Market disruptor: nuclear restarts spell trouble for LNG

So conventional wisdom tells us that there is a boat load of cash to make riding the LNG wave. But aside from the historic price volatility for natural gas that should give investors reason for pause, looking over the horizon, there is one big factor that could disrupt LNG investments: if Japan moves to restart some or all of its nuclear reactors, many LNG terminals may cease to be profitable.

Japan was once the third largest producer of nuclear power after the U.S. and France. After the Fukushima meltdown, Japan replaced its 49 GW of nuclear capacity with imported LNG (which jumped 24%) as well as imported coal and oil. Yet Japan may be in the cusp of a return to nuclear. According to DNV GL's LNG blog, the restart of all of Japan's 50 nuclear reactors would mean it could displace about 51 million tonnes of imported LNG.

This amounts to about one-fifth of the entire global LNG trade, and would cause a significant drop in the JKM spot price. This means the spread between the landing price of LNG in Asia and the wellhead prices of say, Australia, or the United States, would narrow. Without that arbitrage, it wouldn't make sense to send liquefied gas around the world from many places. Marginal projects would be forced out virtually overnight.

The Japanese government put in place new safety regulations last summer that utilities must meet in order to receive approval to restart their reactors. Japan's Nuclear Regulatory Authority (NRA) is currently reviewing applications from seven utilities to restart a total of 16 nuclear reactors, or about one-fourth of Japan's nuclear fleet. More applications are in the offing.

While anti-nuclear resentment runs strong in Japan these days, the government is facing quite a bit of pressure to return to its nukes. Post-Fukushima, Japan posted a trade deficit for the first time in decades due to the huge cost of importing coal, gas, and oil. By one estimate, turning half its nuclear fleet back online could save $20 billion per year, good enough to wipe out a big chunk of its trade deficit – which widened to $12.6 billion in November 2013. Prime Minister Shinzo Abe supports nuclear power, making a return to nuclear more likely.

If the Japanese public and government can begin to trust the new regulatory regime, and accept a return to nuclear power, its LNG demand will plummet. As the largest LNG importer in the world by far, this would leave many LNG projects stuck at sea.

In particular, LNG terminals in the U.S. – which are not the lowest cost producers – would be in trouble. Not all companies that have applied for permits will actually move forward with investment, and thus, would be less vulnerable to nuclear restarts. But the ones that do move forward are taking on the risk as well as the potential reward. But with LNG projects proliferating around the world, many companies will be competing for a smaller pie should Japan return to nuclear power.

Cheniere Energy is the first that comes to mind. Dominion Resources (NYSE: D) is another. Dominion hopes to move forward with a $3.8 billion retrofit of its Cove Point facility on the Chesapeake Bay, which is also the subject of a growing environmental backlash. Some Australian projects that are further behind may lose out as well, such as the Arrow LNG project, a 50-50 venture between Royal Dutch Shell (NYSE: RDS.A) and PetroChina (NYSE: PTR). Woodside Petroleum (WPL) has already scrapped its original plans for the Browse LNG project because of high costs. Its Sunrise project, mired in political disputes, may yet get off the ground, but would be vulnerable to Japanese reactors. Russia has major LNG expansion plans, which would face stiff competition if Japan's reactors turn back on. Novatek (LON: NVTK) has plans to invest $15-$20 billion in its liquefaction facility on t he Yamal peninsula, and Gazprom hopes to put $13.5 billion into a facility at Vladivostok – although the latter would at least be in a very advantageous location.

The future of LNG may indeed be bright, especially when considering that global energy demand has nowhere to go but up. But, investors should be aware of the very large threat that Japanese nuclear reactors present to upstart LNG projects.