Why gas export projects suffer from high development costs?

Only a fraction of the natural gas export projects being developed around the globe will become reality as high costs and weakening gas prices torpedo those that until recently promised huge returns on investment.

Large natural gas field discoveries on and offshore have prompted several countries to plan liquefied natural gas (LNG) export projects, including in North America, Australia, East Africa and the east Mediterranean.

But high development costs and low profit margins in the gas sector mean most of the projects will fail, Royal Dutch Shell’s director of projects and technology told Reuters in an interview.

“There is always so much talk about these big LNG projects around the world, but only a small fraction of them will get built,” said Matthias Bichsel, who is also a member of Shell’s Executive Committee. “Costs in the oil and gas sector are still on the rise and outpacing inflation, and gas projects are extremely price-sensitive because the margins are so thin,” he added.

European forward gas prices, which are used to make investment decisions for big pipeline and gas field projects, have dropped more than 15% since the beginning of the year.

They are close to five-year lows, and most analysts expect further declines as new producers flood markets with gas. Analysts have said many new gas projects will struggle to make the return on investment necessary to receive the required financing.

In Asia, where 70% of global LNG trading takes place, spot LNG prices have fallen more than 35% this year to their lowest since late 2012.

In the east Mediterranean, where Israel and Cyprus have discovered large offshore gas fields, Australia’s Woodside Petroleum last month pulled out of an agreement to take a stake worth up to $2.7bn in Israel’s flagship Leviathan gas project.

Woodside is a specialist LNG developer and was targeting sales in Asia with its involvement in Israel.

“After many months of negotiations it is time to acknowledge we will not get there under the current proposal,” Woodside CEO Peter Coleman said at the time. In Central Asia, France’s Total pulled out of Azerbaijan’s huge Shah Deniz II gas project, which is expected to produce 16bn cubic metres (bcm) of gas for export to Turkey and Europe towards the end of this decade.

Norway’s Statoil had reduced its stake in the project in May.

In North America, several LNG export terminals are also beginning to have trouble attracting buyers.

In East Africa, where impoverished Mozambique and Tanzania hope recent offshore gas discoveries can bring future wealth, analysts have said developers will struggle to find necessary financing and that costly production delays are likely.

“I believe the speed with which the East African projects have been promised is somewhat ambitious since all infrastructure there has to be built from scratch,” Shell’s Bichsel said. Mozambique and Tanzania hope to export their first cargoes around the turn of the decade. In Asia, uncertainty over future pricing of LNG has led consumers to hold off signing 20-year deals amid expectations that prices will soon enter a period of decline.

As a result, final investment decisions on new projects have come to a virtual standstill, while cost blowouts in Australia are further deterring investors from signing up. Bichsel said that in Australia, which hopes to overtake Qatar as the world’s biggest LNG exporter, high labour costs had caused problems for developers.

Shell is building the world’s first floating liquefied natural gas (FLNG) project in Australia, named Prelude, which will be the biggest maritime vessel ever constructed. Despite the troubled perspective for many gas projects, Bichsel said the outlook for the sector was positive. “We’re quite excited about gas, there is a lot it can be used for, for instance gas to liquids, gas for transport or gas to chemicals, and there’s also a lot of work being done to bring down the production costs of LNG,” he said.

“In oil, it’s more maintaining production but in the long term, we’re talking decades ahead, we see a decrease in oil demand and gas will take a more prominent role, including from shale gas. But it’ll take time.”