Even before the Covid-19 pandemic, the liquefied natural gas (LNG) market was set for oversupply in 2020 and 2021 as new projects continued to grow capacity well beyond steady demand growth. The long-term outlook for LNG, however, is brighter than that of other fossil fuels because of its comparatively low cost and lower emissions from production and combustion.
But to find a true competitive advantage amid a volatile market, LNG players should focus their efforts in five areas: capital efficiency, supply-chain optimization, downstream market development, decarbonization, and digital and advanced analytics. If done successfully, LNG could ride out an unpredictable market and find opportunities for faster growth.
Realise capital efficiency
Margins in upstream LNG are unlikely to return to the levels common in the early 2010s. Lower long-term oil prices effectively cap LNG contract prices while ever-more complex and remote LNG projects have amplified costs. Moreover, the large number of proposed but undeveloped LNG projects with similar breakeven prices create intense price competition, leading to narrower margins.
Reducing the capital cost of developing LNG projects could improve margins, however. The cost of LNG projects rose from less than $500 per tonne of capacity at the turn of the century to more than $2,000 per tonne in 2012. In 2017, costs came down to an average of around $900 but could fall further. We have found improved design and execution of greenfield LNG projects can realise savings of 30 to 40 percent, bringing capital costs back into a range of $500 to $600 per tonne.
Modularisation and low-cost floating LNG could be important parts of the solution. Instead of developing one or two custom-designed trains, installing many smaller modular trains could make projects more scalable, accelerate installation times, and reduce cost.
Optimise the supply chain
Despite its growing size and liquidity, the LNG market is far from an ideal “efficient” commodity market. Most LNG flows reflect long-term contract commitments and are unresponsive to short-term price signals. Likewise, the sequence and timing of deliveries tend to reflect long-term plans rather than market needs, thus cargoes often flow to set markets even when another could offer a better price or lower transport costs.
As traded markets develop, supply chains will still be affected by inefficiencies that include contract inflexibility, barriers to infrastructure access, high cost of LNG storage and transport, and differences in product specification.
To realise transportation cost savings and higher LNG prices, companies can assemble a diversified and flexible portfolio of LNG supply and offtake positions as well as secure trading and optimisation capabilities. A McKinsey optimisation model that explores the value potential of different portfolios indicates many could achieve additional margins of $0.30 to $0.50 per one million British thermal unit.
Invest in downstream market development
An acceleration of LNG demand growth requires LNG producers to make significant investments in new downstream infrastructure, including import terminals, pipelines, and power plants. Much of the potential demand growth, however, is in developing markets where utilities’ capital is often constrained, and companies may lack the capacity and capabilities to complete large-scale gas infrastructure projects.
Thus, companies that can fill the capital, capacity, and capability gaps of downstream consumers can grow quickly and achieve higher prices in end-user gas markets where competition is often less intense. Total, for example, recently partnered with Adani in India to build a five-million-tonne-per-annum LNG import terminal and a distribution network that supplies six million households and 1,500 compressed-natural-gas fuel stations.
For LNG producers, identifying, prioritizing, and developing such a diverse range of opportunities requires new capabilities. Passive LNG marketing, for instance, should be replaced with systematic business development where potential opportunities are managed and tracked through a progression pipeline. Producers should also manage risks associated with local energy-market dynamics and regulation.
A switch from more carbon-intensive fuels to gas can mean significant carbon abatement. In the US, for example, the switch from coal- to gas-fired power (facilitated by lower gas prices since 2008) abated more carbon emissions than all the renewable power capacity ever installed in the country.
There are significant variations in carbon intensity between gas supply chains, however, because of the different technologies used for gas production, liquefaction, and shipping. LNG buyers are increasingly concerned about these differences: 33% believe that emissions-intensity clauses will be standard within two to three years.
The LNG industry therefore has a strategic imperative to reduce emissions to sustain its role in decarbonising the energy sector. Using more energy-efficient equipment and reducing gas leaks are just some of the ways LNG players can decarbonise.
LNG producers can begin by quantifying their emissions in comparison to competitors and exploring the best options to reduce them. In many cases decreasing emissions and costs can go hand in hand by, for example, making energy-efficiency improvements. Plant electrification and renewable power supply typically have modest costs. And while emission offsets or carbon capture generally have higher costs, they may be justified by customer demand.
Companies across the supply chain must also test their exposure to future environmental regulation and pricing scenarios. Understanding how these situations could affect their enterprises, whether positively or negatively, will inform how they pursue portfolio composition, project design, and risk management.
Exposure to climate risk can also affect operations. Given its placement on the coasts, LNG infrastructure may be affected by rising sea levels and more frequent severe storms; some locations may also face risks from drought, extreme temperature, or flooding. By addressing these issues alongside their decarbonisation efforts, LNG players can further strengthen their businesses.
Build digital and advanced analytics capabilities
LNG producers can apply digital and advanced analytic techniques to realise significant hidden value potential. One company, for example, used advanced analytics algorithms to model the relationship between input variables, ambient conditions, and production capacity; the insights helped the company increase its revenue by $50 million to $100 million per year. Additional opportunities exist to use digital tools to increase the flexibility and responsiveness of LNG production to market conditions, allowing additional sales at higher prices.
The opportunity is not confined to upstream activities, however. Gas transmission and distribution companies can increasingly rely on technology to optimise network operation, prioritise maintenance activities, and reduce the cost of their field force. Italgas, for example, improved maintenance execution by providing its field force with augmented reality devices. And Cadent in the UK is using remote-controlled robots to repair and upgrade pipes.
The pandemic represents a rare shock to the global gas market, accelerating many of the trends that were already changing the dynamics of the LNG industry. These disruptions, however, also provide an exceptional opportunity for change. Industry leaders should take a critical look at their fundamental operations and processes, identifying opportunities for improvement and growth. By taking bold actions over the next three to five years, LNG can play a significant role in meeting the world’s need for reliable, low-carbon, and low-cost energy supplies.
This article was originally written and published by McKinsey and company.
About the authors
Giorgio Bresciani is a senior partner in McKinsey’s London office, Sven Heiligtag is a senior partner in the Tokyo office, Peter Lambert is an associate partner in the Sydney office, and Matt Rogers is a senior partner in the San Francisco office.