Security concerns since Sept. 11 probably will prevent the construction of any new onshore liquefied natural gas (LNG) import terminals on U.S. soil, Clark Smith, president of El Paso Merchant Energy Global Power, told analysts at Lehman Brothers 2002 CEO Energy/Power Conference on Tuesday. Smith said rather than focusing on new terminals onshore, El Paso is turning its attention to offshore ship-based gasification facilities at which LNG cargoes can be unloaded and transferred to the U.S. gas pipeline grid.

LNG will be a growing component of the supply mix in the United States going forward, said Smith. Growing demand, declining wellhead deliverability in the United States and Canada and increasing exports to Mexico all will increase the need for LNG imports, and El Paso expects to be one of the major LNG importers, he said.

“Much like the oil industry in the United States years ago, we have reached a point where our indigenous gas supply is really having trouble keeping up with demand,” said Smith. “It’s really at a point where we are running at full tilt just to try and maintain what we have in terms of deliverability.

“Even if the rig count increases 25-50%, we are actually getting an offset [from wellhead declines], which is putting more and more [downward] pressure on the amount of gas supply that can be produced,” he said. “The supply-demand gap is widening and is expected to continue to widen.”

Total U.S. gas supply in the second quarter was 3.5 Bcf/d less than in 2Q2001, he said. “When you break it down, you can see that even the higher output from the deepwater Gulf of Mexico and the Rockies is not enough to offset the declines in other areas. What it says is even in a slow economy, if gas demand grows we are going to have to look more and more to imports to try and close this gap.”

Demand was up 500 MMcf/d in the second quarter compared to 2Q2001. The supply-demand imbalance due to high storage levels is quickly going away, he added.

Meanwhile, exports to Mexico are increasing. “Mexico is not developing its reserves. It’s not growing its production to keep pace with demand down there either, and it is really a country that is growing its imbalances,” said Smith. “I think exports [to Mexico], particularly of South Texas gas, are going to grow in the future.”

The United States is going to need much more LNG, and the economics are right to increase imports. “Prices are more than ample enough to track LNG imports into the United States,” said Smith, adding that a Henry Hub gas price of $2.75-$3.25/MMBtu is adequate for covering LNG costs.

“What we have fundamentally is a growing supply of LNG and gas reserves around the world but no market to take the supply to on an indigenous basis; the gas has to be exported out. At the same time, we have the North American market, which is running into a growing tightness in terms of supply-demand fundamentals. It’s the perfect fit.”

The limitation to LNG coming into the U.S. is infrastructure; there is inadequate regasification capacity. El Paso plans to fill in that missing link. “Our LNG business is going to be a very big business. I don’t think it is valued into our stock at all,” said Smith. “We’ve positioned ourselves to be one of the big LNG importers into the United States.”

On the financial front, Smith said he believes El Paso is a “step ahead of our peers” in strengthening its balance sheet. Its liquidity position at the end of July was about $5 billion.

He said that marketing and trading will have to be changed, however. It will be a much smaller operation that is more focused on optimization of assets and services to physical customers. “It’s going to be back to where the industry was a few years earlier before the trading really ramped up to where we got in the last 24 months. The capital requirements, the discipline, the requirements of rating agencies and other parties are going to dictate a smaller business and will require us to get better returns to use that capital. We think there’s a very strong business opportunity here; it’s just not going to be the same business opportunity and won’t be as big an opportunity going forward.” El Paso Production separately announced a Gulf of Mexico exploration joint venture with The Houston Exploration Co. on Tuesday. Under the terms of the agreement, El Paso will contribute up to $50 million for land, seismic and drilling expenditures and pay 100% of the dry hole costs to earn 50% of Houston Exploration’s working interest in up to six specified exploration wells to be drilled during the remainder of 2002 and early 2003. The wells are to be located in Houston Exploration leases in the Central and Western Gulf and in Texas state waters. Houston Exploration will operate two of the wells while El Paso will be operator of the remaining four wells. El Paso also will receive an option to extend the joint venture by payment of incremental fees to Houston Exploration for the drilling of additional exploration wells.

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