By Javier Blas
Get ready for an oversupply of liquefied natural gas. It may sound paradoxical. After all, the Strait of Hormuz remains blocked. The world's largest LNG production facility is out of order, and Qatar says it will take at least three years to repair. And yet, the outline of a long-term surplus has already begun to emerge.
The outlook for LNG prices is crucial in Europe and Asia, where this commodity is either burned to produce electricity and heating, or used as a raw material for the production of chemicals and fertilizers. In these regions, the course of LNG prices is what determines the course of inflation.
The war in Iran significantly skyrocketed LNG benchmark prices – although they remained well below the all-time high set after Russia's invasion of Ukraine. In March, the Asian index, known as JKM, briefly rose to around $30 per million BTU, from less than $11 in February. For comparison, in 2022 it had seen an eightfold increase, reaching $70.
Unless peace talks between Washington and Tehran collapse and the Strait of Hormuz remains closed beyond July, LNG prices are set to fall again – and even remain low for an extended period of time.
To understand why, we need to delve into the internal architecture of the industry. The "beauty" of LNG lies in the fact that, once the gas is cooled to about -160 degrees Celsius, it turns into a liquid that can be loaded onto tankers and transported around the world, almost like oil. Thus, LNG can reach any buyer worldwide, breaking the historical limitation of natural gas pipelines.
The construction of these liquefaction plants requires massive upfront investments, with some costing between $20 billion and $30 billion. Therefore, LNG companies only give the green light for new installations when they have secured enough customers to convince banks that the project is safe. This mechanism helps maintain a relative equilibrium in the market, with the expansion of supply keeping pace with the increase in demand.
And this is where the US-Israeli war in Iran comes in. The closure of the Strait of Hormuz removed 20% of the world's LNG supply*, leaving some importers, particularly in Southwest and Southeast Asia, in a state of desperate shortage. They are not going to forget it. The most affected states – see India, Bangladesh or Pakistan – are precisely the (price-sensitive) energy importers that the industry relies on as future consumers.
Their reaction to this disruption will shape the LNG market for years to come. I foresee a reaction on both the supply and demand sides.
Let's start with the offer. Having experienced the closure of Hormuz, no sensible policymaker in Asia is going to consider this sea "route" safe again. Diversifying sources away from Qatar and the United Arab Emirates will be a priority. Asian LNG buyers will therefore support projects in other places, financing ambitious ventures that just 90 days ago seemed doomed to fail. We can summarize it as follows: "what is outside Hormuz, is being built", with the crisis guaranteeing a construction explosion outside the Persian Gulf.
Since the turn of the millennium, the global LNG market has absorbed every wave of supply relatively quickly, within two to three years. China absorbed much of the wave of the 2009-2011 period, when supply increased by about 40% after the completion of several projects in Qatar. Europe absorbed the wave of 2016-2019, which came after a huge buildup of export capacity to the US due to the shale gas revolution, increasing global production by 45%. It also helped, of course, that Europe had to reduce its dependence on Russian gas from 2022 onwards.
Before the current war broke out, the market was facing a third wave, which was expected to last from 2026 to 2030, bringing a potential oversupply. Not only does this wave remain likely – although it will probably be delayed by about a year due to the closure of Hormuz – but it is expected to be larger and likely longer-lasting. Part of it will come from the movement of Asian buyers to finance more and more projects in North America, Africa and Latin America. But Qatar will also want to increase its production, using its low cost as an incentive to find buyers. That extension is delayed — maybe six months, maybe 12, maybe even 18 months. Whatever the duration, it does not greatly affect what will happen in 2030.
Last year, the LNG industry gave the green light for the construction of a new capacity of 100 billion cubic meters, which is an all-time high, according to new estimates by the International Energy Agency (IEA).
"A long list of projects of more than 700 billion cubic meters worldwide awaiting final investment decision, including approximately 110 billion in the U.S. that have received regulatory approval, remains pending," according to the IEA.
Last year, global LNG production amounted to nearly 600 billion cubic meters. If everything that can be built is built, the global supply of LNG will more than double.
Will there be enough demand? I doubt, or at least, I doubt that this will exist at pre-war price levels. The cost of LNG will need to be further reduced to incentivize greater consumption. It will not be easy. LNG has suffered two blows in four years: First with Russia's invasion of Ukraine and now with the war in Iran. Again, no serious policymaker would have expected the third blow. For the supply, the key move will be diversification away from Hormuz. In demand, diversification will be far from LNG itself. Buyers have options: solar, battery-powered, and coal.
Back in the 1970s, the oil crisis forced developed countries to turn to coal. At the time, they had very few options other than nuclear power. This time, Asia may turn to cheap Chinese photovoltaics – and plenty of coal. Therefore, the most polluting of all fuels may emerge from the conflict in Iran as an "energy security" commodity, not only for electricity generation, but also for the production of fertilizers and plastics through chemical coal processing.
It's a story as old as the commodity market: Today's high prices sow the seeds for tomorrow's low prices. For a short time, the cost of LNG may remain somewhat high, as importing countries, especially in Europe, replenish their reserves ahead of the 2026-2027 winter season, and everyone buys a little more than they need, in case hostilities in the Gulf reignite. However, a "buyer's market" is just around the corner.
Now, just imagine that the Russia-Ukraine war is also over, injecting even more gas into the global market. Who knows when this will happen, but it's just another reminder: the LNG market can go from scarcity to abundance very quickly.
*The LNG market is a sub-segment of the much broader natural gas market. While the closure of the Strait of Hormuz cut off 20% of the world's LNG supply, it cut off only 3% of the broader gas market, which includes pipeline supply.
BloombergOpinion
