Growth for Gas Is International

08/24/2011 11:20 am EST

Focus: COMMODITIES

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Demand is rising quickly, supply growth is slowing, and alternatives like nuclear energy are out of style, meaning that natural gas has lots of room to rise, writes Elliott Gue of The Energy Strategist.

The US is the world’s largest natural-gas producer, annually extracting almost as much gas as the Middle East and Africa combined. North America is essentially a self-contained market, with the US and Canada supplying enough gas to meet their domestic needs.

Just five years ago, conventional wisdom held that US gas production would continue to decline, even as demand for gas as a powerplant fuel expanded. Meanwhile, Canadian output looked to be stagnant at best, and the oil-sands industry was consuming an ever-greater portion of domestic supply. Exports to the US were declining sharply.

In most projections, a big jump in liquefied natural gas (LNG) imports was expected to fill the gap.

LNG is nothing more than a super-cooled version of natural gas. When gas is cooled to around negative-260 degrees Fahrenheit, it condenses into a liquid.

Better still, as gas cools, it takes up less space; LNG takes up roughly 1/610 the volume of gas in its natural gaseous state. To put that into context, a beach ball-sized volume of gas shrinks to the size of a standard ping-pong ball when it’s converted to LNG.

LNG frees gas from the pipeline grid. If you’re able to turn natural gas into a liquid, it can be loaded onto tankers just like crude oil, and transported anywhere in the world.

The discovery and rapid development of North America’s vast unconventional shale fields, such as the Haynesville Shale of Louisiana and the Marcellus Shale in Appalachia, has changed the LNG equation for the domestic market. These fields have proven so prolific that the US faces a glut of gas. In fact, in some years America’s gas storage capacity has come close to being completely filled, forcing producers to shut in wells to reduce supply.

Shale has kept a lid on US gas prices—since early 2009, US gas futures have hovered around the $4 per million BTU level—and with domestic gas production still rising far faster than demand, there’s little scope for a sustained rally over the next few years.

The US has no real need to import LNG. In fact, the country is regarded as a market of last resort for LNG cargoes because North America has more capacity to store gas than most other gas-consuming regions of the world. In total, the US imports less than 10% of the gas it consumes, with virtually all of those imports coming from Canada.

There’s been considerable hype surrounding potential for North America to become a major LNG exporter. But the Kenai, Alaska LNG plant owned by ConocoPhillips (COP) and Marathon Oil Corp (MRO) has operated since 1969, and remains the sole US export terminal. And in February, the facility’s operator announced that the plant would be mothballed once its latest long-term contract expires.

Meanwhile, proposed new LNG export terminals in the Lower 48 are years away from becoming reality. In short, the US and Canada aren’t important players in the global LNG market. Rising natural gas prices in international markets have no bearing on North American markets.

NEXT: International Growth

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International Growth
While LNG isn’t likely to be a major theme for the US over the next few years, there’s plenty of growth and considerable profit opportunity abroad.

Europe and most of Asia don’t have the advantage of vast shale production to meet domestic demand, and many are 100% dependant on natural-gas imports, either via pipeline or LNG.

In Germany and many other European countries, utilities sign long-term gas supply contracts with Gazprom (Russia: GAZP, OTC: OGZPY) for access to pipeline gas. These “take-or-pay” contracts feature prices indexed to crude oil.

By "take or pay," European utilities must accept delivery of a contracted volume of gas or pay a penalty. With European gas markets well supplied in recent years, these penalties have grown significantly.

Over the past three years, the global LNG market has been oversupplied for three main reasons.

  • First, the US was expected to become a major importer of LNG, but US shale gas means that the nation should be well supplied for years to come. Gas that would have gone to the US was dumped into Asian and European markets, overwhelming demand and depressing prices.
  • Second, over the past few years there has been a surge in new LNG liquefaction projects in the Middle East, Africa, and Asia. All that new supply overwhelmed demand and pushed prices down.
  • Finally, demand was hit hard by the 2007-2009 recession, both in Europe and Asia.

But that’s all changing. There are more LNG supply projects coming online, particularly in Australia, but the rate of supply growth is set to slow markedly by 2013.

European demand is bouncing back, and European utilities are increasingly accepting as little gas as possible under their contracts with Russia. Increasingly, these utilities are purchasing volumes on the spot market or importing more LNG.

Germany’s decision to shut down all of its nuclear-power facilities—accounting for nearly one-third of electricity supply—has been a watershed event. Much of the supply gap left by nuclear will be filled with new gas capacity and rising demand for LNG supplies.

Meanwhile, the Chinese government’s long-term plans call for natural gas to account for 10% of the country’s energy mix, one-third of which will be imported via pipelines or LNG. Natural gas has been growing in popularity in China, particularly in power-generation facilities located near major cities.

Concerns about air quality mean that many of the high-rise residences constructed during China’s recent housing boom are equipped for piped gas. LNG imports will be part of the solution. In December 2010, Chinese LNG imports topped 1,000 metric tons, five times their December 2008 level and a new all-time high.

India’s lack of energy resources represents another opportunity for LNG producers, primarily in Australia and Qatar. The country’s Ministry of Petroleum and Natural Gas expects LNG imports to increase from 33 million cubic meters (mcm) per day to 162 mcm per day by fiscal year 2029-30.

Over this period, the government expects natural gas to grow to 20% of India’s energy mix from 9%. LNG imports could easily exceed estimates if expected pipeline imports don’t materialize—a distinct possibility—or domestic production falls short of expectations.

In 2009, Japan imported 85.90 billion cubic meters of LNG, more than twice the level of the world’s second-largest importer, South Korea. Japan produces virtually no gas domestically, and imports no gas by pipeline; the nation’s supply depends entirely on LNG imports.

Some analysts estimate that the uptick in Japan’s LNG consumption in the wake of the Fukushima nuclear disaster will eliminate more than one-quarter of the current global supply overhang.

The LNG supply-demand balance was already tightening at the end of 2010, but the Sendai earthquake and Germany’s renewed anti-nuclear push is accelerating this trend. European spot gas prices have already been running at as high as three times the price of gas in the US.

[Igor Greenwald is on vacation. His column will return next week. Many thanks to Elliott Gue for filling in—Editor.]

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