The Australian Coal Seam Gas (CSG)-to-Liquid-Natural-Gas (LNG) industry began auspiciously, with its champions promising export revenue, royalties and jobs.

The three plants at Gladstone were built during one of the great resource booms of the past 100 years. Demand out of Asia for LNG appeared almost limitless at the beginning of this decade.

However, demand by the world’s largest LNG importer, Japan, has been shrinking, and growth in China and other emerging markets has failed to keep up with the boom in supply. Nominal global liquefaction capacity closed 2016 significantly oversupplied— 29 per cent above demand, and the gap between supply and demand widened over the year despite very low prices.

Even with growth in some emerging markets, and growth in some developed markets like South Korean and Taiwan, the global LNG market remains significantly over supplied.

This glut in global supply will very likely deepen, until 2020 at least, by which time supply will have increased by 34 per cent to 456 MTPA. Global demand will simply not take up the slack.

IEEFA expects that the expanding glut will put relentless downward pressure on prices and lead to many contract defaults and renegotiations.

It is a truism in the LNG supply industry that the product is expensive to store, so the glut we describe in this paper can only be resolved by LNG processing capacity being curtailed.

In all resource markets, highest-cost producers have to curtail production first.

The three Gladstone plants sit at the very apex of the global cost curve, so these plants that will feel the pressure to shut in capacity most acutely. IEEFA expects some liquefaction trains at Gladstone to cease production altogether over the next two years.

The LNG industry in Eastern Australia is fundamentally weak because its elements were developed in the wrong order.

Export contracts were secured, plants were approved with no consideration of the domestic market, plants were built and finally gas fields were developed. Along the way, the gas industry failed to contain the cost of building three plants concurrently, a misstep that led to globally uncompetitive capital costs.

The industry found that when it went to drill for gas— after having secured gas contracts and built the plants—that the CSG fields that were expected to supply the plaints failed to produce the gas expected.

Capital costs of the plants at Gladstone, and operating costs of the gas fields that supply Gladstone, are globally uncompetitive.

What is particularly worrying for the industry in this case is that the very best CSG fields have been drilled, and costs will rise further from here.

IEEFA estimates that if Santos were to write down the value of its Gladstone investment, GLNG, to global comparatives it would amount to a write off up to $3.3 billion. Origin Energy would face write downs of a similar magnitude on its investment in APLNG.

Source: IEEFA. Reproduced with permission.