Baker & McKenzie LLP
By now it is likely a familiar story that, since the mid-2000s, intense drilling activity in unconventional formations, like shale, has led to a glut in natural gas supplies across North America and a collapse in regional gas prices. The need to monetize relatively inexpensive shale gas, and export it to higher-priced markets in Europe and the Asia-Pacific region, has led to the retrofitting of LNG import terminals in the US to add export capabilities, and the planning of greenfield LNG export projects across North America. Less well-known is the troubled progress of LNG export projects in the US and the increasingly fierce global threats to US export competitiveness.
Competition for markets
As of early March 2014, the US Department of Energy (DOE) and the Canadian National Energy Board (NEB) had approved six and eight applications, respectively, to export LNG to non-Free Trade Agreement countries, with 24 and 3, respectively, applications pending. This represents a total of 26.41 bcfd, with 38.9 bcfd pending (per FERC and NEB). According to energy consultancy Wood Mackenzie, while demand in the Asia-Pacific region is expected to grow from around 24 bcfd to 47 bcfd by 2025, there is approximately 76 bcfd of proposed LNG supply capacity worldwide. Approximately 80% of supply projects are in the Big Five producing regions of the US, Canada, Australia, Russia, and East Africa. It remains to be seen how regional gas markets will absorb the predicted excess supply and how increasing attention to global CO2 emissions will impact demand.
Wood Mackenzie's Asish Mohanty said most LNG export projects in the Big Five regions vary considerably to potential buyers in terms of political risk, market proximity, and supply diversity, and carry a high degree of uncertainty on timing. Australia, for example, enjoys a climate of low political risk for LNG projects, as well as close proximity to Asian markets, but is plagued by materially escalating costs, and timing uncertainty; furthermore, most buyers are already exposed to Australian LNG purchases.
In East Africa, gas discoveries are of historic proportions. EIA estimates that Mozambique holds 4.5 tcf of proven natural gas reserves. A series of large gas discoveries made in the offshore Rovuma basin since 2010 are large enough to support LNG export projects, but unfortunately, East Africa lacks basic industry infrastructure and carries high institutional uncertainty, which translates into project delays. In the Rovuma basin, recent discoveries by Anadarko Petroleum Corp. in the Prosperidade and Golfinho/Atum complexes are each estimated to contain between 17 to 30 tcf and 25 to 35 tcf, respectively, of recoverable natural gas resources. Eni has also made large gas discoveries in the basin, at the Mamba Complex and the Coral site, which respectively contain 62 tcf and 13 tcf of gas in place.
Yamal LNG, in Russia, recently reached a final investment decision and looks ready to move forward with a planned export terminal by the Black Sea. As a positive, despite technical challenges posed by the harsh climate near the Arctic Circle, this and other proposed Russian projects are supported by the Russian government as they progress to commercial operation.
US brownfield projects require less capital investment than greenfield projects due to existing infrastructure, and therefore these projects are expected to be the first online. Lower investment costs and depressed gas prices at the benchmark Henry Hub enable US exporters to sell LNG for the lowest prices on the global market. The wildcard for these projects is the DOE, in particular, its lack of transparency regarding the criteria used to evaluate exports to non-FTA countries.
Another cause for concern is the DOE's post-approval revocation authority, which most concerns Asian investors with ample balance sheets and large appetites for energy. The DOE reserves the power to reconsider approvals of non-FTA exports after those approvals have been granted, which worries investors, owners, and potential offtakers. Compare this to, for example, the regime created by Congress to review the national security implications of foreign investment in the US under the Committee on Foreign Investments in the US (CFIUS), where a clearance of a transaction is a safe harbor, and CFIUS cannot reconsider such decisions unless it finds that the parties misled or withheld critical facts from the committee. This post-approval revocation authority in the LNG export context creates great uncertainty and slows final investment decisions.
The slow pace of the DOE's approval process alone is enough to hamper the competitiveness of US projects, especially if the export project is in the middle or end of the queue. A bottleneck at the Federal Energy Regulatory Commission amplifies the problem, with the second filer, Freeport LNG, only expected to receive final project approval in the third quarter of 2014.
