Potential For Risk And Reward For U.S. LNG Exporters
As someone with (very minor) natural gas reserve holdings in West Virginia, I’m envious of those in the Southwest who have an apparently unlimited market in the LNG export business. Numerous countries around the world, and especially China and India, would benefit from increased consumption of natural gas, especially if it were to displace current coal usage. They, and many smaller countries, also still rely on diesel fuel in backup generators as their power grids do not provide reliable electricity supplies. Now, the superabundant shale gas resource has allowed U.S. LNG exports to soar, rising from 40 Bcf to 1 Tcf in just 10 years, with plans for a further doubling of capacity by 2021.
What happened in the early 2000s should serve as a cautionary tale, though. High U.S. gas prices led to plants for enormous investments in LNG import terminals, most never begun and most of the remainder now converted to export terminals. The shale revolution caught most of the industry by surprise; the massive 2003 NPC report on U.S. natural gas foresaw prices in 2015 as ranging between $4.75 to $9/Mcf. The actual was $2.75.
Since shale gas has become so abundant, and U.S. prices so much below world natural gas prices, numerous export projects have been built or proposed. The most aggressive export plans originated several years ago, when elevated oil prices and the nuclear power shut down in Japan sent LNG prices to double digits—reaching over $16/Mcf in Japan from 2012-2014. These were, of course, transient developments which should not have spurred long-term investment, as I warned in 2013.
Which is not to say there are market opportunities. American LNG exporters constitute a disruptive force in a very staid, even calcified market. For decades, producers invested only when they had long-term contracts for their supply, usually priced equivalent to oil based on heat content. (The equivalent would be selling tea based on coffee prices and the equivalent caffeine content.) But since residual fuel oil is significantly cheaper than crude, this meant that many countries continued to burn oil for power generation, long after the U.S. had abandoned the practice.
Now, Americans were offering short-term, even spot sales, sometimes to small buyers who had no regasification terminals but used the LNG tankers themselves to offgas, more expensive but practical for small buyers. As the figure shows, the primary markets for U.S. LNG so far have been the main Asian buyers, but the small scale sales have, to date, been a significant minority of the business. (A “Coals-to-Newcastle” award to those who sold cargoes into the Middle East, the most hydrocarbon-rich region in the world.) Thirty-two countries received exports from the U.S. in 2018, but 48% went to the four largest, Asian buyers.
The success is partly because prices offered were frequently indexed to Henry Hub natural gas, not world oil, prices, meaning that they were seriously discounted compared to traditional exporters—at least when oil prices were above $100. To an Asian buyer paying $10-12/mcf five years ago, a guaranteed price of $8/Mcf is supremely attractive. The huge U.S. shale resource would seem to guarantee that prices will remain moderate for a long time, reducing the price risk for buyers who agree to prices unrelated to world oil, and most other LNG, prices. As the figure below shows, long-term price expectations for U.S. natural gas have been lowered repeatedly.
So do low oil prices make LNG exports a riskier business? Price is a big thing, but it isn’t everything. Buyers are often utilities who can pass on their costs. Japanese buyers crave diversity of supply and Chinese buyers want cleaner fuel, which means a premium can be paid, although how much remains unclear.
European buyers, however, while also mostly utilities have access to pipeline gas from Russia. (China will eventually import some Russian gas via pipeline, but minimal amounts compared to the country’s need.) Russia, with an extensive natural gas pipeline network in place (and expanding) and natural gas which is cheap to produce, will have every incentive to keep up sales to Europe. Recognizing that American LNG exports are likely to have a floor price of around $8/Mcf (Henry Hub, plus liquefaction and transport), they can easily afford to outcompete American exporters.
While some nations like Poland and Lithuania are likely to pay a security premium for diversity of supply, they will probably also realize that merely having American LNG available increases their leverage over the Russians, but large volume purchases might be unnecessary, particularly should they prove too expensive. True, the Chinese importers have been known to be price-sensitive (and the Indians especially so), but overall the market risks seem much smaller in Asia.
This could change, naturally, if U.S. companies overbuild, all hoping for a return to $100/barrel oil and/or customers fearful of Russian ‘dominance’. But I would argue both are thin reeds on which to base billion dollar investments.