Five years ago small-scale LNG was considered new and exotic, with only a few early-established players having practical market experience, writes Andrew Morris.

Driven by stricter emission regulations in the shipping sector and falling gas demand, the market showed potential for an attractive business case. The key challenge was to overcome the chicken-and-egg issue, omnipresent in any discussion about the potential of small-scale LNG, given its need for up-front investment in costly infrastructure.

Today, more than a year after the sulphur emissions control area (SECA) regulations came into force, value chains are being established in some areas, but without the expected pick-up in demand. The commodities slump has raised additional concerns for the sellers’ business cases, while potential buyers are wondering whether small-scale LNG is worth the hassle.

Despite the increased uncertainty, Pöyry maintains that small-scale LNG presents interesting opportunities for diverse energy players. With the right business model it is possible to assemble an attractive business case.

There have been many positive developments in small-scale LNG in recent years, especially on the supply side, as the image above shows: the availability of small-scale LNG has increased significantly. The development of infrastructure for small-scale LNG supply at the large-scale import terminals means that the product is now available in most northwest European markets.

The fall in demand – and willingness to pay – in traditional gas markets has encouraged large-scale gas sellers to look for new growth opportunities. Shell is developing bunkering services in the Amsterdam-Rotterdam-Antwerp region and in North Germany. Gasum is focusing on expansion in the Nordic region, investing heavily in reloading and storage in Sweden and Finland.

The gas majors’ deeper pockets and a recognition of first-mover advantage have made the chicken-and-egg issue less of an obstacle. Although it takes longer than expected, demand is growing in the marine and road transport sectors.

 Marine sector

Marine bunker fuel consumption, mainly high-sulphur fuel oil, in the European SECA is 20 million tonnes a year (mt) –  equivalent to 18.5 mt of LNG – which equals almost half of European LNG imports last year. The scale of the market, combined with emission regulations, makes it an attractive target for anyone aiming to sell small-scale LNG.

There are now more than 150 LNG-fuelled ships in operation or on order in northwest Europe and infrastructure projects are being initiated in a number of ports. Although the global LNG-bunkering market has been slower – due to a lack of emission-control regulation, in the case of Asia, or funding programmes, in the case of North America – Singapore has recently announced ambitious plans to position itself as a major LNG bunkering hub.

The situation also looks promising in China after it announced sulphur requirements in 11 major ports effective from next year and in an extended area from 2019.

 Road transport

LNG is well suited for long distance heavy-duty trucks that cover hundreds of thousands of kilometres per year and have a replacement period of just three to five years. This is a large-scale market: Pöyry has estimated that the diesel oil consumed by heavy duty trucks in Germany alone is equivalent to more than 90 million tonnes of LNG.

The main drivers of growth will be strong tax advantages compared to traditional fuels, combined with infrastructure investment subsidies. Signs of growth are beginning to show, with transportation companies such as Tesco, DHL, and UPS now operating a significant number of LNG-fuelled trucks and fuel-distribution companies opening filling stations.

This is supported by the LNG Blue Corridors initiative that brings together the European Commission and a number of partners to create pan-European networks of LNG-fuelling stations.

Future prices

One of the largest unknowns to potential buyers is the pricing of small-scale LNG relative to the alternative fuels. Gas and LNG prices have fallen to new lows, maintaining a price discount to oil products.

However, the future price level is what really matters. Forward prices of oil products are in a strong contango, with the market expecting a recovery in the mid to long term.

Although the price of wholesale LNG is relatively easy to ascertain, the premium that end users can expect to pay is difficult to estimate, creating a significant risk for potential LNG consumers. These costs mean retail LNG and oil product prices are very close together at the moment, but they are expected to diverge with more investments, competition and market maturity in LNG bringing greater demand from the transport sectors in particular.

One of the key challenges when building a new market is the need for co-ordinated investments and risk allocation throughout the value chain. Generally, market participants prefer only to be exposed to the risks they are familiar with in terms of pricing and contracting terms.

Unless you rely on players with integrated business models covering the entire value chain, an appropriate model of risk sharing between stakeholders is crucial for growth.

Currently there are diametrically opposed expectations between the producer and the consumer that could hinder market development:

  • The typical infrastructure developer prefers long-term contracts to underwrite its investments
  • The LNG seller would also prefer long-term agreements, but is becoming used to a shorter term trading and selling on an opportunistic basis
  • The shipowner considering LNG engines for his or her next ship wants the ability to purchase in any port at a transparent and predictable price without need for long-term commitment similar to the purchasing process for oil products
  • A truck-fleet operator requires a reliable network of filling stations, otherwise its range is limited.

Conclusion

The small-scale LNG market is still immature with large differences by region. Added to this, the potential complexity of the value chain and lack of transparency in price levels poses considerable risk. It requires different entities that have not worked together before to come together and deliver mutually beneficial business models. However, an increasing number of players are taking an interest and new projects are being developed, both on the supply and consumer side.

Alongside this, the regulatory incentives aimed at reducing local emissions of SOx and NOx from transport continue to favour LNG, and unit costs are coming down as volumes increase. We therefore continue to consider the growth potential of small-scale LNG to be significant – potentially up to 13 mt by 2030, equivalent to the current gas demand of Belgium.

source article & image: http://www.lngworldshipping.com/news/view,opinion-smallscale-lng-growth-the-opportunities-and-the-challenges_43971.htm