The Looming Gas Glut

Companies around the world are spending billions of dollars in a scramble to start exporting ever-greater amounts of natural gas with hopes of feeding a seemingly insatiable appetite for the clean-burning fuel. There’s just one problem, which could affect everybody from New Orleans to New South Wales: The world may already have more than it needs.

So much natural gas export capacity has already come online — and there’s so much more in the pipeline — that it risks swamping what demand there will be for the stuff. Qatar, Australia, the United States, and Canada are all aboard or jumping onto the liquefied natural gas (LNG) bandwagon, but it’s unclear just who will buy it all and at what price. That has companies from Exxon to Australia’s Woodside Petroleum rethinking their ambitious gas-export plans and countries from Mozambique to Canada angling to craft incentives to reassure increasingly gun-shy natural gas investors.

"The amount of supply that we have in the works already coming online in the next five years exceeds reasonable assumptions of demand growth," said Jason Bordoff, director of the Center on Global Energy Policy at Columbia University.

Fear of a gas glut, coming just after the world began scrambling to take advantage of what the International Energy Agency (IEA) calls the "golden age of gas," underscores the cyclical nature of a business reliant on huge upfront investments and lengthy lead times. That creates the risk of a boom-and-bust cycle where companies rush to meet projected demand, then panic after everyone else does the same. Goldman Sachs said earlier this month that oversupply could put a number of currently planned, high-profile LNG projects at risk.

"Gas is the manic-depressive fossil fuel," said James Jensen, head of natural gas consultancy Jensen Associates. "When things are going badly, they can’t get any worse, and when they’re going well, they can’t get any better."

Jensen said that leads to supply and demand surpluses because "you get into a situation where the market is weak, and everybody is afraid to commit to projects that are going to come on in four or five years, and then it gets strong and everybody rushes to put in more projects."

That appears to be what’s happening now. The world already has more LNG trading capacity than it needs: There were about 286 million tons a year of LNG export capacity globally in 2013, while global LNG trade amounted to just 237 million tons.

That’s in part a reflection of a big surge by Qatar, the world’s leading exporter of liquefied natural gas. Between 2008 and 2011, Qatar built a spate of new projects and now has 77 million tons a year of LNG export capacity.

Now, other gas-producing countries are scrambling to add even more. Australia has three big LNG projects operating and seven more that will come online in the next few years. If all goes as planned, that would push Australia’s total export capacity to 83 million tons a year by 2017, which would allow the country to overtake Qatar as the world’s top LNG exporter. Even more export projects are under discussion there.

Meanwhile, the United States is moving to take advantage of its own natural gas production boom to turn from gas importer to gas exporter. The Department of Energy has conditionally approved eight U.S. LNG export projects, with a total capacity of more than 80 million tons a year; analysts expect that at least five of those projects could actually get built, with an export capacity of close to 70 million tons. Canada is also hoping to ship natural gas to Asia.

As if that weren’t enough, newcomers to the global energy boom, including countries in East Africa and the eastern Mediterranean, are also eyeing LNG exports as a way to fuel their own economic development.

The problem is figuring out just how much demand there really will be for all that gas. Asia, and especially China, is expected to be the main driver, accounting for the overwhelming bulk of natural gas demand in the years to come, according to the IEA.

But there are several huge question marks that could radically affect those projections. Japan’s imports of LNG have surged since 2011, when it shut down all its nuclear power plants in the wake of the Fukushima accident. Buying so much expensive gas is not a long-term option for Japan — fuel imports pushed the country to its first trade deficit in more than three decades. The question for Shinzo Abe’s government is not whether, but when, the country will restart at least a portion of its nuclear reactors, which would severely dampen Japanese demand for LNG.

The other big question marks are in China. In theory, as China cleans up its economy and environment, it will need a lot more natural gas. But it’s not clear just how much — or whether it has already lined up much of what it will need.

