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LNG Imports, Demand Seen as Uncertainties for U.S. Market

U.S. natural gas output is falling, but supply is no longer constrained, and this summer the U.S. gas market may see a big jump in liquefied natural gas (LNG) imports, which has created uncertainty about supply and demand both in the short- and long-term, energy analysts said last week.

Global supplies in the form of LNG are about to experience the largest incremental addition of liquefaction capacity in a single year, Barclays Capital analysts said last week. Nameplate liquefaction capacity is estimated to jump by 5.6 Bcf/d this year, and where that capacity lands is posing "the greatest uncertainty" for U.S. supply/demand balances in this summer's injection season.

"In addition to incremental supply, weakening LNG demand in Europe and Asia over the past three months has likely exaggerated the global glut," wrote Barclays analysts James Crandell, Biliana Pehlivanova and Michael Zenker. "Exactly how much LNG comes to U.S. shores, however, will depend not only on excess volumes globally, but also on the relative strength of U.S. prices."

The trio's analysis of the current forward curves on the two sides of the Atlantic Basin, for the New York Mercantile Exchange and the UK National Balancing Point, "suggests that incremental flows to the U.S. should be strongest in 3Q2009, with a pickup likely as early as 2Q2009. Given the uncertainties that are playing out in the global natural gas market, the range of outcomes for LNG imports to the U.S. is unusually wide..." with the most uncertainty this summer.

The Barclays team estimates that U.S. LNG imports will average 2 Bcf/d in 2Q2009, 2.6 Bcf/d in 3Q2009 and 2.8 Bcf/d in the final quarter. "These estimates, however, could change significantly with shifts in the relative forward pricing of Atlantic Basin markets, relative strength of European and Asian demand, and more potential delays of liquefaction plants scheduled to come on-line."

U.S. gas producers have been laying down rigs at a quick clip since last September, with the rig count now about half of what it was at the 2008 peak, according to Baker Hughes Inc. However, Barclays and other energy analysts have noted that the steep pullback in U.S. drilling has been accompanied by an equally sharp decline in demand, particularly in the industrial sector.

Domestic gas output is close to tipping into sequential decline, according to Barclays, but analysts expect supply to be above 2008 levels until the second half of 2009. Canadian imports continue to run below 2008 levels, but if more LNG imports begin to arrive later this year, that would compensate for fewer imports.

"Our projections imply that inventories could stand at 3.9 Tcf at the end of the summer 2009 injection season, providing a test of U.S. capacity to store gas, with all the attendant bearish implications," wrote Crandall and his colleagues.

A new multi-client study by Cambridge Energy Research Associates (CERA) also found that demand, rather than supply, would challenge North American gas markets over the next 10 years.

A "revolution in technology" pushed North American gas markets into an era in which supply is no longer constrained, CERA researchers said in "Rising to the Challenge: a Study of North American Gas Supply to 2018." The supply outlook is based on an analysis of gas fields using CERA's gas market modeling capabilities, which concluded that the North American gas market now will be "largely" supplied by North American gas production.

"North American gas production is no longer opportunity constrained," said CERA Senior Director Robert Ineson. "Resource-bearing shales and tight sands are extensive, and North America now has a sufficient inventory of drillable prospects to maintain or, if necessary, increase productive capacity for at least the next 10 years -- even after the current recession becomes a memory."

Benefiting disproportionately from technology, unconventional gas output "undoubtedly" will be the main driver of supply growth in the years ahead, CERA noted.

"Domestic gas producers explored a variety of technologies to exploit the known unconventional resource base," CERA said. "The success of these efforts became evident in 2007-2008 when production in the Lower 48 United States grew rapidly -- from a 2007 low of 49.8 Bcf/d in February to 56.7 Bcf/d in July 2008, an increase of 6.9 Bcf/d and almost 14% in just 17 months."

Rising gas output has been achieved "even as painful recession has taken hold," noted CERA. Going forward, "North American gas production will be limited primarily by demand, which is falling sharply due to the global economic crisis. The market is struggling to absorb existing production -- as reflected in the current price trend -- rendering new drilling in higher-cost areas uneconomic."

Technology has led to higher-volume wells, and now, with the effects of the recession, the cost of new gas supplies may be lower for the immediate future. "However, as the economy rebounds, key commodity prices will rise again, driving new gas production unit costs up as well. Full-cycle unit costs are expected to increase from a weighted average of $4.63/Mcf in 2009 to $7.54/Mcf in 2018."

Given the increased productivity of unconventional wells, the analysis concluded that it would not be necessary to increase drilling activity to maintain or increase production. After years of developing unconventional gas with its long-lived production, in the aggregate, the average decline rate has fallen. This means, said CERA, that a smaller quantity of new production would be required to offset natural production declines.

According to CERA, the Lower 48 states' dry gas productive capacity will increase to 60.6 Bcf/d in 2018 from 53.5 Bcf/d in 2009. Canadian capacity is seen growing to 19.6 Bcf/d in 2018 from 15.8 Bcf/d.

The North American gas supply "renaissance" also is expected to have global consequences, especially for LNG, said Ineson. "The development of unconventional gas is reshaping the outlook for natural gas supplies in North America, with far-reaching significance for the industry, consumers and the global gas business. Growing North American production will decrease North America's need for LNG, triggering changes in projected LNG flows and potentially affecting prices and the viability of projects worldwide."

LNG is expected to remain competitive in North American markets, but it "will compete more with higher-cost conventional supplies than unconventional gas," CERA said.

Chesapeake Energy Corp., a top domestic gas driller, has taken heed. Chesapeake late last month curtailed 7%, or around 240 MMcfe/d, of its gross gas and oil production through March (see NGI, March 9). In the past six months it's cut 75% of its conventional drilling. However, drilling now will be reduced by 85% over the coming two months, McClendon told attendees last Tuesday at the Howard Weil Energy Conference in New Orleans.

"You simply cannot make money in a sub-$7-8 environment," McClendon said. He's seen signs that the gas supply and demand market may rebalance by 3Q2009.

"You are beginning to see a demand response to prices," McClendon told reporters. "I think it's coming out of the coal stack. I think we are beginning to see electrical generation members come our way." Still, he doesn't have confidence that the gas rig count will rebound this year.

The gas rig count also is unlikely to bounce back any time soon, said the CEO. "We would be very surprised to see much of a rig count increase in 2010 and 2011, even with a healthy rebound in prices."

According to a report by McKinsey Global Institute (MGI), U.S. demand for fossil fuels -- natural gas, oil and coal -- will remain "exactly flat" to 2020, with only gas projected to grow at a rate of just 0.6% a year. In the report, "Averting the next energy crisis: The demand challenge," MGI examined global energy demand across a range of end-use sectors and energy supply across fuel types.

"We project that the United States will actually cut its per capita energy demand to 2020, partly reflecting action to boost the economy's energy productivity -- the level of output achieved from the energy consumed," the report stated.

To download the 150-page report, visit www.mckinsey.com.

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