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Reuters story reprinted - strange death of US LNG by John Kemp

The Strange Death Of U.S. LNG (Again): John Kemp

By John Kemp, (Reuters columnist), Dec. 10 09

London (Reuters) - North America's perennially unlucky liquefied natural gas (NYSEMKT:LNG) industry has mistimed the cycle once again.

Massive expansion of shale production has left the country with a bevy of regasification facilities unlikely ever to be used at anywhere near their forecast capacity, and a string of additional projects that will now have to be cancelled.

In 2009, the United States is set to import up to 475 billion cubic feet of LNG, mostly from Egypt and Trinidad and Tobago. While this is a slight rise from last year's 350 bcf, it is way below the 1.8 trillion cubic feet the Energy Information Administration was projecting just five years ago in its Annual Energy Outlook 2005 (AEO2005).

Back in the early 2000s, at the peak of the panic about "peak gas" in North America, bullish projections about LNG demand unleashed an investment boom. LNG was seen as the crucial source, bridging the gap between steadily rising demand and falling domestic supply. The EIA projected the United States would need to import 4.33 tcf by 2015 rising to 6.37 tcf by 2025.

Bullish projections set off a scramble to build new facilities. The United States now has 11 terminals in operation (with a combined annual capacity of 5.1 tcf). Another four are already under construction (which will add 1.8 tcf when they are complete).

But developers have secured approvals for a further 17 (9.5 tcf of capacity) not yet in construction. At an even more speculative stage, proposals have been submitted for another eight (4.1 tcf) and sites for six more have been identified (2.5 tcf).

Once projects already in construction have been completed, capacity will jump from 5.1 tcf to 6.9 tcf. But if all the projects approved, proposed and identified were brought into commission, capacity would surge to an extraordinary 22.9 tcf.

Projects always operate at far less than their maximum rated capacity. Developers assume relatively low utilisation rates of 35%-40%. But at present the industry is managing less than 10% and there is no likelihood of much improvement in the next five years.

The huge expansion of domestic shale production has displaced much of the forecast LNG demand and left investments effectively "stranded". EIA has cut its projected demand for LNG in each of the last four years. Projected imports for 2015 have been cut almost 75% from 4.33 tcf to 1.15 tcf.

In even worse news for the industry, the EIA sees no recovery even in the longer term. The forecaster is now projecting imports will peak at 1.42 tcf in 2018 and then fall to just 0.8 tcf by 2030, scarcely ahead of today's level.

Peak imports could be met with today's facilities. There will be no need for any of the new facilities under construction let alone the facilities which have been approved or proposed but are still on the drawing board.

This is not the first time the industry has been seized with enthusiasm for LNG, only to find demand has disappeared by the time facilities become operational. The first four receiving terminals (Everett, Cove Point, Elba and Lake Charles) were built between 1971 and 1982. But they never received substantial volumes and by the late 1980s all were shuttered.

For most of the last 20 years, U.S. LNG terminals have been mothballed. Cove Point and Elba ceased operating in 1980s. Lake Charles, the last to open, only operated for a short period before closing. Cove Point was recommissioned in 1995, but purely as a storage facility. It was not until the early part of this decade, when gas prices began rising, that the terminals were re-opened to receive international shipments.

The problem is that domestic sources have responded faster to price signals, while LNG terminals take so long to build they get overtaken by events. History is now repeating itself. High prices combined with new technologies (horizontal drilling and massive hydraulic fracturing) have brought on record volumes of shale production much faster than LNG terminals could be built.

While the current terminals may not remain completely empty, they will operate far below the levels needed to make them a commercial success.

To ensure expensively built terminals see some use and give themselves more flexibility, several operators have applied for licenses to start exporting LNG. The idea is not to export domestic U.S. production, but give themselves an option to re-export foreign gas.

If domestic prices rise high enough, LNG will be vaporized and sent out into the U.S. pipeline network. If not, cargoes can be reloaded and sent to higher-priced markets in Europe and Asia. LNG terminals will be repurposed as storage and trading hubs.

Most facilities have enough storage to hold two to three cargoes, and some of the newer ones have been designed to hold as many as four. Holding tanks can be used to exploit seasonal pricing swings and benefit from storing gas in a contango market.

ConocoPhillips has sought and obtained authorization to re-export as much as 500 billion cubic feet (150 cargoes) over two years from its Freeport, Texas terminal. The first has been sold to Citigroup, which has chartered a tanker, scheduled to arrive around Dec. 4, to take gas to Europe or Asia.

For some time, analysts have been predicting the development of an LNG market would force a convergence between natural gas prices in different regions (North America, Europe, and Asia). At the moment prices are strongly segmented because physical arbitrage is limited.

But with LNG, arbitrage would force convergence, especially between North America and Western Europe, as importers compete for scarce gas molecules. North America would compete with Europe to attract LNG cargoes, with the tightest market, and highest bidder, setting the marginal gas price for both regions.

In practice, the arbitrage is working, but in the opposite direction. LNG has become the mechanism by which the United States is exporting its gas glut to other markets. As U.S. shale production expands, surplus molecules are being repelled towards Europe, intensifying downward pressure on European spot market prices.

Shale is displacing LNG in North America, and LNG is replacing Russian pipeline gas on long-term oil-linked contracts in Europe. As a result, North America's ghostly fleet of gas terminals is pressuring the oil-linked pricing mechanism for much of Europe's long-term contracted supplies.

LNG (traded at prices linked to Henry Hub in the United States or the UK National Balancing Point) is substantially cheaper than pipeline gas (which has risen in line with oil prices).

European importers are maximizing LNG while taking minimum contract volumes of Russian gas. Media reports suggest at least some customers might fail to take their minimum obligations and risk huge penalty payments as a result.

A more global gas market is emerging, with LNG playing a key role, but one characterized by a surplus of production rather than the shortage the industry anticipated.