The LNG Question by mThink, May 23, 2005 During 2000, natural gas prices in the United States took a longanticipated turn, and market watchers are now waiting (at the time of writing) for mean reversion to happen. And waiting, and waiting. No, all energy traders did not collude to bring about this turn of events, not even the so-called Texas Cartel. And no, the prevailing price deck does not mean we are running out of natural gas or that we do not still have a rich, deep North American resource base. Rather, the price deck we see today, and which will likely last a bit longer (with some adjustment if oil cools off), is a logical result of long-term business cycles in the natural gas industry, the progression of North American resource development and patterns of policy/regulatory treatment for what is now considered to be a premium fuel and feedstock. The upshot is that at a time when supplies in both the lower 48 states and Canada are mature and maturing, and with natural gas consumption at least stable (demand growth need not even be a factor), imported liquefied natural gas (LNG) is increasingly looked to as the balancing item for the entire continental marketplace. How did we get to this juncture? The Natural Gas Policy Act of 1978 was an acknowledgement of pent-up demand (notwithstanding an alphabet soup of policies meant to discourage natural gas use during a time of perceived shortages and curtailments) and policy-induced supply imbalances. The resulting strong price signals for new exploration and production unleashed a wave of drilling not just in the lower 48, but also in Canadas huge Western Sedimentary Basin. Collapsed oil prices and a pervasive gas bubble stymied resource development and led to extensive upstream industry consolidation (see Figure 1). De-bottlenecking the interstate natural gas pipeline grid with the U.S. Federal Energy Regulatory Commissions final restructuring rule, Order 636, implemented in 1992, capped several years of rule making to achieve broad, efficient market clearing transactions between independent buyers and sellers along a common carriage pipeline tollway. With similar, indeed front-running, initiatives by Canadas National Energy Board, a common market for natural gas the largest in the world evolved along the Canadian and U.S. border. The Clean Air Act Amendments of 1990 and the Energy Policy Act of 1992 enshrined natural gas as a cleanburning fuel for electric power generation and extended the argument that a wholesale market for electric power was the regime most appropriate for a wholesale-market-driven natural gas industry system. The Supply-Demand Question Today, roughly 16 percent of the natural gas we use comes from Canada. Almost 3 percent of our natural gas consumption is supplied by imported LNG through four operating terminals (Everett, Mass.; Cove Point, Md.; Elba Island, Ga.; Lake Charles, La.). We export Alaskan natural gas production in the form of LNG from the Cook Inlet to Japan, a trade route established in 1969 and one of the first in the emerging worldwide LNG industry. We also export to Mexico, via pipeline, an amount of natural gas roughly equivalent to what we import as LNG. Demand for natural gas is growing in Canada for applications like electric power generation but also, importantly, for the expanding production of crude oil from oil sands in the province of Alberta. And demand for natural gas has grown, and will continue to grow, in Mexico, for industrial and domestic use and electric power generation, a consequence of Mexicos economic emergence and growth. Meanwhile, a number of factors at play are making outlooks for natural gas supply-demand balances in North America uncertain, at best, contributing to bullish forward prices and underscoring the role LNG may play in the future. Policy constraints inhibit development of what many believe to be a large, relatively untapped, resource base in Mexico. The body of law associated with Mexicos Constitution restricts exploration and production activities to Petroleos Mexicanos (Pemex), the sovereign oil company. Pemex has been chronically underfunded as income from oil sales is routinely diverted to Mexicos general treasury. The company has been in search of mechanisms to increase the level of private investment in its upstream businesses, but a complex array of political and social factors have kept success out of reach thus far. As a result, Mexico finds itself becoming an LNG importer as decision makers search for supply alternatives and portfolio diversification, and a way of making the natural gas marketplace more price competitive. The engine for Canadas natural gas pipeline exports, the Western Sedimentary Basin, remains an important component of North American supply. Drilling is moving into new, deeper and thus more expensive terrain. As in the U.S., exploration companies are delving into Canadas unconventional resources, mainly coal seam gas. A frontier many hoped would yield new, prolific fields, offshore Atlantic Canada, has proven to be complex and disappointing. The potential for resource development offshore British Columbia remains just that, as public dialogue on environmental and community impacts struggles on. What of the lower 48? If not for development in our own coal seam gas plays and the hot Barnett Shale play in Texas, the U.S. would be hard-pressed to show meaningful gains. The unconventional natural gas resource base in the U.S. encompasses about one-third of our prospective future domestic supply. Technical advances must continue to be made for commercially successful operations in coal seam, tight sands and other plays; what seems to work well in one basin and play does not easily transfer to others. Progress has been made in Gulf of Mexico deep water offshore exploration and production and in building the pipeline fairways needed to link deep water blocks to the onshore pipeline grid. But oil proneness among the deep water blocks really means that companies are not yet in the gas window. To get there means deeper drilling in deep water, something that few operators seem willing to take on. Meanwhile, older, mature shelf production continues to decline and offshore moratoria continue to prohibit drilling in the eastern Gulf of Mexico and off the east and west coasts. Access to public lands is often touted as a barrier to resource development, but access to private lands is also a factor. Alaska remains a prime target for growth in both oil and natural gas resource development, and the outlook for natural gas pipeline transport from