LNG Economics

LONDON–By 2035, global liquefied natural gas demand is expected to increase to as much as 600 million metric tonnes a year, up from the 315 MMTPA needed in 2018, a new McKinsey & Company analysis predicts.

According to the report, “Setting the Bar for Global LNG Cost Competitiveness,” since October 2018, eight LNG projects have reached final investment decision, adding 84 MTPA of LNG to markets. It says this capacity addition is expected to prolong excess supply into world markets into the late 2020s, well beyond the 2022-23 forecast of a year ago.

The Qatar North Field LNG Expansion–the world’s most cost-competitive source of LNG, which is expected to add another 33 MTPA of supply–may, depending on when it starts construction, extend the expected period of oversupply by several years, McKinsey warns.

However, the analysis calculates that considering existing supply, announced post-FID projects and the Qatar North Field project, unmet LNG demand could reach 140 MTPA by 2035, the equivalent of adding 25 standard LNG trains globally.

“However, more than 100 projects totaling 1,100 MTPA of proposed capacity are in contention to fill this supply gap, indicating that global competition among pre-FID LNG projects is set to rise sharply,” McKinsey says.

Among all the likely pre-FID LNG projects, McKinsey says its cost curve projects each would need a minimum of $7 per million British thermal unit to stay competitive. “That being so, only about one in 10 of announced projects is likely to be competitive enough to reach FID. This poses an urgent question for operators: How can they improve the cost competitiveness of their LNG projects?” the analysis asks.

Project Pricing

McKinsey says the full break-even price for an LNG project can be broken down into four elements:

• The cost of feed gas, which can be lowered through access to privileged upstream gas and liquids resources;
• Capital and operating expenditures on liquefaction facilities, which can be reduced by optimizing development projects;
• Royalties and taxes, which can be managed by engaging host governments and stakeholders; and
• Shipping cost and trading margins, which vary by proximity to destination markets and can be managed through shipping-fleet optimization, including portfolio trading margins.

Of these elements, McKinsey says terminal operators have the most control over liquefaction facilities’ capital and operating expenditures, with the remaining elements primarily influenced by plant location and the size of an operator’s LNG portfolio. “For example, royalties and taxes are set by governments, shipping cost depends partly on the distance to the demand center, and operators with large portfolios can shift supply to optimize trading margin,” the report indicates.

Capital expenditure on liquefaction facilities accounts for about a third of the overall project break-even price among pre-FID LNG projects, although it can increase to 40%-60% in cases where the feed-gas price is lower, McKinsey says. It adds facility operators seeking to lower their projects’ overall break-even price are well advised to target this expenditure in their cost-reduction efforts.

Improving Capital Expenditures

McKinsey says its experience working with LNG operators to improve their competitiveness has helped it identify three pre-eminent cost levers: prefabrication, train size and digital technologies.

LNG projects often are built in remote areas with limited local pools of skilled labor, “Setting the Bar” describes. The need to import construction workers affects not only the labor rate, but also infrastructure costs, such as those incurred building large construction camps. In addition, the report says the logistical challenges of building in remote areas can reduce overall productivity and prolong construction schedules, especially for plants in regions with geopolitical instability or extreme weather conditions.

To mitigate these challenges, McKinsey says some operators are using prefabricated modular units for LNG projects. Because the units are built off site in fabrication yards, where labor costs are lower and productivity is higher, it maintains they are cheaper to build than conventional alternatives. McKinsey says in its experience, net of additional costs, modularization could reduce capital expenditure on a typical remote plant by 5%-10%.

Each train size and technology category has its own advantage and disadvantage, the report says:

• Small-scale LNG trains (less than 2 MTPA) require lower capital expenditures up front, but may compromise efficiency.
• Industry standard medium trains of 3-6 MTPA feature components that are more commoditized and the pool of experienced suppliers is larger, bringing costs down.
• Megatrains greater than 7 MTPA can offer improved capital and energy efficiencies, but may be more appropriate in larger-scale developments.

Selecting the right-sized train will depend on the nature of the LNG project, McKinsey says, adding “To optimize the cost of any plant, operators need to explore the full range of options and the technologies appropriate to each option, including cold boxes, compressors and turbines.”

As most LNG plants traditionally have been based on medium trains, the report says the pool of engineering, procurement and construction (EPC) contractors and subcontractors with experience designing and constructing those trains is larger than bigger or small trains. In a heated EPC market with less appetite for new projects, it cautions that developers may have to pay a premium for mega or small-scale trains for which only a handful of contractors have relevant experience.

In its discussion of digital technologies, McKinsey points out the complexity of LNG projects and the demand they impose on schedule planning, materials, labor management, and equipment procurement and deployment.

“Implementing proven digital solutions, such as digital twins–real-time digital replicas of physical assets–could improve the quality of engineering, reduce planning misalignments between parties, and improve the management of materials and equipment. Such an approach can, for instance, help with tracking missing or misplaced equipment and specifying quantity tolerances,” describes “Setting the Bar.”

McKinsey adds that using advanced analytic tools in operations such as predictive maintenance also can improve plant utilization and efficiency. In the long term, it estimates that digital technologies can reduce staffing requirements and cut on-site costs and timelines as much as 20%.

“Each LNG project is unique and presents challenges and opportunities of its own, so there is no magic recipe,” McKinsey assesses. “Operators need to work on a case-by-case basis and apply a combination of the levers described above to improve the competitiveness of their projects.”