LNG newbuilding market in a ‘perfect storm’
The pressure of the energy transition has set back investment in hydrocarbons by years, ESG considerations serving to restrict the energy investment needed. Then the Covid pandemic worsened the situation further by hiding underlying energy growth.
When China’s economy came back online, we saw quite a substantial growth in the requirement for gas. LNG supply was outstripped by demand and its price went up. At some point, it was no longer able to maintain its market share and coal kicked in, which is why 2021 was a record year for coal as well. Many European countries ‘kept the lights on’ only thanks to coal going back online.
All this meant that months ago, before the Ukraine crisis, we were already seeing an increase in investment in liquefaction plants and a greater appetite for expanded Qatari production of gas and other infrastructure go-ahead decisions. The market was in a growing spiral.
Against this backdrop, the Ukraine crisis occurred, providing a shock to the market as an already-stretched maritime supply chain will be requested to replace pipeline gas supplied by Russia.
Additionally, IMO’s first two short-term GHG reduction measures – EEXI and CII – will be implemented shortly on the existing LNG fleet. This is expected to put more pressure on ships’ operations and productivity. Perhaps the major impact of EEXI will be that it cuts the speed of ships, especially in periods of high demand, like forthcoming winters. Many ships will only be able to sail at lower speeds, for example 17 knots rather than 19, further restricting supply capacity.
Another key constraint is shipyard capacity. We could tackle the supply problem if it were possible to renew the existing LNG fleet at a significant rate, but there are currently only four yards across the world building full size LNG carriers in any number – Hyundai HI, DSME, Samsung HI and Hudong-Zhonghua – and historically the production of LNG ships has barely exceeded 50 vessels annually. There are two Chinese new entrants, DSIC in Dalian and Jiangnan Shipyard, but these are only just starting their LNG journey and it will be years before they have the expertise and capacity to produce a significant number of units.
Also, shipbuilding capacity is finite, limited by physical infrastructure and supply chain capacity, and countries like Korea want to maintain their output at a certain level. If shipyard slots are taken by any other types of ship – such as large container vessels – slots for LNG carriers may not be available. This is the situation at present where further LNG orders are lining up and cannot be addressed, with deliveries being prolonged until 2026 and beyond.
During the recent surge of orders, slots were taken by forthcoming projects like those of Qatar – primarily expansion of its North Field but also of the US LNG terminal where it has an ownership stake, as well as the potential replacement of some of its older vessels. There’s also a list of projects like Total’s project in Mozambique or the Petronas project that are currently holding on to newbuild slots that may be confirmed imminently.
Normally, these shipbuilding capacity constraints cause an increase in newbuilding prices but of late, another key issue has been the cost of materials. We have seen unprecedented increases in the price of steel as well as in that of nickel, used for LNG containment systems, and these rallies are expected to last. The recent increase of around $40m in the cost of a large new LNG carrier is likely to remain and even increase further, and this is adding to the rush to try and secure future supply chains. Gas traders and energy majors may soon find themselves with the challenging dilemma of having exports available and clients ready to buy at high prices, but not having the link to their markets.
Which brings us back to coal. No society is willing to accept and live with the prospect of energy blackouts, so coal is likely to continue to be there as a refuge and buffer to energy shortage and price hikes. Coal will remain a vital part of the energy mix where it still accounts for about 30% of the total market. The challenge for gas will be to maintain its existing share, win over coal’s 30%, and take part in a coal-to-gas energy shift, but the problem is that shipping may be coming into effect as the weak link in this.
There are currently some 141 large LNG carriers on order but 28 of these refer to Russian interests and are therefore at risk – currently they are stalled as all steelmakers, suppliers, yard, banks and so forth comply with sanctions. Most projects will probably be cancelled, and any hulls underway or remnants of the build assigned to other projects – except in the case of the 15, project specific, sophisticated ice-class vessels being built by Samsung and Zvezda. This may provide opportunity for an acceleration of current projects, or open market activity for the highest bidder.
For the next three years until 2025, modern in-service LNG vessels will be able to benefit from a strong market and the system inertia in building tonnage to absorb demand shocks. Perhaps this is the reason why we are seeing a second-hand market develop for the first time in older ships that can be bought for a relatively attractive price. Ships that are 20 years old were worth their scrap price of around $15m to $20m, depending on whether they had been drydocked, before the Ukraine crisis, but are now more like $30m to $40m.
To conclude, the recent energy crisis shows that there seems to be no balance between energy security and energy transition. The energy supply chain is vital to them both and it is clear that the fundamentals are showing we have great challenges ahead. We need to adapt the pace of regulatory change, and at the same time focus on the footprint of the existing fleet, bearing in mind that LNG itself is still a transition commodity. If an LNG ship does not reach its destination, its cargo could be replaced by coal in the energy mix, and this doesn’t seem like a step to the right direction.
Source: Lloyd’s Register