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Wobbly Demand, Supply Glut Increases Risk to Australian LNG Expansion

COVID-19 has weighed on demand among Australia’s most significant LNG buyers though year-on-year growth remains positive. However, a distressed price environment, resulting capex cuts, a running clock on continually ageing gas assets and rising domestic demand carry risk for future Australian LNG expansion.

Preliminary data from our LNG Journal Market Tracker suggests Australian LNG exports will have fallen by around 0.2mmt (-2.6%) month-on-month to c. 6.8mmt from around 7.0mmt exported in March. Partly due to seasonal demand reductions throughout the Pacific, a likely tumbling of Japanese demand will have the most significant short-term effect, we think.

Short-term demand reduction in Asia

Accordingly, ranking among the most significant importers of Australian gas, Japan is likely to have curtailed imports by almost a third by the end of April and is thus probably going to weigh on monthly Australian export growth. Although Japanese imports dipped in February as part of seasonal demand variations, they nonetheless supported Australian exports to the Far East throughout March and into early April whilst China battled with COVID-19 and curtailed LNG offtakes.

China and Japan changed batons for top Australian LNG importer in April

This short-term trend, however, reversed in April with Chinese imports of Australian LNG overtaking those by Japan since the second week of April. Whereas China has been keen to jump-start its economy and even began to import LNG from the United States after a hiatus lasting more than a year, Japan was forced to introduce its own state of emergency to tackle the spread of COVID-19.

South Korean demand decline is likely slowing already

Australia’s third most significant importer – South Korea – has also felt the negative economic impact of COVID-19. The country has so far been meticulous in implementing social distancing and tracking measures and thus avoided slamming on the brakes with a full lockdown. However, its economy contracted by 1.4% in 1Q 2020 as services and private consumption were hit particularly hard, according to an advance estimate by Bank of Korea. South Korean monthly LNG imports from Australia decreased by 0.22mmt (-22%) in March but that reduction will likely have slowed to around 0.06mmt (-7%) in April, our preliminary data suggests.

Australian LNG still likely to see modest growth year-on-year

Whilst likely having to contend with a fall in month-on-month demand in April this year, our preliminary data suggests Australia will still see slight year-on-year growth of around two cargoes, equating to 0.15mmt (2.3%) in April. However, we think at least half of that growth may be bunkered at Singapore.

Although the COVID-19 outbreak has had a quick, sharp impact on certain sectors within Asian economies, evidence so far suggests overall LNG demand is not curtailed to quite the same extent and trending downwards more gently at a time of seasonally lower demand. Indeed, some importers such as Thailand and India have increased overall imports in April to benefit from extremely low spot prices, our data indicates.

Instead, the prevailing supply glut outstripping current demand growth and a weaker global economic outlook for the remainder of the year is set to have a more profound impact on Australian LNG, in our view. Rather than low prices alone – we expect the majority of contracted Australian LNG to have been hedged at floor prices significantly above Brent’s current sub-$20/bbl range – operators are deferring final investment decisions (FID) and curtailing CAPEX with potential repercussions on future Australian gas production.

“Growth projects deferred until business conditions improve”

Notably, Santos slashed its 2020 capex budget by 38% and delayed FID for the Barossa offshore development until further notice. Gas from Barossa was previously earmarked to secure feedgas supply to the Darwin LNG plant, which is currently dependent on the ageing Bayu-Undan field discovered in 1995.

Fellow Australian LNG producer Woodside has also announced a CAPEX cutback of 62%, including deferral of the planned Scarborough and Browse developments as well as a second train at Pluto LNG. Japan’s INPEX also indicated it will be cutting expenditure.

Domestic competition

Concurrently, Australian LNG is facing growing competition not just for markets abroad, but also feedgas domestically, a March report by Australia’s independent Energy Market Operator suggests. It highlights that existing and committed gas developments would be sufficient to meet domestic east coast demand until 2023 but that additional sources of gas supply are required to address a potential shortfall from 2024. Since its inception, LNG capacity in Queensland in particular has had to contend with public backlash for not seemingly prioritising domestic supply over exports.

Consequently, we see three LNG growth constraints pulling in different directions in Australia at the moment – current and imminent capex reduction announcements, the clock running on ageing gas assets (likely hastened if less drilling investment) and domestic demand growth with its potential for political pressure if growth exceeds supply and increases domestic prices. These factors embody a much more profound risk to future LNG capacity expansions in Australia than COVID-19, in our view, as their combined effect is potentially far-reaching.

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