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drawing of FLNG ship offloading to an LNG carrier

21 Nov Rethinking Canada’s LNG industry model

Is there a better way for Canada to prosecute its LNG ambitions besides following in Australia’s footprints with a suite of onshore greenfield projects? I was giving a lecture at the University of Calgary this past week on the LNG sector, when this topic came up. The students’ interest reminded me that I wrote about this idea in January 2014. Time to revisit.

The LNG project model is discredited

The Canadian approach to the development of the LNG industry looks like how Australia set out to develop its LNG sector (and very similar to how oil sands developed). Multiple competitive projects, each pursuing their own design agenda, with limited collaboration, in a government climate that is promoting rapid resource development. Australia’s projects have all suffered schedule delays, cost overruns or both, in this model, and if Canada follows in this path, I fear for its future.

Unfortunately, the Canadian projects will have many of the same features that have troubled Australia’s sector.

  • Remote build sites. Many of Canada’s LNG projects (specifically, the LNG plants) are scattered up and down the wild BC coast. Remote sites lack local workforces, power facilities, road infrastructure, airports, roads and bridges.
  • Complex Logistics. Remote locations, tricky fiords and absolutely everything needing to be moved in means logistics will be complex, demanding and costly.
  • High (transient) Labour Cost. Canada will also have to fly in much of the build teams because there’s not enough local labour. BC’s strong unions will drive higher unit costs than comparable in the Gulf coast area. Same as Australia.
  • Low Productivity. Complex logistics, fly-in workforce, strong unions and Canada’s already restrictive workforce rules conspire to depress the productivity of Canadian construction sites.
  • Large Train Size. Most of the Canadian projects are configured with large liquefaction trains (4 million ton capacity, and multiple trains). These designs drive operating scale economies once built, but clearly are a strain to deliver cost effectively.
  • High Complexity. The greater the complexity of the designs, the more costly they are to deliver. Projects that feature rich gas, new pipelines, off-grid power, and challenging moorage contribute to higher costs.
  • Over-heated Supply Chain. By building multiple projects at once, Canada risks overheating its supply chain. In Australia, this lead to shortages of services and companies and triggering overinvestment in the sector that ultimately led to bankruptcies.
  • One-off Project Solutions. Limited collaboration drives multiple parallel and duplicative investments in physical infrastructure (pipelines, gas plants). Australia found it very hard to drive collaboration, as has Alberta’s oil sands.

The Floating Model

I envisage a very different industry model. Instead of eventually ending up with a small number of on-shore LNG facilities, how about a fleet of floating LNG plants? The plants would be clustered off shore in an area selected for its minimal environmental impact. The plants would be fed from a sea floor gas manifold, connected to gas pipelines that transport gas from field to port through a single land corridor. More projects could be built faster, in parallel, with similar cost profiles (because of the competition to build the FLNG kit).

The Government Take

This industry model provides significant benefits to the state:

  • Improved royalty recoveries. This industry design maximizes royalty recoveries in four dimensions. Royalties can be recovered faster as the FLNG plants can be built quicker. Royalty rates will improve as all FLNG projects yield a similar overall cost profile (later plants do not inherit the high cost structure of the earlier plants). Royalty flow is steadier because during shutdowns and turnarounds, gas can be redirected to substitute plants or other plants already in operations. Finally, royalties are greater in volume as the industry can grow bigger in scale.
  • Lower environmental impact. Floating facilities means minimal land disturbance, and therefore faster project approvals, less impact on traditional ways of life for First Nations, less impact on habitat and faster stakeholder agreements. LNG vessel movement would not impact near shore fisheries or harbours. Less on-shore infrastructure (roads, bridges, water, power, etc) is required because the LNG facilities are not built (a good outcome for a cash-strapped government).
  • No end of life remediation. At the end of the life of the gas fields, there’s no significant remediation of plant – FLNG kit just floats away to the next basin, or is broken down for scrap and recycled.
  • Safer. Any catastrophe on an FLNG plant would be contained off shore. Vapours would dissipate with minimal risk to on shore residents. Emergency response infrastructure would be shared and minimized, reducing standby costs. On-shore plants require a Fort Knox security infrastructure to keep them safe from abuse.