Other challenges that can delay planned US export terminals include access to labor, especially with the growth of other gas-based industries. Smith said the construction of Freeport LNG will directly and indirectly create between 24,000 to 30,000 jobs across the US. Other often-cited obstacles are environmental opposition to project development and the relative distance to Asian customers compared to the other Big Five regions. The geographical challenge is exacerbated by delays in the expansion of the Panama Canal, which would provide a faster route to Asia for cargos sailing from the Gulf Coast and East Coast. A work stoppage that ended on Feb. 21, 2014 pushed the completion date for the Panama Canal expansion to 2016 from 2014, and information published about the dispute resolution is neither clear nor comforting. Future work stoppages and further completion delays can be expected, whether or not the disputes are publicized by the involved parties.
By the time US export projects are ready, the world may no longer be waiting. Already, this sentiment is being expressed in industry circles about the greenfield $45 billion LNG development on Alaska's Kenai Peninsula. The same can be said in regards to US LNG exports in general. Japan, already the largest purchaser of US LNG and home to the biggest investors in US LNG projects, announced in late February a plan to restart nuclear reactors closed after the 2011 Fukushima Daiichi disaster, and build new nuclear capacity—calling on nuclear to become Japan's baseload energy source, supplemented by wind and solar. The resurgence of nuclear in Japan will likely continue the downward pricing pressure on Canadian LNG, which in turn decreases the differential between the higher-priced Canadian LNG and US LNG. This also points to the potential for US dominance more clearly in medium-term rather than long-term scenarios, as Japanese demand for LNG will be systematically reduced as gas-fired generation is replaced by rising nuclear capacity. Andrew Kunian, chief executive officer of Eos LNG, which seeks to build a floating LNG export terminal offshore Brownsville, Tex., told Baker McKenzie." The United States can become the new and improved gas OPEC." The potential is clear.
So what can the US government do? Be more like Canada. In other words, hurry up. North of the border, the NEB has approved projects more quickly than DOE, and Canadian projects have the advantage of being closer to Asian markets. There are, however, a number of challenges, including technical challenges associated with laying pipe under the Canadian Rockies and the digestion of the British Columbia's proposed post cost-recovery 7% levy on LNG profits, both of which are manageable and predictable. Less manageable will be the potentially billions of dollars attributed to benefit sharing plans with the First Nations aboriginal communities.
In sum, US export projects are somewhat favored due to their price competitiveness, but all eyes are on DOE to see if it can transform itself into a facilitator of a competitive US market by removing itself as a gatekeeper. If US competitiveness and American jobs are not compelling reasons, perhaps the
energy security of Western Europe is and US policymakers will consider the value associated with giving European allies an additional alternative to Russian gas, particularly in light of Russia's recent use of military force against Ukraine.
Indeed, there has been some indication from members of Congress recently that many would support legislation encouraging or even mandating DOE to expedite non-FTA export applications, or at least those applications submitted by projects that have demonstrated intent to export LNG to Europe and thus weaken Russia's economic influence in the region. Still, when it comes to government support and the physical route to Asia, Canadian projects represent a fiercely competitive and compelling alternative to US projects.
It remains to be seen whether the LNG trade develops into a relatively seamless global market as the oil trade did during the last century, or whether the future holds more modest growth in the global LNG trade, and natural gas remains a commodity with wide variations in regional pricing.
Natalie Regoli is a partner in Baker & McKenzie's Houston office and a member of the Major Projects Practice Group. Her legal practice focuses on LNG / gas matters and she has experience throughout the lifecycle of LNG / gas projects, petrochemical facilities, and other major capital projects. Regoli focuses on the development, financing, EPC, and claims / dispute resolution of major capital projects. She has worked with governmental units, project sponsors, shareholders, investment bankers, credit rating agencies, commercial bankers, and corporate trustees.
Brian Polley advises on upstream energy transactions for Baker & McKenzie, with an emphasis on the representation of exploration and production companies in acquisitions and divestitures of producing properties. He also advises clients on LNG, project development, and oil and gas issues related to title instruments and opinions, private equity, and national security reviews of foreign investments.