Natural gas and a global market

October 1, 2012

On September 25, the C. T. Bauer College of Business kicked off its Fall 2012 AGL Resources Distinguished Leader Speaker Series with a panel of experts who spoke on the topic of Liquefied Natural Gas.  Steve Cittadine, President, Storage and Fuels for Sequent Energy; Dean Purcelli, Strategic Marketing Advisor for Encana Natural Gas, Inc.; and Michael Wortley, Vice President – Business Development for Cheniere Energy spoke to the audience of over 150 students, faculty, and industry participants about the growing role of LNG in the energy supply chain. LNG, or liquefied natural gas, (“Gas on water”, as Daniel Yergin describes it) is natural gas that has been converted to liquid form for ease of transportation.  It takes up 1/600th the volume of natural gas.

The world today faces two major challenges in energy.  As the economies of the developing nations mature, the challenge is to enhance supply to meet the demands from these growing markets.  Even as we do this, however, our second challenge is to achieve adequacy without compromising the environment.

Given the recent developments in shale development, natural gas, it would seem, offers a solution to both challenges above. Shale gas production has increased from nothing to 25 bcf/d in less than 10 years.  The U.S. Energy Information Administration’s Annual Energy Outlook 2012 projects U.S. natural gas production to increase from 21.6 trillion cubic feet in 2010 to 27.9 trillion cubic feet in 2035, a 29% increase. Almost all of this increase in domestic natural gas production is due to projected growth in shale gas production, which grows from 5.0 trillion cubic feet in 2010 to 13.6 trillion cubic feet in 2035.

Using thermal equivalence of the two commodities (one barrel of oil contains the energy equivalent of the 5.825 million BTU of natural gas), the price of one mmbtu of natural gas should be roughly one-sixth the price of a barrel of oil.  Currently Brent Crude oil trades at $100 per barrel, and gas (Henry Hub price per mmbtu) at $3.  After including liquefaction, shipping and other costs, the price per mmbtu of Liquefied Natural Gas (LNG) delivered is around $7.20.  Hence there is a margin of around $7.80 when compared to the price of oil.  Even with higher shipping costs to Europe and Asia, the differences are positive. While American gas costs $2.50 per mmbtu, the equivalent prices in Europe and Asia are $12 and $16, respectively. In addition, natural gas is a cleaner option to coal and oil.

Per estimates from the U.S. Energy Information Administration (EIA), net additions of wet natural gas in 2010 totaled 33.8 trillion cubic feet (Tcf), which represents a 17% increase compared to the previous record in 2009.  Dry natural gas reserves increased from 272.5 trillion cubic feet to 304.6 trillion cubic feet between 2009 and 2010. Within the U.S., the savings in converting from diesel to natural gas are significant especially for high horsepower users of power.  At the same time, the increase in production along with a market that does not equilibrate the world price of LNG has resulted in global opportunities for profit.  By re-engineering its import facility at Sabine Pass in Louisiana, Cheniere Energy now has “take-or-pay” contracts to export LNG to countries like Korea and India.

With new discoveries of gas, the market for exports becomes viable.  The transportation costs, however, remain significant. At the same time, the story of oil tells us that transportation costs (which used to be over 30% of the total cost of oil, and today account for 5%) can and do decline with improvements in technology.  Pipelines are expensive to build, and LNG facilities need significant investments. As the price of steel has increased, the cost of building regasification plants has increased.  Even with these costs, Cheniere Energy’s price to deliver LNG to Asian markets ($10) remains lower than the oil-equivalent price ($15). Even if Henry Hub price of gas were to increase by $4, this trade would remain profitable.

Japan is the world’s biggest LNG importer, and China is building LNG terminals.  As the emerging markets in Asia begin to increase their imports of LNG, it is anticipated that the market for gas will move from long-term contracts that are indexed to the price of oil to short duration contracts based on a global gas market. While the nature of the gas business is changing the face of the global market for gas, the geo-political aspects of these developments are not trivial.  The most important of these will be the role of Gazprom as the major gas supplier for Europe and Asia.  The story of LNG has just begun.