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Longer Payoff for North American LNG Projects Than Many Believe, Says Expert

Investors dreaming of big returns from exporting North American natural gas may have to wait for a payoff because of overbuilding, a leading authority said in a new analysis.

Rice University's Ken Medlock is a frequent contributor on research about the possibilities for U.S. liquefied natural gas (LNG) exports (see Daily GPI, July 12, 2013; Aug. 9, 2012). He published a report earlier this month identifying obstacles to making returns on domestic exports in the near term. North American gas exports aren't expected to be part of the picture until 2016 or later, but it may take years before there's any payoff, he found.

Medlock, senior director of the Center for Energy Studies at Rice's James A. Baker III Institute for Public Policy, said that from about 2016 to 2025 the cost of liquefying U.S. gas and shipping it to Asia-Pacific markets likely will exceed the difference in the commodity price in the two regions. He is a principal in developing the Rice World Gas Trade Model, which assesses the future international gas trade.

Natural gas prices in Asian markets have been as high as $19.00/Mcf or so, while domestic gas prices generally have stagnated at $4.00/Mcf and below, recent winter weather withstanding, he said during a conference call Tuesday. Medlock also presented the findings on Friday at a conference at Rice on the geopolitics of natural gas.

Higher Asian prices, combined with the overabundance of North American supply, led to a rapid buildup/makeover of export terminals to carry gas from the Gulf Coast, British Columbia and in Oregon (see related story). LNG export terminal construction has become "a classic case of overbuild," Medlock said.

Once the North American terminals are in operation, they will find themselves competing with other huge export terminals. Gas supplies subsequently would flood Asia-Pacific markets and pressure commodity prices.

"The capacity that is added will result in a price impact in the Asian market that is pretty dramatic," Medlock said.

"Developing U.S. export capability is only one margin of response that is being fueled by the recent price differentials between the U.S. and Asia that are in excess of $14.00/Mcf," the analysis found. Other margins of response include:

?      Potential development of shale gas resources in China;

?      Pipeline infrastructure investments to carry supplies from Russia, Central Asia and South Asia to Northeast Asia; and

?      More LNG supplies sourced from East Africa, the Middle East and Australia.

"Asian and European consumers generally view adding U.S. exports to their supply portfolios as desirable, particularly because they are tied to a liquid gas market and there is low risk of disruption. Meanwhile, incumbent producers in these regions view the prospect of U.S. exports as a competitive threat that could transform the Pacific Basin market."

Constraints on meeting the unexpected demand shock following the nuclear plant disaster in Fukushima, Japan led to LNG spot prices in Asia rising to unprecedented levels, Medlock said.

"We see similar circumstances arising in the continental North American market, when extreme cold grips certain regions and drives up local demand in excess of what existing pipeline capacity can deliver. Indeed, prices in these places can rise higher in the wake of these weather-driven demand shocks than what has been seen in Japan.

"But fortunately for consumers in the U.S., these regional price shocks are very short-lived because the weather-related demand shocks are also short-lived, and the depth of the U.S. market provides substantial liquidity through which price differences are quickly arbitraged."

It's going to be a competitive race to Asia until about 2025, when LNG markets between North America and Asia converge, Medlock found. And once there is comparable pricing, North American suppliers likely would slow export capacity development.

Price differentials will begin to disappear as soon as North America begins carrying gas to LNG markets. In addition, Japan by then may be putting its nuclear capability back online in a big way.

As more supplies pressure Asian markets, domestic gas prices then should rise, but the prices may converge more quickly than many believe, he said. Beyond 2025, some North American export terminals may find it no longer be profitable to operate.

However, once North American gas exports are operating, gas markets would be connected worldwide, providing not only more liquidity, but less reaction to big events, like the Fukushima disaster.

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