By R. Bruce Striegler

It’s impossible to discuss natural gas markets without factoring in the price of oil, which then takes the conversation to liquefied natural gas (LNG). Patricia Mohr, Scotiabank economist and commodity specialist explains, “In the Asia Pacific region, especially Japan, which is one of the world’s biggest markets for LNG, historically prices for LNG have been tied to the landed price of crude oil in Japan, referred to as the Japanese Crude Oil Cocktail.” The term is a commonly used reference price index for long-term LNG contracts in Japan, as well as Taiwan and South Korea. It’s published monthly by the Japanese government representing the average crude oil import price into Japan.

The Canadian natural gas market is facing depressed prices in an integrated market, requiring significant capital requirements for unconventional gas drilling. This, combined with no current means to export LNG to offshore markets, lack of capital to build LNG facilities, shale gas depletion curves, and U.S. natural gas exports into eastern Canada, presents a challenge. With Canada’s exports destined solely for the U.S., now awash with its own recently developed massive shale gas supply, Canadian gas exports declined 6.1 per cent over the same period last year. Natural gas is produced in quantities in British Columbia, Alberta, Quebec, Nova Scotia and the Northwest Territories. Significant exploration of natural gas reserves is taking place offshore Nova Scotia, B.C. and Quebec. However, forecasts from the 2012 U.S. Energy Administration’s Annual Energy Outlook suggests that Canadian gas exports into the U.S. will continue to decline between now and 2035.

Canadian natural gas prices fell 36 per cent last year, together with oil prices, ending the year at US$2.46 per thousand cubic feet. This after having spent the year consistently below the US$3 level, and creating significant economic pressure for producers. Canada is the world’s fifth largest producer of natural gas at 14.1 billion cubic feet per day. Statistics from the Canadian Association of Petroleum Producers estimate Canadian year-end 2013 reserves at 69.3 trillion cubic feet. This compares to U.S. Department of Energy figures showing a sharp increase in proved natural gas reserves in 2013, more than offsetting the significant decline in 2012, and setting a new record of 354 trillion cubic feet.

Bucking the trend, in December the B.C. government generated $38 million in bonus bids for oil and gas leases to energy companies, compared with $7.8 million in December 2013. In total, B.C. generated $330 million from oil and gas leases in 2014, according to the Ministry of Natural Gas Development, and 90 per cent of all drilling activity last year took place in just one of B.C.’s four natural gas plays: the Montney. The Montney is a massive shale gas formation straddling the B.C.-Alberta border. It’s one of four major unconventional gas plays in northern B.C. but is considered the richest because of its abundance of “wet” gas (natural gas liquids).

Surging LNG production: can Canada be among

the winners?

Just as global demand for LNG continues to increase, so does global supply, with projected exports post-2015 coming from Equatorial Guinea, Australia, Indonesia, Russia, Canada and the United States. With greater competition in the global export market, demand for Canada’s LNG is at risk of decreasing. Australia especially is poised to be a challenge to would-be producers including Canada, with dramatic increases forecast for their production of LNG. Australia is well into development of required infrastructure for gas liquefaction plants and marine terminals. The industry rational is that first to market is first to lock in international contracts.

Global export capacity is expected to surge by 34 per cent, jumping from 290 million tonnes per annum (mtpa) at the end of 2013 to almost 400 mtpa by 2018. Australia in particular is in the midst of a massive LNG construction phase, with export capacity expected to more than triple over the next three years. Worldwide demand for natural gas is on the rise: 81 per cent of the forecasted growth is expected to come from non-OECD countries like India and China, with growth rates of 400 per cent in China.

Transportation sector increasing use of natural gas

The transportation sector is the single largest contributor to greenhouse gas emissions, making it a natural target for ‘clean’ fuel. Natural gas vehicles are increasing at a rate of 15 per cent per year, with 15 million operating in more than 80 countries. With commercially-produced LNG, the reduced bulk that makes LNG portable also makes it a viable transport fuel. In October last year, China unveiled a policy specifically designed to spur the transport sector’s use of LNG as part of its push to clean up the heavily polluted air of its cities. The policy targets buses, taxis and shipping. It sets a target for natural gas to fill 10 per cent of energy demand by the end of the decade. Five LNG import terminals have already sprung up along China’s east coast, and another dozen are planned.

In British Columbia, the government promotes the use of natural gas as a fuel in heavy-duty transport vehicles. Utilities can spend up to $62 million on vehicle and ferry incentives, $12 million on compressed natural gas (CNG) fuelling stations, $30.5 million on liquefied natural gas stations, for a total of $104.5 million. Utilities also have up to March 31, 2017 to deliver these programs. Abbotsford trucking company Vedder Transport operates a fleet of 50 Peterbilt 360 liquefied natural gas trucks featuring Westport HD systems. The trucks are used on routes within southern British Columbia, primarily servicing the bulk food Industry.

