From Fracked to Floated: The Next Chapter in the U.S. Natural Gas Story

If a revolution is defined as the overthrow of an old system in favor of a new, then the shale revolution warrants the term. We now ask: Are the first LNG cargoes from the United States just another chapter in the volatile shale revolution, or the first chapter on a new and sustaining U.S.-centered global LNG marketplace?

Shale Gale 2.0: How U.S. LNG Became Relevant

Natural gas is now the fastest growing fossil fuel globally, driven by strong shale supply growth, low cost, and increasingly stringent environmental policies. Natural gas usage is projected to grow 2 percent per year over the next 20 years while oil grows at half the rate of gas and coal half the rate of oil. The United States has found itself in the right place at the right time as its ample shale gas supplies (it is by far the largest producer) and low production cost (currently second- or third-lowest on the landed cost curve to major markets) have it well positioned to serve this expanding market. It’s also worth mentioning that the United States benefits from one of the world’s most developed field-to-consumer midstream pipeline networks. Canada is a distant second shale producer, and significant shale resource exploration efforts are underway in several countries, but with only a small minority—including Algeria, Australia, and Russia—developing gas with the primary intentions of exporting. chart1The majority—such as China, Saudi Arabia, Argentina, Mexico, and South Africa—are pursuing development for mainly domestic use and the true potential of these resources remains unclear as the infrastructure to bring gas to market is in various stages of construction. In the meantime, those regions who are currently significantly short on gas (for example, Europe, China, Japan, India, and some parts of Latin America) will continue to look to the global market to close the gap. Analysis of the various gas trade scenarios suggests a range of possibilities exist for U.S. LNG based on a few key variables. Under most likely scenarios, for now and for the near future, we should assume that U.S. LNG volumes will continue to find a competitive place in the global LNG trade. But how much?

The Dance Floor Is Getting Crowded

The first LNG cargoes from the U.S. via Cheniere Sabine Pass have shipped and are now a part of the roughly 30 tcf/a global natural gas market. With the likely entry of other new players, the supply optionality for LNG consumers is likely to continue to increase. This notion is surprising when we consider the approximately 20 tcf/a of additional LNG projects currently being considered in North America alone. chart2The business case for Sabine Pass was founded on the ability to secure long-term, take-or-pay contracts for the majority of its volume while holding a portion aside for the (sometimes) more lucrative spot market. As new players on the supply cost curve emerge, consumers will again be evaluating the most attractive suppliers and contract terms. As for the spot market portion of the business plan, we have recently seen how easily the spot market can narrow when oil prices reduce to a point where oil vs. gas competition, depressed oil-indexed LNG spot prices, and softening demand combine to reduce profitable spot market participation to some limited pockets of opportunity. For those more confident in an oil price rebound, consider the fact that more than 70 percent of LNG spot trade is confined to Asia Pacific. If current estimates of Chinese shale production in 2020 are underestimated by just 10 percent, the results would likely displace 20 percent of the global spot market for LNG, and would come largely at the detriment of emerging Atlantic basin producers (for example, the United States and Canada). So while the U.S. has established its presence, there are several headwinds that will keep the domestic LNG build-out in check. As U.S. projects are completed and others clamor for project approval, LNG supply is also increasing elsewhere across the globe, with about 4.5 tcf/a currently under construction in Australia and elsewhere. Considering these dynamics, 3-7 tcf/a is a more likely LNG terminal build-out in the U.S.—out of the roughly 20 tcf/a proposed and under construction currently.

Key Takeaways: Making Sense of the Global Gas Balancing Act

Commercial dynamics will be…dynamic. The share of long-term contracts in LNG trade has gone from 95 percent in 2000 to approximately 70 percent in 2015, and with more supply options and capacity buyers will become increasingly reluctant to sign long-term contracts. The debate on the dominating pricing mechanism in the future will likely continue as some reconsider the value of oil-linked contracts while others see benefits in a move toward hub-based pricing (such as those considering Singapore’s new LNG price index). Moreover, some of the largest buyers in Asia are coordinating efforts through JVs (including Jera Co. and Kora Gas Corp.) to increase their leverage over suppliers.

chart3Projects will become increasingly difficult to execute. Since LNG project financing is dependent on supply contracts, the reluctance of buyers to engage in long-term contracts has significantly increased the investment costs of facilities. For example, one producer has experienced a near doubling of their cost of capital over 5 years during execution of multiple projects. High project costs coupled with supply beginning to outpace demand means one-fourth of the currently proposed projects is a more likely LNG terminal build-out scenario for the U.S.

The LNG landscape will continue to evolve with a mix of economic, environmental, and political drivers. For example, more than half of Europe’s natural gas imports come from Russia, and as political tensions ebb and flow this could add considerable pressure for Europe to displace their expected 6 tcf of 2020 pipeline imports from Russia with LNG from the United States and elsewhere (despite the gas cost advantage enjoyed by Russian pipeline gas). Japan is considering the post-Fukushima restart of nuclear reactors (which could further deplete demand for LNG in the region), while Germany works to exit nuclear altogether. Additionally, as pen is put to paper on curbing carbon emissions, natural gas is increasingly being looked upon as the bridge to non-hydrocarbon-based energy. Energy companies are now behind the carbon tax push with Shell, BP, Total, and others agreeing that a price on carbon “should be a key element” of an international agreement to address global climate change.

The impact of each of these decisions will ripple throughout the LNG marketplace and continue to merit a keen understanding of the fundamentals to stay on top of the situation. After all, regardless of one’s position on the political, economic, or environmental merits of natural gas trade, all agree that as the global balance of natural gas shifts it will continue to create infrastructure hot spots of distress and opportunity—with the winners claiming to be the ultimate victors of the shale revolution.