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Genie on the loose - Part One

LNG Industry,

How much, how soon, how expensive and for how long? Those might be summarised as the critical questions regarding North American LNG exports. Around the world, LNG buyers, sellers and traders are asking how much LNG could actually get produced in North America and how quickly the export volumes can be ramped up to scale. They also want to know how much the LNG will cost and for how long the exports will remain economic in light of presumably increasing US natural gas prices and potentially declining global LNG prices. In large part, these questions regard the extent to which North American natural gas prices linked to the Henry Hub price point could become a major index for global LNG trade over time and how much that will impact the future terms of LNG trade in the Pacific and Atlantic Basins.

For LNG buyers, the increasing prospects for large scale LNG exports from North America are like the proverbial genie in a bottle. The new LNG holds the power and promise to fulfill the buyers’ key wishes for lower prices, greater supply flexibility, and enhanced supply security. But unlocking the genie requires new business approaches. Vertical integration, feed gas supply and deliverability, tolling, and equity are among the key words in this regard. Many buyers in Asia and Europe have found that a full supply chain approach involving a mix of upstream supply and transportation, liquefaction tolling, and/or equity investments are critical to closing a deal with the genie.

But what will happen once LNG buyers have loosed the genie on global LNG markets? Will the low cost LNG volumes mount quickly and wreak havoc on global markets and prices or will the impacts be more subdued, gradual, and orderly? After all, genies can be capricious and unpredictable – so be careful what you ask for!

Shale power source

The LNG genie’s power resides in the rocks thousands of metres below North American soil. In many respects, the global questions about how much North American LNG can be exported at low prices, and for how long, boil down to questions about the still untested ability of shale gas production to support a variety of competing demands at an increasingly large scale in the world’s biggest natural gas market.

The full extent of shale’s long-term staying power remains to be seen. In recent years, the increase in unconventional gas production has exceeded the decline in conventional gas production. As a result, US natural gas prices have progressively declined as shale production in North America has increased. Shale drilling increased steadily through mid-2010, but then rig counts in less profitable ‘dry’ shale plays began to decline. As prices hit bottom in late 2011 and early 2012, shale rig counts in the NGL-rich ‘wet’ shale plays also began to fall. The natural gas markets became saturated and production growth decelerated.

However, even through this year’s remarkably cold winter in North America, the evidence of shale production’s resilience has been impressive. Despite some cold-induced production outages, supplies held up reasonably well. There were some severe regional price spikes, but they were short-lived and overall 2014 prices are expected to increase just over 12% above 2013 levels (from US$ 3.73 to 4.14/million Btu). It is not surprising that prices spiked and price expectations increased, but rather that the spikes were short-lived and the increases moderate. The recent resilience of US supply and markets shows that the US can deliver economic LNG exports over the long-term.Looking ahead, the critical question will be the extent to which the liquids-rich shale plays and production sweet spots can continue to support ever greater demands for shale production and relatively low and stable prices.

Analysis shows that the potential is great, but during the next decade some of the liquids-rich resources and production sweet spots could become strained and limitations could begin to emerge. A lot will depend on the speed of indigenous demand growth, the extent of LNG exports, and the velocity with which new shale resources are explored, developed and brought online.

The increasingly robust potential of North American shale gas production and booming output have driven investors and LNG industry leaders to pursue LNG exports. Now the critical questions will be how much output shale can achieve, how fast, and at what production cost?

The development of ‘shale spreads’

From a global market perspective, the viability of US LNG liquefaction projects can be understood using the concept of ‘shale spreads,’1 which represent the price differential between shale-driven US natural gas prices and other regional benchmark gas prices. Of primary importance are two particular shale spreads:

  • The Atlantic shale spread – the differential between the Henry Hub gas price and the UK National Balancing Point (NBP) price.
  • The Pacific shale spread – the differential between the Henry Hub gas price and the average Japanese LNG import price.

The increasing price differentials have opened a substantial window of opportunity for North American LNG exports to Asian and European markets. This window occurs because the shale spreads have grown to levels that far exceed the liquefaction and shipping costs from US ports to LNG markets in Asia and Europe.

The new shale spreads have achieved levels ranging from US$ 10 to US$ 14/million Btu for the Pacific and US$ 6 to US$ 8 for the Atlantic. These shale spreads far exceed estimated liquefaction and round trip shipping costs to reach Asia and Europe of approximately US$ 5 and US$ 4, respectively.As a result, so far there has been plenty of ‘arbitrage’ money on the table to entice investors and traders. Depending on the volume and duration of North American LNG exports to Asia and Europe, the shale spread arbitrage could represent tens if not hundreds of billions of dollars per year of future value for LNG buyers, aggregators, and traders.

The multi-billion dollar question this raises for industry players is: “how long will the window of opportunity remain open?”


1. Christopher Goncalves coined the terms ‘shale spread,’ ‘Pacific shale spread,’ and ‘Atlantic shale spread’ at a CWC Conference in November 2011.

Written by Christopher Goncalves and Anthony Melling, Berkeley Research Group LLC, USA. Edited by Ted Monroe

Read Part Two here

The full version of this article is available in the May 2014 issue of LNG Industry.

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