The world’s two biggest producers of liquefied natural gas — Royal Dutch Shell and BG Group — are planning a tie-up worth nearly $US70 billion ($90bn) just as conditions for the fuel in Asia, the region that consumes more LNG than any other, are at their worst in years.

Until recently, prices for LNG — supercooled so it can be liquefied for export — have been much higher in Asia than in either the US or Europe. In part that is because demand for gas has been growing in countries like China and Japan.

Three-quarters of the world’s LNG demand comes from the Asia region, according to the International Group of Liquefied Natural Gas Importers.

But LNG prices have tumbled in recent months in tandem with the slide in global oil prices. Sales of LNG in Asia are often based on long-term contracts, often 20 years in duration, with prices linked to oil. About 25 per cent of sales are made on a shorter-term basis, with spot prices pressured by both cheaper oil and new supplies.

Spot Asian LNG prices have now fallen to levels last seen before the 2011 Fukushima nuclear accident led to an increase in Japanese gas demand. They have dropped from a peak of about $US20 a million British thermal units in February last year to less than $US7/mmBtu, roughly in line with gas prices in Europe though still higher than prices in the US.

Shell and BG didn’t respond to questions, but their executives dismissed any concerns about falling LNG and oil prices at a news conference last week. BG chairman Andrew Gould echoed the opinion of some analysts that an LNG behemoth could withstand the industry’s problems. “In the lower price oil environment that this industry is facing, there will be strength in scale,” Mr Gould said.

Shell’s acquisition of BG would create the world’s dominant producer and supplier of LNG and is a bet that countries like China and India will eventually use less coal and more cleaner-burning natural gas. Together, the two companies produced 45 tonnes of LNG last year, nearly 20 per cent of the total global output.

But the company’s strategy is linked heavily to energy prices and doesn’t produce significant profits until oil prices recover to about $US90 a barrel, from about $US58 on Friday.

The merger also comes as demand for LNG in Europe has been declining since 2011 due to recession. In 2014, European consumption fell to a 10-year low, according to recent figures from BG. Last year, European demand was about 14 per cent of the global market, BG said.

BG said last month it expected LNG prices to become more volatile over the next few years, even as a wave of new supplies begins reaching Asia and new markets in Egypt, Jordan, Pakistan, The Philippines and Poland.

The weakness in Asia’s LNG market is expected to reverse in the longer term, but the price drop has, for now, put the economics of some major global LNG projects in question — including those owned by Shell and BG.

In December, BG reached a milestone when it shipped the first LNG cargo from its Queensland Curtis facility, in which it had invested $US20.4bn. But the company had to take a $US4.1bn writedown on the project this year, driven mainly by a reduction in BG’s assumptions about future energy prices.

“When you get married you don’t choose all of the relations. They just come as a set,” said David Hewitt, head of Asian oil and gas research at Credit Suisse. “I don’t think anyone would pretend that the (QCLNG) asset is attractive from an economic-return perspective.”

BG’s QCLNG plant had already been bedevilled by cost overruns. Australia remains one of the world’s most expensive places for gas projects, with the cost of projects rising fourfold in the past decade. Currency fluctuations, high commodity prices and a shortage of labour contributed to the steep rise in costs. BG is also feeling the effect of lower LNG prices in Asia in its trading business. Like other oil and gas producers, BG makes money not just from producing gas, but also by contracting LNG supplies from other producers and selling them into higher-priced markets.

BG’s revenue and other operating income fell 32 per cent in the fourth quarter in its LNG shipping and marketing business. With Asia no longer commanding premium prices, BG may also have trouble finding a market for the first LNG exports from the US later this year.

Extracted in full from The Australian.

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