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Could an LNG glut wipe out Aussie producers like Origin and Santos?

Just as Australia approaches the homeward stretch on several significant LNG projects, Texas-based oil and gas titan ConocoPhillips (NYSE: COP) has warned that supply could outstrip demand if the majority of globally planned LNG projects go ahead.

That’s not the kind of news companies and investors want to hear after a lengthy period of investment and development that has seen hundreds of billions of dollars staked on the commodity by the likes of Origin Energy (ASX: ORG) and Santos (ASX: STO), as well as many big international companies. If true it could represent a big threat to the future price received by producers.

Conoco made the claim during a presentation at the South East Asia Australia Offshore Conference in Darwin last week. Head of the company’s commercial Australia operations Mike Nazroo is quoted by The Australian saying “In the longer term, capacity additions look set to catch up with, and even overtake, demand.” New projects planned in North America, East Africa, Nigeria and Russia will add to supply and may have lower operating costs than Australia’s projects.

The claim is supported by research done by consulting firm McKinsey that suggests that the current number of proposed projects globally is twice the number that will be required to meet demand from 2020 onwards.

Could this spell disaster for Australia’s projects? Given the timeframe involved it is unlikely. If supply is forecast to exceed demand, the price for LNG should drop. When potential new projects are evaluated against this, the lower price will mean projects generate a lower rate of return that may make them uneconomical on paper.

This does however place an even higher importance on costs. We have already see the impact of high costs on Woodside Petroleum (ASX: WPL), which abandoned plans to build an on-shore LNG processing plant at James Price Point in favour of a lower cost floating LNG (FLNG) option.

Australia does have the significant advantage of being a relatively short distance away from the main growth region for LNG, Asia. This means lower transport costs to export the final product.

Foolish takeaway

Production from Australia’s LNG projects has already been kicked off by Woodside’s Pluto LNG, and as others come online next year strong cash flows will start to reimburse the massive investments and sunk costs made by energy companies.

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Motley Fool contributor Regan Pearson does not own shares in any companies mentioned in this article.

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