The spark: Global events spur energy security concerns

Global events over the last couple of years have reconstituted the energy landscape and led to severe volatility and price hikes while bringing the topic of energy security to the forefront. The situation was never more apparent than in Europe, where Russia, following the West's embargo of Russian oil and oil products, retaliated by drastically curtailing gas exports to the EU, which relied on Russia for 40% of its gas demand in 2021. Russian pipeline exports to the EU and UK fell significantly to only 62 billion cubic meters (bcm) in 2022 from 139 bcm in 2021. The loss of Russian pipeline gas represented about 3% of the global market. With the global gas markets suffering a major shock, liquefied natural gas (LNG) drew renewed interest and attention as one potential remedy to address energy security concerns in Europe.

Due to its meaningful reliance on pipelined Russian natural gas, Europe lacked sufficient LNG infrastructure to fully process the sudden need for additional imported LNG. Europe is responding by quickly building out its LNG processing infrastructure and regasification capacity, including floating storage. The consulting company Eurasia Group estimates that with the addition of new terminals built under emergency programs in 2022, EU regasification capacity has risen to almost 170 bcm--enough to replace lost Russian gas supplies, albeit at higher prices.

Governments and companies in the EU announced plans for an estimated 130 bcm of new LNG import capacity since the beginning of 2022, including more than 20 projects based on floating storage regasification units (FSRUs). There are another dozen or so terminals that if built, will bring Europe's regasification capacity to almost 300 bcm, which would be well above most regional demand forecasts. Luckily, the EU escaped severe supply shortages in 2022 due to a mild winter, concerted efforts to reduce energy demand, and successful endeavors to find alternative sources of LNG. Indeed, according to the International Energy Agency (IEA), Europe imported record cargoes of LNG, increasing its imports of LNG by over 60% (or 70 bcm), to 115 million tons per annum (MMtpa).

Ignition: LNG prices and new contract signings soar

With the sudden need to replace Russian gas in Europe and LNG in short supply, natural gas prices soared globally, with the Japan Korea Market (JKM) and Dutch Title Transfer Facility (TTF) indices posting record highs and the Henry Hub index reaching heights it hadn't seen in years.

These high prices, concerns about energy security and supply, and the unprecedented differential between global LNG prices and Henry Hub, served to fuel a wave of new LNG supply contracts. Indeed, according to S&P Global Commodity Insights (SPCI), a record 70 MMtpa of new firm contracts were signed in 2022, driven by activity from eight pre-FID (final investment decision) projects in the U.S.. Liquefaction projects in the U.S., and to a lesser extent Mexico, were the overwhelming focus of supply-contract activity in 2022, with 83% of all LNG deals (preliminary and firm) signed with projects in those two countries.

Although LNG prices and contract activity was robust in 2022, new LNG liquefaction FID's came in well below IEA's expectations.

The IEA believes this was largely due to inflationary pressures on material and labor, as well as supply chain issues. It's also likely LNG producers, still feeling the sting from the 2019-2020 glut in LNG that resulted in falling prices and returns, were hesitant to bring any new LNG capacity online. Also, since it can take three to five years to construct an LNG facility, many producers were reluctant to construct such projects due to concerns about long-term economic viability and project returns given global decarbonization efforts.

Although additional LNG liquefaction capacity was underwhelming in 2022, this is going to abruptly change.

Accelerate: LNG supply ramps up

We expect European demand and a potentially belated recovery in Chinese demand will be the key driver for LNG in the next couple of years. Europe will continue to seek replacement of curtailed Russian pipeline imports, which were equivalent to 25% of the global LNG market, but will compete with Asia--and China in particular--for LNG cargoes because demand from China will increase with economic re-openings from its COVID lockdowns. Given this backdrop, new import regasification capacity being built, and a dearth of new LNG liquefaction capacity over the next couple of years, we expect the global spot LNG market will remain tight until new capacity comes online in 2025-2026. As such, prices will likely remain structurally elevated.

However, with the record amount of new contracts signed and a focus on energy security, there will be a tsunami of new liquefaction capacity coming to the market beginning in 2025-2027. In 2026, expected new capacity of approximately 64 MMtpa will exceed the previous five years combined and will boost global liquefaction capacity by roughly 13%. With another 40 MMtpa of expected supply in 2027, the LNG supply shortage will likely dissipate and the market will be more balanced with prices likely following suit.

