From the Editor: LNG’s position in the hydrocarbon mix is unique [Gas in Transition]

Flush with income from high energy prices in 2022, new investment in fossil fuels across the supply chain is expected to rise 15% in 2023, according to the International Energy Agency’s (IEA) World Energy Investment Report 2023. This will bring investment back to pre-pandemic levels.

However, investment in new fossil fuel supply is expected to increase by only 6% to $950bn. Moreover, the IEA estimates that half of this increase will be eaten by inflation, implying that the real increase in expenditure is relatively low.

The report also notes that more than half of oil and gas company free cash flow has been directed into debt repayments, share buybacks and dividends. Only Middle Eastern oil companies will spend “meaningfully more in 2023” than in 2022 and they are the only subset of the industry spending more than pre-pandemic levels.

The implication is that oil supply is going to become more and more concentrated in the Middle East in particular and among OPEC members and the wider OPEC+ group more generally, which includes Russia. Moreover, Saudi Arabia’s early June decision to cut output in July by 1mn barrels confirms a pattern of a more aggressive approach to pre-emptive supply cuts to support oil prices.

These are worrying trends. The oil market may well have a scorpion’s tail as demand eventually peaks as a result of the energy transition.

And what of coal?

From a European or US perspective coal demand is in terminal long-term decline, but the global picture is very different -- coal demand reached an all-time high last year. Coal investment rose 20% in 2022 to $135bn, mostly in China, India and elsewhere in Asia-Pacific. This region also saw a drop in LNG imports last year, not because the lower carbon fuel was unwanted, but because prices were driven too high by Europe’s gas crisis amid an inelastic supply chain.

The IEA report notes that energy security concerns and power shortages in India and China led to the development of new coal mines as well as the expansion of existing brownfield sites. China added around 300mn mt of new coal production capacity, more than the rest of the world put together. At the same time, its LNG imports fell by 16mn mt, about 20%, compared with 2021, according to the country’s customs data.

Similarly, India’s LNG imports fell 16% to a five-year low of 20.55mn mt in 2022. 87 new coal mines have been awarded licences to start production since 2020 and 106 mines were offered in a seventh round of auctions in March this year. The Indian government expects total coal production in the country to exceed 1bn mt by 2023-24. 

It is not as if China and India are ignoring the energy transition – far from it. China, in particular, is a world leader in wind and solar deployment, as well as electric vehicle manufacturing and use. India’s renewable energy capacities are also growing strongly, but even with rapid rates of development, both require more coal to meet growing power demand. Coal demand would be lower if more LNG were available.

Comparing spending on coal to the IEA’s Net Zero Emissions (NZE) scenario, the report says: “The misalignment for coal is particularly striking: today’s investments are nearly six times the 2030 requirements of the NZE scenario.”

The point is that coal may be down, but it is far from out, and the potential and need for fuel switching remains immense. This is the gap which LNG needs to fill.

Not all hydrocarbons are equal

LNG is needed to displace coal in Asia, bringing early greenhouse gas emissions reductions and improvements in air quality and health. It is also needed as a counterweight to cartel control of the oil market. LNG production is increasingly diverse and there is very little likelihood of a cartel emerging.

The IEA says fossil fuel investment is muted because of concerns over rising costs, uncertainties over long-term demand, calls for greater industry action on climate change and pressure from investors to focus on returns rather than production growth.

However, these concerns should not dominate LNG investments in the same way because LNG growth can come at the expense of oil and coal.

Demand uncertainties

Russia’s cuts in pipeline gas exports to Europe have certainly spurred new investment in LNG infrastructure. According to the IEA report, including export projects already under development, a new wave of supply estimated at 170bn m3/yr is expected to hit the market in 2025-2027. About 60bn m3/yr of capacity has seen financial investment decisions since Russia’s invasion of Ukraine, “nearly double the rate of new approvals compared with the last decade.”

However, that statistic does not tell the full story. Spending levels remain well below the levels of the 2010s and, as the report notes, “2022 was far from a bumper year for investment in LNG.” The total committed capital was only $24bn, similar to levels in 2021.

On the demand side, however, EU-based companies announced or revived plans for around 130bn m3 of new LNG import capacity. Europe’s regasification capacity is expected to increase by 50bn m3/yr from 2022-2025, an increase of 20%.

At the same time, and more significantly for long-term demand, Asia is set to add over 100bn m3 of regas capacity over the same period, more than half of which will be in China. Given Asia’s heavy reliance on coal, there is more certainty about its need for LNG than in Europe.

Demand outlook should recover

According to risk consultants Timera Energy, European LNG demand, having seen a major step up in response to the loss of Russian pipeline imports, is likely to stabilise before declining moderately over the next decade. It sees Asian demand growth as the most uncertain factor shaping the LNG market in the next ten years. Although it does not downplay the uncertainties, it sees the new wave of LNG supply bringing spot LNG prices back to a level which is competitive with alternative fuels.

From 2030, strong underlying Asian demand growth is likely to support market rebalancing, offsetting declines in European LNG demand, although the price level at which Asian fuel switching takes place will be driven by the evolution of coal prices and potential carbon price signals across the region.

Timera sees Asian LNG demand rising from 250mn mt/yr (340bn m3/yr) to 400mn mt/yr (544bn m3/yr) by 2033, while European demand stays at levels similar to those of 2022.

The wave of new supply in the second half of this decade seems certain to moderate prices, but price moderation is necessary for Asian LNG demand growth. Only within Asia does sufficient potential for fuel switching exist to boost LNG demand and reduce emissions alongside fast expanding renewables.

Yet the caution displayed by the industry, as a result of legitimate concerns – uncertainty over the energy transition, rising costs as the new wave of construction drains supply chain capacities, and policy uncertainty – suggest not that too much LNG capacity is being built, but that structural under-supply of LNG could persist, booms and busts notwithstanding.

The high capital cost and long lead times of new liquefaction plants mean there will always be a lumpiness to the investment cycle, which results in self-reinforcing price volatility.

However, LNG developers have less reason for caution than other parts of the hydrocarbon complex.  The need to reduce still growing coal use in Asia is immense and urgent. The oil market carries the potential of becoming increasingly problematic, even as the world economy continues to rely upon it. Where, then, can the world turn as renewables scale up, if not LNG?