The downside is the reduction in one-time construction job creation. This will not be viewed favourably by a labour-sensitive government, but Australia has already seen the effects of the end of the construction cycle. Some 30,000 jobs in Queensland related to building the gas industry disappeared. Unemployment is now creeping up, labour costs reached ridiculous levels and are very sticky, national productivity is low, and the future for those highly paid workers is very uncertain as there are no new plants to be built.

I also wouldn’t worry too much about the consequences of delaying the LNG industry in BC. The Americans have slowed down sanctioning new projects, Australia has no more projects on the horizon, the Russians have only just opened up their export focus on Asia, and China’s air quality isn’t getting any better.

Big Benefits for Business

Under an FLNG concept, the project proponents, particularly the newer projects, gain substantially:

  • Lower capital costs. By building the FLNG plants in the big shipyards of Korea, Taiwan and Japan, the labour shortfall expected (and resulting wage escalation) is neatly sidestepped. Projects will return their cost of capital quicker, derisking the projects. More financing options for FLNG begin to open up as there are pools of capital interested in financing such steady use, but moveable equipment.
  • Reusable plant. One of the best features of FLNG is that the kit can be redeployed at end of basin life, or to other more promising basins as economics dictate. Land-based plants just get mothballed and leave a permanent eyesore behind.
  • Optimized plant utilization. By designing in the potential to share gas through manifolds, projects will be able to achieve higher plant utilization rates. This structure enables gas swaps and other convenient mechanisms to keep plant operating at the highest possible rate.
  • Improved project scale. Smaller gas players, that would otherwise be unable to finance an LNG plant, could pool together their gas interests and supply a tolling plant. This style of development is also more scaleable and better able to match gas field development timing.
  • Shared infrastructure. Of course, the off-shore plants will require on-shore services for provisioning supplies, repair equipment, personnel, training, etc. Such on-shore services could also be grouped together to minimize costs, and improve economies of scale.
  • Lower turnaround costs. Turn arounds would take place in a shipyard or on board, not on shore, reducing demand on infrastructure, lowering costs and congestion. And because another FLNG ship can take the place of the ship under turnaround, cash flow is not interrupted, merely reduced.

The biggest benefit to Canada, however, is Canada’s potential to maximize global LNG market share. If Canadian projects pursued this path to development, Canada’s share of future LNG trade would be considerably greater because the industry could move so much faster. All of BC’s surplus gas could be monetized, including other shale resources and conventional fields in Alberta and Saskatchewan. And it may even be a necessary strategy to be competitive with the lower brownfield expansion costs of the Australian projects, the likely FLNG developments in East Africa and the US LNG projects.

Complications, always complications

I can hear the Canadian engineers now with all the complications they foresee. How to handle gas variability for example (raw gas composition will vary from field to field). And FLNG technology is just under development, not field proven (although the first floater has just entered service). And there’s money already sunk in land acquisitions, prior engineering studies, pipeline routings, project negotiations, partnerships. And there’s fish and whales and birds to think about, not to mention the risk of subsea earthquakes.

Is it too late for a rethink?

With only one of the BC projects now sanctioned (and yes, it does not follow the Australian design. Coincidence?), it’s not too late to revisit how the province’s resources will be monetized. But the government should be very clear that the projects will absolutely not move in this direction on their own. If Australia’s projects are any guide, the Canadian projects will need a sharp shove to look at the resource in any way other than their single, roll-your-own gas value chains.

Special thanks to Nicole Walshe for the doodle at the top, featuring a floating LNG production ship off loading a cargo of LNG to a carrier.

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