Exports

Energy economist Medlock discusses future of U.S. LNG, crude oil exports

Is U.S. policy keeping pace with the rapidly evolving discussions on liquefied natural gas and crude oil exports? During today's OnPoint, Kenneth Medlock, senior director at the Center for Energy Studies at Rice University, discusses the economic and strategic impacts of exporting these resources. He also talks about the market uncertainty affecting the future of LNG exports, and the pricing and refining challenges facing crude oil exports.

Transcript

Monica Trauzzi: Hello and welcome to OnPoint. I'm Monica Trauzzi. With me today is Kenneth Medlock, senior director at the Center for Energy Studies at Rice University. Kenneth, it's great to have you here.

Kenneth Medlock: It's great to be here.

Monica Trauzzi: Ken, much of your work is focused on energy exports and energy economics. You were the principal in the development of the Rice World Natural Gas Trade Model. The Japanese this week signed a long-term deal with BP for natural gas exports at North American prices, a 17-year deal, and the U.S. EIA notes that the Panama Canal expansion will allow for the passage of larger vessels with larger capacities that will have the potential to increase product transport through the canal. The game is changing very quickly. Are the policies in place? Are the policies in line to keep up with that fast-paced changing game?

Kenneth Medlock: That's a great question, and, as a matter of fact, that's been the core focus of a lot of the discussions on Capitol Hill and really all over the country over the past few years. And the DOE actually instituted a change in the way it's actually going to issue permits to export, which at the end of the day is really relying more on market capability and demonstrating market capability for these firms to actually move. And so, that could bode well; however, the time that it has taken for permits to be filed, reviewed -- go through the multiple rounds of review, because usually you go through the DOE to get the preapproval, then FERC to get all your environmental impact and everything else done, then back to DOE.

It's quite onerous and can be quite expensive, and given the uncertainty that pervades the marketplace, that's problematic for a lot of players. And so, at the end of the day, things that would help expedite the permitting process would actually help the market to react much quicker and much more fluidly and at the end of the day settle the debate about how much natural gas the U.S. actually will export.

Monica Trauzzi: You used the word "uncertainty," and that's a word we hear often from Republicans in Congress. They say there's uncertainty in the market, because there hasn't been a strong-enough signal from the government on the future of exports and the approval of these LNG facilities. Is the administration working at the right pace? I mean, they're working pretty quickly, and DOE is keeping up with the promises that they made. Certainly Secretary Moniz is keeping up with the promises that he made on pacing of approvals. So how much uncertainty, exactly, exists within the market, because the companies know that these projects are being approved?

Kenneth Medlock: Well, uncertainty, I said that in a very general sense. So, yes, there's uncertainty around how long it will actually take to get a facility certified and approved for exports, but beyond that, the uncertainty is more market-oriented, and that actually influences the firm's decision to move forward with the investment. So, what will the price in Asia be? What will the price in Europe be, particularly given all the geopolitical tensions that're actually in play right now? And that injects another element of uncertainty, simply because policymakers are trying to think about U.S. natural gas and U.S. crude oil, even, as geopolitical levers, and historically that had not been the case. So, there's a lot on the table. Most of the uncertainty, though, really is market-oriented and less about regulation.

Monica Trauzzi: So what number of approved facilities should secure final financing and become operational?

Kenneth Medlock: Well, there're multiple questions in the one you just asked, actually. When you say "should," I typically try not to be normative, because at the end of the day, what ought to occur is allow the market to determine the answer to that question, because it will. If you begin to see certain new facilities come online -- I guess there're two that've received final approval now, actual facilities, and if they come online and if they actually begin to lower price overseas, then that will dampen the demand to continue to expand LNG export capability from the U.S., so capital markets will respond accordingly. And at the end of the day, that's what we want, right? We actually want capital markets and markets in general to be able to respond to the appropriate regulatory environment to demands that're in play.

Monica Trauzzi: It's difficult to predict pricing, and I hate for pricing -- to ask pricing predictions on this show, but what's that sweet spot on natural gas prices for exports?