the North Slope looks increasingly positive. Both Alaska and Mackenzie Valley pipeline projects will constitute major, multibillion dollar investments of the like that have not been seen for some time. Unknown and almost unknowable are factors such as changing preferences for energy as future demand is modified by expectations about real energy prices and costs. Likewise, we cant fully anticipate the intensity of fuel competition if higher natural gas prices persist. Weather is a significant short-term variable, but longer-term temperature patterns are also important. The myriad viewpoints on global warming notwithstanding, we are on pace for a typical, roughly 30-year cycle in heating degree days. We face the risk of an increasing incidence of periods when colder weather results in sharp calls on natural gas inventories. Nothing galvanizes public and political attention on natural gas more than a voting bloc of consumers freezing in the dark. The global warming debate has generated complacency about complex short term and long-term weather and climate patterns and cycles. These trends likely will do more to affect public viewpoints and debate on energy in the coming years than any of the theories scientists might put forth. Enter LNG? Given the driving forces that prevail around natural gas supply-demand balances, the prospect of expanding LNG import receiving capacity has gained great attention. Excluding Everett, the remaining three existing import facilities are in the process of, or planning for, receiving and storage capacity expansions. About 50 new projects throughout North America, and including locations like the Bahamas, have been proposed, planned, are moving through the regulatory permitting process or are beginning to be constructed. Many of these projects are being pursued by familiar names ExxonMobil, ChevronTexaco, Shell, BP, BG, ConocoPhillips all have developments under way. New entrants include names such as Freeport LNG, Cheniere Energy, and Calhoun LNG as well as established energy utilities such as Sempra, Florida Power & Light and Atlanta Gas Light. New thinking is permeating the industry. At this writing, Excelerate Energys Energy Bridge, a combined LNG ship/onboard re-gasification technology hatched out of El Paso Energy and developed by Exmar, was delivering its first 3 billion cubic feet of cargo about 100 miles from the Louisiana coastline. Excelerate and competitors, including Tractebel, which operates the Everett terminal in Boston, are looking to use Energy Bridge or similar approaches off New England. Most of the international oil companies have offshore LNG facilities on the drawing boards that would receive, store and re-gasify LNG for shipment via offshore pipelines to onshore customers. Freeport-McMoRan is hoping to utilize salt cavern storage of re-gasified LNG that would be received and stored on an offshore platform. In Mexico, onshore facilities at Altamira, Tamaulipas on the Caribbean (Shell and Total) and Baja California (Sempra and Shell) are under construction. Expectations are that Irving Oil and Repsol will develop a receiving terminal in St. John, New Brunswick, while Anadarko, TransCanada and others compete in Nova Scotia. LNG from Atlantic Canada and Mexico projects will principally serve customers in the U.S. or offset scarce North American domestic production. The dynamism in this early wave of new LNG developments means that any of these developments could be out of date by years end. During this initial period of announcements, positioning and early development, certain realities have set in with respect to where new projects might be located, how they will be operated and managed, and whether they can achieve commercial success. A large number of first entrants (new greenfield projects under development now as compared to the established receiving terminals) will be along the upper Gulf of Mexico. A friendlier development climate and strong cluster of downstream petrochemical buyers has provided an edge to the third coast. With the decline in natural gas production along the shelf, pipeline capacity is available to carry natural gas from LNG projects to customers further north, or to displace Gulf Coast onshore production from local use. In some instances, building new or expanding on existing LNG import receiving and storage capacity will be the easy part, relatively speaking. More difficult will be the necessary expansions or additions to natural gas pipeline capacity, including disputes about pipeline rights-of-way. All of these realities are grounded in a common theme: whether, where and how the consuming public and our political representatives accept new LNG projects, or any new energy infrastructure projects for that matter. LNG developers have abandoned locations where public opposition caused progress to grind to a halt. They can take some solace from public resistance to an array of innovative energy proposals including renewables (stated preferences for wind power apparently are insufficient to overcome opposition to some projects). Indeed, public resistance to locating and building new energy infrastructure in the U.S. and many other countries may be one of the more compelling but least understood and therefore most poorly articulated issues of our time. Soft Risk or Hard Risk? If one engages in a thought experiment on 9/11 and its aftermath, it is possible to imagine that the conspirators planning this abomination cared less about the direct effects than the broader and longer-lasting psychological impacts. Its possible to imagine months and years of careful study of the U.S. economy and populace, monitoring demographic and political trends to assess everything from geographic shifts in where we prefer to live (overwhelmingly along our coastlines) to how we derive economic wealth (our casual use and enjoyment, apart from the typical daily aggravations, of our immense infrastructure systems) to our lifestyles (the what, me worry? here-today, gone-tomorrow attitude that permeates American society as soon as the first-borns of new immigrants are assimilated into the melting pot). Its all possible to imagine, but lets not give too much credit here. Rather, 9/11 happened at a time in history when an assortment of other factors was already at work, with the overall result being that we are trying to build critical new infrastructure in a most inconvenient context. LNG has the added hurdle of being less familiar than the corner gasoline station. And given that even this icon of American life is not well understood, LNG