Canada in the race for LNG demand

Kitimat LNG rendering courtesy of Kitimat LNG

With abundant natural gas reserves, a politically stable economy, strong legal and business systems, access to skilled labor and close proximity to Asian markets, Canada may be one of the most attractive places to do business in today's fast-growing and very dynamic liquefied natural gas (LNG) market.

But the longer Canada waits to take advantage of the current global demand opportunity, the longer foreign suppliers with considerable proven gas reserves have to secure contracts with Asian markets. It's up to the holders of Canadian natural gas assets to make the most of the country's natural advantages and get in the LNG game.

Facing the competition

Canada faces stiff competition from foreign powerhouses when it comes to exporting LNG. Countries around the world are all fighting for their share of the LNG pie. Aggressively locking in multi-year contracts and building out the right infrastructure is the order of the day for countries around the world, including Australia, Russia, Malaysia, Qatar, the US and, more recently, Mozambique — all hoping to snag some of the growing demand we're seeing in emerging markets.

Today Qatar dominates LNG exports, followed by Indonesia, Malaysia, and Australia. But in recent years, Russia and Iran have come onto the scene with considerable proven reserves and the advantage of close proximity to Asian markets. And the seven LNG terminals announced by the US have the potential to put the country ahead of Qatar as the world's leading exporter. But recent political headwinds against natural gas markets in more than one of these countries (especially the US) are causing some degree of market uncertainty and creating new opportunities for Canada.

Why Canada?

Canada is the third-largest producer of natural gas in the world, at approximately 14 billion cubic feet per day (bcfd), and holds proven reserves of more than 70 trillion cubic feet (tcf). Canada has always been a net exporter of natural gas, as production far exceeds domestic supply requirements. Currently, approximately 9 bcfd are exported to the US.

The challenge is that the US has been the country's only external customer to date. Recent shale and other unconventional gas developments in the US and Canada have dramatically changed the North American natural gas reserves picture. Some analysts suggest that North American natural gas reserves may support current production levels for more than 100 years. All of this has hurt US export potential and the traditional value proposition for Canadian gas. Without new markets, Canadian gas will be stranded or sold at significant discounts to world prices.

These reserves, coupled with Canada's economic environment, make it an attractive place to do business. Canada offers demand markets an important diversified supply base. Although future volumes of LNG from Canada may be relatively small on a global scale, they represent a secure and stable supply channel when compared against other countries and can play an important role for Asian buyers looking for diversified supply, including Japan, China, South Korea, and Vietnam.

Canada's proximity to these demand markets also creates a competitive market with foreign exporters like Qatar and Australia. Canada is separated from Asian markets by approximately 4,000 to 5,000 nautical miles compared with Qatar at 6,000 to 7,000 nautical miles and is not significantly different in distance than from Australia. The resulting transportation cost differential is a significant equalizer.

Canada also has the advantage of having existing Asian investment. Several foreign companies have already made investments in Western Canada upstream gas assets to integrate their natural gas supply value chain and create supply security. Examples of recent investments into Canadian natural gas assets to support LNG export projects include those made by Petronas (Malaysia), Mitsubishi (Japan), and Kogas (South Korea).

Existing investments have the potential to open doors for Canadian companies to further integrate down the value chain and seize opportunities to supply LNG through long-term contracts with these firms. But Canadian market players looking to capitalize on global LNG demand will need to accelerate projects and build the necessary infrastructure to export to Asian markets.

Putting challenges at ease

One of Canada's primary challenges in breaking into the LNG market is its lack of infrastructure. Significant investment in new pipelines and liquefaction terminals will be crucial over the next five to 10 years. But LNG projects are often too big and too risky for companies to tackle on their own. Liquefaction participation also requires a big balance sheet and a long-term investment and return horizon.

Without the proper infrastructure in place to move product — both to Asia and south of the border —Canadian natural gas risks selling at a discount, harming investment returns, driving up the cost of capital for the required Canadian investments, and leaving billions of revenues, royalties and taxes on the table for various Canadian governments. Significant capital investment for constructing infrastructure is imperative for Canadian LNG export to reach its potential.

