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Natural Gas: Reconsidering Exports

Last week I argued here that it would be premature for the Department of Energy to authorize massive exports of natural gas, notwithstanding the astonishing recent boom in American shale gas production. I worried that precipitous large-scale exports could tighten U.S. supplies and raise prices, with negative ramifications for U.S. industrial concerns that depend on cheap gas.  For that reason I argued that gas should be exported not in its raw form but only as a low-cost input to higher-value production and job creation by American companies. A number of readers agreed with me about that.

But not all have.  One who does not agree with me is Charles Blanchard, the U.S. power sector analyst at Bloomberg New Energy Finance, who tends to know what he is talking about, and whose view is layered enough and smart enough that we thought we’d post it in full.  Here's how Charles views this:

There is little doubt that low domestic gas prices stand to benefit the U.S. economy by lowering electricity prices, heating bills, and feedstock costs for industry. Nevertheless, we see no reason for the Department of Energy to constrain exports of liquid natural gas (LNG), despite the upward pressure exports might put on domestic gas prices.

First, the interests of fossil fuel producers and environmentalists are (unusually) aligned: higher domestic gas prices would bode well both for gas producers and higher-cost renewable energy projects. Second, the future of natural gas as an industrial feedstock actually relies less on gas prices than it does on the price of oil. Most important, we think that concerns of LNG exports putting massive upward pressure on U.S. prices are overblown. That is not to say that gas prices will not rise substantially from their current, depressed levels--we think they will--but rather that the impetus for this will emanate from within the United States, as old age and EPA regulation force the closure of dozens of gigawatts of coal power plants.

While LNG exports would put some upward pressure on U.S. gas prices, the "global convergence" story is fundamentally misunderstood. For example, if gas is selling for $4 per million British thermal units in the US and $10 in Europe, one might think that exporters would cash in on a $6 margin, and that U.S. prices could eventually rise by up to $6, or that US and European prices would meet somewhere in the middle.

However, the actual profit from this hypothetical transatlantic trade would be closer to $2, after factoring in charges to recover the massive costs of building and operating an LNG export facility, shipping the gas on purpose-built tankers, and then regasifying it upon arrival. Our analysis indicates that the current, $2 effective spread between U.S. and European prices will in any case have disappeared by 2015, when the first U.S. LNG export terminal (in the lower 48) is due to come online.

It is also important to understand and take into account the interplay between U.S. natural gas prices and global oil prices. Today, it is actually the latter that is dictating where and how much U.S. drilling takes place. In addition to providing heat and power, natural gas and its associated liquid “byproducts” are used as a raw feedstock for certain industrial consumers – especially the petrochemical industry. Depending on local geology, gas from the well often contains heavier hydrocarbon chains, collectively referred to as natural gas liquids (or NGLs). Because they substitute primarily for petroleum-based products, NGL prices are linked to crude oil prices, which are currently much higher than gas prices in terms of energy content (U.S. crude oil is trading around $17 per million British thermal units, versus around $3.40 for gas). Given the magnitude of this spread, rising gas prices won’t put a damper on liquids production--only falling oil prices can do that.
Substantial LNG import capacity in the United States puts a ceiling on gas prices. Conversely, an export conduit would create a price floor. As demand catches up with new supplies from shale and other unconventional gas plays, neither will be needed--gas prices will settle at a level somewhere between the two.

So, that’s Charles’ view.  What do you think?