2 Major Challenges Facing LNG Projects

2 Major Challenges Facing LNG Projects

There are clearly some huge opportunities in the global liquefied natural gas trade. International demand for the cleaner-burning fuel has doubled over the past decade and is expected to double again by 2025, led by growing energy consumption in China and other developing countries.

A handful of oil majors are extremely optimistic about the future of LNG and are investing aggressively to secure a dominant position. Yet LNG projects face a few major challenges, including extremely high development costs and buyers' hesitance to sign long-term contracts. Let's take a closer look.

Cost inflation
Over the past few years, cost overruns and project delays have become commonplace for LNG projects. In Australia, for instance, spiraling wage costs, a strong Australian dollar, and competition from other projects has made the economics of new LNG projects much less attractive.

As an example, Chevron's Gorgon LNG project is now estimated to cost roughly $52 billion, up $15 billion from the company's initial estimate of $37 billion, due largely to high labor costs and a strong Australian dollar. Similarly, ExxonMobil's PNG project in Papua New Guinea is now expected to cost $19 billion, up $4 billion from the company's initial estimate of $15 billion.

As a result of soaring costs, some companies are deciding to hold back on LNG projects or scrap them altogether. Royal Dutch Shell is considering canceling its Arrow LNG project in Queensland, Australia, due to the project's challenging economics. The move could save the Netherlands-based oil major -- which is under pressure to reduce capital spending -- some $5 billion, based on a projected $10 billion development cost estimate that will be shared equally with partner PetroChina .

Hesitant buyers
Another major challenge for LNG projects is securing long-term contracts with foreign customers, especially in Asia. Many are hesitant to ink long-term deals with LNG producers in places like east Africa and Australia due to disagreements about price and regulatory uncertainties. This inability to secure long-term buyers has led to a sharp decline in the number of LNG projects proceeding to final investment decision, or FID, outside of the U.S.

Anadarko Petroleum stated earlier this year that potential Japanese customers have expressed reluctance to ink long-term contracts to purchase gas from the company's proposed LNG facility in Mozambique due to policy-driven uncertainties. Producers are waiting for more clarity about the future of Japan's energy policies, as well as further details about U.S. policy regarding gas exports to Japan.

In contrast, U.S.-based LNG projects have found it relatively easy to entice foreign buyers, thanks to the nation's cheap and abundant supply of natural gas. For instance, the Freeport LNG project recently received government approval to export more gas to nonfree-trade nations, has already secured binding 20-year liquefaction tolling agreements with Japan's Osaka Gas, Chubu Electric Power, and Toshiba, as well as South Korea's SK E&S LNG and BP.

The bottom line
Unfortunately, factors such as cost and cautious customers are largely out of energy companies' control and depend on variables such as commodity and labor prices, exchange rates, and policy-related uncertainties.

But if companies like Exxon and Shell can manage to keep development costs in check and avoid delays as much as possible, their investments in LNG should pay off handsomely over the long run, considering that these projects tend to generate massive amounts of stable cash flow over very long periods of time with limited capital requirements after the initial up-front investment.

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The article 2 Major Challenges Facing LNG Projects originally appeared on Fool.com.

Fool contributor Arjun Sreekumar has no position in any stocks mentioned. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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