Consultants at Energy Security Analysis Inc. (ESAI) said they expect the U.S. gas market to become the “sink” for any unwanted or spillover global LNG supply in the future, which could mean significant downward pressure on domestic gas prices at certain locations.

However, not all market experts agree on that assessment. Benjamin Schlesinger, president of Schlesinger and Associates Inc. in Bethesda, MD, said that such fears of an LNG-related supply glut are unfounded.

In a report issued last week, ESAI predicted that as much as 30% of the gas supply at certain Gulf Coast pooling points, such as the Houston Ship Channel and the Henry Hub, in 2010 could be coming from LNG, which means domestic producers supplying those same points will face stiff competition from global gas supply and prices at those locations will drop sharply.

“When you start looking at the impact in specific places like that, it’s much bigger than you might otherwise think it would be,” said Scott DePasquale, natural gas analyst at ESAI.

Boston-based ESAI lowered its 10-year forecast of Henry Hub gas prices by 90 cents/MMBtu to $4.09/MMBtu because of the aggressive investments expected to be made in U.S. LNG infrastructure and the significant destruction of domestic industrial gas demand.

DePasquale said the Cameron, LA, LNG import terminal will be delivering about 350 MMcf/d in 2010 and 122 MMcf/d of that will go directly to the Henry Hub. The same sort of impact will be felt at the Houston Ship Channel, and as well on Trunkline because of the expansion at the Lake Charles facility.

In total, ESAI expects there will be five operating LNG terminals in the Gulf Coast region in 2010, including the following projects: the existing Lake Charles LNG terminal; the FERC approved Cameron terminal; the Freeport, TX, terminal proposed by Cheniere Energy; the Mexican approved Altamira project proposed by Shell; and an offshore Louisiana project — Shell, ExxonMobil, El Paso and ChevronTexaco have all announced plans to build one. ESAI said minimum LNG supply in the Gulf Coast region in 2010 should be about 2.5 Bcf/d. Total U.S. LNG supply in 2010 should be about 6.4 Bcf/d from 12 terminals, including five along the Gulf Coast, five along the East Coast and two on the West Coast.

The rapid pace of LNG development has come about as a result of the difficulties domestic producers are having maintaining supply and the resulting higher floor price of natural gas.

“Each incremental Btu is getting more expensive to produce,” DePasquale said. “Drilling costs are going to be up 3-6% this winter from last year.” The reason costs are so high and rising is that the majors haven’t spent an additional penny on drilling research and development since 1996.

“If you are a big company like British Petroleum do you put the money into developing the technology to help the drill bit withstand pressure below 2,000 feet or do you send that money overseas to get cheap gas and take the risk in developing your LNG structures? Most folks are choosing to go the LNG route,” said DePasquale.

The long-term need to replace domestic reserves with more expensive and deeper-level resources has increased the cost structure associated with North American gas exploration and production (E&P) and created a fundamental market support level near $3.00/MMBtu — a price level where ESAI assumes producers are covering costs and recouping a minimum level of returns.

“Long-term price floor certainty has made investors in LNG infrastructure more confident that their assets will be profitable over the next 10 to 20 years,” noted DePasquale. “Investor confidence has triggered aggressive capital allocation to import terminal development, feasibility studies, and has renewed interest in long-term contract negotiations with foreign producers.”

As LNG becomes an integral part of domestic gas supply, imports will have a dramatic effect on market dynamics, supply volumes, and price volatility, according to ESAI.

“The ultimate deliverability and interruptibility associated with LNG imports will also give way to significant changes in natural gas cash and futures markets,” said DePasquale. The level of influence will depend on “how many forthcoming LNG contracts are short-term or ‘spot…'” He said that as LNG imports slowly become more of a baseload and daily supply alternative, the variability of shipments will significantly alter the daily flows of gas in the heart of U.S. distribution hubs — a phenomenon that will bring increased price volatility in cash and cash-related financial product markets.

“And this increase in short-term volatility will be difficult to predict due to the opaque nature of ‘spot’ cargo trading,” ESAI said.

Over time, ESAI said, domestic E&P companies will be threatened by the relatively cheaper LNG. With an LNG landed cost near $2.75/MMBtu, and factoring in ESAI’s forecast for a long-term domestic price floor of $3.00/MMBtu, imports would also put strong downside pressure on production basin gas prices.

“While domestic LNG infrastructure is developed, Gulf producers will have even less incentive to aggressively develop the North American resource base,” said DePasquale.

Benjamin Schlesinger, however, believes domestic production will remain “the bedrock for…supply in North America” in the years ahead. He dismissed any suggestion that demand for producers’ gas may be displaced by the expected massive growth in LNG over the years.

“The demand is that strong” for both LNG and domestic production to co-exist in the U.S. energy market, Schlesinger told NGI. He is banking on that demand strengthening “more in the future” — in the latter part of this decade and next — as more new and expanded LNG import terminals come online across the nation and in Mexico.

Schlesinger sees LNG prices influencing prices for domestic gas only “in some cases.” The siting of LNG terminals in “outlying areas,” such as Boston, may put “downward pressure” on the basis differential in the region, he said. But LNG “won’t have much impact [on prices] in the Gulf,” he believes. Domestic production is about 15 Tcf/year in the region, and a “few LNG terminals [aren’t] going to make that much difference.”

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