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Lake Charles LNG suffered from uncertainty, delay before Shell's sudden exit

Royal Dutch Shell PLC's recent decision to exit the Lake Charles LNG project dealt a serious blow to the export venture it had been developing with pipeline giant Energy Transfer LP, but the move also left market observers wondering about broader implications for the LNG sector.

One of the world's biggest LNG players had walked away from its only equity position in a U.S. LNG project. Did this mean Shell, which handles about a fifth of the world's LNG production, has a dimmer view on the fundamentals of U.S. LNG than other observers? Or is Lake Charles LNG among the first of many LNG developers that will feel the effects of the coronavirus pandemic that has brought financial strain to projects and muddied the supply outlook for the years ahead?

But there is another explanation. Shell's decision appeared to be a long time coming, the result of years of uncertainty over Shell's role, a lack of progress signing long-term contracts, and other projects passing Lake Charles LNG in the development race, including another Shell export venture in Canada.

Lake Charles LNG received federal approval in 2015 to begin construction of the terminal, but the project remained in investment limbo for years. One of the main advantages of the project, which would have three gas liquefaction trains and a total LNG production capacity of 16.45 million tonnes per annum, has been that it was one of the few existing U.S. regasification facilities proposed for development into an export terminal, which brings cost and logistical advantages. But as time went by, the advantages became less pronounced, experts said.

"The brownfield advantages that Lake Charles does bring likely aren't as competitive as LNG train expansions, and projects like Golden Pass LNG could obviously get to market faster and didn't require binding sales contracts to start construction," said Eric Smith, an analyst of LNG projects and managing partner of the research firm Webber EPC. "Energy Transfer is not the type of company to put out billions of dollars with no binding contracts."

Shell had those types of partners when it made its move on LNG Canada in October 2018. The Shell-led consortium that commercially sanctioned the project included large buyers of LNG — PetroChina Co. Ltd., Korea Gas Corp., Malaysia's Petroliam Nasional Bhd., and Japan's Mitsubishi Corp. No long-term supply contracts were announced before they greenlighted the project.

When that relatively novel approach was repeated with the February 2019 decision by Qatar Petroleum and ExxonMobil to move ahead with Golden Pass LNG in Texas, it demonstrated the advantage of LNG projects backed by integrated majors. Even as Lake Charles LNG stalled, analysts said Shell's involvement in the project meant it could still get over the line.

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'Unforeseen delay'

But as Shell concentrated on LNG Canada, Energy Transfer publicly acknowledged its frustration with a lack of progress on Lake Charles LNG and cited differences with Shell over costs and other issues. In November 2018, Energy Transfer Chairman and CEO Kelcy Warren said the partnership with Shell had "at best, stalled."

"Shell does not have this project up high on their to-do list, I think, but we do," Warren told investors at the time.

In an August 2019 request to extend the certificate approval for Lake Charles LNG, Energy Transfer said an "an unforeseen delay in the originally projected construction schedule" stemmed from Shell's acquisition, completed in 2016, of the British oil and gas company BG Group PLC, the company that was originally contracted for the full production capacity. The acquisition led to negotiations of new project agreements and a reevaluation of the project by Shell.

Before that request, the uncertainty over Shell's role had seemed as if it had been resolved. In March 2019, Shell and Energy Transfer announced a project framework agreement that laid out commercial terms for developing the facility. The agreement established that Shell would serve as the project lead and, if the project was sanctioned, as construction manager and operator of the facility. Energy Transfer would be the site manager and project coordinator prior to the final investment decision. Lake Charles started soliciting bids from potential off-takers in April 2019.

Shell was to take half of the off-take from Lake Charles LNG, and Energy Transfer sought to tie the other half to long-term supply agreements in order to underpin financing. But the competitive environment for securing such deals was becoming increasingly difficult, which proved a struggle for several U.S. developers. By February 2019, Energy Transfer was pointing to trade war to U.S. and China as a factor that made it more difficult to market the LNG from Lake Charles.

In December 2019, FERC granted the request from Energy Transfer subsidiaries for a five year-extension to complete the Lake Charles LNG terminal and related facilities, giving the developers until December 2025.

But a global gas glut was building, and analysts increasingly wondered if new LNG projects would be able to advance to construction in 2020. By February, Shell was attributing weak LNG market conditions to a big increase of U.S. LNG exports and weaker-than-expected demand during a mild winter.

"It's definitely true that the brownfields are running out," Shell's Maarten Wetselaar, director of integrated gas and new energies, told an analyst during a Feb. 20 presentation on Shell's 2020 LNG outlook. "We partly controlled the last big one in Lake Charles, and we'll see how competitive that is as the bids come in and as the structure dries up."

Energy Transfer takes over

The coronavirus pandemic hammered global gas demand in the weeks since that presentation, and it created tremendous supply and demand uncertainty as the world economy suffered. Shell said it would cut its spending for the year from about $25 billion to $20 billion or below to weather a crash in oil prices and slowing demand.

This presented a clear rationale for Shell to reconsider Lake Charles LNG, analysts said. Shell attributed its decision to exit the project to "current market conditions."

"It looks to us like the business case is much weaker for new LNG commitments here," Robert W. Baird & Co. Managing Director Ethan Bellamy said in an email. "Also, if you're cutting back capital, doing so on projects with a multi-year lead time makes sense."

Energy Transfer and Shell declined to disclose whether Shell would remain an off-taker for LNG from Lake Charles LNG. Several major energy projects worldwide, including other Shell ventures, have been delayed with the turmoil in energy markets. But Shell cautioned against interpreting its decision to pull out of the Lake Charles as reflecting a shift in the company's view of U.S. LNG or global gas markets.

"We remain confident in the long-term fundamentals of the LNG market, and that's reflected in our robust integrated gas portfolio," Shell spokesperson Curtis Smith said in an email. "The move we made specific to Lake Charles was an effort to preserve cash against the backdrop of current market conditions."

Shell's Wetselaar said the company continues to believe in "the long-term viability and advantages of the project." Shell will continue to support Energy Transfer with the ongoing bidding process for an engineering, procurement and construction contract for Lake Charles LNG and then a planned phased handover of the project's remaining activities.

"ET would have been a good partner because of their willingness to spend money," Bellamy said. "As a partnership, Kelcy Warren doesn't have to keep shareholders happy and can proceed as he sees fit."

Energy Transfer plans to keep pursuing the Lake Charles LNG project, but the company said it might reduce the size to two trains with a total capacity of 11 mtpa. The company said it would also evaluate bringing in "one or more equity partners," but that "a final investment decision will be dependent on market conditions and capital expenditure considerations."

Energy Transfer spokesperson Lisa Coleman said the company is focused on commercially developing the project with a targeted final investment decision in early 2021.

But market observers continue to wonder about the project. "What is their real advantage?" Webber EPC's Smith said. "They don't have Shell now. All the big boys have made their move in this wave ... It feels like they have missed the window."