For U.S. LNG, is the window half open or half closed?

By Jenny Mandel | 04/27/2015 09:03 AM EDT

After years of work behind the scenes, the United States has four liquefied natural gas export projects under construction, several more facing final investment decisions in the coming months and the first LNG cargo slated to ship from Cheniere Energy’s Sabine Pass, La., terminal before year’s end.

After years of work behind the scenes, the United States has four liquefied natural gas export projects under construction, several more facing final investment decisions in the coming months and the first LNG cargo slated to ship from Cheniere Energy’s Sabine Pass, La., terminal before year’s end.

But despite that visible progress for the industry, there is growing concern that weak oil prices, disappointing world economic growth and a global gas glut have turned the economics of U.S. exports on their head.

For at least two years, industry stakeholders have been warning that the United States faced an unprecedented "window of opportunity" to jump into the LNG export game and claim a share of the market for U.S. producers before it became saturated and new contracts dried up.


Has that window for LNG export projects finally slammed shut?

"The drop in international oil prices relative to U.S. natural gas prices has wiped out the price advantage of U.S. LNG projects, reversing the wide differentials of the past four years that led Asian buyers to demand more Henry Hub-linked contracts for their LNG portfolios," warned Moody’s Investors Service in a widely quoted assessment earlier this month.

That report essentially described the doomsday scenario for would-be exporters of U.S. natural gas, cautioning that the oil price plunge had stolen away the oil and gas majors’ investment budgets just as the fundamentals for LNG shifted.

"Despite the hype over the past few years about gas-linked contracts, oil-linked contracts still dominate the industry, causing LNG revenues to fall for existing suppliers," Moody’s said. "Lower oil prices are causing LNG suppliers to curtail their capital budgets. This will result in the cancellation of a majority of the almost 30 proposals in the U.S., 18 in western Canada and four in eastern Canada."

Part of the issue is how gas prices have shifted in the separate basins that make up the world LNG market.

Historically, Asian LNG prices have been indexed to oil prices while those in European markets have had a far weaker connection to crude. U.S. natural gas is priced based on supply and demand on the country’s extensive gas grid, which has recently yielded prices significantly below Europe and Asia.

When crude prices dropped last year, Asian LNG prices followed, cutting into the arbitrage opportunity that has fueled interest in U.S. LNG exports.

As Jim Jensen, an independent consultant who has tracked LNG for years, explained in a recent presentation for the Center for Strategic and International Studies’ Gas Market Study Group, the U.S. LNG industry is threatened by low oil prices in two ways.

First, there’s the cut into the "Asia premium," the margin that Asian buyers pay over what product, shipping and other costs would imply based on the prices in the United States and Europe. He calculates that based on 2013 average natural gas costs, the Asia premium amounted to $7.88 per million British thermal units of gas — effectively doubling Japan’s LNG costs.

Jensen calculates that with the oil price plunge the premium has about disappeared. Today, he said, the cost to purchase natural gas in the United States, liquefy it and ship to Asia is about what it costs to buy the LNG in Japan — eliminating the enticing arbitrage opportunity that has fueled U.S. LNG export interest.

But in addition to that, Jensen notes that low oil prices cut into the profitability of shale gas plays where the co-production of natural gas liquids is an important part of the financial equation, because the prices for such liquids are tied to crude. Since low domestic natural gas prices have generally pushed U.S. drillers toward these "wet" gas plays for the supplemental income, much of U.S. drilling is at risk.

"If the Saudis intend to send a message that they are no longer willing to support a price umbrella for costly competitive oil development, they have also allowed the rain to fall on the prospects for many current LNG project proposals," Jensen concluded. "Even if today’s price levels are only temporary, they make a strong statement of the price risk for much of the LNG capacity being considered for Asian markets."

The Moody’s analysts see the commodity price plunge as dividing the LNG industry in two.

"In new supply areas such as Australia and the U.S., the winners are the early movers that already have their liquefaction projects under construction, have ready access to developed sources of natural gas supply and are assured a new source of cash flow longer term," they wrote.

"On the other hand, many sponsors, including those in the U.S., Canada and Mozambique that have missed that window of opportunity as oil prices have declined, will face a harder time inking the final contracts, most likely resulting in a delay or a cancellation of their projects."

Not an open-and-shut case

Many LNG industry stakeholders dispute Moody’s bleak assessment, though.

Last week, Bob Franklin, Exxon Mobil Corp.’s president of gas and power marketing, gave a talk at the Johns Hopkins School of International Studies in which he said Washington, D.C., needs to get on board right away with regulatory reforms to ease the path for LNG projects but that the prospects remain good for some proposals to proceed.

Franklin took aim at an export review process conducted by the Department of Energy for businesses hoping to sell LNG to countries that lack free trade agreements with the United States, saying the drawn-out and unpredictable process at DOE threatens to stifle U.S. participation in the global industry, resulting in lost jobs and missed economic opportunities.

Exxon Mobil is partnering with Qatar Petroleum International on a proposal to add export capacity to the existing Golden Pass LNG import terminal, located down the road from Cheniere’s Sabine Pass facility on the Louisiana-Texas border.

"The government’s slow-walk policy [on non-free trade export permits] amounts to a de facto ban on LNG exports," Franklin told listeners. "Most applications, including ours, are languishing in approval purgatory" (EnergyWire, March 25, 2014).

As evidence that DOE should move quickly to approve all pending applications, Franklin pointed to a slew of studies by federal agencies, think tanks and corporate interests that concluded there would be limited or no harm from LNG exports, and significant benefits from liberalizing trade and increasing the country’s geopolitical influence.

