CNOOC Signs Landmark CBM-to-LNG Supply Deal with BG Group

Mega Contract

BG Group and the China National Offshore Oil Corp. (CNOOC) have signed a binding 20-year sale and purchase agreement for 3.6 million t/y of LNG from BG's proposed Queensland Curtis LNG (QCLNG) terminal near Gladstone in Australia, in what amounts to a vote of confidence in Australia's coalbed methane (CBM)-to-LNG sector. The BG-CNOOC contract, which not only is one of the largest LNG supply contracts signed from Australia but is also the world's first binding sales and purchase agreement for the supply of LNG from CBM, was signed yesterday in China's capital, Beijing, by CNOOC president Fu Chengyu and BG Group CEO Frank Chapman. At the signing ceremony Australia's energy minister Martin Ferguson expressed hopes that Australian LNG can become the predominant source of supply for a series of new LNG regasification terminals being built along China's coastline.

Under the terms of the agreement, which follows the non-binding heads of agreement (HoA) previously signed in May 2009, CNOOC will acquire a 5% equity interest in the reserves of certain unspecified CBM tenements in the Walloons Fairway of the Surat Basin worth around US$270 million, which will boost the company's reserves and enable it to gain some technical understanding of the development of CBM (also known as coal seam gas, or CSG). CNOOC will also become an equity investor, holding a 10% stake in the project's first liquefaction train, QCLNG 1. CNOOC will reimburse BG Group for 10% of the costs incurred on Train 1, which will be paid in cash upon the project reaching a final investment decision (FID), expected by the end of 2010. The offering of equity in LNG projects and stakes in upstream fields has been a consistent strategy pursued by producers to entice Asian buyers to sign contracts—and this is likely to have been a key reason behind the contract signing—while agreements by BG Group and CNOOC to form a consortium to construct two LNG tankers also indicates flexibility on shipping terms. The conversion of the HoA into a binding contract will increase investor confidence in QCLNG, helping BG in its aim of being one of the first projects to reach an FID. The 3.6-million-t/y contract accounts for almost half of the initial 7.4-million-t/y capacity of the two-train liquefaction project that is due to commence operations in 2014, although the company also harbours longer-term ambitions to expand the terminal's capacity to 12 million t/y.

The binding deal suggests that, despite the reported lower heating value of LNG derived from CBM and the preference to date of buyers to secure contracts from conventional LNG projects in Australia, there is demand for CBM in China. This is good news for investors, as the country is set to become the world's third largest gas market by 2020. Chinese buyers have been looking to Australia because it is a regional supply source with a stable political and economic environment and the country's huge reserves provide opportunities for securing long-term contracts. PetroChina had already signed a massive supply deal to import 2.25 million t/y of LNG from ExxonMobil's stake in the Gorgon project back in August 2009, and CNOOC's deal is even bigger, valued at around US$40 billion if crude oil prices are US$70/b (see Australia - China: 19 August 2009: ExxonMobil and PetroChina Sign US$41-bil. Gorgon LNG Supply Contract). PetroChina is also likely to convert an HoA into a binding contract to purchase LNG derived from CBM from a Shell project, also on Curtis Island. These contracts do suggest that Australia is likely to become a predominant supply source for China, particularly if the Qataris refrain from lowering LNG pricing formulas. For CNOOC, the lower heating value of LNG derived from CBM means that output is likely to be priced more competitively than conventional LNG, which could actually increase its attractiveness, given that the company has to sell into a market where a state-regulated gas pricing system is still in force.

Outlook and Implications

The deal is contingent upon approvals from the Australian, Queensland, and Chinese governments and the QCLNG project reaching an FID. Nevertheless, BG Group has been working hard on the QCLNG project in recent months through opening front-end engineering and design (FEED) tenders, pushing forward environmental negotiations with the government and concluding an agreement with Origin Energy to share output from two permits, ATP 620P and ATP 648P, to boost the reserve base underpinning the project (see Australia: 25 February 2010: Origin Energy Teams Up with BG Group in Australia's CBM-LNG Sector). In order to increase its investment capabilities for QCLNG BG Group has also sold power stations in the U.S. market for US$450 million. BG believes that moving swiftly on developing the project is crucial to gain a "first mover" advantage, believing that once one CBM-LNG project is approved in Queensland others are likely to be delayed, potentially setting back production start-ups beyond the 2014–15 window when a large number of liquefaction projects are due to commence operations in Australia (see Australia: 19 March 2010: BG Group Racing Competitors to Get CBM-LNG Project Approval in Australia). Whether BG Group can secure an FID first remains uncertain, as rival competitor Santos is aiming for an FID deadline of mid-2010. Nevertheless, the Australian and Queensland governments are unlikely to want to delay approval of projects that promise returns by dint of the benefits they can bring in terms of foreign investment employment opportunities in Queensland. Indeed, Australia's Foreign Investment Board has already approved the deal, and the magnitude of the supply deal and its symbolic importance as an indicator of the future prospects for Australia's CBM sector mean that other approvals are unlikely to be delayed.