Beijing has already signed one huge, $400 billion natural gas deal with Russia to get significant amounts of Siberian gas through a pipeline. The two countries are reportedly in talks on another gas deal that would give China even more Russian gas, further reducing Beijing’s demand for expensive imported LNG. China is also trying, despite disappointing results so far, to tap into its own abundant shale reserves to ramp up its domestic production of natural gas, which, if successful, would reduce the country’s need for LNG even more.

China is also trying to rejigger its economy to make it cleaner and less reliant on energy-intensive heavy industry. Shifting the economy more toward services would curb its future need for energy: Steelworks, cement plants, and aluminum smelters suck up a lot of power, while services like finance, shopping, and health care don’t. But so far, there are limited signs that China has been able to seriously pull off much of a rebalancing.

Cleaning up China — where smog from coal pollution has become a serious health threat and a political liability — would likely lead to greater use of natural gas. But coal is still cheaper. That means that an ongoing struggle between environmental and economic imperatives will shape China’s future demand for gas.

"China is a wildcard, because essentially demand is very uncertain," Jensen said.

The implications are potentially troubling for export projects in Australia, Canada, and the United States, not to mention hopeful newcomers like Mozambique and Tanzania.

Costs for LNG terminals in Australia, particularly in western Australia, are much higher than elsewhere, due to inflated construction costs and hugely complicated projects that aim to tap into offshore, deep-water gas deposits in forbidding conditions.

The Ichthys project offshore western Australia, for example, calls for the construction of a 550-mile undersea pipeline from a gas field in the Timor Sea to an onshore LNG facility. Costs have soared 30 percent since backers pulled the trigger, from about $34 billion to about $44 billion so far. Chevron’s Gorgon project is even more nightmarish, with costs that have increased by almost 50 percent, to $54 billion.

That means the looming supply glut could hit the next planned round of Australian projects especially hard. And that would be bad news for Australia, says the Oxford Institute for Energy Studies. LNG projects currently account for one-third of all business investment in the country, and Australia is banking on natural gas exports to pick up the slack for slowdowns in coal and iron exports.

"The costs there are just staggering," Bordoff said. "Combine that with the potential for oversupply, and I think a lot of the new projects in Australia will be challenged."

The shifting supply picture is also putting Canada in a bind. Government officials, confident that the country would be well positioned to meet Asian energy needs, have maintained a tough regulatory and fiscal approach to new projects. That has frustrated some companies; Malaysia’s Petronas, for example, warned earlier this month that it might have to put the kibosh on a $32 billion LNG plant in British Columbia.

Now, the local government is reacting. On Oct. 21, the regional government sweetened tax terms to make sure it can attract that kind of hefty energy investment.

Plenty of U.S. policymakers are also worried that the slow pace of government approval for U.S. LNG projects means they risk missing the boat. Sen. Lisa Murkowski (R-Alaska), the ranking member of the Senate Energy Committee, has long warned that government foot-dragging could make U.S. projects late to the natural gas party. Since they have to wait so long for regulatory approval, projects in the United States have to wait to line up finance and start construction, which will push back the start of gas exports until the whole market is more crowded.

And while the low cost of natural gas and export terminals in the United States should give the country a leg up in competing with a flood of other new suppliers, the murkier outlook means there is still plenty of risk for the projects that are awaiting a final decision on multibillion-dollar investments.

"The window for U.S. LNG is limited," Goldman Sachs concluded, according to Bloomberg.

Not all is doom and gloom, though. There is one potentially big upside for the natural gas market: Europe.

Europe has a lot more LNG import capacity than it uses. Relatively cheap, piped gas from Russia has long been more appealing. But Russia has been threatening Ukraine, and the rest of Europe, with a disruption in energy imports all year.

Unlike previous cases where Russia cut off supplies, Europe seems genuinely spooked this time, and is trying to find alternatives to fickle Russian energy supplies. The European Commission recently concluded that LNG would be the best way for Europe to deal with any sudden supply shortfall this winter. In the future, tapping into more abundant, if still pricey, supplies of LNG might be Europe’s alternative to Russian energy blackmail.

"If there is an aggressive effort to try to reduce European dependence on Russia, that will have a strong influence on LNG markets," said Jensen.