Friday, February 23, 2007

Another Third Way

It's not unusual for big energy projects to be canceled, as the key factors determining their ultimate profitability--project cost, start-up timing, and feedstock and product values--shift. We need to be cautious about reading too much into the cancellation of any individual project. Nevertheless, ExxonMobil's announcement this week that it is terminating its planned Gas-to-Liquids (GTL) project in Qatar seems to reflect issues beyond this endeavor's sensitivity to the construction cost inflation that has hit the entire oil and gas industry. It is a signpost of the competition between alternate outlets for natural gas, and an indication of the direction of gas globalization. The outcome of this trend will determine what Americans pay for natural gas and its derivatives in the future, because of our growing reliance on imported gas from outside North America. It is also relevant to the future price of oil.

There's been a good deal of speculation in the industry about which of the two main approaches for bringing remote gas to market would win, or whether they might co-exist. Liquefied Natural Gas (LNG) had a substantial head start over the modern version of Gas-to-Liquids (GTL), which represents another branch of the WWII German Fischer-Tropsch family tree. Both of these processes turn natural gas into a liquid that can benefit from the transportation and marketing flexibility that crude oil naturally enjoys. However, LNG returns to the gaseous state after delivery, while GTL's products compete directly with petroleum products. So what's at stake here is whether gas deposits too distant to be pipelined to customers will end up augmenting gas supplies, or supplementing global crude oil production. With local gas production falling short of demand in North America and Europe, and with growing concerns about future global crude oil availability, this is an important question.

So what does the cancellation of Exxon's GTL plant in Qatar say about this dilemma? Interestingly, it points in a different direction altogether. Certainly it reflects the increased risk that higher construction costs would raise the project's breakeven relative to crude oil and expose Exxon to losses, if oil prices weaken. But the most significant fact here is that GTL didn't lose out to an LNG project. The 1.5 billion cubic feet per day gas feed for this project is apparently going to stay in Qatar, fueling power generation and supplying feed for chemicals and other industries. Viewed from the perspective of consuming countries, this is the worst possible news. This gas won't be turned into ultra-low sulfur diesel, indirectly shoring up oil supplies, or allowed to compete with other LNG projects, and thus holding down global gas prices. Instead, it will end up competing with gas-consuming industries in North America and Europe, which make petrochemicals, plastics and fertilizer and already face severe cost disadvantages.

This outcome shouldn't surprise us. Developing countries need to get the most income from their resources. Exporting the raw material makes sense, if you don't have the capital--financial, intellectual and human--to turn it into higher-valued products, or if you doubt your ability to gain access to foreign markets for those products. But in a world of transparent global capital flows and falling tariffs, going after that extra value added must look very tempting. The forces of globalization are helping to create a truly global natural gas market, on which we will rely increasingly in the years ahead, because we've chosen to constrain our own gas production by restricting gas drilling. But those same forces have the potential to dry up that global supply, simultaneously starving and outcompeting the developed country industries that would use it.

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