By Todd Thurlow
The shale gas revolution continued in 2013 with monthly natural gas production in the lower 48 states reaching 74.5 Bcf/d in July, the highest level of marketed production since 1973. Similarly, domestic oil production grew by 1.0 million barrels per day in 2013, the largest annual increase in history. This growth in domestic crude production, to 7.44 million barrels per day, was driven primarily by tight oil production growth in the Bakken and Eagle Ford shales. As a result, prices for both natural gas and petroleum products in the U.S. remained fairly stable, as shown in Exhibit 1.
Exhibit 1: Recent Natural Gas and Diesel Prices
Source: U.S. Energy Information Administration.
As Exhibit 1
illustrates, the price spread between natural gas and wholesale diesel of approximately $18/MMBtu remained fairly constant throughout 2013.
At the same time, the pace of LNG export license approval by the Department of Energy (DOE) accelerated with five new LNG projects receiving approval to export LNG to Non-Free Trade Agreement countries. But what has happened on the domestic, small-scale LNG front ?
Small-Scale LNG Market Development
At this time last year, the wealth of positive press highlighting new liquefaction plants, truck fleets, and marine vessels indicated continuing strong expectations. Numerous studies from notable groups suggested a strong, realizable value proposition. However, since that time some in the press have become more cautionary; industry notables such as Shell and Blu LNG have slowed their development or tabled plans, and adoption remains in the single digits. Development activity remains high and there is plenty of capital available for projects, but the process of bringing SSLNG projects to market is taking longer than expected. Exhibit 2 characterizes the current status of small-scale liquefaction facility development and suggests there is almost 5,500 kgpd of liquefaction capacity in development across the country, of which less than three percent is under construction.
Exhibit 2: Small/Mid-Scale Liquefaction Facility Development Activity
The good news, as Exhibit 2 illustrates, is the robust liquefaction project pipeline, the total of which exceeds the installed capacity of the current fleet of small scale liquefaction facilities. This pipeline clearly reflects the continued belief in the natural gas fuel value proposition. Established players like Stabilis Energy, Clean Energy, Applied Natural Gas, and Noble Energy continue to pursue liquefaction projects along with new entrants like Westpac and Waller Marine.
However, the reality is that LNG fuel adoption has been slower than hoped in part because of the commercial differences between how consumers historically purchased fuel and the needs of project-financed infrastructure. Project developers initially sought 15-year supply contracts with take-or-pay provisions to support project financing, while end users historically purchased fuel on a spot-basis or under contracts with terms rarely longer than one year.
However, suppliers are adapting by leveraging LNG supply from peak shavers and other existing sources to build a customer portfolio large enough to support development of a new liquefaction capacity. At the same time, investors willing to bear market risks are actively considering funding liquefaction projects entirely with equity, for a time, while demand builds to levels sufficient for traditional bank financing. This more incremental, organic business development approach has contributed to the slow pace of SSLNG project development.
After years of decline in the U.S. Jones Act fleet, newbuilds are once again on the rise. The fleet, nearly 200 vessels strong in 2000, is now less than half that size. Yet a combination of vessel age, pending emission regulations, and new market demand are forcing changes, and widening natural gas fuel oil price spreads are convincing operators that LNG might be the answer.
The average age of the Jones Act fleet is 22 years, with many vessels well beyond the typical operating life of most ocean-going vessels. Replacement decisions, always complex, are made more so by sulfur dioxide limits taking effect next January and nitrous oxide limits taking effect soon thereafter, challenging the selection of fuels and emissions abatement technologies.
Further, while regulatory limits are clear, enforcement is not. Though some speculate that regulatory enforcement will be intermittent at best and penalties insufficient to drive behavior, last August California levied fines against several operators. More recently, the EPA and U.S. Coast Guard started finalizing ECA enforcement guidelines. While vessel age drives replacement decisions for some vessel types, others are seeing increased market demand.
As a result of aging assets and new demand, 42 “LNG-ready” vessels are under development or construction for the Jones Act market including 23 tankers or Ro/Ro container vessels, 13 ferries, and six offshore supply boats. Given the average age of the Jones Act fleet, it’s not surprising that newbuilds feature prominently and many will be LNG-ready.
Exhibit 3: U.S. Jones Act “LNG-Ready” Vessel Announcements
Source: Pace Global
To meet growing LNG fuel demand, suppliers are stepping up on the East, West, and Gulf Coasts. In the East, Jacksonville, Florida is emerging as a first mover with TOTE signing an LNG fuel supply deal with Wespac Midstream. This deal spawned several other announcements from big-name industry participants like Clean Energy and Sempra interested in serving the Jacksonville market.
Along the West Coast, the first LNG cargo was delivered to Hawaii. For some time, high fuel prices and tightening emissions regulations drove interest in LNG from the local utilities and the Governor. For the moment, LNG importation remains at a standstill as utilities determine how best to deliver it, though numerous large and small players vie for this prize. Hawaiian LNG will provide the marine community another cargo to carry and LNG fuel on both ends of a journey. Further, Hawaiian LNG will likely be supplied from the mainland U.S., requiring deliveries by Jones Act carriers. As there are no Jones Act LNG carriers, this poses both a challenge and an opportunity.
Along the Gulf Coast, Harvey Gulf launched its first of six planned duel-fueled offshore supply vessels. While Shell retreated from its planned Geismar, Louisiana liquefaction plant, other local liquefaction projects continued development, notably the large export facilities, most of which will have excess LNG fuel available for local markets. Large liquid gas markets and extensive infrastructure along the Gulf Coast allow suppliers to deliver at attractive prices.
What does all this activity mean to the marine community? The underlying fundamentals driving the value proposition remain strong and are beginning to overcome the vessel owner’s challenges. In the short run, owners will request EPA waivers and switch to distillate, technology permitting. However, judging from previous efforts, those waivers will require clear plans and timelines for meeting the regulations, and some will choose LNG.
First to convert in the U.S. will be the coastal fleet. While tightening emissions limits are the immediate cause, the need to replace aged vessels coupled with the competitive advantage LNG provides and the risk of more stringent standards will drive fuel-switching. Operators serving dedicated routes on contract will convert first, since their business models provide predictability and time to accrue savings to offset incremental capital. Further, U.S. port operators may follow key European ports like Rotterdam in offering fee reductions for LNG-fueled vessels.
Inland vessels convert next. As vessels age and replacements are considered, inland operators will consider competitiveness and fuel options. Larger operators will develop new LNG-ready designs, perhaps taking advantage of new midstream refueling regulations. If Europe is a guide, the first LNG-only powered harbor tug is in operation.
In our view, over the next few years LNG will provide a significant portion of U.S. marine fuel demand. Vessels will convert when economically advantaged and will become anchor tenants for liquefaction plants and supply chains. Few owners recognize the strategic role they play in an LNG fuel project as an anchor tenant, and the value their fuel contract and credibility can bring a supplier.
Without this understanding, some announced their intentions before negotiating a fuel contract, thus eroding their bargaining position. – MarEx
Todd Thurlow is Vice President of Pace Global, a leading energy consulting company.