The original sin of LNG

Every business person – secretly – dreams of controlling a monopoly.  They want everyone to beat a path to their respective doors to buy whatever is on offer. For the price and on the conditions they decide. It’s a natural urge.

The realist in us tells us that in a normal world, competition is going to make short work of this dream. But in certain businesses, monopolies or monopoly-like situations are way more frequent. Or that’s what the players in those businesses think should be. They have a feeling that the world must treat them very nicely as otherwise … .

LNG is such a business. Well, it was not until very shortly that it started to change. Right now, LNG has to deal with the biggest wave of supply excess the world has ever experienced. Many players in the industry don’t know how to deal with this. Every time they perceive some faint light and think it’s the end of the tunnel. And every time it turns out to be the headlights of the train that is going to crush them.

Let’s take a moment and feel with those poor LNG suppliers. Theirs is a hard lot. It sure is. But the situation was not unexpected. Yes, many will pretend that it is. Yet, any fair-minded observer of the LNG market should have seen this coming for many years.

Ergo, my compassion for those producers knows bounds. 

Look back 15 years. Big LNG suppliers played “Masters of the Universe”. They had big maps where they stood and debated. But not how to work the market. They allocated volumes a bit like a manorial lord of the old moved his assets around. 

The Qataris are the perfect example. They split their total LNG volumes into 3 thirds. One for Asia, one for Europe, and one for the US. That’s as good as it gets when one likes simplicity. It also smacks a bit of Napoleon Bonaparte who directed his divisions in a sandbox.

And they built terminals in the US. Those were not for selling LNG to importers but rather Natural Gas to customers. They created wholly dependent distribution companies inside the consuming markets themselves. They wanted to capture extra profits there as well. They called it “going downstream”. Most big players did this – the Qataris were only the most visible in the LNG world. 

LNG sellers also brought their supplier mindset to the consumer market. Consumers were little more than petitioners for the wares of the grandiose supplier. That’s how LNG buyers were treated during the times of high-price LNG. If you were not big, important, and had a lot of cash, they did not even talk to you.

Then came shale. The one-third allocated to the US, plus many volumes from other producers turned homeless. Never before was there so much uncontracted LNG that went into the spot market.

Understand:  future volumes must be presold to a creditworthy buyer. This comes before investors/lenders consider putting down the money to build new stuff. Consider the sales agreement to be the collateral of the LNG business. Without it, a project becomes almost impossible. 

So, here comes shale and makes the stitched together longterm agreements LNG is usually equipped with as useful as an elbow on the forehead. What to do with all that LNG now?

But the producers had no time to think this to the end. Before pain kicked in for real, the mother of all Black Swan events happened. 

Fukushima

Japan has always been the biggest LNG buyer by any metric. Because of the closure of their nuclear plants, Japan bought all LNG they could lay their hands on. At almost any price. No need to fix those volumes of new long-term contracts when the spot market is such a blast.

But as so very often, the Japan madness wore off. Japan reoriented its power production. They brought some nuclear back online and expanded the role of coal. It’s cheaper this way. But the Japanese madness had already triggered investment decisions on new monster projects. They were under construction now. The wave of uncommitted LNG grew larger once more.

And just when LNG oversupply finally started to hurt, China happened. China wanted cleaner air and directed its gaze toward gas.  Plus there was a plethora of new, smaller LNG markets with big growth potential such as Egypt and Pakistan. Once more, the overhang got absorbed, prices rose and everyone was happy. A fresh wave of LNG projects got the thumbs up. And the US – where all this madness started – turned from importer to exporter.

Each of those events was the trigger for even more LNG supply adding to the wave that crashed upon us.

This was disruption on a scale to force out old paradigms lightning fast. In came the Young Turks of LNG and not only did they reinvent the business. They also willfully ignored its fundamental nature. This comes back to bite them now. 

LNG is a longterm business. Decisions taken now will produce an effect in 5 to 10 years for another 20 years duration. Using short-term events to justify investment decisions for long-term business is never wise.

Most of the time you won’t be able to enjoy the benefit of the short-term effects. It takes many years for any project to become operational after all. And then you might be faced with a market that’s different from anything you have planned for when you signed the contract.

The old LNG folks knew this. They understood the nature of the beast. But most of them are gone or are about to go. Those still in the business have given up under the juggernaut of the Young Turks of the LNG business. 

Yes, I make a pretty open reference to the Young Turks movement in the late Ottoman Empire under Enver Pasha. Enver Pasha did not accept the reality of what the Ottoman Empire had become. That it was past its prime and a second-rate power at best. And that competition with the modern European powers would destroy it. He projected characteristics into the Empire that it could not possibly fulfill anymore. And by doing so, he hastened its downfall.

The Young Turks of LNG do the same thing now. They see a quick short-term business that should bow to the whims of market developments. They completely ignored the billions that are at stake and that markets are fickle by nature. It’s like a Ponzi scheme that moves towards its climax.

But hasn’t humanity progressed by spurts and waves? We have never done the linear thing. Humanity has always over-interpreted developments and overreacted as a result. The failures it has endured as a result had pushed whatever domain was the target of its zeal onto a new, higher level. 

The long-term nature of LNG dictates what will happen over the next 10 years. They have dictated the last 10. Keen observers of the scene should not be surprised by the current wave of LNG. And the resulting pains of project developers. They need to learn a new trade while relearning to deal with the fundamental nature of LNG.

Marus Aurelius counsels in his Meditations: “Focus on what nature demands, as if you were governed by that alone. Then do that, and accept it, unless your nature as a living being would be degraded by it. Then focus on what that nature demands, and accept that too—unless your nature as a rational being would be degraded by it.”

LNG should not try to escape its nature. It needs to accept that methane is a complex energy supply chain. Complexity demands preparedness, rehearsal, and training. Today’s world needs a clean energy source that also provides reliability and availability. 

We cannot deal with the complexity if we are not ready to go back to the roots. Looking at things through simple eyes. Without coloring or wishful thinking.

“Whatever happens to you has been waiting to happen since the beginning of time. The twining strands of fate wove both of them together: your existence and the things that happen to you.”

LNG has left the confines of the garden of Eden where it has hatched and grown for almost half a century. Sooner or later, it will rise to the challenge.

In part 3 of this series, we will look at what the Garden of Eden was. We will probe its inner workings and what this means to the current state of plentiful LNG.