Tuesday, April 29, 2008

WSJ Says: Don't Bet on LNG to Reduce US Natural Gas Prices

Econ 101 taught us increased supply = lower prices. That's the main argument for new liquefied natural gas import terminals. Unfortunately, the Wall Street Journal warns things are a bit more complicated than that and we shouldn't bet on LNG to reduce North American natural gas prices. This is Econ 202 stuff at least...

Amidst concerns about a potential North American natural gas supply crunch, several energy developers are betting big on new terminals to import liquefied natural gas into the United States market. Three terminals are proposed in Oregon, and they have generated considerably controversy and strong opposition from local communities.

There are many reasons to be concerned about imported liquefied natural gas, or LNG, natural gas that has been supercooled to -260 degrees F in order to turn it into a liquid ready to transport on specially-designed tankers from LNG exporting countries like Indonesia, Russia, Iran and Qatar. From increased dependence on foreign fossil fuels to increased greenhouse gas emissions, seized farmland for new pipelines and health and safety concerns, citizens of potentially impacted communities have found plenty of reasons to rally against LNG terminals and pipelines.

The principle argument to forge ahead with new LNG terminals despite these concerns is the assumption that increasing North American natural gas supplies with LNG imports will reduce prices. It's a simple "laws" of supply and demand that increased supply will reduce prices, right? That's what we all learned in economics 101, right?

Unfortunately, a recent front page article in the Wall Street Journal (April 18) warns us that the economics of LNG is a bit more complicated than that. This is economics 202 stuff at least (the online copy is here, sub$cr. required).

The gist of the story is that we shouldn't be betting on increased LNG imports to help lower natural gas prices in the US. Read on to find out why...

Unlike oil, which is easily shipped globally and has been a globally traded commodity for some time, natural gas has developed more regional markets separated by delivery constraints, each with different gas prices. LNG changes the game, and increased global LNG capacity is making natural gas a global commodity with a global price. That's bad news for the United States, where natural gas prices are about half what Japan is willing to pay for a shipment of LNG, for example.

According to the WSJ article: "Today, a tanker of liquefied natural gas, or LNG, pulling into port in Japan can command close to $20 per million BTUs, roughly double the price of the U.S. benchmark."

As with any globally traded commodity, the marginal price sets the price for everyone. If Japan is willing to pay $20 per million BTUs (mmBTU) for LNG, prices globally will float up towards this price, and that's about what we should expect to pay here in the Northwest if an LNG terminal is built. We'll essentially be linking our mostly regional market to an intensely competitive global market for LNG, where the price is set by the highest bidder.

It'd be foolish then to bet on LNG, for which international competition can drive prices up to around $20/mmBTU, to help lower Northwest (or North American) natural gas prices, which are now in the vicinity of $6-8/mmBTU. In fact, the very opposite could occur. If LNG prices set the marginal supply cost for LNG in the Northwest, domestic natural gas prices may even rise to this new marginal cost. That's how commodity markets work, isn't it (told you this was Econ 202 kind of stuff)?

In short, the main argument for new LNG terminals in North America (and here in the Northwest) is that they will help reduce natural gas prices regionally by increasing supply. Problem is, that's not how this competitive global market works. Instead, we'll merely be hooking ourselves up to another global market for a foreign fossil fuel and put ourselves in a competitive bidding war with Japan, Korea, India, China, Spain, and others to see who lands that next shipment of LNG. Not exactly a competition I'd like to get into.

Oh, and did I mention that there's talk of forming a new cartel of LNG exporting countries, just like OPEC, to manipulate the markets to exporters' advantage. The Department of Energy's Energy Information Administration cautions:
"One risk that cannot be ignored is the likely formation of an LNG cartel, given that so few countries control such a large portion of the world’s stranded natural gas reserves, and its power to affect LNG prices."
This was new stuff for me - I thought the old Econ 101 argument seemed pretty sound - and I didn't expect this kind of warning to come from the Wall Street Journal of all places. Seems like we've got yet another reason to be cautious about proposed LNG terminals in Oregon and elsewhere.

[Graphic credits: LNG terminal map from MSNBC; LNG tanker and terminal from LNGWorldwide.com]

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