The Future of Natural Gas, Part II

As I discussed in the last edition of Oil & Energy Insider, this morning I made the keynote address at the Dominion Transport-hosted meeting of natural gas executives in western Pennsylvania.

My address comprised my primary take on natural gas prospects and is entitled “Natural Gas Moving Forward: LNG, Hubs, and Pricing Prospects.”

As always, I try to keep you in the loop of what’s happening when I meet with the movers and shakers, so today I’ll be sharing the rest of my address with you.

On Tuesday, I sketched out the current and short-term projections for natural gas production and demand, along with the picture attending four expanding end uses for gas – electricity generation, industrial applications, for vehicle fuel, and as feeder stock for petrochemicals.

Today we are considering a fifth use for gas, the liquefied natural gas (LNG) market – along with the changes about to take place in the use of hubs to determine prices.

Here’s how LNG is about to change the global energy markets…

The Growing Market for LNG

LNG is natural gas cooled to a liquid state, moved by tanker, re-gasified on the receiving end, and then injected into existing pipeline networks for distribution. Because it relies less on pipelines, LNG is often more amenable to international trading than natural gas.

LNG global demand should reach 420 million tons a year (mt/y) by 2020, and 500 mt/y by 2025. Given that 1 billion cubic feet of natural gas translates into 21,000 tons of LNG, demand in 2020 should come in at an equivalent of around 20 trillion cubic feet a year (tcf/y). By 2025, it should move up to about 23.8 tcf/y.

On the other hand, global LNG projects on stream and in development amount to 677 mt/y, equivalent to 32.2 tcf/y. So something has to give. Obviously, not all of these projects will be completed.

How the U.S. Is Becoming an LNG Export Powerhouse

The same is true of the U.S. market. Through last week, the federal government has approved 46 LNG export licenses for nations with which America has a free trade agreement (FTA), with another six pending, while 12 have been approved for any nation in the world not on a sanctions list (non FTA), with another 25 pending.

To date, 47.92 billion cubic feet per day (bcf/d) in FTA exports have been approved, translating into 17.5 tcf/y or 36.7 mt/y of LNG. The figures for non FTA export capacity amount to 45.1 bcf/d, 16.46 tcf/y, and 34.6 mt/y.

These are non-additive figures and express LNG plant capacity, not in-hand contracts. So there is some duplication. Leading the list of companies having export permission are Cheniere Energy Inc. (NYSEMKT:LNG), with permission for 5.68 bcf/d (2.1 tcf/y, 4.4 mt/y), and Freeport-McMoRan Inc. (NYSE:FCX), with 6.02 bcf/d (2.2 tcf/y; 4.6 mt/y).

Once again, these amounts are non-additive since they include combined FTA and non FTA figures. In the case of FCX, there are separate petitions from Main Pass Energy Hub using the same facility capacity.

Dominion’s Cove Point is in the mix for at least 1 bcf/d.

Not all of this export capacity will be utilized. Nonetheless, from nothing today, even Russian gas giant Gazprom (OTC:OGZPY) is estimating that the U.S. could control 8% of the global export market by 2020. The flow of rising surplus shale/tight production will be moving internationally without having an appreciable impact on domestic pricing and zero effect on domestic availability.

Why LNG Pricing Is About to Change

Here’s the biggest impact from all of this. It is going to be a world-changing scenario.

Global spot market purchases should account for 50% of total trade by 2020, up from 28% today. As LNG trade becomes a regular fixture, hubs worldwide will be established, with pricing having less to do with long-term pipeline contracts and more to do with 30-day or less one-time exchanges. The whole issue here is about guaranteed volume.

Four huge changes are underway on the global stage:

  1. Natural gas pricing will progressively become disjointed from crude oil.
  2. There will be increased efficiency of deliveries and better control over global storage inventories.
  3. Contract arbitrage will emerge quite unlike anything we have ever experienced. (As an aside, I now spend more time on this matter than any other single issue in my international gas finance dealings.)
  4. Price convergence.

This last point is the main reason international LNG trade is so attractive. This morning, gas is priced at about $2.75 per 1,000 cubic feet at the NYSE pricing hub of Henry Hub in Louisiana. But it is the equivalent of $6.74 at the U.K. National Balancing Point, and more than $7.50 for Platts JKM (Japan Korea Marker, the main Asian benchmark). Arbitraging contracts and delivery points is going to make some people a lot of money.

And a major rise is transpiring in Mexican demand for U.S. pipelined natural gas as well as LNG. It’s up more than 300% in less than three years and should reach 4.6 bcf/d by 2024.

The Emergence of an Integrated Global Gas Market

Finally, I’d like to make some comments on hubs. LNG is going to provide the development of a genuine international trade in gas, with prices progressively separating from those for crude oil. Currently, main locations like Henry Hub and Baumgarten in Austria are the result of primary trunk pipeline interconnections.

Yet there are 22 main trading points in the U.S., another three in Canada, and nearly 100 worldwide.

With LNG providing the rise of genuine spot markets and a wider array of pricing points, the importance will move from the impact of transit to the importance of usage. Henry Hub is already becoming less significant. For example, Dominion’s South Point in western Pennsylvania already has more contracts.

From today’s dependence on the intersection of main pipeline systems, hubs will be prioritized by two elements:

  1. The transference to end-user streams – crackers, LNG production facilities, along with the more traditional distribution centers; and
  2. The ability to swap and arbitrage contracts worldwide based upon the spot needs for volume at different locations.

Please understand the importance of what we are rushing into: nothing less than the emergence of an integrated global natural gas market.

Years ago, I counseled North American producers that before too long the volume they brought out of the ground in Texas, Arkansas, Pennsylvania, or Alberta would impact the price end users would pay for gas in places like Singapore.

That scenario is now playing out… quickly.

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