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In the Nation's Interest

Gentlemen, Go to Your Corners! The Fight over U.S. Natural Gas Exports

By Jeffrey Hooke
Vice President and Director of Economic Studies

The U.S. shale gas boom could be a “game changer” for U.S. manufacturing, particularly for energy intensive industries that use a lot of natural gas like chemicals, plastics or electricity (which is being increasingly generated with gas). Plentiful U.S. natural gas, available at relatively low prices, will enable those U.S. industries to sell to their customers-- domestic or foreign -- at better pricing and to undersell their international competitors.

Foreign firms will operate at a disadvantage: they will be paying more for natural gas than the U.S. companies, and all things being equal, their cost of production will be higher than the U.S. offering. Thus, the U.S. manufacturers will be in a “sweet spot,” i.e., they’ll be among the lowest-cost producers of international commodities, where their profits are assured.  U.S. exports of chemicals, plastics and other energy- intensive items should increase, and domestic manufacturing jobs should climb.

The Multibillion Dollar Issue: Which Domestic U.S. Sector Should Be Globally Competitive -- Manufacturing or Energy?

Some prominent U.S. manufacturers want to keep the natural gas “in-country” by refusing government approval of exports; that way they’ll maintain an indefinite advantage over global competitors, who will have to contend with low-cost US manufactured imports. CED might call such tactics “co-opted capitalism.”

In the other corner are U.S. gas producers, who want to have the option of exporting the resource, if global prices permit.  They want little government restriction on exports.

U.S. Natural Gas is a Non-Tradable Commodity, For Now

In the United States, natural gas is considered a “non-tradable” commodity. Why? Producers lack the infrastructure to sell the product overseas.

Pipelines: In theory, pipelines would be the best means to deliver U.S. gas to major markets, like Japan, China and Western Europe, but the vast ocean distances make pipelines impractical. The largest exporter via pipelines is now Russia, which has a sizable nearby market in Europe and which just signed a new gas export agreement (via future pipelines) with China.

Perhaps 95% of the world’s natural gas never leaves a pipeline on its way to the ultimate customer.

LNG, the Non Pipeline Alternative: The “non-pipeline” method for transporting natural gas is liquefaction, the delivered product of which people refer to as liquefied natural gas (or LNG). LNG enables producers to transform a non-tradable commodity into a tradable product. It broadens the gas producer’s customer list, and it subjects natural gas to (i) global forces; and (ii) potentially higher prices linked to natural gas substitutes, like oil. The LNG process involves seven steps outlined below:

Seven Steps in Exporting U.S. Natural Gas

• Transport the gas to an LNG plant via pipeline
• LNG plant converts  the gas into a liquid
• The liquid is piped into an LNG gas tanker
• The tanker sails to a foreign port that has its own LNG plant
• The tanker offloads the liquid into the LNG plant
• The foreign LNG plant converts the liquid back into gas
• The gas is then shipped via foreign pipeline to the ultimate user

Clearly, this process is not cheap. LNG plants require sizeable investment, and even the tankers are expensive. We could expect the market prices of gas, like crude oil, to be the resource cost plus shipping, so the cost of U.S. LNG in a foreign country will exceed that at the end of a U.S. pipeline.

Principal LNG Exporters Have Political Risk

The amount of natural gas consumed via LNG is a tiny fraction (less than 5%) of world demand, and the principal consumers are Japan, South Korea and Western Europe. The top five LNG exporters are:

• Qatar
• Malaysia
• Indonesia
• Nigeria
• Australia

The expansion of the LNG business is hampered by geography and capital costs. The large natural gas reserves tend to be situated in nations with a relatively high degree of political risk. This makes the multinational energy firms wary of the sizable capital commitments needed to start up an LNG plant. 

By way of illustration, a typical LNG plant might cost $2 billion to construct, and the dedicated ocean-going tankers another $1 billion. This is a major commitment for private industry to make, even with the political-risk protections offered by multilaterals and ex-im banks for investments in certain emerging economies. Even state-owned energy companies pause before taking on such obligations.

Further, rather than build the facility on a “speculative basis,” the plant’s owners want to line up creditworthy customers for the plant over a 20-year period (much like an office building developer tries to pre-lease a new property). Finding such customers is a tall order, since many are reluctant to sign up for long periods, particularly if the plant is in an emerging-market location.

The U.S LNG Industry Has Positive Attributes

The United States, in contrast, is a highly developed economy with minimal political risk.  The domestic energy producers and capital markets here can easily absorb the costs, and foreign customers are likely to be more amenable to signing a long-term deal in the United States versus Nigeria or Indonesia. The economics of U.S. plants are favorable as well. See the following for an illustration of sending US. natural gas to Japan, where the quoted price is $16 per million British Thermal Units (mmBTU), a standard measure of gas volumes:

Economics of U.S. LNG Exports to Japan (US$ per mmBTU)

As the table shows, U.S. natural gas is competitive with Japanese prices on Day One, by a factor of $5 per mmBTU. The economics of shipping to Europe are also favorable, with some variation in the numbers. But, the cost overseas still is substantially higher than the U.S. users.

The Upcoming Fight on US Natural Gas Exports

Only one proposed U.S. LNG plant has both (i) the requisite permits and (ii) the long-term customer contracts needed to finance the construction. A single LNG plant can export about 0.7% of annual U.S consumption, so fourteen new plants – each requiring 4-5 years of permitting and building – would represent about 10% of annual domestic demand. Years could pass before we know whether this level of activity increases local natural gas prices.

Should the government derail the nascent LNG industry through restrictive policies? Both producers and users are leaving their corners, and round 1 is underway. Watch this space for updates.