The recent nearly 50% drop in oil prices may slow the momentum behind the development of US liquefied natural gas (LNG) facilities, according to Fitch Ratings. Oil price declines have weakened global LNG prices and could increase Henry Hub gas pricing, weakening current US LNG project economics.
Traditional LNG sponsors have been super majors and national oil companies with a diverse portfolio of assets and strong credit quality affording them the opportunity to make through the cycle investment decisions that consider their long-term production and reserve profile. US LNG sponsors have tended to be nontraditional including smaller, less diversified international oil companies and utilities, with more limited financial resources. This generally requires them to secure tolling arrangements with fixed-price availability payments ahead of financing.
The recent drop in oil prices has tempered longer term market oil price expectations, which could challenge off-take contract negotiations creating delays and/or changing the terms of tolling arrangements. The oil and gas price outlook is a key component for a sponsor to make a final investment decision and/or off-taker to sign a long-term (e.g., 20-year) agreement. LNG project economics rely on a generous spread between oil-linked LNG and natural gas feedstock prices. Spread volatility, as illustrated by recent price movements, may challenge favorable long-term assumptions driving development of additional US liquefaction capacity.
Low Henry Hub prices in a robust oil-linked LNG pricing environment help support the US LNG value proposition. However, expectations that increasing global oil supply will exceed tepid global demand growth in the short-term have led to sharp oil price declines and weakened global LNG prices. A prolonged, material reduction in US shale oil-directed drilling could result in lower associated gas volumes potentially leading to higher Henry Hub prices.
Fitch expects natural gas prices to remain subdued over the next several years, excluding short-term volatility from weather-related demand, and oil prices to improve. This should keep the US LNG value proposition intact – Fitch long-term oil/gas price ratio of 17.0x – for projects currently under development. Nevertheless, the oil price drop could slow the momentum behind new US LNG facilities in the Federal Energy Regulatory Commission approval queue. The recent oil price decline as well as idled LNG regasification facilities in the US should act as a reminder of the financial risks associated with these costly, long-dated directional bets.