Platts is reporting that Engie has halted talks with NextDecade over a supply agreement with its Rio Grande LNG. In a written statement to Platts, Engie said “[We have] decided not to proceed with commercial discussions with NextDecade on this gas supply project. We will not be making any further comment.”

Our initial read is that the SPA’s cancellation will likely have major implications for LNG and the entire U.S. O&G complex. We expect that, going forward, EU (and probably U.S.) regulators will carefully scrutinize methane emissions when evaluating future O&G projects. But the impact could, potentially, be much greater. It’s possible that existing flows of crude, LNG, ethane, and other NGLs could face greater regulatory scrutiny and penalties. We will have to watch this trend carefully.

We suspect the sudden emphasis on methane emissions is at least partially attributable to a new satellite system dedicated to monitoring methane emissions. On October 21^st, GHGSat launched a new tool that tracks methane emissions from space. It’s hard not to draw a link between the launch of the methane tool and news of the project cancellation, which both occurred on the same day.

Engie and Rio Grande LNG: what the heck just happened

On October 21^st, Politico broke a shocking story: Engie agreed to a $7 billion, 20-year contract with Next Decade’s Brownsville-area Rio Grande LNG, only to have it blocked by French regulators over fears of methane emissions in the Permian basin. This story is stunning for several reasons: this deal would represent the first Sales and Purchase Agreement, or SPA, signed by a U.S. LNG exporter since Plaquemines LNG inked an agreement with EDF in Feb 2020; more French/EU regulatory scrutiny of methane emissions could pose enormous risks not only to LNG, but even to crude oil exports; and, finally, we’re surprised that Engie chose Rio Grande LNG over other projects. We – at least for now – expect the deal to receive approval after some bureaucratic tussling, but also expect that emissions are moving to center stage for LNG projects.

U.S. LNG’s offtaker difficulties

U.S. LNG exporters haven’t contracted offtaking capacity since the Plaquemines/EDF tie in. Before that, the last deal we’re aware of was the Rio Grande/Shell arrangement, reached in April 2019 for 2 MTPA. We’ve also heard that these SPAs were of “low value” for the respective LNG projects, as Shell and (probably) EDF were able to obtain preferential rates due to their status as “foundational shippers.” By signing onto a project in its commercial infancy, foundational shippers can often secure steeply discounted rates. We won’t be surprised if Rio Grande offered similarly lucrative terms to Engie – although, to be clear, the quantity and $/MMBtu terms have not been publicly disclosed. If, on the other hand, Rio Grande was able to secure a sizable quantity commitment on competitive terms, that would be a big deal for the project – and could indicate that some of the pessimism surrounding the industry has been misplaced. We will have to wait and see until more information becomes publicly available.

Regulation troubles?

If U.S. LNG begins to consistently runs afoul of EU methane emissions the consequences could be dramatic, and not just for natural gas. Could Permian or (less probably) Bakken-sourced oil exports face similar penalties? Our perspective is that while regulators will increasingly scrutinize emissions, potentially weighing on the shale patch, we expect the Rio Grande/Engie deal to ultimately receive approval (and, indeed, a U.S. Senator is pushing for a rapid approval of the contract).

At the same time, keep in mind that important constituencies in France will lobby against LNG imports, and France has significant options for baseload power. About 75% of French electricity generation is sourced from zero-emission nuclear power and, interestingly, EDF operates France’s 58 nuclear reactors. The EU regulatory environment could be more complex than we understand over here in Texas.

Brownsville-area LNG faces structural disadvantages

We’ve always been highly skeptical that the Brownsville-area LNG projects would receive FID. Brownsville is relatively geographically distant from upstream production and liquid trading hubs; doesn’t have a sizable O&G labor pool to draw from (unlike Corpus, Houston, Port Arthur/Lake Charles, and even New Orleans); local projects have faced intense local environmental opposition; and some of the projects have faced permitting difficulty. We’ve heard that at least one of the Brownsville-area LNG projects wanted to site in Corpus Christi but could not secure space on that port’s highly congested docks. Brownsville, it seems, was the 2^nd best choice after Corpus Christi and happens to be the first deep water port as you travel south from Corpus.

… but is overcoming it, potentially?

Rio Grande LNG may have two competitive advantages over other projects, however. It secured highly favorable tax treatment from the local county government, and could enjoy economies of scale from its (massive) train sizes. The project could also offer superior environmental benefits when compared to other LNG projects (despite the spat over methane emissions).

Rio Grande and Cameron County reached an agreement in 2017 wherein Rio Grande LNG received a tax abatement valued at $373 million. This tax abatement could potentially allow Rio Grande LNG to undercut the prices of competitors in other jurisdictions, such as Corpus Christi, the TX/LA border, or southeast Louisiana. Rio Grande would also presumably “front-load” tax abatement savings for the initial customers, and then use its economies of scale and sunk costs to attract additional, follow-on customers.

Rio Grande LNG’s massive (~5.4 MTPA) train sizes could conceivably represent a competitive advantage, despite the industry’s trend towards smaller and smaller train sizes. Rio Grande LNG has filed two FERC applications: in its first application, it listed the number of trains at 6 and a total nameplate capacity of 27 MTPA. In a subsequent application, it obtained approval for a 5-train redesign, while holding its total nameplate capacity constant at ~27 MTPA.

Curiously, NextDecade may have completed the redesign for “environmental economies of scale.” Rio Grande has hyped the CO2 savings from the 5-train redesign, saying the redesign will lower CO2 emissions by 21%. NextDecade has also put out press releases saying it is targeting carbon-neutrality at Rio Grande LNG.

Wait and see, LNG

There are a lot of moving parts in this saga. We believe that, on balance, the Rio Grande-Engie deal is more likely to proceed than not, but note that there is considerable regulatory uncertainty. We’re going to follow this story very carefully, as greater EU regulatory scrutiny of methane emissions could have important repercussions for the entire U.S. O&G complex.