Liquid Natural Gas Markets
American Oil and Gas Reporter
March 2002

By Dylan Powell
Special Correspondent

HOUSTON-In 1954, a custom-built transport ship called the Methane Pioneer left the Louisiana coast bound for the United Kingdom's Canvey Islands. It was the first shipment of liquid natural gas-a milestone in free-market capitalism and engineering. And it began an adventure in technology and economics that is still carrying the industry into uncharted waters. Where to next?

According to Harvey Harmon, vice president of planning and analysis for El Paso Global LNG, the burgeoning market now taking shape around the world is only the start for LNG. It can help satisfy growing demand for natural gas in the United States while creating new opportunities abroad, and it is relatively safe and environmentally sensitive. "We are truly at the dawn of a new golden era for LNG," he asserted during a presentation at a Strategic Research Institute conference on LNG economics and technology, held last month in Houston.

Keith Meyer, vice president of marketing for CMS Panhandle Pipe Line Companies, also shared his insights with conference attendees. To understand the state of the North American LNG market, one must view it in the context of overall gas demand in North America. Despite the temporary storage overhang, Meyer said, gas demand is expected to outpace supply going forward, keyed by anticipated growth in the power generation market-by far the largest contributor to the upward trending line in future gas demand projections.

Meyer observed: "A lot of power demand comes from simple appliances that are always 'on'. A personal computer is a perfect example. A lot of people turn their computers 'off' and they think they are no longer consuming power, but they are. Today's PCs are always on, consuming power continuously. The same is true with a microwave or a range. It is those hundreds of millions of things that are always on that drive a lot of power demand in and of themselves, much less when they are actually being used."

Driven by anticipated growth in gas consumed to fire electric generation, North American gas demand is expected to climb from 72 billion cubic feet in 2000 to nearly 110 Bcf/d by 2015. To meet this demand, supply must increase at the rate of 2.5 Bcf/d on an annual basis. Considering that the average annual increase over the last five years has been less than 1 Bcf/d, Meyer said imports are likely going to have to be a part of the equation in years to come.

Deliverability increases from traditional North American supply basins in the United States, Canada and Mexico have so far been hard to achieve-despite high levels of gas drilling throughout much of 2000-01. Many factors, including increased regulatory pressures, the steady maturation of traditional supply basins, and Canada's upcoming conformity to the Kyoto protocol, may conspire to create a future shortfall, according to Meyer.

Furthermore, North American supply growth will likely come from the Alaskan and Canadian Arctic frontier, the Rocky Mountains, and deep structures/deep waters in the Gulf of Mexico, and these areas may have problems achieving targeted levels of growth. For example, Meyer said, the Rockies have problems with land access, Alaska with environmental and political obstacles, and the Gulf of Mexico is experiencing a trend of short-lived production.

"If we look at where the gas is going to come from to supply this growing demand, there is one fact that we are confronted with: traditional North American basins are in decline," Meyer stated. "Every producer out there has been throwing as much technology as they can into increased deliverability of reserves."

Fundamental Problem
"Here's the fundamental problem," noted Michelle Michot Foss, director of the Energy Institute at the University of Houston. "Worldwide, there is roughly 1,000 trillion cubic feet of 'stranded' natural gas. That is, there is no local market sufficient to allow that gas resource to be developed. In these situations, there are three options: build local demand, build a regional pipeline system to transport the gas, or convert the gas to LNG form to ship long distances to markets where demand is highest."

Developing local demand is obviously the most difficult and longest-term option, while achieving adequate economics with a pipeline requires having an undersupplied market within a reasonable distance. While the LNG option requires investing in special facilities on both the sending and receiving ends, as well as purpose-built tankers, Foss pointed out that it does opens access to far-away premium marketplaces such as in the United States.

"The process for LNG is to liquefy the gas using high pressures and low temperatures, ship it in specialized LNG tankers, and regasify it at the receiving terminal," she outlined. "The market for gas in the United States is driven by price, which has to be high enough to offset the costs of the LNG value chain, which-although much lower than in the past-are still substantial. Generally, a price of $3.50 an Mcf is considered the minimum to support a new project."

As the marginal cost of finding and producing new reserves in the United States goes up, cheap stranded gas elsewhere in the world might start looking better and better, according to Foss.

