U.S. Natural Gas Prices Unlikely to Jump with LNG Exports

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Written by John Egan for Industrial Info Resources (Sugar Land, Texas)--Ken Medlock would probably like to see more lawmakers in his class on energy economics. If so, there probably would be less hand-wringing in Washington and elsewhere over how potential exports of liquefied natural gas (LNG) from the U.S. could affect the domestic price of natural gas.

Medlock, who teaches economics at Rice University, is the author of a new study that pooh-poohs the potential for LNG exports to meaningfully push up the price for gas paid domestically. The study, "U.S. LNG Exports: Truth and Consequence," pointedly noted the difference between a policy decision to authorize a particular level of LNG exports, and making an assumption that exports will automatically rise to their authorized level. The global market for LNG, which is not a lawmaker or policymaker, will make that decision.

"The lens that has been offered policymakers to address the question of U.S. LNG exports is inappropriate because it assumes a level of exports without accounting for the international market reaction," Medlock wrote in a study released last week by Rice University's James A. Baker III Institute for Public Policy. "The question before policymakers is one of licensing a capability, not licensing a fixed volume. Therefore, this issue must be viewed in the context of international trade if informed policy decisions are to be made. The bottom line is that certification of LNG exports will not likely produce a large domestic price impact."

In Asian markets, LNG currently fetches about $13 per thousand cubic feet (Mcf), down $2-$3 per Mcf from prices earlier this year, but still well above the current $2.75 Mcf price for natural gas at Henry Hub, Louisiana. The spread between Asian LNG prices and U.S. natural prices would seem to create the potential for hefty profits, even after allowing for liquefaction and transportation costs.

Several U.S. LNG import facilities have sought LNG export licenses from the U.S. Department of Energy (DoE) (Washington, D.C.), hoping to capture that potential profit. Earlier this year, Cheniere Energy Incorporated (AMEX:LNG) (Houston, Texas) received an LNG export license from DoE. That led some elected officials and manufacturers to express concern that U.S. LNG exports could push up domestic gas prices, hurting gas-intensive manufacturers and consumers. For more on this issue, see May 4, 2012, article - FERC Grants LNG Export License to Cheniere--Who Will Win Next License?

But Medlock claimed that a variety of short-term forces, including the loss of nuclear power in Japan following the meltdown of the Fukushima Dai'ichi nuclear reactor, pushed LNG prices to unsustainable highs. His study argued that a variety of forces will lower LNG prices in the coming years:

• Shale deposits being developed in other markets, such as China, India, Australia and several countries in Europe, will become commercially attractive in price environments in excess of $7 per Mcf. Overseas supplies of LNG originating in shale deposits "effectively serves as a sort of backstop on long-term prices," he wrote.
• The development of pipeline gas supplies from Russia and Asia will displace the need for some LNG, which will act to further lower prices from their current levels.
• Foreign exchange rates will affect dollar-denominated LNG supplies abroad. A stronger U.S. dollar makes dollar-denominated commodities more expensive. Medlock said this is a frequently overlooked factor shaping supply and demand for LNG.
• An increasingly competitive global LNG market will accelerate movement away from traditional contracts linking LNG prices to oil prices. Removing that linkage will mean LNG prices should be priced according to its marginal costs, rather than demand for another commodity.

Medlock wrote that U.S. LNG exports are not likely to be very large over the long term. And he asserted that LNG exports will not have a large impact on domestic natural gas prices. He doesn't project a specific amount of exports, but he used the traditional instructional tools of economics (supply and demand charts) to allay concerns that LNG exports could drive up domestic gas prices. "To separate truth from fiction," he wrote, "one must apply the appropriate analytical framework grounded in international trade; specifically, domestic market interactions with the market abroad will determine export volumes and therefore U.S. domestic price impacts."

Today, about 25% of U.S. natural gas comes from shale formations--about 14 billion cubic feet per day (Bcf/d), up from virtually nothing in 2000, Medlock noted. And the Bakes Institute recently estimated as much as 50% of all U.S. gas production could come from shale formations in the 2020s. So he sees no supply problem on the horizon.

Medlock criticized other recent studies that have claimed that U.S. exports of 6 billion cubic feet per day of LNG would increase domestic gas prices by between $0.22 per Mcf and $1.50 per Mcf. "None of the recent studies performed by various groups in attempt to lend an analytical voice to the discussion actually considers whether or not exports will occur. Each simply takes as given particular export volumes under different scenarios."

What these other studies lack, he said, is an understanding of how prices act as a feedback mechanism governing LNG supply and LNG demand.

Jesus Davis, Industrial Info's vice president of research for the Oil & Gas Production, Transmission and Terminals industries, echoed Medlock's outlook. In an interview, Davis said: "The U.S. has about a dozen LNG export terminal projects jockeying for position, but we expect that only two or three will get built, including the Cheniere project at Sabine Pass. If the dozen or so export projects were built, it could make a huge difference in domestic natural gas prices. But since only a handful will be built, the impact won't be that dramatic."

"When you start adding LNG capacity, it really affects market dynamics," Davis continued. "Although the U.S. is really late to the LNG game, we do have some strategic advantages. Australia is really accelerating its LNG terminal build-out, but those projects are really expensive because the gas deposits are located in remote areas, far from the port facilities, and most of the basic infrastructure doesn't exist yet. We understand that welders in Australia now earn a six-figure salary because project developers there will pay almost anything to get their projects done as soon as possible."

"In the LNG business, the U.S. has a lot of advantages, including a well-developed infrastructure and a number of existing LNG import terminals" that must be reconfigured so they can export the product, Davis said. "We're like the Wal-Mart store that comes to a small town and captures a lot of business because it has a low cost structure."

Industrial Info Resources (IIR), with global headquarters in Sugar Land, Texas, and eight offices outside of North America, is the leading provider of global market intelligence specializing in the industrial process, heavy manufacturing and energy markets. Industrial Info's quality-assurance philosophy, the Living Forward Reporting Principle™, provides up-to-the-minute intelligence on what's happening now, while constantly keeping track of future opportunities.