There has been a lot of talk lately about the opportunity for BC to create an export market for Liquified Natural Gas (LNG). On the face of it, it seems like a no brainer. LNG proponents commonly state that gas that sells in BC for about $3/unit can sell for closer to $15/unit in Asia. While that is true, it does not necessarily mean there are guaranteed profits to be made by exporting natural gas from BC to Asia. Taking a closer look at how natural gas prices are set provides some insight into why the economics of LNG aren't quite as strong as some might suggest.
Anyone who has ever entered into a mortgage knows that there is a tradeoff between the level of the interest rate charged and the length of time the interest rate is fixed for. Usually, the longer the interest rate is fixed, the higher the interest rate is. LNG pricing works in a similar way.
LNG contracts, like mortgages, can be either short term or long term. And LNG prices, just like mortgage interest rates, will vary with the length of the contract term. An LNG exporter who is willing to take on a lot of risk could choose to not enter into any long term contracts and instead sell each unit of LNG short term, on the so called "spot market". This is the market that people are referring to when they talk about the high LNG prices in Asia.
If, on the other hand, an LNG exporter wanted to minimize risk, they would enter into long term (20 years or more) contracts to sell their output at a set price. However, in return for this long term price stability, they would have to accept significantly lower prices than available in the short term.
So what about the proposed LNG plants on BC's west coast? What is their risk tolerance and what price can they achieve for their LNG? There are about a dozen proposed LNG plants for the Kitimat area from a wide variety of companies. However, the one thing they all of these companies have in common is that they will all be required to make multi-billion dollar upfront capital investments. And no company will commit to spending the billions needed to construct an LNG facility without ensuring a guaranteed price for the LNG they will subsequently export to Asia. The only way to ensure a guaranteed price is through long term contracts at substantially lower prices than LNG is currently trading for.
Although there have been many press releases about proposed LNG plants for the west coast, not one of them, (to my knowledge) has managed to secure a customer for buying its output. This is likely due to a mismatch between high price expectations driven by current LNG prices, and the low price reality driven by the need for long term contracts to justify the upfront investment.
