The Role of LNG in North American Markets

June 2008

With the recent rise in natural gas prices, industry analysts and traders have weighed in on the various reasons for the latest jump in prices. The last time such dramatic increases occurred was in the weeks following Hurricanes Katrina and Rita in the autumn of 2005. These two hurricanes disrupted natural gas production in the Gulf of Mexico. Between that period and 2008, the price of natural gas in North America has been much lower, partially because of the lack of damaging hurricanes since then, relatively mild winters for 2005-6 and 2006-7 and increased imports into the USA of liquefied natural gas (LNG). This article will focus on the role of LNG.

LNG is natural gas that has been cleared of impurities and converted to liquid ("liquefied") by cooling it to approximately -161°C. As a liquid, its volume is roughly 600 times smaller than in gaseous form and it can be stored or transported via special tankers. Upon shipment to a receiving terminal, LNG is reconverted to its gaesous form ("regasified") via warming and can be then fed through an existing network of conventional pipelines for distribution.

What role can LNG Play ?

The importance of LNG lies in its benefit to both consumers and suppliers as it allows for natural gas to reach destinations which would be unreachable with conventional pipelines. According to the Institute of Gas Technology, the transportation costs of LNG are lower than those of offshore natural gas pipelines if the distance travelled exceeds approximately 1100 km while transport via onshore natural gas pipelines is more expensive than LNG shipment if the distance travelled exceeds 3500 km. As there are reserves of natural gas in Australia, Indonesia, Trinidad and Tobago, Nigeria and Angola, sending natural gas from these countries to areas of high consumption in Eastern Asia, North America or Western Europe would entail the construction of prohibitively expensive pipelines and thus the resource would go unused without the option to sell it as LNG. On the other hand LNG tankers can go to any port designed to receive them and thus are not restricted in the same way as pipelines which have fixed points of entry and exit.

For North America, much of its demand for natural gas has been satisfied by existing deposits and transported by pipelines crossing the length and breadth of the continent. Over time, natural gas has become more important in meeting North American energy demands partially as a way to reduce reliance on crude oil and partially in allaying environmental concerns since burning natural gas yields less carbon dioxide ("greenhouse gas") per unit of energy than crude oil or coal. According to projections by the U.S. Energy Information Administration (EIA), the demand for natural gas by 2030 in the USA may exceed supply by 6 trillion cubic feet.

With all of these features, LNG is becoming an important part of dealing with this projected gap in demand and supply. However, there are certain factors working against a headlong rush towards greater LNG consumption in North America.

Pricing considerations for LNG

The increased flexibility of LNG shipments relative to conventional pipelines means that shipping decisions are more dependent on price and output often goes to the highest bidder. A supplier of LNG often has more flexibility than a supplier of conventional natural gas and can serve a global client base. As a result LNG is less of a regional commodity and more of a global one like crude oil.

As the graph shows, the USA imported more LNG in the spring and summer of 2007 when the difference between average prices for natural gas in the USA and Europe was low. However, European prices have risen relative to North American prices since the early autumn of 2007 and have remained higher. The average European price was at least $2/mmbtu higher than in the USA. Consequently, LNG suppliers had greater incentive to ship their output to Western Europe in order to earn greater profits. Since the winter of 2008, the basis has begun to fall more in the USA's favour, but according to the EIA's figures, there has not been a corresponding increase in imports and they have remained far below the 5-year average. As expensive as gas prices are in North America right now, prices elsewhere in the world are higher.

In a related point, Japan, South Korea and Taiwan have been heavily dependent on LNG for power and heating needs because of a traditional aversion to nuclear power, a lack of offshore inbound pipelines and a long-standing policy of being less dependent on Middle Eastern crude oil. As such, these countries have relatively inelastic demand for LNG leading to prices that are much higher than in Europe or North America. Given a choice, most LNG suppliers prefer to supply to Eastern Asia over other parts of the world, thus putting North America at an additional disadvantage in attracting LNG imports.

Developing the infrastructure

Another point concerns the matter of LNG facilities themselves. The substantial costs of extracting gas, building LNG tankers, and liquefacation and regasification facilities would discourage new entrants and favour large, integrated companies that are already active in the business (e.g. BP, Shell, Gazprom). Thus getting more LNG supplies into circulation could take time and may not be a "quick fix" as relatively few companies can afford the costs. Only six LNG terminals are already active in the Lower 48 states as of March 24, 2008. According to the EIA, the USA can import at maximum roughly 5.8 billion cubic feet (bcf) of LNG per day or 2,117 bcf per year. However, the EIA also reports that the USA imported 75.72 bcf of LNG in the first three months of 2008, and it estimates that the total will be 530 bcf by year's end. 2008's estimated imports would thus require only a quarter of available capacity. Since these plants are experiencing less than 100% use, this has not been a strong contraint at present.

Additional facilities are either approved or still awaiting approval from the regulatory agencies. These pending sites are predominantly located in the Gulf Coast and the Northeastern Seaboard with some sites seeking approval in the Pacific Northwest and California.

Lastly, the presence or proposed construction of LNG facilities have been opposed by envrionmentalists and residents who believe that the risks of an explosion or a tanker collision at a nearby LNG terminal outweigh the benefit of increased natural gas supply.

In conclusion, the wholesale
integration of LNG into the natural gas supply of North America is a more complicated process than at first glance. Efforts to develop "unconventional" natural gas should also be considered as part of the strategy in managing the balance between future supply and demand of natural gas.