Thursday, November 03, 2011

Do LNG Exports Threaten the Shift to Gas?

Last week US liquefied natural gas provider Cheniere signed a long-term agreement to sell BG (formerly British Gas) LNG exported from the Gulf Coast. The governor of Alaska was also recently quoted suggesting that his state's surplus natural gas might find a better market in Asia than if sent to the lower-48 via a new pipeline. Both stories indicate just how much the shale gas revolution has altered the US energy balance. They also provide further validation of its likely staying power. Coincidentally, they reminded me that time was running short to respond to my residential gas supplier's offer to lock in an annual fixed price, as I did last year. That's relevant, because even though the risk of a big spike in natural gas prices looks very low now, the prospect of future US gas exports--an unthinkable idea only a few years ago--serves notice that the shale bonanza is also stimulating new segments of demand that compete with existing ones and will tend to drive prices higher.

Cheniere's role in all this looks like a classic lemons-to-lemonade story. Their Sabine Pass LNG terminal and two others in development on the Gulf Coast were designed to import gas and feed it into the domestic pipeline system. They weren't the only ones to pursue this idea, which looked entirely reasonable when they were planned. In the first half of the last decade US gas production was in decline and LNG imports were climbing, facilitated by rising gas prices that made imports at the higher global gas price attractive, at least seasonally. The combination of a surge of shale gas output and the largest US recession in decades turned these plans on their head. Now Cheniere is redeveloping Sabine as an LNG liquefaction and export facility, with construction scheduled to begin next year.

The Wall St. Journal's Heard on the Street column had a good analysis of Cheniere's deal with BG. It closed with the observation that, " is natural that excess supply should seek a market." That got me thinking, not just about what I might be paying for natural gas to heat my home in a few years, but about whether exports pose a threat to ambitious notions of displacing large increments of coal-fired electricity with power from gas turbines, shifting large numbers of US cars and long-haul trucks to compressed natural gas (CNG) or LNG, and building new US chemical plants to capitalize on the abundance of shale gas. Most of these plans depend on gas remaining fairly cheap, particularly relative to oil. The current price of natural gas at its key Henry Hub trading point is the equivalent of $22.50 per barrel, a level that we haven't seen for oil since March 2002. Could gas exports drive up domestic prices to the point at which these other uses couldn't compete?

The answer depends both on how much gas would be exported and on the shape of the supply curve for shale gas. If the latter is steep--if not much extra supply can be brought on without requiring big increases in price--then exports could begin to look like a zero-sum-game at the expense of today's consumers and tomorrow's other new uses for gas. However, if large quantities of shale gas are waiting in the wings for only small increases in price, then while all these uses would be in competition with each other, they should be able to coexist at prices that leave gas considerably more attractive than oil, and competitive with both coal and the cheapest renewables. Assessing which view is likelier isn't simple, because it involves multiple shale basins and evolving federal and state regulations, but in general the data I've seen supports the more optimistic view. Many estimates suggest that most US shale plays would produce attractive returns at around $5-6 per million BTUs (MMBTU), compared to current prices around $4, which have left some producers with poor wellhead economics.

If that's correct, then even a big increase in demand from multiple sources, including a stronger economy, additional power generation, new chemical plants and LNG exports, might not boost natural gas prices by more than $1-2/MMTBU before significant additional supply came onstream. (A reality check on that is the sharp drop in the number of gas wells being drilled when prices slid below $6/MMBTU in late 2008, as the recession and financial crisis took hold.) $1/MMBTU sounds like a big jump at the wellhead, but for consumers it would represent an increase of only about 8% after transmission and distribution costs are added. For power generation in efficient combined cycle plants, it would raise costs by less than $0.01/kWh. And for vehicle use, it equates to an extra $5/bbl, or around 12.5 cents per gallon of gasoline-equivalent fuel. Although not trivial, such increases would be smaller than we've seen from market volatility over the last few years.

Putting the Cheniere/BG deal in perspective, the 3.5 million tons of LNG per year involved equate to 0.5 billion cubic feet per day of gas, or 0.8% of 2010 US "dry gas" production (natural gas with the valuable ethane, propane and butane removed.) The facility's total planned capacity of 9 million ton/y works out to 2% of US gas last year. By comparison the Department of Energy has forecasted US gas production growing by about 3.3 BCFD, or 6% in the next five years in their base case, and by up to 14% in their high-shale-resource case. These figures indicate that there's room for several of these demand sectors to expand, including both power generation and LNG exports, without putting intense pressure on prices. This issue is attracting some attention, including from the US Senate, which has scheduled a hearing next week to consider the consequences of gas exports.

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