Easwaran Kanason

Co - founder of PetroEdge
Last Updated: April 15, 2019
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Business Trends
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How’s this for a first? As the world’s demand for LNG continues to grow, the world’s largest LNG supplier (Shell) has inked an innovative new deal with one of the world’s largest LNG buyers (Tokyo Gas), including a coal pricing formula link for the first time in a large-scale LNG contract. It’s a notable change in an industry that has long depended on pricing gas off crude, but could this be a sign of new things to come?

Both parties have named the deal an ‘innovative solution’, with Tokyo Gas hailing it as a ‘further diversification of price indexation’ and Shell calling it a ‘tailored solutions including flexible contract terms under a variety of pricing indices.’ Beneath the rhetoric, the actual nuts and bolts is slightly more mundane. The pricing formula link to coal indexation will only be used for part of the supply, with the remainder priced off the conventional oil & gas-linked indexation ie. Brent and Henry Hub pricing. This makes sense, since Tokyo Gas will be sourcing LNG from Shell’s global portfolio – which includes upcoming projects in Canada and the US Gulf Coast. Neither party provided the split of volumes under each pricing method, meaning that the coal-linked portion could be small, acting as a hedge.

However, it is likely that the push for this came from Tokyo Gas. As one of the world’s largest LNG buyers, Tokyo Gas has been at the forefront of redefining the strict traditions of LNG contracts. Reading between the lines, this deal most likely does not include any destination restriction clauses, a change that Tokyo Gas has been particularly pushing for. With the trajectory for Brent crude prices uncertain – owing to a difficult-to-predict balance between OPEC+ and US shale – creating a third link in the pricing formula might be a good move. Particularly since in Japan, LNG faces off directly with coal in power generation. With the general retreat from nuclear power in the country, the coal-LNG battle will intensify.

What does this mean for the rest of the industry? Could coal-linked contracts become the norm? The industry has been discussing new innovations in LNG contracts at the recent LNG2019 conference in Shanghai, while the influx of new American LNG players hungry to seal deals has unleashed a new sense of flexibility. But will there be takers?

I am not a pricing expert but the answer is maybe. While Tokyo Gas predominantly uses natural gas as its power generation fuel (hence the name), it is competing with other players using cheaper coal-based generation. So in Japan, LNG and coal are direct competitors. This is also true in South Korea and much of Southeast Asia. In the two rising Asian LNG powerhouses, however, the situation is different. In China – on track to become the world’s largest LNG buyer in the next two decades – LNG is rarely used in power generation, consumed instead by residential heating. In India – where LNG imports are also rising sharply – LNG is primarily aimed at petrochemicals and fertiliser. LNG based power generation in China and India could see a surge, of course, but that will take plenty of infrastructure, and time, to build. It is far more likely that their contracts will be based off existing LNG or natural gas benchmarks, several of which are being developed in Asia alone.

If it takes off  the coal-link LNG formula is likely to remain a Asian-based development. But with the huge volumes demanded by countries in this region, that’s still a very big niche. Enough perhaps for the innovation to slowly gain traction elsewhere, next stop -  Europe?

The Shell-Tokyo Gas Deal:

Contract – April 2020-March 2030 (10 Years)

Volume – 500,000 metric tons per year

Source – Shell global portfolio

Pricing – Formula based on coal and oil & gas-linked indexes

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In 2018, the United States consumed more energy than ever before

U.S. total energy consumption

Source: U.S. Energy Information Administration, Monthly Energy Review

Primary energy consumption in the United States reached a record high of 101.3 quadrillion British thermal units (Btu) in 2018, up 4% from 2017 and 0.3% above the previous record set in 2007. The increase in 2018 was the largest increase in energy consumption, in both absolute and percentage terms, since 2010.

