Decrypting Yemen’s LNG Future

A year ago Yemen joined the ranks of the world’s liquefied natural gas (LNG) exporters, launching a two-train liquefaction terminal at the port of Balhaf. The 6.7mn tonne per annum (tpa) plant is significantly diversifying the country’s industrial base, commercialising a valuable natural resource that until then had been flared, re-injected into oil fields, or simply left in the ground.

Moreover, given the strong economies of scale accompanying liquefaction projects, the Yemen LNG (YLNG) terminal could easily be expanded in the future should the economic and geological conditions prove favourable. Most of the expansion debate until now has concentrated on the supply factors, citing Yemen’s limited known reserves base.

Proven gas reserves in Yemen have been put at 490bcm at end-2009 by the BP Statistical Review. At end-2010, remaining commercial reserves at the Marib-Jawf contract area, which provides all of YLNG’s gas feedstock, are expected to be 283bn cubic metres (bcm) or 10trn cubic feet. Yet assuming full capacity utilisation from 2012, in its present size YLNG will only need 223bcm of reserves over its lifespan to 2033. Greater exploration activity and/or commercialisation of known associated gas deposits at oil fields clearly provide scope for additional trains at the terminal.

The gas supply projections for YLNG need to be counterbalanced with the demand outlook. After all, secure and lucrative markets for Yemeni LNG will encourage gas exploration, providing the reserve backbone for additional trains. In its comprehensive 2007 report on Yemen’s gas industry, the World Bank estimated the total gross revenues from the two-train YLNG terminal at between $27.5bn and $39bn, based on different price assumptions in the project’s two original markets – the US and South Korea. This $11.5bn difference in revenues will largely determine whether the new trains are built or not.

Since the YLNG consortium decided to go ahead with the project in 2005, the outlook for global LNG demand has darkened. The biggest game-changer has been the rise of unconventional gas production, which has altered the competitive landscape in the two main LNG markets – the Atlantic Basin comprising the Americas and Europe and, to a lesser extent, the Pacific Basin serving Asia.

Shale Shock
In the Atlantic Basin, the well-documented shale boom in the US had propelled the country to the status of the world’s largest gas producer in 2009. As a result, strong growth in US gas imports, which was expected to absorb cargoes from new LNG producers such as Yemen, Peru and Russia has not materialised. In 2009, the US imported just 12bcm of LNG, well below the 2007 high of 22bcm.

Although volumes are expected to recover by 2012-2013 on the back of stronger economic growth and clean energy policies, the stellar upward gas import trajectory envisioned by analysts as late as last year has been severely flattened. The largest US LNG import terminal, the Sabine Pass plant in Louisiana, has recently received approval to export gas, turning upside down all assumptions regarding North American LNG market. Even if the economics of shale drilling prove overoptimistic, gas pipeline projects from Alaska and Canada’s Northwest Territories remain on the table to provide a boost of supplies to the main North American consuming regions.

At end-2009, total regasification capacity in the US stood at 117bcm, representing average utilisation rate of just 10%. The world’s largest gas consuming country has clearly become a buyer’s market. LNG prices have consequently fallen. The nine cargoes of Yemeni LNG sold so far this year in the US by project partners Total and GDF Suez fetched an average of just $4.50 per million British Thermal Units (mn BTU), according to Bloomberg data.

In comparison, Japan, which relies almost exclusively on LNG for its gas needs, has paid an average of US$11.2/mn BTU in 2010. Moreover, the situation is unlikely to improve in the foreseeable future. Most forecasting agencies are predicting that the Henry Hub benchmark price, which determines US LNG prices, will fluctuate in the weak US$4-5/mn BTU range in the coming years.

Club Med
LNG demand in Europe, the second branch of the Atlantic Basin market, is also uncertain. Gas demand among LNG consumers such as Spain, Greece, Portugal and the UK remains weak owing to ongoing economic difficulties, while in the stronger northern European markets LNG faces tough competition from Russian and Norwegian piped gas. Middle Eastern LNG currently sells in Western Europe for $6-8/mn BTU.