"In addition to this 'demand pull' there is a 'supply push', as holders of stranded gas reserves look for ways of getting their production into big markets like the United States, Northeast Asia, etc.," she said, adding that the LNG option also makes sound economic sense for foreign oil-producing nations looking to utilize flared gas resources-even if they sell LNG at break-even prices-because the World Bank often penalizes countries that fall out of preferred flaring standards.

Four elements compose the LNG value chain: exploration and production, liquefaction, shipping, and regasification. Exploration and production efforts typically require around 7 Tcf-11 Tcf in reserves to justify a project in the eyes of investors. Exploration and production costs include feasibility, initial drilling and development. Liquefaction is the most expensive component, according to Foss, followed by shipping and regasification (which includes port costs, storage and vaporization). Each of these elements contributes to the economic feasibility of LNG shipments and how they compete with other energy sources in the global market.

On The Rise
Today, LNG makes up only about 1 percent of North American supply, but that number is on the rise, Harmon said.

"The worldwide LNG business is expanding rapidly," he reported. "In fact, in the last few years, it has been one of the fastest growing markets in all different aspects of the global energy industry."

Harmon added that the emergence of natural gas as the world's fuel of choice, the many new players entering the sector, and improvements in technology have all dramatically changed the industry since its inception.

"The LNG industry worldwide has averaged 7 percent growth per year, with a compounded annual growth rate over the next six to seven years projected at 10 percent. Volume growth over the next six to seven years is expected to be as high as 12 Bcf/d," he said.

The largest producers of LNG are Indonesia, Algeria and Malaysia, with Japan, Korea and France as leading global consumers. LNG comes into the United States from countries such Australia, Indonesia, Algeria, the United Arab Emirates, and Trinidad and Tobago. According to Sarah Banaszak, an economist for the U.S. Department of Energy, there are four domestic LNG import facilities, located in Everett, Ma., Cove Point, Md., Elba Island, Ga., and Lake Charles, La.

From an economic perspective, how does the construction of LNG infrastructure compare to the cost of building new pipeline infrastructure? The economics differ depending on the project, Banaszak said. "With LNG, you have a large incremental investment to build a facility, but then traveling over long distances to get the gas to market rises at a lower rate relative to pipeline. Pipelines have a much more dramatic increase in the per-mile cost to market. It really depends on what market you are looking at," she remarked. "If pressed to define the cross-point at which LNG becomes cheaper than pipelines, people say generally between 1,000-2,000 miles."

Banaszak added that costs for both options are in flux. LNG costs change with the reengineering of plants, potential breakthroughs in design or offshore terminals, while pipeline costs change with larger-diameter pipe, higher pressures and the ability to operate in deeper waters.

According to estimates by Salomon Smith Barney, landed prices for LNG ranged from $3.10-$3.80 an Mcf coming from South America. Larger transportation costs, at around three times the distance, bring LNG from the Pacific Basin in at from $4.15-$4.90 an Mcf. Imports from the Alaskan North Slope, meanwhile, come at $3.50/Mcf, with Sable Island LNG imports coming into Boston at $3.12/Mcf.

"A cost of $3/Mcf is not bad coming from South America, $3.25/Mcf gets you a pretty good African supply source, and $3.50/Mcf gets you gas from the Middle East and beyond. You need a good pricing pull to bring in LNG," commented CMS' Keith Meyer, adding that LNG may have an edge in that it does not require huge blocks of demand to place infrastructure in areas such as the Arctic.

Gas prices (to be more exact, gas price volatility) are also driving increased interest in LNG over the long term. While LNG may have been a lot more attractive a year ago with spiking prices, $2-an-Mcf gas should not last long, said El Paso's Harmon. "As people who have been in this industry for any length of time can tell you, it is very cyclic," he remarked. "We believe natural gas prices will come back shortly after the U.S. economy comes out of recession."

Technology And Terminals
Technology advancements along all segments of the value chain have improved economics substantially, pointed out Rhone Resch, vice president for energy markets at the Natural Gas Supply Association. "The cost of feed gas has come down quite dramatically. Technology has reduced feed gas costs to $0.60-$1.00 an Mcf, in part because exploration and production costs have improved through advancements such as 3-D seismic, cheaper well completion and slim-hole drilling," he observed. "All of these technical improvements have enhanced both the speed and economics of gas deliverability."

