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Bulls and bears: what’s next for Australian LNG?

So what might the export phase look like over the next couple of years? There are a wide variety of risks to the picture, but we can make a couple of informed calls. The most obvious is that export volumes will increase materially as projects come on stream. The other is that, on the basis of current oil curves, we are likely close to passing the worst for Australian LNG export prices.

The purpose of this article is to put some context around those calls and make some sort of sense of what this might mean for Australia.

The LNG export phase

As Australia has moved into the very beginning of the LNG export boom in 2015, actual export volumes are proving to be slightly disappointing. The first quarter of this year was a fresh record of around 6.75 million tonnes (MMt) of exports (using port data and data from our major trading partners) as the Queensland Curtis LNG (QCLNG) Project started to export. However, the second quarter proved disappointing; I estimate around 6 MMt in the second quarter.

Given that the second train at QCLNG was operational in the third quarter, exports should again rise in Q3. This story is set to continue through the end of 2015 as GLNG starts to export and into next year as Australia Pacific LNG (APLNG) and Gorgon LNG projects come on stream.

To be sure, there are varying degrees of risks surrounding each project and this may delay or slow the point at which Australia becomes the largest sea borne exporter of LNG. However, as Chart 1 highlights, by the end of 2018, Westpac expects export volumes to be running close to 80 MMt/a up from 25 MMt/a in 2014.

At what price Australian LNG?

While the industry can debate what Australia’s final export volumes might look like into the end of this decade, the price of LNG in Asia over coming years will be critical. Given that long-term LNG contracts in Asia tend to be based on formulas linked to the lagged price of oil, I use historical data to create a forecast model based on Brent prices.

Creating such a model can be difficult. Some contracts can be complex in nature. It has been common for instance for contracts to have formulas that have caps and floors. The impact of these “˜S-curves’ would tend to be more obvious at higher and lower prices to varying degrees. The nature of contracts will also change over time as demand for LNG in Asia changes. All this can make it difficult to isolate and create a “˜one-size-fits all’ model.

Above: Chart 1 – LNG exports from Australia – the coming boom. Source: Various websites, Westpac Strategy Group.

Above: Chart 2 – fixed versus non-fixed slops in LNG models. Source: Westpac Strategy Group.

Chart 1 plots Westpac’s preferred models using the following methodology:

    P =C+S*Brent (t-x)

    Where P is the price of LNG in Japan in $/MMBtu

    C is a constant expressed in $/MMBtu

    S is the slope or coefficient

    x is the average price of Brent lagged by 3 to 6 months.

Westpac uses a constrained regression model to plot a best-fit line based on the assumption that the “˜S-curve’ kicks in at fixed points, e.g. AU$60 and AU$90. The model run two models, one that has gradients fixed above AU$90 and below AU$60 and one that has non-fixed slopes.

Armed with the above equations, we can attempt to forecast prices based on historical and forward Brent prices.

Above: Chart 3 – Australian LNG prices to rise modestly in 2016 and beyond.
Source: Bloomberg, Westpac Strategy Group.

Chart 3 suggests the model appears to do a fairly good job of forecasting Australian LNG prices in Japan over the last 10 years, and it has been correctly forecasting the 50 per cent drop in LNG prices this year.

While it has arguably over-forecast the recent drop, the current shape and level of the Brent curve backs up the earlier point that the industry is close to passing the worst for Australia’s LNG export prices.

The export boost to Australia

Given the volumes and price forecasts in Chart 3, what impact will LNG exports from Australia play in terms of shaping Australia’s trade situation in coming years?

To create an estimate of what this profile looks like, a range of assumptions need to be made: an estimate of export volumes and prices needs to be made; a forecast of the level of the AUD/USD currency needs to be made, in addition to predictions of shipping rates and other associated costs. So, at best, any forecast should be seen as an estimate of what the profile might be, given current market pricing and project guidance.

Above: Chart 4 – LNG export values set to rise in 2016 and beyond.
Source: ABB, Bloomberg, Westpac Strategy Group.

Chart 4 plots the forecast profile against actual outcomes. On this basis, the current quarter looks to be the low point for the value of LNG exports from Australia in this part of the price cycle. As the industry moves through 2016 and into 2017, the industry should start to see a more material boost to Australia’s trade situation as larger volumes more than offset weak but modestly improving prices.

LNG exports in 2015 will most likely add AU $16 billion to Australia’s trade position. In 2017, that number could rise again to AU$28 billion. By 2018, Australia could be looking at AU$32 billion. That is an AU$16 billion boost to Australian exports versus 2015 in coming years, or around a 1.3 per cent lift to Australian GDP over the next three years in current prices.

It is likely that LNG will, at some point between now and the end of this decade, become Australia’s second largest export commodity. LNG prices will thus have a larger impact on Australia’s terms of trade. If the price forecasts made in this article prove correct, then LNG prices should help to stabilise and even boost the terms of trade in 2016 and beyond. Household incomes and state government revenues will also benefit from dividends and royalties.

However, it’s not all good news. While the export phase will add to income and overall growth, the end of the investment phase will detract from future growth.

The RBA estimates that LNG investment contributed an estimated 0.25 per cent on average to Australian GDP growth between 2008 and 2013.

Further, not all of the above income will accrue to Australia. Westpac estimates that only 10 per cent of new LNG projects in Australia are owned by Australian oil and gas companies. As a result there will be a hit to the capital account as multinational company profits are repatriated.

Risks to the outlook

The increasing weight that LNG will play within our terms of trade also opens Australia up to future risks. Australian supply is set to rise sharply just as new United States supply starts to hit global markets. The very different pricing structure of US LNG could undermine pricing in Asia.

The changing mix of Asian energy production and the potential for further changes going forward means demand will continue to shift. This is an area of increasing concern.

Chinese imports of LNG in the year to August are down 3 per cent versus the same period a year ago while imports of pipeline natural gas are up 9.8 per cent, suggesting increased gas on gas competition. Finally, this is all happening at the same time as global thermal energy markets have been hit hard and weak global will likely continue to weigh on them.

An unclear path ahead

In conclusion, LNG export volumes will increase materially as projects come on stream and the author believes Australia has likely passed the worst for LNG export prices from Australia.

It is clear from this that the positive impact on Australia’s trade situation from LNG should become more obvious through 2016 and into 2017. Beyond that though, becoming the world’s largest LNG exporter will open up the Australian economy to a new set of risks. Those risks that will make it all the harder to forecast what sort of impact the LNG industry will have on the Australian economy as the industry continues to adjust to the end of the wider resource investment boom.

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