Shell sold 64mn t of LNG in 2021, making it the market leader—with a 17pc share of the 380mn t traded globally—and placing it ahead of QatarEnergy, TotalEnergies and Cheniere. In February, as the company launched its annual LNG Outlook, it was clear that even the market leader was taken aback by the events of 2021 and what they imply for the future.
The most obvious signal of LNG turmoil in 2021 was the spot price, as represented by the Asian JKM price, and the gas price in the liquid traded markets of northwest Europe, as represented by the TTF.
“What surprised us most was not that prices went up but how much they went up and how resilient they were,” says Steve Hill, Shell’s executive vice-president for LNG marketing. “What we saw in the second half of the year was unprecedented—the level of prices achieved, the sustained period for which we saw those high levels of prices, and the fact that it was a global issue not a local issue. Those were all new factors we have not seen before.”
Crucially, several of the factors that drove prices so high look set to continue, at least for the coming year and possibly much longer. “There absolutely is a scenario in which tight markets and high prices continue to last for some time, and the biggest factor is the uncertainty regarding what happens next with Russia,” says Hill. “We are forecasting a tighter medium-term market than we were last year and an earlier need for new LNG investment.”
One such factor is the strength of demand in Asia, especially China, where imports continue to defy forecasts, growing by 12mn t in 2021—a rise of 18pc.
“Chinese demand has been growing very strongly, and we expect that to continue,” says Hill, adding that, while domestic supply and pipeline imports were also up in 2021, LNG played a “disproportionately large role”, partly because of growing seasonality. Shell is a big supplier to China, which last year overtook Japan to become the world’s biggest LNG importer.
Events in Europe also contributed. “Europe was a complicated story in 2021,” says Hill, “but important because LNG prices were driven by the European gas market for much of the year”.
Demand for natural gas was up significantly compared with 2020, thanks partly to the post-Covid economic recovery, but an unexpected decline in pipeline imports from Russia led to low storage inventories and a tight market.
Resulting higher prices eventually caused a supply response. “But it took longer than many expected,” says Hill. “Asian efforts to restock inventories before winter meant that cargoes did not come to refill Europe until very late. It was not until December that we started to see a big influx of US cargoes.”
Several other factors played a role. Imports into Brazil tripled to 7mn t/yr because of the impact of drought on hydropower. Japan’s capacity to switch from LNG to oil at times of high prices has plummeted, and supply was constrained by operational and gas supply issues at some liquefaction plants. Global trade was up 21mn t, to 380mn t, but only because US exports grew by 24mn t.
A return to long-term contracts
Looking ahead to the middle of the decade, Shell sees post-pandemic demand for LNG outstripping new supply.
“The message we delivered last year was that demand would recover much quicker than supply,” says Hill. “Covid saw demand destruction, but we forecast that demand would bounce back strongly, which it has. Whereas we said the impact of Covid on supply would take much longer to work through, and we are seeing that play out.”
The volume of new supply expected to reach the market over the coming four years will be much less than over the past five. Moreover, upstream investment generally is lower than pre-Covid, so domestic gas production, especially in Southeast Asia and Europe, is expected to fall, leaving a gap LNG must fill.
“Buyers have started to recognise this market tightness and have been contracting new firm long-term supplies to provide more security of supply and reduce their exposure to the spot market,” says Hill.
“China is doing a good job of taking control over its future security of supply exposure. In 2021, of all the long-term contracts that were entered into by end-country importers, two-thirds of the volumes were contracted by China. Conversely, only 10pc were entered into by European buyers.”
Overall, spot and short-term contracts account for around 30pc of the global market. The enthusiasm on the part of Chinese buyers for more long-term contracts is explained partly by a much higher proportion of spot and short-term supply in China because the market has been growing so quickly, increasing exposure to high spot prices and supply uncertainty.
Europe is in a more precarious position. While its gas market is expected to shrink over the coming decade, domestic production and pipeline imports are expected to fall even faster, so Shell’s forecast is that more LNG will be needed.
“That is probably a message that not everybody was expecting,” says Hill. He cites the example of Germany, which is phasing out nuclear power and coal, while renewables are growing rapidly. “But renewable generation needs a partner to bring reliability and that today is still natural gas. So we expect gas demand to increase.”
At first sight, Europe appears to be well supplied with long-term contracts, but many are divertible to other markets—so vulnerability to the spot market is expected to increase. Meanwhile, regulatory uncertainty around gas in Europe is making it harder to sign long-term contracts than in China.
Exposed to volatility
“Unfortunately, right now Europe is exposed to significant volatility,” says Wael Sawan, director of Shell’s integrated gas, renewables and energy solutions business, “and there are multiple dimensions”.
These include a steep decline in domestic production, the need to ensure there are incentives to fill storage infrastructure and more clarity on the part of policymakers as to the future of gas.
“Right now, a lot of the rhetoric is moving away from gas investment, creating more dependence on international imports,” says Wael.
Looking decades ahead, Shell has reiterated its view that LNG demand will almost double to 700mn t/yr by 2040, thanks largely to rapid growth in Southeast Asia, South Asia and China.
In China, demand will be driven by economic growth and coal-to-gas switching. In Southeast Asia and South Asia, LNG will be needed to fill the growing gap left by declining domestic gas production, demand described by Hill as “very certain because it is simply replacing domestic gas with LNG into existing customers through existing infrastructure”.
“For the next few years, we have quite a tight set of market conditions where demand could exceed supply,” says Hill. “We then definitely have a significant supply/demand gap opening up from the middle of the decade. The supply/demand gap is bigger than we were forecasting this time last year, based on continued strong demand growth and more uncertainty, more issues with the supply mix.”
Shell is more convinced than ever that LNG and gas will “continue to be a critical part of the overall energy transition for coming decades”, and that efforts to reduce emissions from the LNG supply chain will accelerate. But good policymaking will be a key determinant of the outcome.
“2021 was the most eventful year since we started doing these outlook presentations,” says Hill. “But it also gives us some clues as to what can go wrong if the energy transition is not managed well.”