Overseas Markets Should Help Cap U.S. Natural Gas Prices

My previous post noted that U.S. LNG exports in the past two years equate to the shortfall in natural gas inventories and thus could be argued responsible for the 50% increase in prices recently. Current plans calling for the construction of as much as 18 bcf/d of capacity in the next few years should be interpreted cautiously; recall that in 2003, 5.3 bcf/d of import capacity was planned given long-term expectations of tight U.S. gas markets and continued high prices. As the figure below shows, LNG imports never reached more than a fraction of that level, and the country is now a net exporter. Most plants were never built though some were later converted to export facilities. Could there be a new boom and bust cycle in LNG exports? Quite possibly. At present, 8 bcf/d of capacity is under construction, and another 8 bcf/d is approved but not under construction (as of late October). If all were built and operated, they would absorb a fifth or more of current domestic gas production levels. Already, this appears, in combination with cold weather, to have raised prices in the U.S. But the fear that LNG exports might drive up long-term natural gas prices should be scrutinized carefully. One of the strengths of the U.S. LNG industry is its willingness to compete on prices; most other nations and companies tend to set prices equal to crude oil equivalent prices and wait for demand to materialize. This often means that natural gas deposits are left unexploited for years. The U.S. has a reserves-to-production ratio of 12 years, while Australia’s is 32 years and Indonesia 43 years. The latter two are admittedly isolated from markets, but this is exacerbated by policy choices. And export prices for LNG are far higher than those for domestic sales or pipeline exports, as the figure below shows. However, this is misleading since the earlier, high-priced sales were generally low-volume exports. (The second figure shows that before 2017, when LNG prices were high, U.S. LNG exports were minimal.) Until recently, nearly all exports were from Alaska to Japan, and the startup of new projects, such as Sabine Pass, has resulted in larger sales volumes but usually at lower prices. In part, this is due to the practice of signing contracts with prices set according to U.S. Henry Hub natural gas prices, not market prices. But also, the global LNG market has weakened substantially. The weakness of the U.S. LNG industry is the high cost of its raw material. In many parts of the world, natural gas has been only very slightly exploited so that conventional gas fields are often huge and relatively cheap to produce. The cost of feedstock for U.S. LNG plants is not fixed by production costs in the field dedicated as their supply, but the spot price in the U.S. market. This means that the variable cost of U.S. LNG is much higher than the variable cost for, say, Russian natural gas pipeline exports. Fixed or sunk costs must be paid whether operating or not, while variable costs are only incurred when sales are being made. Thus, if the price of natural gas in Europe is below $6/Mcf, the Russians might be losing money but continue to sell gas because they are covering their variable costs and a significant portion of their fixed costs, while U.S. operators, faced with a Henry Hub price of $4.50/Mcf, which represents a variable cost (along with labor and fuel at the liquefaction plant), might choose to postpone sales until either overseas prices improve or U.S. prices decline. It helps that much of the current LNG production is going to Asia, where there is minimal pipeline gas available (so far), and prices are usually higher than in Europe. Plus, the buyers are regulated utilities that can pass through costs and are more interested in stable long-term supplies. Newer LNG producers should take this difference into account when planning investment and considering market potential. The other implication is that LNG markets will help to provide a ceiling on U.S. domestic gas prices; when prices pass $4/Mcf, demand for U.S. LNG exports will abate. Of course, other factors especially the price of oil will determine precisely what U.S. gas price will make large-scale European sales attractive, but the $8-10/Mcf prices of a decade ago seem highly unlikely.

https://www.hellenicshippingnews.com/overseas-markets-should-help-cap-u-s-natural-gas-prices/