Early-stage shale drilling in Central Europe and massive new pipelines that Russia is planning to build from its Arctic fields should be a concern for YLNG. The outlook for Yemeni gas on the European market as a whole, however, is not as gloomy as might at first appear.

According to Russian investment bank Troika Dialogue, 70% of the new European regasification capacity currently under construction is located in the Mediterranean or the UK, markets that will be relatively little effected by an influx of fresh gas supplies to Europe from the Barents Sea or the Yamal peninsula. YLNG’s proximity to the Suez Canal provides it with a slim competitive advantage over LNG export giant Qatar.

Asia Powers On
While the Atlantic LNG market has been cloaked in uncertainty, Asia remains a bright spot of global LNG demand. London-based research house Business Monitor International forecasts LNG consumption in the four main regional importers Japan, South Korea, China and India will rise from 140bcm in 2009 to 187bcm in 2014 and 260bcm by 2020, an 85% increase. Even after subtracting Asian LNG exporters such as Australia and Indonesia, net LNG demand across Asia-Pacific will rise from 76bcm in 2007 to 82bcm in 2014.

The presence of Korea Gas (Kogas) in the YLNG consortium provides an opportunity to channel cargoes from any new Yemeni trains into a rapidly expanding market. Under a long-term gas sales and purchase agreement (GSPA) Kogas already buys 2mn tpa of YLNG’s gas. In mid-2010 this gas was sold at a premium gross price of around $11.45/mn BTU, according to Bloomberg.

In vying for supply deals for the new South Korean regasification terminals YLNG would face strong competition from Australia, where several mega projects fed by subsea gas and coal bed methane (CBM) are due onstream by the middle of the decade. Good business relations between Yemen and South Korean conglomerates should ease the negotiation process and may provide YLNG with a competitive edge.

Natural Markets
A major potential new market for YLNG is India, which given its geographical proximity can be considered a natural destination for Yemeni gas. Owing to its slower decentralised decision-making process India has lagged behind another rising LNG consumer, China, in building regasification capacity. India’s economic outperformance, however, is creating an ever-greater pressure on the government to provide new sources of gas and LNG import terminals are expected to mushroom from mid-2010s onwards.

Finally, an emergence of the Middle East as a large net gas consumer provides an underrated expansion opportunity for YLNG. Despite the region’s massive hydrocarbon reserves, the runaway gas consumption in the Gulf states is opening a supply gap. Kuwait and the UAE already have floating regasification terminals and unless politically unpalatable gas price increases for the domestic consumers are implemented, a steady rise in LNG import requirements is inevitable. Yemen is perfectly placed to meet this demand.

Hybrid Advantage
Overall, despite the turbulent swings in regional LNG prices and demand, Yemen is well positioned to maximise revenue from its existing trains and to expand its liquefaction capacity. First, the country’s location makes it what the International Energy Agency (IEA) calls a ‘hybrid’ LNG producer, able to target both the Atlantic and Pacific markets.

Related to this geographical flexibility is the elasticity of the offtake deals held by GDF and Total, which allows them to divert a large share of their combined 4.5mn tpa of contracted Yemeni LNG to higher paying markets. The extra revenue made by exploiting arbitrage in the LNG markets is split between the Yemeni government and private partners, benefiting both. So far this year, the French firms have been able to reroute US-bound cargoes to India, China, Japan, Spain and Kuwait, netting the government extra returns of $0.3-15mn per cargo.

Finally, without underestimating regional complexities it is important to keep in mind the overall global LNG outlook. Despite the sharp fall in the US gas import demand projections, LNG buyers will continue to outnumber LNG sellers. According to the IEA’s 2009 International Gas Market Review, global liquefaction capacity will increase by 50% in 2008-2013 to 410bcm. In contrast, regasification capacity will rise from 637bcm at end-2008 to 813bcm just by the end of this year. The discrepancy between world’s supply and demand is clear. Strategically located projects backed by leading global LNG traders and buyers such as Yemen LNG are well-positioned to exploit this demand.