Consumption of fossil fuels—petroleum, natural gas, and coal—grew by 4% in 2018 and accounted for 80% of U.S. total energy consumption. Natural gas consumption reached a record high, rising by 10% from 2017. This increase in natural gas, along with relatively smaller increases in the consumption of petroleum fuels, renewable energy, and nuclear electric power, more than offset a 4% decline in coal consumption.

U.S. total energy consumption

Source: U.S. Energy Information Administration, Monthly Energy Review

Petroleum consumption in the United States increased to 20.5 million barrels per day (b/d), or 37 quadrillion Btu in 2018, up nearly 500,000 b/d from 2017 and the highest level since 2007. Growth was driven primarily by increased use in the industrial sector, which grew by about 200,000 b/d in 2018. The transportation sector grew by about 140,000 b/d in 2018 as a result of increased demand for fuels such as petroleum diesel and jet fuel.

Natural gas consumption in the United States reached a record high 83.1 billion cubic feet/day (Bcf/d), the equivalent of 31 quadrillion Btu, in 2018. Natural gas use rose across all sectors in 2018, primarily driven by weather-related factors that increased demand for space heating during the winter and for air conditioning during the summer. As more natural gas-fired power plants came online and existing natural gas-fired power plants were used more often, natural gas consumption in the electric power sector increased 15% from 2017 levels to 29.1 Bcf/d. Natural gas consumption also grew in the residential, commercial, and industrial sectors in 2018, increasing 13%, 10%, and 4% compared with 2017 levels, respectively.

Coal consumption in the United States fell to 688 million short tons (13 quadrillion Btu) in 2018, the fifth consecutive year of decline. Almost all of the reduction came from the electric power sector, which fell 4% from 2017 levels. Coal-fired power plants continued to be displaced by newer, more efficient natural gas and renewable power generation sources. In 2018, 12.9 gigawatts (GW) of coal-fired capacity were retired, while 14.6 GW of net natural gas-fired capacity were added.

U.S. fossil fuel energy consumption by sector

Source: U.S. Energy Information Administration, Monthly Energy Review

Renewable energy consumption in the United States reached a record high 11.5 quadrillion Btu in 2018, rising 3% from 2017, largely driven by the addition of new wind and solar power plants. Wind electricity consumption increased by 8% while solar consumption rose 22%. Biomass consumption, primarily in the form of transportation fuels such as fuel ethanol and biodiesel, accounted for 45% of all renewable consumption in 2018, up 1% from 2017 levels. Increases in wind, solar, and biomass consumption were partially offset by a 3% decrease in hydroelectricity consumption.

U.S. energy consumption of selected fuels

Source: U.S. Energy Information Administration, Monthly Energy Review

Nuclear consumption in the United States increased less than 1% compared with 2017 levels but still set a record for electricity generation in 2018. The number of total operable nuclear generating units decreased to 98 in September 2018 when the Oyster Creek Nuclear Generating Station in New Jersey was retired. Annual average nuclear capacity factors, which reflect the use of power plants, were slightly higher at 92.6% in 2018 compared with 92.2% in 2017.

More information about total energy consumption, production, trade, and emissions is available in EIA’s Monthly Energy Review.

April, 17 2019
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April, 17 2019
Your Weekly Update: 8 - 12 April 2019

Market Watch

Headline crude prices for the week beginning 8 April 2019 – Brent: US$70/b; WTI: US$63/b

  • Crude oil futures continue to extend their gains in its best quarterly performance in a decade, touching US$70/b for Brent as an escalation of violence in Libya spooked the market
  • Fighting between the Libyan government and forces of strongman Khalifa Haftar lifted prices on supply-side risks, just a couple of weeks after Libya’s largest field restarted output
  • OPEC chimed in on the situation, with Saudi Arabia stating that oil markets were ‘moving in the right direction’ with no need to ‘deepen output curbs’, walking back on the Kingdom’s stance ahead of OPEC’s June meeting
  • Also within OPEC, power failures in Venezuela reportedly slashed the country’s crude output by half with the outages causing production to dip below 600,000 b/d at peak; meanwhile, the US has begun to sanction companies delivering Venezuelan crude including firms in Liberia and Greece
  • In the US, recent figures show that US crude oil exports hit a record 3.6 mmb/d while total crude and product exports reached 8.2 mmb/d, with markets expanding from just 10 five years ago to 24 countries including South Korea, the UK, the Netherlands and China
  • After six consecutive weeks of declines that brought the active US rig count almost below 1000, the Baker Hughes index showed a big jump of 19 rigs – 15 oil and 4 gas – to 1025 active sites
  • Crude oil prices should be trading with an upward slant – Brent at US$69-71/b and WTI at US$61-63/b – but a change of heart within OPEC on the crude deal extension could cap gains