Even better than administrative action alone, he said, would be a legislative move to require fast LNG export decisions. The House passed such a measure in January, and Senate lawmakers have considered a similar measure that could advance within the next few months (EnergyWire, Jan. 29).

Franklin acknowledged that conditions are tough right now for new projects but said he does not see that as a deal-breaker and that, with the right regulatory change, the industry could continue to grow. "I would expect more projects to move forward," he said. "What I wouldn’t be prepared to say is exactly which ones and how many."

Another stakeholder who sees growing room for new projects is David Montgomery, a former vice president with NERA Economic Consulting who has led several natural gas export analysis projects, including one under contract for the Energy Department that has helped to steer national policy on the issue.

In an interview, Montgomery said the "window of opportunity" concept stems from two ideas, one meaningful and one illusory.

The deceptive part of that window is the vision of a vast arbitrage opportunity between sky-high Asian prices and dirt-low U.S. gas rates, Montgomery said. The reality is that full-blown economic models like the one NERA relies on show that price gap quickly shrinking away as new supplies enter the market — as has taken place over the past year.

"It doesn’t really change the fundamental amount of LNG trade that was going to happen" to see that dramatic price difference disappear, he said, "but it dampens the enthusiasm."

But the other element of a "window" of time for the industry that is real, Montgomery said, is the significant first mover advantage available to the first few companies with product to sell.

Due to the extraordinary capital expense of a liquefaction plant and the financial incentives that creates, "Whoever gets in there first is basically in a position to scare off competitors," Montgomery said. By his analysis, the projected demand for LNG imports is not currently accounted for with export facilities so that first mover advantage is still there for the taking.

But if the United States has a process that runs two or three years longer than that of competitors like Canada, Australia or Qatar, he said, that will limit developers’ ability to sit at the table.

Henry Hub exposure

David Goldwyn, former State Department coordinator for international energy affairs and president of Goldwyn Global Strategies, agrees that the U.S. industry has succeeded in positioning itself well in the first wave of projects.

"Two years ago we were looking at rising demand for LNG and lots of different countries who had projects, and the argument was that if we didn’t move then we’d lose the opportunity to get contracts from 2018 forward," Goldwyn said. "I think you look back and with the projects that were approved … they were nearly all subscribed."

Now, he said, shifting conditions mean the market has entered a new phase.

"Will there be more contracts? Are there opportunities left?" he asked. A ranking of proposals from all around the world shows that greenfield projects that aim to build liquefaction from scratch are generally the most expensive, while building onto existing facilities like many U.S. developers are proposing is significantly cheaper.

Another consideration for buyers is the price and reliability of the proposed gas supply, and there Goldwyn sees a big U.S. advantage in low production costs and the seemingly endless supply of shale.

"New projects [around the world] will have to offer some exposure to Henry Hub pricing," Goldwyn said. Despite the fact that an oil linkage is currently helping Asian buyers, he said he expects that tie-in to continue to erode as sellers are pressed for better contract terms. "I think they’re going to have to offer either a better formula [for oil linkage], or something akin to Henry Hub pricing."

"There’s an argument to be made that there’s another window of opportunity opening, and U.S.-based projects, if they’re able to get online quickly, may be more competitive because of the pricing they’re able to offer and … the reliability of the gas," he said.

Better risk

Looking at LNG sales from the buyer’s perspective, another consideration quickly comes into focus.

Hidehiro Muramatsu, general manager of the Washington, D.C., office of the Japan Oil, Gas and Metals National Corp. (JOGMEC), said the key interest for Japanese energy traders and utilities in purchasing U.S. LNG lies in diversifying their energy portfolios.

"Diversification means not only the price differential but also the gas supply source," Muramatsu said in a March email.

Today, 80 percent of the country’s LNG supply passes through the Strait of Hormuz between Iran and Oman, largely from Qatar, the world’s largest supplier. Shipping U.S. Gulf Coast cargoes to Tokyo avoids that chronically sensitive region and shifts the most restricted portion of the route to a passage through the Panama Canal, a transit that is currently in the midst of a major widening project that will allow it to accommodate modern LNG tankers.

With several contracts in place for Japanese firms to buy Gulf Coast LNG, Muramatsu said some Japanese companies are looking to expand their options still further.

"The shrinking price differential makes some LNG projects on the West Coast less attractive than before," Muramatsu said. "Some Japanese companies are, however, still looking for the possibility and opportunity to export LNG from the West Coast of the U.S. and Canada."

James Jensen, the consultant who notes the oil price risk to U.S. wet gas production plays, pointed to a different motivator for buyers pursuing U.S. contracts. A key element of the appeal, he said, is the redefining of traditional LNG contract terms that shift risk and reward from the seller to the buyer.

All of the U.S. export contracts so far, he noted, are unusual in that the pricing is tied to the origin, rather than the destination, of the sale. They also differ from traditional contracts in giving the buyer title at the point of purchase, rather than upon delivery at one particular port, so buyers can resell cargoes if they so choose.

As he sees it, just holding contracts like those give buyers more leverage in negotiating flexibility with other sellers down the line.

Jensen said 60 percent of the contracts written so far for U.S. Gulf Coast supplies have gone to portfolio buyers "whose profit depends on the ability to buy at North American commodity prices and resell at international prices; these projects are clearly at risk."

But he added, "For destination market buyers, such as Japan or Korea, the diversified U.S. contract structure is a plus in future contract negotiations, even if the pricing advantage of U.S. gas disappears."