Tuesday, August 18, 2009

Worldwide LNG

LNG has become the proverbial elephant in the room when it comes to U.S. natural gas prices. As I've said in the past, the real driver of gas prices will be the domestic economic recovery, but one of the big unknowns is how the excess capacity in the worldwide LNG market will impact the U.S. supply, which could suppress natgas prices for a long time to come.

Cheniere Energy, which is a developer and owner of LNG ports in south Texas and Louisiana, has some interesting information in its recent investor materials that help Regular Bobs like me understand the LNG industry. The basic premise behind LNG is to convert natural gas, which is only feasible to transport in its natural state in pipelines, to a liquid state that is easier to transport to allow for shipment all over the globe. LNG allows the natural gas market to become more like that for oil.

To grossly simplify things, natural gas is piped from the production fields to a facility where it is supercooled through a process called liquefaction and loaded on monster tankers to be shipped all over the world. Once it gets to a destination, it is offloaded, regassified, stored and then transported to the end user. It all sounds very simple, but it is extremely expensive to build the liquefaction and regassification plants along with the additional storage facilities and many new pipelines. Over the past decade, huge amounts of capital have been invested to make the LNG market a reality. Massive facilities have been built and much new liquefaction capacity will be coming online for the next few years, as shown on the chart below from Cheniere. It is staggering.

This chart is what scares domestic gas producers. This LNG is coming from very low cost international producers like Qatar that can eat the cost of liquefaction and shipping and still undercut anyone in the world on price. In other words, supply growth is pretty much independent of commodity price. With the worldwide economic slowdown, gas consumption has slipped while liquefaction capacity has increased. The chart below shows the consumption by various regions (here is link to list of OECD nations).

Until the shale boom of 2008, conventional wisdom in the U.S. held that natural gas was a limited resource worldwide and it would have to be imported, much like oil, because we would surely run out of the stuff. For the past decade, there was a boom of developing these expensive ports to receive, regassify, store and ultimately transport LNG all over the country. The U.S., while a fairly minor player on the LNG consumption side, has one of the world's largest natgas storage networks. As a result, when gas is stacked up elsewhere, it can usually find a home in a tank on our shores.

Given the explosion in domestic drilling that has led to huge increases in U.S. natgas supply, producers cast a wary eye towards LNG. At the same time, investors who have funded these massive port projects get a queasy feeling looking at the new shale finds. So far, the ports are seeing fewer cargoes than expected.

The slide below is very interesting because it shows the worldwide quantities and flows of LNG. The "nameplate capacity" is approximately 37 Bcf/day (blue boxes below), but assuming lower utilization rates, there is approximately 30 Bcf/day of available LNG in the world. Current consumption outside of North America (green boxes) is +/-26 Bcf, which implies that there could between 4 and 11 Bcf/day available to the Americas. Right now North America is importing about 2.5 Bcf/day. Given the number of proposed and under construction projects (yellow and green dots), that potential overcapacity isn't likely to decrease any time soon.

I was pleased to see news that China might be normalizing its domestic natural gas prices to make imports from pipelines and LNG more attractive. Combined with greater investment in gas power generation, China could become the destination for much of that excess LNG.

One advantage of LNG is that it makes natural gas more of a worldwide commodity, available to those without direct pipeline access. It also acts as a mechanism to redistribute excess supply. While I fear the excess supply arriving on our shores, theoretically supply will follow the highest prices and not just be forced to find the last open parking place in the lot. Since prices for gas are much higher in Europe and Asia, don't expect much LNG to come to the U.S. except to be dumped (which is, of course, the worst case scenario for domestically produced gas).

As countries all over the world come to appreciate the benefits of natural gas, I am of the belief that in a normalized worldwide economy a happy medium will be achieved where LNG is able to find a home at a decent price and will not be a long-term source of anxiety for U.S. natgas producers. My short-term outlook, however, is not as bright.

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