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The shale boom in North American natural gas has had consequences that were unthinkable just a few years ago. Among these developments is the emergence of North America as a major potential source of liquefied natural gas (LNG) exports. This by itself is remarkable enough. What is more, the large number of projects (announced projects comprise over 300 million metric tons of capacity or around 40 billion cubic feet (Bcf) per day - greater than current global LNG consumption) has initiated a struggle over the business model for new LNG liquefaction projects. See Figure 1.
The IHS CERA outlook for North American LNG exports reflects actual progress made by projects and perceived changes in drivers of growth. In Canada, projected ultimate liquefaction capacity is about 4 Bcf per day, with the projected build-out reaching this level after 2020. In the US Lower 48, first LNG exports are expected by 2016, with capacity growing to just under 6 Bcf per day by 2020. Export levels are projected to be just below capacity. See Figure 2.
The policy environment in Canada is generally supportive of LNG exports. Canada will remain a gas exporting country, and given the surge in production in the US the search for new markets makes sense. Moreover, Canada possesses significant shale resources that could support LNG projects. In the US, the policy environment could be described as tentatively supportive, with the Department of Energy working through permit applications at a deliberate pace. Why, then, have US projects moved ahead of Canadian projects in terms of commercial development?
The stakes are high. In recent years, delivered LNG prices into East Asia have moved in the $15 to $20 per million British thermal units (MMBtu) range. The projected cost of North American LNG delivered to East Asia is generally in the $11 to $12 per MMBtu range. Though Canadian projects are closer to the market, the required development of pipeline capacity across the Canadian Rockies means that the delivered costs of the more distant US Gulf Coast and Canadian projects is roughly similar. Hence, there is a large spread to be captured, and a struggle is under way to capture it.
The Asian buyers are best positioned to win this battle. The North American LNG projects are independent efforts - there is no national oil company to coordinate efforts. Moreover, Asian buyers can pursue a vertical integration strategy - a classic response to illiquid markets - by acquiring gas reserves in the ground. Asian companies are already investing in North America on a large scale. See Figure 3. However, North American producers are unlikely to be able to turn the tables. It is easier for an Asian buyer to become a North American producer than it is for a North American producer to become an Asian utility.
The predominant model for projects that have been successful in attracting the long-term contracts necessary to support financing and construction has been a tolling or quasi-tolling model. At the same time, projects seeking oil-based pricing have struggled to line up offtakers. While it is true that a price of $15 per MMBtu can be developed based on either an oil- or a gas-based index, the controversy over the choice of index is a bit of a red herring. The real battle is over who captures the rent embedded in the current trans-Pacific price spread. By entering into tolling structures or by purchasing reserves in the ground (or both), buyers are increasingly well positioned to capture this arbitrage. Oil-based pricing, rightly or wrongly, is associated with the maintenance of wide price spreads into Asian markets, and the relative success of the tolling model reflects the determination of buyers to reduce these spreads.
The ultimate results of this struggle remain in doubt, and the outcome will not be known for years. But the fact that there is a struggle at all illustrates how broadly the shale boom has affected the energy world.
Posted 25 July 2013
This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.
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