World's biggest LNG project is starting in the worst market in years
After years of delays, cost overruns and labor unrest, Chevron Corp's Gorgon project, one of the world's most expensive liquefied natural gas ventures, faces another challenge: the weakest energy prices in more than a decade.
As Chevron prepares to start exports from the development off northwest Australia, oil prices -- which traditionally determine the value of LNG shipments -are languishing near 12-year lows. The project will add to a wave of new supply, including the first deliveries from the U.S., amid weakening demand.
Gorgon highlights the challenge of investing in major energy projects amid unpredictable and volatile prices. Brent crude has more than halved since Chevron decided to go ahead with the development in 2009, and its cost has ballooned to $54 billion from $37 billion. While the company says it's focused on returns over four decades, current market conditions will reduce near-term cash flows.
"Falling oil and LNG prices will greatly affect the economics of all new projects coming online now," James Taverner, a Tokyo-based analyst at industry consulting firm IHS Inc., wrote in an e-mail. "Gorgon is one of the most expensive LNG projects in the world. Low LNG prices will hurt its margins."
Chevron, which signed a preliminary supply agreement earlier this week to sell Gorgon gas to a buyer in China, is concentrating on the long term. The San Ramon, California-based company has agreements in place with buyers covering more than 80 percent of its LNG from the Gorgon and Wheatstone ventures in Australia, it said in an e-mail.
"Legacy assets such as Gorgon will drive long-term growth and create significant shareholder value for decades to come," Chevron said. "Gorgon will generate substantial earnings over its expected economic life of 40+ years."
Today, however, the market is reeling. Spot LNG prices in northeast Asia have tumbled by more than two thirds since early 2014, sliding to $5.65 per million British thermal units, the lowest since at least 2010, based on data compiled by Energy Intelligence Group. A Singapore LNG index fell for the sixth consecutive week to $5.461, according to Singapore's Energy Market Co. "The real bloodbath for spot LNG" prices will come later, said Jeff Brown, president of consulting firm FGE in Singapore, who estimates prices may fall further and trade in the $4 to $5 range between the second half of 2016 and 2018. That could prompt buyers in Asia to seek revisions to their long-term contracts, he said. Qatar's RasGas Co. last month agreed to cut the price of gas it supplies to Petronet LNG Ltd. by almost half under an existing 25-year contract with India's biggest gas importer.
"Will that start to threaten the sanctity of contracts?" Brown said. "Will buyers try to find ways to renegotiate? We don't necessarily think that contracts will get renegotiated across the board, but there will be pressure."
The world has changed since 2009, when Brent crude finished the year at about $78 a barrel. Today the costs have increased, and crude has tumbled to near $28. Gorgon is due to begin exports in early 2016, according to Chevron.
Prices have dropped well below the average $11 to $13 that Australian LNG developments starting between 2015 and 2017 need to break even, including capital costs, according to Fitch Ratings Ltd.
Australia, forecast to overtake Qatar as the world's largest supplier of supercooled gas by 2020, is boosting its exports just as those prices sink. The value of Australia's LNG shipments is forecast to rise 23 percent to almost A$21 billion in the year ending in June as a lower LNG price outlook tempers the expected 45 percent surge in export volumes, according to a government report last month.
Oil should rise to about $70 a barrel by the end of the decade, according to FGE. Low prices in the first few years hurt the cash flowing into a development like Gorgon, but they "do not make a project bad overnight," given Chevron has supply contracts spanning 25 years, Taverner of IHS said. "It is unfortunate timing to start up a long-gestating LNG project in such a weak market," he said. Origin Energy Ltd. and Santos Ltd. also have started up LNG projects in Australia in recent months. With more than 40 million tons per year of new supply being added over the next two years in Australia, Gorgon isn't alone, he said.