is quite disadvantaged. The U.S. has more LNG facilities than any other country more than 100 small storage and peak shaving facilities where domestic natural gas production is routinely stored for seasonal use apart from our coastal import terminals. An irony, not missed among thoughtful people in the energy arena, is that when it comes to new approvals for new import terminals we seem to prefer our LNG facilities inland. A convergence of conflicts among multiple uses in bays, ports and harbors, along with other demographic and political transformations, coastal urbanization and the post-9/11 psyche, combined into the stew most often referred to as NIMBY or not in my backyard, among many other variants. But this is way too simple and cavalier a diagnosis. The phenomena at play are much more complicated, and in teasing out the threads in order to identify and implement a cure, or at least to get through triage, developers and government regulators need to consider that it is all about local control. Our legal and regulatory tradition for more than three decades has been to enable local public input related to new projects. The public interest is legitimate and, in the long run, project developers and operators benefit hugely from good will that comes with respect for the public interest. As canny political operatives know, however, the public interest is ephemeral and a construct of rent distribution regardless of whether the economic rents are monetary or whether they are less tangible benefits associated with projects. The end result is a regulatory process, starting with the National Environmental Policy Act and going well beyond, that has served the public interest by enabling input and justifiable opportunities for rentseeking behavior in order to get projects done. In political settings, control of agenda is always key and locating and obtaining permission to build new infrastructure is nothing if not an exercise in politics. In this age of democratization, control of agenda is even more sought after. Indeed, control of agenda is, now, often the end game. It is no longer adequate to merely have the right to participate. Instead, activists desire to frame the decision parameters. Given that opposition moves at the speed of light, literally, activism against projects may be well established before the project is even announced. Internetspeed communication coupled with desire for agenda-setting control has yielded a blossoming of entrepreneurial initiatives and individuals who can dominate news media and run circles around companies and government agencies that tend anyway to be process-bound and focused on public input and rent distribution. Put this way, the problem of public acceptance is divorced from anything that could be construed to be particularly American. The dynamics become broader in scope, and seemingly disparate instances of local opposition begin to look like they might have more in common. Even remote locations for instance in developing countries where less familiar languages and cultures would appear to imbue truly distinctive characteristics to the problem can be reduced to the question of agenda control. What to Do? Business and government are quite rational to be cautious about giving up ground. Costs for companies to develop projects through elaborate multistakeholder arrangements in which agenda control is relinquished can skyrocket. Managers may be proud of such schemes, although they are often less successful than advertised and they rarely guarantee long-term success. The risk grows that by the time these arrangements are put into place, the window for commercial success is closed; alternative sites, where host communities are more accepting of the project, or less able to oppose it (the true source of environmental injustice), will inevitably crop up and often win out. At minimum, managing such an endeavor is time-consuming and commands skill sets not widely available. For all the attraction of corporate social responsibility and implications from the push on CSR for how energy companies approach and develop new infrastructure projects, it is usually neither practical nor satisfying to anyone (except perhaps the publisher of the annual CSR report or the many consultancies and organizations attempting to operate in the field). For their part, government institutions are rarely strong enough or deep enough to embody solutions that deviate far from familiar processes. The end results of the problem of public acceptance and agenda control are never discussed, and perhaps this is where things ought to begin. An isolated case or two in which projects fail and alternatives are not found, or found only at higher cost, are not worrisome. Consistent failure and substitution of higher-cost alternatives, in the aggregate, impact all energy customers, most of all those for whom energy is a greater portion of their disposable income. This means the worst of all worlds frequent occasions of environmental injustice combined with increasing costs of energy for the most sensitive segments of a society. Across an economy overall, the end result is, inevitably, higher energy costs and lost competitive advantage. The Way Forward Americans are often accused of being addicted to cheap energy. Well, its true, and it has been a powerful force in development of our modern national economy. In fact, the power of the U.S. economy is precisely that energy costs, in real terms, have tended to grow at lower rates than our gross domestic product (see Figure 2). Even during those periods when real energy costs skyrocketed, the U.S. economy, in total, weathered the storm in amazing fashion. Our flexible, market-based economy enables actually facilitates adjustment, substitution and technical innovation. Hard work has been done to introduce market forces to the energy sector, and many positive gains have been achieved creating options and opportunities that we have not had previously. Yet it is easy to look at history and forget that we have lived a long time off of infrastructure systems that in many cases are easily a century old. We will, and must, continue to operate these systems while at the same time expand, improve and add to our infrastructure base. LNG will be an important component of our natural gas, and overall energy, supply portfolio. New LNG projects will be successfully developed they already are and provide a bridge to whatever the future holds. And what does the future hold? Who knows? The point is to get there. Filed under: White Papers Tagged under: Utilities