Royal Dutch/Shell’s market-leading investments in LNG have been widely publicized, as are its LNG-powered trucks in Canada. In October last year, it also commissioned two LNG-powered ships to service its Gulf of Mexico offshore rigs from Houston. A report by ship classifiers Det Norske Veritas last year predicted that 30 per cent of new vessels will be LNG-powered by 2020. Tankers that carry LNG are an obvious early target. Another classifier, Lloyd’s Register, said the use of LNG as a fuel will pick up from 2019 and could be as much as eight percent of global bunker fuel demand before 2025. This February, BC Ferries signed a 10-year contract with FortisBC to supply liquefied natural gas for three ferries currently under construction. The first vessel is expected to be operating in late 2016, with the other two ferries set to join the fleet the following year. Fortis will supply about 7.8 million litres of gas a year by the time all three vessels are in service.

Asian utilization of LNG continues to rise

To underscore the volume of LNG consumption in Japan, in early February Tokyo Gas, the third-largest Japanese LNG importer, reported natural gas sales last month of 1.65 billion cubic metres, equivalent to 1.2 million tonnes of LNG. That’s a rise of over four per cent compared with the same month a year ago. In the residential sector, volumes totalled 511.7 million cubic metres, up 1.2 per cent, sales in the industrial sector were 632.4 million cubic metres, a rise of 9.8 per cent. Wholesale supplies to other gas companies totalled 224.2 million cubic metres and business sector sales were little changed at 286.2 million cubic metres. A month earlier, Japan’s largest utility, Tokyo Electric Power, said its imports of LNG in January amounted to 2.28MT, up 2.9 per cent compared from 2.21MT a year ago.

Canadian natural gas production is split almost evenly, 7.95 billion cubic feet per day (CFD) is exported to the U.S. and 7.9 billion CFD is used domestically. Domestic demand is split between industrial use, including gas used in oil sand extraction, at 41 per cent, residential use at 20 per cent, electricity production accounts for 18 per cent, commercial use is 15 per cent and transportation and agriculture make up the remaining 5 per cent.

Indonesia’s Ministry of Energy and Mineral Resources is spending IDR 10.8 trillion ($849 million) over the next three years on oil and gas infrastructure, including transmission and distribution pipelines, CNG refuelling stations and floating storage and regasification units (FSRU’s) to ensure the domestic market can use more of its own resources. The government is looking to double the length of the country’s gas transmission pipeline network, work expected to take until 2025, from 7,910 km to 15,528 km, and to expand the gas distribution pipeline network from 4,629 km to 42,524 km. Domestic buyers used 54 per cent of the gas Indonesia produced last year, and Jakarta hopes infrastructure development will enable a greater shift from oil to gas in the power, industrial and transport sectors. After accounting for more than one third of global liquefied natural gas exports throughout the 1990s, Indonesia’s share of the global market is currently about 7 per cent. This declining share is a result of both growing global LNG demand and lower Indonesian exports.

Patricia Mohr says that in this volatile environment, it’s not surprising that some of the big players that have announced major plans to develop LNG processing operations and terminals in B.C. are taking a second look. “Petronas, (Malaysia’s state-owned oil and gas corporation) is an example. They’ve delayed making a decision on their Pacific Northwest LNG project. I think they probably did it because they really need to re-assess what the price outlook will be for LNG in the Asia Pacific market, under a new scenario for crude oil.”

Perhaps the federal government’s mid-February announcement that companies will receive a capital cost allowance of 30 per cent for equipment used in natural gas liquefaction and 10 per cent for buildings at a facility that liquefies natural gas, will provide the incentive needed to complete LNG deals with some of the multi-nationals who have made initial investments in B.C. Tax relief will be available for capital assets acquired between now and 2025.

Mohr says it is not obvious where prices will settle. “I think the current price for crude, both international prices as well as West Texas Intermediate (WTI) in North America is way over-sold. I expect, initially, there will be a quite a drop in drilling activity across the U.S. and Canada, as well as internationally.” Mohr forecasts that there will be a supply-side adjustment to much lower oil prices. “At these low prices, exploration and production are really almost uneconomic in most regions, except for the very low-cost producers in the Persian Gulf. I think that by the middle of this year, oil prices will start to firm-up again. But I don’t expect a big improvement, we may see it rise to just under $100 per barrel; for 2016, I’d use the forecast of about $70 per barrel.”