Currently, the U.S., Qatar, and Australia account for approximately 60% of global LNG supply. The U.S., Mexico, and Qatar are expected to account for the majority of near-term LNG supply additions due to the immense momentum of supply contracts and development progress achieved in 2022. In the U.S., SPCI expects capacity to double by the end of the decade to 170 MMtpa (becoming the world's largest supplier), outpacing all other nations in LNG supply growth through 2027. In the U.S., there are currently four large projects (40 MMtpa) that have or are expected to reach FID this year, including the Plaquemines LNG Phase 2 (6.7 MMtpa), Lake Charles LNG (10 MMtpa), Port Arthur (13 MMtpa), and Rio Grande LNG (10.8 MMtpa). Once the four projects are completed, total U.S. gas exports, including both pipeline exports and LNG, could equal 30% of today's domestically available gas supply. This is building on the 25 MMtpa approved for FID in 2002 at the Plaquemines LNG Phase I (13.3 MMtpa) and the Corpus Christi LNG Stage 3 (10.4 MMtpa). There is potentially further upside as more projects and trains beyond this forecast have signed firm offtake contracts. Qatar Energy signed multiple partnership deals and contracts and is on pace to reach FID this year for 16 MMtpa on its second expansion of the Qatargas project, which with its North Filed East project, will bring the country's total export capacity to 125 MMtpa at end of 2028.

Pump the breaks: Demand to slow amid energy transition

After 2026, the prospects for LNG becomes murkier and the healthy LNG supply and demand picture could potentially begin to exhibit cracks. Many of these projects will come online just as the growth in global LNG demand likely begins to slow, possibly resulting in a market that is oversupplied. SPCI forecasts at some point in 2027 that demand will outstrip existing capacity and projects that are under construction and FID'ed. However, there is the risk that high prices could lead to a significant uptick in new liquefaction FIDs of existing pre-FID proposed projects. The continued volatility and higher prices of LNG in the spot and long-term contract markets could also dampen demand for LNG from consumers and governments; interestingly, already this spring it is telling that the return to single-digit $/mcf (million cubic feet) LNG prices has failed to re-ignite Asia-Pacific demand, and Europe continues to significantly reduce its gas consumption–-possibly representing permanent demand destruction in some regions. Moreover, the energy transition story continues to gather steam and there are doubts as to whether natural gas, or LNG for that matter, can ever be carbon neutral and labeled the "transition fuel".

Although Asian countries have long been LNG's top consumers and are primarily responsible for LNG's historical growth (Japan, South Korea, and Taiwan alone account for over 40% of the LNG traded between 2015-2022, according to BP Statistical Review of World Energy), several countries are adopting policies to limit their dependence on imported LNG. South Korea and Japan, in particular, have made it clear they will be reducing their imports of LNG and promoting other forms of energy such as nuclear and renewables to achieve decarbonization goals and energy security. South Korea plans to reduce LNG's share of electricity generation to just 9.3% by 2036 (from 30% in 2021). Japan has also announced its intentions to reduce its share of LNG in the production of electricity by 17% by 2030 and become more reliant on nuclear and renewables. Uncertainty of future LNG demand will likely cause buyers to refrain from securing new long-term contracts as contracts come up for renewal.

In China, LNG imports reduced significantly by 20% last year as prices reached all-time highs and COVID shutdowns were in place. Due to high LNG prices and China's openness to Russian gas, the country is reducing reliance on LNG and could continue to focus on cheaper, piped-in Russian and Central Asian gas. The rest of Asia remains concerned about likely higher prices and energy security that could further dampen the LNG demand growth story.

Moreover, despite Europe's frenetic build out of LNG regasification facilities, which is a near-term response to a financially and geopolitically costly dependence on natural gas, it has sharply accelerated its push to reduce its carbon footprint and instead focus on alternative and renewable energy. EU buyers have been sending mixed signals with recent contract signings. By not signing commitments beyond 2030, they are potentially signaling that they are committed to carbon emission reduction goals of 55% by 2030 and net zero by 2050. Indeed, the European Commission and Eurostat forecast that European overall gas demand could fall by 40% or more by the end of the decade.

Structurally higher LNG prices, the pace of global decarbonization implementation goals, growth in renewable energy investments, and price sensitivity could undermine growth in LNG demand in the later part of the decade. With the wave of new LNG projects coming online in 2025-2026, including unconstrained pre-FID supply, and concerns about LNG demand growth trajectories, it's possible the current tight LNG market shifts into a market that is oversupplied, resulting in lower prices and profit margins for many LNG exporters. We expect LNG expansion from the U.S. and Qatar over the next couple of years will benefit from the strong, albeit temporary, European demand and higher prices. However, after that, later-stage LNG supply from some African projects and possibly some U.S. projects may miss a window of opportunity to garner higher netbacks.