energy Regulatory Commission (FERC) indicated proposed and potential LNG export projects totalling in excess of 100 mtpa.  Although not all of these are likely to be realised, it could significantly impact the LNG supply availability to the US market. This, coupled with increased domestic demand in what is already a huge market could put upward pressure on US gas prices. 

The extent to which the market will be affected and the rate and extent of price rises will depend on the gas production cost curve, driven largely by shale gas availability.
  
A key question is the extent to which potential US LNG export based on low US gas prices will reduce the incentive for additional investment to develop new LNG export capacity elsewhere.
 
In summary, experience over the past 10 years has taught us that markets can shift rapidly from famine to feast but the reverse is also possible in the huge US gas market

6. The issue of fracking. Do you think fracking regulations and opposition will slow down the development of shale/ unconventional gas resources in North America? By how much, in terms of timing and cost?

MJ: The meteoric rise in shale gas production has taken many people/markets by surprise. So far the environmental impacts, although recognised, have been managed.  It is too early say whether longer term environmental issues will adversely affect future development.

Some adverse consequences have been observed, for example a minor earthquake in the UK, but so far these have not adversely affected production or cost significantly.

7. Floating LNG projects. How significant an impact will FLNGs will have on the world’s natgas supplies?

MJ: There are significant reserves of natural gas offshore and uneconomic to develop via onshore terminals.
 
Floating LNG is a game changer in the LNG business. Following many years of research and development FLNG projects are moving ahead. Shell’s development of a floating facility for its Prelude field is under construction and is likely to set the trend for future developments. Other players are also seeking to develop offshore opportunities and address the challenges of offshore LNG production.

The  technical challenges should not be underestimated, not least the ability to move from field to field with varying gas qualities and the need for treatment; the requirement for liquids handling, the production facility to vessel transfer and the logistics of supplying facilities hundreds of kilometres offshore.

Despite these challenges, there are a number of potential projects that are being considered based on a range of sizes between 1 and 5 mtpa.  The amount liquids and the ability to handle them will be a key factor in the economic viability of potential projects.
  
Part 2 of this OxfordPrinceton Programme interview will be published on www.EnergyAsia.com on Monday, June 11.