Nothing terminal in a US gas export eruption

Fears that the US liberalising of natural gas exports poses a dire threat to Australian LNG projects are likely overblown, with the gap between American and international prices set to narrow.

The US Energy Department’s authorisation of a second export LNG facility over the weekend won’t come as a shock to those pumping several hundred billion dollars into Australian export LNG projects.

With about 20 applications to build export LNG terminals in the US to take advantage of the US shale gas revolution and the big differential between US domestic gas prices and LNG prices it was inevitable that, despite a raging debate about reserving gas in the US and the strength of the manufacturing lobby, at least some of those applications would be approved.

The Freeport LNG project in Texas that gained conditional approval from the Energy Department is a two-train project, with active marketing of gas for a third train, that would have the capacity to liquefy up to 1.9 billion cubic feet of gas a day. Previously, the only facility in the US with approval to export to countries which don’t have a free trade agreement with the US was the Sabine Pass terminal in Louisiana.

The Freeport facility (co-located with an import terminal) is being planned as effectively a tolling facility for third parties, although the consortium reserves the option of sourcing gas on its own account. Interestingly, the consortium has nominated the Eagle Ford shale region in Texas – where BHP Billiton has its biggest and best shale gas and liquids reserves – as the probable source of most of its feed.

With the US awash in shale gas its potential exports of surplus gas in the form of LNG have been seen as a substantial threat to the wave of massive export LNG projects being built in Queensland and Western Australia.

The Freeport consortium (which, ironically, includes Dow Chemicals, one of the fiercest opponents of exporting US gas as well as ConocoPhillips, a partner with Origin Energy in one of the Queensland export LNG projects) has already secured contracts with Japan’s Osaka Gas and Chubu Electric for its first train and BP for its second, confirming that the US gas will compete for Asian customers with the Australian projects.

The lure is the price differential between the Henry Hub-based domestic US gas price and the oil-linked prices available for LNG in Asia. When the queue of applications for export permits began lengthening in the US the Henry Hub price was below $US2 per mBTU and LNG prices in Asia were about $US15 per mBTU.

While the Henry Hub price is now above $US4 per mBTU there is still an attractive margin available, despite the estimated liquefaction and shipping costs of perhaps $US8 per mBTU, but not quite as attractive as it was before prices recovered.

The forward curve for US gas prices shows them pushing up further towards and through the $US5 per mBTU level towards the latter part of this decade. If the US economy were to recover more quickly and strongly than anticipated it is conceivable that the domestic gas price would trend higher.

While there is no doubt that large-scale exports of US-sourced LNG would have an impact on the prices available to the Australian projects and the other major Middle Eastern suppliers, the near-term scale of that threat can be over-stated given that any material decline in LNG prices would undermine the appeal of exports for US producers.

Even if it gets the remaining approvals it needs, the $US10 billion Freeport project, for instance, won’t even start construction until the end of this year and won’t start producing LNG from its first train until at least the end of 2017.

If there is to be a material impact on the market the US would need to approve a number of the other projects, so it is unlikely that they could have a major impact on the market much before the end of the decade.

Most of the Australian projects still under construction will be producing LNG in the middle of this decade – a number of them from next year. Most of their output is contracted for 20-plus years and all the Queensland projects and many in WA have their major customers as equity partners.

While the Energy Department has downplayed the impact of LNG exports on domestic gas prices, once US shale gas gets access to international energy prices there is little doubt that if the US completely liberalised gas exports US domestic prices would rise and international prices would fall until there was only a modest arbitrage between the two, reducing the appeal of further exports.

Those gloomy about the prospects for Australian LNG highlight the big capital cost blowouts that have been occurring, although a large element of those blowouts relates to the strength of an Australian dollar that is now weakening. New technologies, like Shell’s floating LNG technology, also offer the prospect of significantly lower development costs for new projects.

Most of the projects, however, cover their costs at oil prices below $US40 a barrel and recover their cost of capital around the $US50 a barrel level, which suggests they ought to be able to withstand lower gas prices and still generate attractive returns in an environment where demand for energy in the region continues to grow very strongly.

If the US does become a significant competitor in the Asian LNG market it will inevitably have a negative impact on the economics of the local projects.

It is, however, too early to determine how negative that impact might be given the complex politics around large-scale LNG exports in the US and the reliance by any aspiring US exporter on a continuing and strongly favourable relationship between US domestic prices and international prices.