Maintaining a social license to operate is also making its way to the top of the business agenda. Successful companies must excel at managing this challenge — or risk stranding their capital. Canada's oil and gas industry has become the target of environmentalists and other special-interest groups from around the world, particularly because of infrastructure construction. Upstream shale gas extraction and production, pipeline transportation, tanker transportation, liquefaction, and relationships with First Nations groups are all environmental challenges facing companies operating in the LNG space. Succeeding at the regulatory process will be key.

Companies can address these concerns by focusing on demonstrating their ability to meet the highest environmental, safety, and sustainable business practices. The industry can benefit by making the public and invested parties aware of the issues associated with LNG and the possible solutions. Demonstrating their commitment to environmental sustainability will also enable companies to gain the necessary approval for new infrastructure. The industry will also have to show that new LNG developments will be good for all Canadians, both economically and socially.

Finding the labor to advance projects is another challenge Canadian LNG proponents will face. High levels of development and construction activity are causing shortages of skilled labor across Canada. Exacerbating this challenge is the increased need for skill sets that are more and more difficult to come by. As a result, specialized skills are coming at a higher cost. Skill shortages are ultimately leading to higher salaries, training costs, and perquisites, all of which are driving up project costs. This issue is also occurring in Australia, challenging project timelines and returns there.

Foreign entrants into Canada will have to seek and obtain approval from Investment Canada for any acquisition of a Canadian company. While Canada ranks very high in terms of openness to foreign investment, recent announcements of high-profile transactions involving inbound Asian buyers of Canadian-owned companies are putting the country's reputation to the test.

Working together

Companies will have to address each of these challenges to make the most of LNG opportunities this year. That's where strategic joint ventures and partnerships come into play.

More and more industry players are turning to JVs and strategic partnerships to mitigate challenges and maximize success in Canada's oil and gas market. Collaborating enables both parties to share leading practices around technology, environmental reclamation, social and economic performance, as well as to create a common labor pool. JVs and partnerships can help Canadian companies accelerate their LNG plans and provide access to complex foreign markets for the LNG off-take. But even more importantly, these partnerships can inspire a broader level of Canadian support for foreign investment.

For all the advantages of JVs and partnerships, there are also complexities — many of which could make or break the success of the collaboration. Companies must take a close look at their business operating model. Strategy, business processes, information systems, structure and governance, people management and corporate culture define a JV organization.

By evaluating these components, your company can shed light on new opportunities to improve business performance efficiencies, including on-site requirements for people, low-cost country sourcing, remote operations and better use of technology. Understanding how people, processes and technology factor into your operating model is critical to ensuring that a partnership aligns with your company's own strategic direction. Foreign buyers often cite knowledge and expertise transfer as a key desire relative to Canadian acquisitions. Achieving this objective will be a critical component of any successful JV arrangement.

When all the pieces are in place for successful JVs and partnerships, Canadian companies stand only to gain. In many cases, these alliances can make all the difference between making the most of global demand opportunities and losing ground to foreign suppliers.

Going forward

There's no denying Canada's potential in the global LNG market, but success for players won't come easily this year. Canadian companies will have to accelerate infrastructure development, seek new capital sources and tie down long-term customers to expand their piece of the global LNG demand pie.

Increased investment from sources outside the US will most certainly change the way Canadian companies think and operate. They will have to develop a greater understanding of the business practices, processes, and cultures of other countries to make the most of JVs and partnership opportunities. Companies will face growing pains and encounter challenges, but the benefits are tenfold. Those that are up to the test will come out on top.

But more than anything, Canadians themselves will have to adopt a more global mindset. The capital required to fund the growth of Canada's natural gas assets will increasingly come from global sources, especially Asian state-owned enterprises. The viability of Canada's natural gas assets depends on this foreign investment. Simply saying no isn't an option anymore.

About the author

Barry Munro is a partner at Ernst & Young LLP (Canada) and is its Oil & Gas Practice Leader. He is based in Calgary, Alberta. The views expressed herein are those of the author and not necessarily those of Ernst & Young LLP.