LNG not magic bullet for US gas supply woes

Is LNG the answer to US natural gas supply woes?

Thanks to Federal Reserve Chairman Alan Greenspan's recent testimony before Congress, that has become the question of the moment. Projections of LNG import capacity doubling to 6 bcfd by 2007 were posited as the cure for future gas price spikes being alleviated only by demand destruction.

But the issue is more complicated than it seems. And the hurdles to expanding US LNG imports go beyond the usual litany of regulatory and permitting obstacles and timeframe needed for substantial new grassroots LNG regasification capacity.

In a recent research memo, Wakefield, Mass.-based Energy Security Analysis Inc. raises five issues of concern about increasing US dependence on imported LNG.

LNG issues

Concerns over rising US dependence on energy imports may be a bit of a red herring, as the US has adapted to rising oil imports. Just as the development of the supertanker enabled imports to undercut domestic oil supply in the 1960s, ESAI notes, technology advances bringing LNG supply costs to a breakeven point of $2.50/MMbtu in the 1990s are allowing LNG to take up the slack from declining low-cost indigenous supplies.

"As the cost of developing indigenous supply begins to exceed the cost of imports, it is desirable for an efficient economy to allow those imports to play their natural role," ESAI said.

Investment in LNG import capacity provides incentive for major oil and gas companies to focus more exploration and production investment abroad—where the resource targets are much larger—and less in the US.

"If the (Bush) administration and Congress do not want this migration of investment efforts overseas to occur, they should increase US investment incentives," ESAI said.

Third, LNG import volumes will be variable and contribute to US gas price volatility. Most countries significantly dependent on LNG imports have heavily regulated gas markets and are locked into long-term supply contracts.

"So far, no country wih robust, open, and liquid markets for natural gas relies on LNG as a baseload resource, so little evidence exists as to how this resource could ultimately change the face of the US spot and futures natural gas markets."

Then there is the question of LNG import security policy. There is no LNG analog for the Strategic Petroleum Reserve, whose development took a decade and whose management remains a source of contention. There is also inadequate US gas infrastructure at present to accommodate storage of imported, regasified LNG.

Finally, the US energy market needs to develop a financial risk management mechanism specifically for LNG, as the rise in spot trade may prove ephemeral because of the post-Enron Corp. demise in large energy marketers.

"As things stand now, in the absence of significant changes to the makeup of the US gas market, the United States is poised to become the primary 'interruptible' destination in a world of 'fixed' LNG contracts, making dependence on LNG a complicated development," ESAI said. "To firm up LNG supply, the market needs to develop mechanisms that will enable utilities to sign long-term contracts to the satisfaction of the regulators."

That said, "LNG is here to stay," ESAI said, citing the supply need and expressing confidence that solutions will be found.

Price concerns

But one issue ESAI didn't dwell upon was that of how US gas price volatility in the interim will affect LNG developers' plans for new capacity.

US gas futures prices recently pierced the watershed floor of $5/MMbtu, easing some of the very concerns about price spikes that Greenspan voiced. How much lower could they go?

Ohio energy economist James L. Williams sees continued 2-year cycles of gas price volatility in the US—and not all of the price pressure upward.

He notes that when the year-on-year gas storage deficit nears 300 bcf, gas prices drop below crude on a btu basis. Storage is near that level now, and the recent gas-to-crude premium has been shrinking (although normal temperatures in summer and winter could easily change all that). Williams thinks the market is either overestimating natural gas or underestimating crude prices.

"We continue to see the industry locked into 2-year cycles, with high prices one year leading to more exploration and excess supply the next. The excess will drive prices down in the second year." he said. "The second year's low price discourages exploration, setting up the conditions for high prices in the third year and repetition of the cycle."

In other word: The more things change, the more the stay the same.

(Author's e-mail: bobw@ogjonline.com)

OGJ Hotline Market Pulse

Latest Prices as of July 18, 2003

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NOTE: Because of holidays, lack of data availability, or rescheduling of chart publication, prices shown may not always reflect the immediate preceding 5 days.

*Futures price, next month delivery. #Spot price.

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