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Shell’s Big Bet On Prelude Floating LNG May Be A Flop

By Irina Slav – Jul 15, 2020, 3:00 PM CDT

It was the last of the large LNG projects that put Australia in the lead for global LNG exports. It was the biggest jewel in Shell’s LNG crown. But this jewel hasn’t produced any LNG since February, and its future is unclear.

The Prelude floating liquefied natural gas project, with an annual capacity of 3.6 million tons, began shipping LNG last June. The first cargo shipped more than eight years after the final investment decision was made, and two years after the FLNG vessel arrived at the site, one Wood Mac analyst pointed out at the time. In February this year, production was stopped following a technical problem.

Production at the world’s largest FLNG installation still hasn’t been restored, and it remains unclear when this will happen. Building it and putting it into operation cost between $12 and $17 billion, according to external estimates. Now, there are concerns that it may flop.

The gas market situation is difficult enough. Just like in oil, there is a substantial glut in natural gas, and demand is lagging far behind. According to Rystad Energy, global natural gas output is set for a 2.6-percent decline this year because of the coronavirus pandemic. Next year, demand should begin to improve, driven by the low prices currently plaguing the sector. But that’s only if the pandemic goes away for good and without a fight, which at the moment is not happening.

In this situation, it may not be that bad that Prelude is not operating at the moment. There is an oversupply of LNG, prices are low, and Shell said in a recent update that it will take a hit because its 2019 term sales contracts for LNG were tied to oil prices.

Related: The Race To Complete The World’s Most Controversial Pipeline

That hit may be nothing compared to what Prelude may need to break even, at least according to analysts from Goldman Sachs quoted by Tim Treadgold in an article for Forbes. According to them, the commercial breakeven price for gas produced at Prelude is as much as $20 per thousand cubic feet. This compares with prices between $2 and $3 per thousand cubic feet in April in the United States.

The difference is impressive, and it certainly would explain why, as Treadgold notes, Shell is in no hurry to restart operations at Prelude.

The question is whether it would become profitable at all, it seems. The current glut will clear in the not too distant future. This is what most LNG market watchers agree on. Gas—and LNG—has enjoyed growing demand as a replacement for coal in power generation, and after the current crisis passes, demand will likely once again start to increase. But supply is increasing, too.

Last year, according to Shell’s LNG Outlook 2020, saw a record number of new LNG capacity additions as the industry raced to secure a spot in the long-term LNG market. And more capacity is coming, too, despite the current challenges. Just last month, French Total secured $15 billion in financing for a new LNG project in Mozambique. Exxon delayed its final investment decision on the $30-billion Rovuma LNG project, also in Mozambique, until next year, but it has not canceled it. Shell itself recently said it was interested in more LNG projects, this time in Russia.

In other words, the long-term outlook for LNG remains positive. The outlook for Prelude, perhaps, not so much. With so much supply already on stream and more coming, competition in the space will only continue to intensify, meaning prices will remain low for longer. And if they do, Prelude may never reach its commercial breakeven level.

“With Prelude now producing LNG for more than a week and the first shipment of LNG being imminent, we are further de-risking the delivery of our $8-10 billion organic free cash flow target in 2020,” Shell’s Integrated Gas & New Energies Director, Maarten Wetselaar, told analysts in June 2019. Hopes were justifiably high and plans were ambitious. But nobody could have foreseen the coronavirus pandemic then.

Now, with 2020 demand forecasts in the trash and new ones pointing towards declines in everything energy-related, things are different. New plans will need to be made, although perhaps not as ambitious as previous ones. LNG will certainly have a lead part to play in the energy mix of the future. But what part costly floating LNG projects will play in LNG remains an open question.

Prelude is an impressive achievement, regardless of its problems. As the largest floating LNG facility in the world, it has a total capacity of 5.3 million tons of hydrocarbon liquids annually, including, besides the LNG, 1.3 million tons of gas condensate and 400,000 tons of liquefied petroleum gas. Floating LNG was to be a game-changer: boosting the efficiency of gas production by adding the processing to the place of extraction. But now it has to prove it is cost-competitive with other, more traditional approaches to LNG production.

By Irina Slav for Oilprice.com

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