By Sarah Kent and Sarah McFarlane
Big Oil is betting on natural gas as the fuel of the future, but
companies face a challenge to show they can make as much money
producing and selling cargoes of gas as they could from tankers of
crude.
Last week, Royal Dutch Shell PLC announced a liquefied natural
gas project in Canada that will cost $14 billion to build, while
Exxon Mobil Corp. and partners are expected to approve a
multibillion-dollar LNG project in Mozambique in 2019. That is a
similar timeline to Russia's roughly $20 billion Arctic LNG-2
project, which is part-owned by France's Total SA.
Natural-gas projects historically have delivered lower returns
than big oil projects, and as a result companies and shareholders
have prioritized oil developments. That's something the companies
are working hard to change.
Still, according to Edinburgh, Scotland-based consultancy Wood
Mackenzie, the weighted average internal rate of return for
liquefied natural gas projects currently in the pipeline is about
13%. That compares with 20% for deep water projects and 51% for
unconventional oil developments like shale.
"The problem for oil companies is that gas is much more
difficult to make profitable," said Eirik Wærness, chief economist
at Norwegian oil company Equinor ASA, formerly known as
Statoil.
The case for gas also becomes more difficult, at least in the
short term, when oil prices are high as they are again today,
though oil companies invest on a long-term horizon.
Yet big oil has little choice but to double down on gas.
Companies have discovered fewer large new oil deposits than natural
gas opportunities over the past decade. And governments, including
China and many in Europe, are seeking to reduce pollution by
burning cleaner fuels for transport and electricity. A new
natural-gas power plant emits around half as much carbon dioxide as
a new coal or fuel-oil plant.
Rising global demand also makes a compelling case for
natural-gas investment. Oil consumption is expected to rise by just
0.5% a year out to 2040, according to Wood Mackenzie, a substantial
slowdown from previous decades. Some forecasts anticipate demand
will stop growing altogether within the next decade.
Natural gas consumption, though, is expected to rise to 24% of
the world's energy mix by 2040, from 22% in 2016, according to the
International Energy Agency. LNG's share of that market is set to
rise to almost 40% in 2023, from around a third in 2017, the IEA
forecast.
"It's all a balancing act," said Brian Youngberg, senior energy
analyst at brokerage Edward Jones. "At the end of the day, oil is
the most profitable product they produce, but demand is going to
slow so you need to start managing that transition."
At the same time, oil companies are eyeing efforts to curb
global warming that could make lower-carbon natural gas more
competitive. Policies like a substantial price on carbon "moves the
dial on gas," Mr. Wærness said.
By 2025, both Shell and BP PLC will be producing more gas than
oil. French oil giant Total SA's production is already a near 50-50
split. Exxon Mobil Corp. is also planning significant new
investments in LNG. The companies are selling the shift as a smart
strategic bet on a growing market.
"The good news is that the natural gas market will continue to
grow, and this explains why we are aggressive, offensive and
expanding," Total CEO Patrick Pouyanné told investors last month.
"On the contrary, the oil market will stabilize and even
decline."
Investors have embraced the strategy, with some reservations.
While big gas projects generate lower returns, they are profitable
and provide much more stable long-term cash flow than most oil
developments -- very attractive characteristics for shareholders
who want to know their dividends are secure. And internal rate of
return is just one way to gauge attractiveness. Many big gas
projects offer additional opportunities for profit-generation
through trading and business integration.
The natural-gas projects provide "very stable and consistent
cash flow and this is something oil-and-gas companies have never
really had, and what has made them so cyclical," said Richard Hulf,
a manager of the Global Energy Fund at Artemis Fund Managers.
Companies are continuing to make significant oil investments,
providing a balance to higher risk, higher reward projects that
many investors like.
Yet the dash for gas highlights broader risks for the sector in
an age of lower-carbon energy and an eventual shift away from
fossil fuels altogether to more renewable energy.
"The pivot to gas the industry is engaging in will over time
probably mean the industry is pursuing a dramatically smaller
overall profit pool -- unless gas pricing moves to energy
equivalence with oil, which is unlikely," said Nick Stansbury, head
of commodities research at Legal & General Investment
Management.
Investment in renewable energy for electricity generation is
already outpacing fossil fuels globally, driven by falling costs of
producing wind and solar power. More than half of power-generating
capacity added in recent years has been in renewable sources,
according to the IEA.
"Longer term it's the logical thing to be doing if you believe
that the gas market has got more longevity and is going to continue
growing," Wood Mackenzie analyst Tom Ellacott said.
Big oil companies are working to drive down costs, secure buyers
and leverage their market clout to maximize returns. Shell pushed
back the approval of its Canadian LNG project by two years and
split it in half as it worked to bring down the costs. It expects
the project to generate an internal rate of return of 13%.
The moves point to the potential for a more sober oil-and-gas
industry, less prone to the dramatic slumps that come with
oil-price cycles yet with equally less promise to reach heady
peaks.
"You will see lower return on investments for some of these
[gas] projects," said Espen Erlingsen, a partner at Norwegian
consultancy Rystad Energy. "I guess that's something they have to
live with."
Write to Sarah Kent at sarah.kent@wsj.com and Sarah McFarlane at
sarah.mcfarlane@wsj.com
(END) Dow Jones Newswires
October 09, 2018 15:02 ET (19:02 GMT)
Copyright (c) 2018 Dow Jones & Company, Inc.
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