Kenneth Medlock: Oh, boy. Well, a lot of the work that we've done trying to characterize well performance and shale plays and understand what the depth of the resource actually is in terms of how much it is and at what price it's profitable indicates long-term pricing in the U.S. anywhere between $4.50 and $6.50 at MCF. And so, when you think about profitable return to infrastructure to move natural gas in the form of LNG to places like Asia and Europe, you need generally a $3 to $4.50 uplift over that, depending on which destination you have in mind. And so, that puts you in the place of, well, if the price in Asia's consistently $12, then there's a lot of room to run with export capability from the U.S. If it dips down into the $10 range, then now you're kind of running up into razor-thin margins and beginning to challenge some of the facilities that've been proposed.

And so, in terms of a sweet spot, it really does depend on what that demand ultimately is overseas, what other players, other sources supply aside from U.S. natural gas coming to play, and there's lots of them. I mean, we've seen the Russians express tremendous interest in the Chinese market, East African producers with the new finds off the coast of Mozambique and Tanzania. Australia is massive and will continue to grow, so there's a lot of other players in the mix, too, and that's the other thing we have to keep in mind. It's not just about the U.S. It's about how the international market responds to all of these other new sources of supply.

Monica Trauzzi: How much do local fracking debates play into the modeling that you do? I mean, do you think that that has a broad and general impact on the number of supplies that we'll eventually end up with?

Kenneth Medlock: It depends. The local fracking debate had an influence in Europe. It's had an influence even in places like Australia. I've even heard rumblings of it being influential in terms of local community response in places like China, which some people would think that's impossible, but it has resonated; however, there are other overarching concerns, namely energy security. Countries like China, the demands for energy are tremendous. You're talking about upwards of 400 million to 500 million people moving into a middle-class-type income level over the next decade or so, and they're going to need the energy. And so, that becomes the overriding and overarching issue that really is going to drive those demands forward and ultimately what they do to meet those demands.

Monica Trauzzi: Larry Summers recently called for a lifting of the crude export ban, and he basically says it's a no-brainer from a jobs and pricing standpoint. How rapidly is the discussion moving in that direction, and do the economics of the argument make sense?

Kenneth Medlock: The economics certainly make sense, and, really, what Larry Summers was talking about was crude oil in terms of his remarks, and the debate there is much different, actually, than the debate over natural gas exports, simply because there's legislative action on the books already that create a law that effectively ban exports of crude oil, whereas with natural gas there's a regulatory process to move forward. And we've seen that already in action, but when you start talking about legislative action to change the nature of the law, the nature of how we produce and ultimately sell crude oil, that's a longer slog, if you will.

So I think the level of education about the issue is elevating. There still is a lot to be said and a lot of eyes to be opened, if you will, over what the actual economic implications are for lifting the ban on crude oil exports. There's still a big discussion about it's going to negatively affect consumers in terms of the price at the pump, big discussion about it's bad for U.S. energy security because it's our oil; we ought to keep it at home. There's the discussion about the environmental impacts of increased production of crude oil, increased upstream activity in general.

All of these things are very relevant discussions, and there've been a couple of studies that've been released over the last month and a half or so, but there's still a lot more work that is being done, and I think this is one of those debates that's probably going to take a while to play out. I don't see, obviously, anything happening before the midterms, but next year I think you'll see a lot of discussions, quite a few hearings on Capitol Hill, and this discussion's going to get elevated pretty rapidly.

Monica Trauzzi: And what about refining capacity, because much of the current capacity in the U.S. is set to handle sort of heavier crude. Is that a critical component that should be a part of the debate?

Kenneth Medlock: It is already actually part of the more technical discussions around this. I mean, one of the reasons the light sweet crude gets discounted is because every refiner has the kit to refine light sweet crude, but if you're geared to bringing in heavy crudes from Venezuela or Mexico, those are discounted relative to what the light sweet crude is now, and if you're going to refine that, you're going to be -- it's suboptimal for you, because you're basically not utilizing the refinery the way it was designed. And so, what that means is that you're going to want to discount on that crude so that you're whole in terms of "I spent money to put this in place so I could handle these crudes." And so that's where the rubber hits the proverbial road, because at the end of the day if you see more and more of that constraint become binding, then the domestic crude oil price will get driven down, but that doesn't matriculate into product prices.

Monica Trauzzi: Very interesting. We'll end it there. Thank you so much for coming on the show.

Kenneth Medlock: Thank you. No problem.

Monica Trauzzi: Nice to have you here.

Kenneth Medlock: Thanks for having me.

Monica Trauzzi: And thanks for watching. We'll see you back here tomorrow.

[End of Audio]

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