Headlines of the week

Upstream

  • US President Donald Trump has issued a new permit by executive order approving TransCanada’s Keystone XL pipeline, aiming to circumvent a court ruling that blocked the project on environmental concerns
  • Lukoil and its Kazakh partner KazMunayGas have signed a contract to jointly explore and develop the Zhenis block of the Caspian Sea on a 50:50 basis
  • With Saudi Aramco releasing official reports on its finances and production ahead of its planned IPO, the report revealed that its giant Ghawar field was only producing at some 3.8 mmb/d, far lower than the presumed 5 mmb/d that had become conventional wisdom in the market

Midstream & Downstream

  • ExxonMobil has sanctioned a major expansion at its refinery in Singapore, aiming to convert fuel oil and other bottom-of-the-barrel products into lubricant base oils and other low-sulfur distillates as it grapples with new IMO regulations that will significantly reduce demand for fuel oil
  • Chevron’s takeover of the Pasadena Refining System plant from Petrobras has stalled from its planned April 2 date to an indeterminate Q219 timeline
  • Curacao has renewed efforts to find an operator for its 335 kb/d Isla refinery, after Motiva and a Chinese firm dropped out of the running, while its current operator PDVSA faces challenging conditions from American sanctions
  • Adnoc has signed a major long-term contract for its Group III base oils from the Ruwais refinery to Xiamen Sinolook Oil, a major Chinese base oil trader
  • Sinopec confirmed that its Jiujiang Petrochemical refinery in Jiangxi has begun to produce clean gasoline after a 300 mtpa alkylation unit was installed last year
  • The US EIA confirmed that US refineries racked up a fifth consecutive year of record refinery runs, averaging 17.3 mmb/d in 2018 with a peak of 18 mmb/d
  • Greece’s attempt to sell a majority stake in state oil refiner Hellenic Petroleum has failed with no binding bids received, despite interest from Glencore, Vitol and Algerian state firm Sonatrach

Natural Gas/LNG

  • Shell has inked a new type of LNG contract with Tokyo Gas, signing a 10-year deal for 500,000 tpa with the pricing formula linked to coal indexation instead of the traditional link to crude oil, aligning LNG with a rival power fuel
  • While LNG continues to roll forth on the US coast of the Gulf of Mexico, a Mexican project has also gained approval, with the 7.6 mtpa Energia Costa Azul by Sempra Energy winning US approval to receive US natural gas for processing into LNG that can be re-exported to other countries
  • Marathon Oil has signed a contract to process natural gas from Noble’s Alen field at the Punta Europa site in Equatorial Guinea, merging it with LNG and LPG output currently sourced from Marathon’s own Alba gas/condensate field
  • Japan’s utility major JERA has signed up with the LNG Canada project in Kitimat to purchase up to 1.2 mtpa of LNG beginning 2024 for 15 years
  • Oil Search and its partners Total, Kumul Petroleum and ExxonMobil have formally signed an agreement with Papua New Guinea to develop the offshore Elk-Antelope and P’nyang gas fields, with a planned capacity of 5.4 mtpa
  • Australia’s Woodside has signed a 10-year sales agreement with China’s ENN for supplying 1 million tpa of LNG from the Scarborough field beginning 2025
April, 12 2019