U.S. Shale Gas Sets Sail…Now What?

By Jane Nakano, Kevin Book, FEB 25, 2016 

On February 24, a tanker carrying liquefied natural gas (LNG) left the Sabine Pass LNG terminal off the coast of Louisiana. The first LNG cargo from Cheniere Energy Inc.’s Sabine Pass LNG Project is a significant milestone for the U.S. energy industry, marking the dawn of shale-based LNG exports by the United States. What other implications does the Sabine Pass export have for the United States? Does the shipment foretell the economic viability of U.S. LNG projects or the competitiveness of U.S. LNG exports? This Critical Question illustrates the significance of the Sabine Pass LNG shipment and considers the opportunities and challenges for the U.S LNG export business in the period of low energy prices.

Q1: Is the United States exporting natural gas for the first time?

A1: The United States is hardly new to the gas exporting business. The United States has been exporting natural gas to Asia—primarily Japan—in the form of LNG from Alaska since the late 1960s and to its North American neighbors, Canada and Mexico, via pipelines since the early 1970s and as LNG and compressed natural gas (CNG) more recently. Moreover, the United States has a history of reexporting the volumes imported into the United States that U.S. markets no longer need. The customers for reexports have included Brazil and Chile in South America, Spain and the United Kingdom in Europe, as well as China and India in Asia.

Q2: What makes the Sabine Pass LNG export special?

A2: The Sabine Pass facility is the first of the U.S. LNG export projects to have applied for and obtained U.S. government export authorization since the onset of shale gas production transformed the North American natural gas market. Authorized in 2011, the project became the first to liquefy U.S. natural gas extracted from shale and other tight formations and ship it to overseas destinations.

The source of the gas liquefied and shipped from Sabine Pass isn’t the only difference, either. U.S. LNG export contracts are not encumbered by restrictive destination clauses. As a result, Sabine Pass buyers will be able to resell surpluses, subject to a few restrictions. (Free trade agreement [FTA] cargoes cannot be resold to non-FTA parties; the Department of Energy [DOE] requires all buyers to report contract terms, and no sales or resales are allowed to parties subject to diplomatic or trade sanctions.)

Pricing matters, too. Although it may not be obvious amid the current global oil glut, U.S. cargoes also have potential to provide buyers significant discounts during periods of high oil prices because they are linked to the Henry Hub price—a U.S. domestic gas price—rather than indexed to oil benchmarks.

Q3: Who is buying and benefiting from the Sabine Pass LNG exports?

A3: The customers for the Sabine Pass Trains 1 through 4 include BG Group (now a unit of Royal Dutch Shell ), Gas Natural Fenosa (Spain), KOGAS (South Korea), and GAIL (India). As the Sabine Pass project is authorized to export gas to countries with or without a free trade agreement with the United States, a customer from almost any country in the world (with a few exceptions like those designated by the U.S. government as state sponsors of terrorism) with sufficient financial means could line up to purchase (or repurchase) the LNG from the Sabine Pass.

Most of the offtake from the Sabine Pass Train 1 was sold to BG Group for 182.5 million British thermal units (mmBtu) per year over 20 years at a cost of 115 percent Henry Hub plus a fixed liquefaction fee of $2.25/MMBtu.
And, BG Group sold the first cargo to Petroleo Brasileiro SA—commonly known as Petrobras—a Brazilian state-owned energy company. This is noteworthy against the background that the export project was launched amid the emergence of strong interest among European and Asian buyers in importing U.S. LNG in order to benefit from the differential between low gas prices in the United States and high prices of oil-linked LNG supplies from traditional gas exporters. The export to Brazil in fact underlines the inherent advantage of shipping gas to a closer market as the proximity reduces transportation cost.

In general terms, U.S. LNG exports benefit global gas importers by expanding the global pool of gas supplies available for purchase, increasing the market liquidity, and introducing more flexible contractual terms. Also, some note that U.S. LNG exports help Europe lessen its gas import dependence on Russia. The Obama administration also carefully scrutinized the potential impacts to the U.S. domestic economy as it considered projects that would export to destinations without free trade agreements.

In December 2012, DOE released a study by NERA Economic Consulting that examined exports ranging between 6 bcf/d and 12 bcf/d (180 million cubic meters per day and 360 mmcm/d) and found they would deliver “net economic benefits” across the U.S. economy. In December 2015, DOE released a study it commissioned from Oxford Economics and the Center for Energy Studies at Rice University’s Baker Institute that examined exports in the 12–20 bcf/d (360 mmcm/d to 600 mmcm/d) range and generally found “marginally positive” benefits for the broader economy. Both studies concluded that net benefits would increase in proportion to export volumes.

Q4: Do the Sabine Pass LNG exports foretell the economic viability of other LNG export projects in the United States? How competitive are U.S. LNG supplies?

A4: The Sabine Pass export is only the first in a wave of U.S. LNG export projects scheduled to come online by 2020 that will source gas supplies from shale rocks in the U.S. lower 48. The total liquefaction capacity under construction is 9.1 billion cubic feet per day (bcf/d) or 68 million tons per annum (mmtpa) to date—a volume that could make the United States the third-largest LNG exporter in the world by 2020 (after Australia and Qatar).

Market conditions have changed dramatically since the six pending LNG export projects first sought export authorizations from DOE. U.S. natural gas production growth flattened in the wake of the second half of 2014 oil price collapse. This probably reflects a combination of operators focusing on oil-rich “sweet spots,” leaving less scarce capital for thin-margin gas production and fewer wells drilled of all kinds (more than half of U.S. wells produce oil and gas in different proportions, so fewer wells mean less “associated” gas). In an environment where oil and gas companies are dramatically paring back their capital budgets, multibillion-dollar LNG projects are receiving renewed scrutiny, especially amid global gas market conditions.

Low global oil prices mean low delivered LNG prices in the world’s primary destination markets, especially Asia. The Tokyo Harbor spot price for LNG fell from $18.30 per million MMBtu in March 2014 to $7.10/MMBtu as of February 2016. The disappearance of the Asia premium weakens the business case for U.S. LNG, not just for project sponsors wary of committing billions of dollars during a period of across-the-board commodity price weakness, but also for buyers who may not regard delivered costs of U.S. LNG in the $9–10/MMBtu as a bargain. That said, LNG is a long-term investment, and supply diversification has its own value for importing countries.

LNG trade has been relatively flat during the last two years. Optimists might point to lower capacity utilization at liquefaction facilities as an indication that supply constraints may be starving the previously fast-growing market. Pessimists might be more inclined to suggest that a global economic slowdown may be affecting LNG, too. Slower growth comes at a time when the market is getting more crowded, also—a situation which would be aggravated by additional U.S. projects coming online absent a significant and perhaps unexpected upturn in global gas demand.

Jane Nakano is a senior fellow with the Energy and National Security Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Kevin Book is a senior associate with the CSIS Energy and National Security Program.