A Game-Changer for Liquefied Natural Gas?

 | Aug 19, 2011 | 2:30 PM EDT
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North America has some natural-gas export facilities, but few more will ever be built. Natural gas is too expensive in North America compared with other suppliers, and the capital costs required to build new export facilities are in the billions. If that were not enough of a deterrent, a new challenge appears: the floating liquefied natural gas (FLNG) vessel.

The idea of an FLNG vessel is that it can sail to offshore gas discoveries, extract wet gas, freeze it to liquefied natural gas (LNG) and offload the LNG to tankers for shipping to Western and Asian markets. It is more than just an idea. Royal Dutch Shell (RDS.A) already announced that it is building the world's first FLNG.

Shell describes it upcoming FLNG as a game-changer. The company plans to first deploy this massive vessel over the Prelude gas field near Australia, where it would cool the produced gas into a liquid on the spot. Typical ocean­going carriers offload LNG for delivery to nearby markets.

According to Shell's website, "From bow to stern, Shell's FLNG facility will be 488 metres. It will be the largest floating offshore facility in the world -- longer than four football fields laid end to end. When fully equipped, and with its storage tanks full, it will weigh around 600,000 tonnes -- roughly six times as much as the largest aircraft carrier. The sheer size gives it stability in the open seas – even when buffeted by the 280-kilometres-per-hour winds of a Category 5 cyclone. This ability to ride out even the worst of storms saves valuable production days."

Shell and others believe FLNG facilities will be cheaper than building onshore LNG export facilities. FLNG systems would avoid the need for long underwater pipelines and coastal infrastructure. Not only would the system be cheaper, it would bring fields on stream faster, reduce projects' environmental footprints and make it economic to exploit remote offshore deposits.

Oil & Gas Eurasia describes another advantage. A FLNG can produce gas without touching the host nation's soil. This reduces security risks, "which is why Shell wants to use the technology in Iraq -- even though the reserves are onshore -- and why several players want to use FLNG in Nigeria."

At $5 billion a copy, FLNGs are expected to cost about the same as their onshore equivalents. And they have the added advantage of changing locations. So, when a field has depleted or the markets change, the vessel can move to a new location.

While the capital costs for FLNG may be comparable, the production costs are not. For now, offshore producers pay far less than Henry Hub prices for feedstock. This gives them a tremendous advantage compared with their landlocked competitors. If local prices become intolerable, the FLNG vessel can move to markets that are more favorable.

Shell may be the first mover, but other majors are not just standing by. According to Reuters, "Exxon Mobil (XOM), Chevron (CVX) and Australia's Woodside Petroleum are also eyeing floating LNGs."

The competitive advantage that the FLNG offers poses a challenge for the four LNG liquefaction facilities proposed for North America. To make these onshore projects work requires that their owners secure long-term demand and hefty margins. But no matter what they do, they will achieve cost leadership.

Two of these onshore export facilities are proposed by Cheniere Energy Partners (CQP) and Freeport LNG Development (Freeport is associated with ConocoPhillips (COP)). Both facilities are proposed to be located in the Gulf of Mexico. As was previously reported, Cheniere is expected to incur financial challenges in building its facility. Both companies will have physical and financial challenges delivering their product from their Gulf of Mexico facilities to distant Pacific markets.

The other two facilities make better sense; they are located on Canada's West Coast and can easily reach Asian markets. Further, they can monetize the trillions of cubic feet of gas uncovered in British Columbia, and they are not tethered to Henry Hub prices.

Petroleum News reports that one of these Canadian projects has ties to Shell Canada. The Kitimat LNG project, with Apache (LNG) as operator and EOG Resources (EOG) and EnCana (ECA) as partners, plans to ship 10 million metric tons a year starting in 2015.

The second Canadian project is BC LNG Export Cooperative, and it is located near Kitimat LNG. It is owned by Canada's Progress Energy Resources and its Malaysian partner Petronas. They plan to ship 900,000 metric tons a year starting in 2013.

Even with West Coast locations and untethered feedstock, these two LNG projects cannot outperform a FLNG. From a cost-leadership and risk-management perspective, onshore facilities come in second.

Shell is first to market with innovative technology that will assure its position as a cost leader. The FLNG is a bold move, and it is a smart move. It will reward shareholders as the world becomes more dependent on natural gas.

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