The LNG Question

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 Canada’s 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 Commission’s 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
Canada’s 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 Mexico’s 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
Mexico’s 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 Mexico’s 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 Canada’s 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 Canada’s “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 can’t 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 Energy’s
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 year’s 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.
It’s 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). It’s all possible to imagine, but let’s
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, it’s 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.