The most expensive link in the chain, liquefaction, has declined almost 60 percent over the last 30 years. Technology improvements such as larger gas turbines, facilities with greater capacity, and improved air-cooling technology have all contributed, according to Foss. Regasification costs have also improved, and technology is even extending the life of LNG vessels.

"LNG ships are running for more years than folks thought they would," said Foss. "In the old days of the 1980s-90s, it was expected that the life cycle of an LNG ship was about 15 years. Ships now are running 20-25 years, and will probably will run longer."

Energy leaders are not just offering idle speculation as testament to their faith in LNG, but they're investing. Worldwide, there are more than 35 proposed LNG import terminals. All four existing U.S. LNG terminals have either recently been expanded, are under expansion, or are planning to expand, according to Banaszak. Dynegy has also proposed a new domestic terminal in Hackberry, La., to build off of existing infrastructure in the region.

Other new terminals have been investigated in the lower-48, but building an LNG facility can be difficult with myriad environmental regulations and permitting requirements. To address these issues, many companies are planning to build facilities near the United States, but outside its territorial boundaries. For example, Banaszak noted that terminals have been proposed at Ensenada, Baja, and Altamira, Mexico, as well as Grand Bahama and Bimini in the Bahamas to serve U.S. markets.

"Not many people realize that there are very few accidents that have occurred within the industry, and no deaths relating to the release of LNG," she related.

In fact, Banaszak added, if released, LNG tends to rise upward and dissipate, unlike other fuels. Even so, LNG is often perceived by the public as much more hazardous that standard natural gas, and overcoming that perception will take an educational effort, especially in the wake of the Sept. 11 terrorist attacks.

Safety And Security
"There is no question that after Sept. 11 there was an increased dialogue on LNG within the intelligence community," Resch said. "We are working with the FBI, CIA, military, Coast Guard, and state and local officials to help them understand the inherently safe nature of LNG."

Plans to reactivate a terminal in Cove Point, Md., struggled amidst fears that hijackers could use LNG vessels to attack the Calvert Cliffs Nuclear Plant less than four miles away. The facility is now scheduled to reopen, Resch updated, with capacity expanded by almost 50 percent (to 7.8 billion cubic feet a day).

Overall, the natural gas industry is well versed in safety and security issues. In a recent piece for the Houston Chronicle's Op-Ed page, Dean Liollio, chairman of the Texas Gas Association and chief executive officer of Reliant Energy Entex, assured that the natural gas industry has strengthened security in the wake of the terrorist attacks. He cited five specific actions that the natural gas industry was taking to make domestic gas activities as secure as possible, including:

• Numerous alert systems;
• Frequent security reviews;
• Continuous monitoring;
• Emergency response plans; and
• The deployment of additional resources to security efforts.

The new awareness of security issues aside, LNG's future is regarded as bright; a logical solution to the nation's growing demand for natural gas, held El Paso's Harmon. "If you add the numbers, there are more than 5,000 Tcf of proven reserves in the world today, and much of it is stranded gas," he stated. "The equivalent of about 17 percent of annual U.S. demand-4 Tcf of gas-is flared worldwide each year. Nigeria alone flares 2 Bcf/d, or about 700 Bcf annually. The gas is out there to help meet U.S. demand requirements."

Harmon noted that if existing U.S. LNG terminals were fully utilized, the 1 percent of the market supplied by LNG would grow to 5 percent. If the most feasible proposed LNG projects are ultimately built and added in the mix, he said LNG's share could grow to as much as 10 percent of annual supply needs.

As Foss observed, "Pretty much everyone has been dusting off LNG studies and strategies, trying to figure out whether now, finally, a sustainable market is developing.

In the end, the eventual size of the U.S. LNG market will hinge on overall natural gas demand, and the ability to keep pace with domestic supply and Canadian imports, Foss contended. "The two key considerations are industrial demand for gas, and the pace of gas-fired power development," she concluded. "A lot of demand was permanently last when gas prices soared last winter. Gas-fired power development depends on electric power demand and market restructuring."

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