Why US shale won't ruin our gas boom

The release of an economic analysis in the US overnight that essentially concluded that exporting US gas as LNG would create net economic benefits for its economy will be interpreted, and is being interpreted, as a threat to the massive wave of Australian investment in LNG. The level of threat can be over-stated.

The report produced by NERA Economic Consulting has produced a very rational outcome. If gas is valued more highly in export markets than it is for domestic use once the liquefaction, transport and re-gasification costs are taken into account, then of course it will produce a net economic benefit.

That's precisely the argument gas producers in Australia make when they oppose the notion of "reserving" gas for the domestic market.

There is, however, a natural flow-on effect from exporting gas as LNG, which is that it ought, over time, to push up domestic gas prices until, after factoring in the processing and transportation costs, there is something of an equilibrium between domestic and export prices.

As the NERA study concluded (and it is an obvious conclusion) while domestic prices would be higher than they might be without exports they would always be lower than the price of LNG – or there would be no incentive to export and invest the massive amounts of capital and add the substantial costs involved in export LNG facilities.

If one assumed that the US did become a major exporter of gas, of course it would add significantly to LNG supply and therefore could be expected to exert downward pressure on LNG prices, reducing the returns relative to domestic sales within an economy where gas distribution networks are ubiquitous and efficient and supply can be increased or decreased easily in response to fluctuations in demand.

The NERA report concluded that the net benefits to the US economy would be highest if it were able to produce large quantities of gas from shale at low cost, world demand for gas increased rapidly and LNG suppliers from other regions were limited.

There is clearly an opportunity for the US to produce shale gas at a relatively low cost and demand for LNG is rising steadily but there is a lot of new and contracted supply in the pipeline, much of it from Australia, and the impact of export LNG on domestic gas prices in the US would push domestic gas prices up and reduce the incentive to export.

The actual quantum of benefits NERA has assessed from US LNG exports is, in the context of the US economy (with GDP of more than $US15 trillion) relatively small – ranging from about $US4.4 billion to $US47 billion in 2020.

Also small would be the economic impact on the US domestic economy, although not necessarily the political impacts.

The manufacturing lobby in the US (and to a much lesser degree here) regards the shale gas revolution as an opportunity to rebuild its competitiveness on cheap energy and is therefore opposed to anything other than limited exports.

While NERA concluded that only a small proportion of US manufacturing would be adversely impacted – about 10 per cent, in trade-exposed sectors with high energy costs – and that the impact would be modest, the politics of energy independence, manufacturing employment and the prospect of a massive ramp up in the fracking required to exploit shale gas reserves are sensitive and explain why only one of the 16 or 17 applications to build export terminals in the US has yet been approved.

While large-scale US LNG exports, if they occurred, would weigh on LNG prices relative to what they might otherwise have been they don't directly threaten the existing LNG projects or those already in the pipeline, which are secured by long term contracts (generally around 20 years) and often by cornerstone customer equity interests.

While the LNG price remains linked to the oil price (in the long-term, particularly if US gas is exported using Henry Hub pricing, there is a question mark over the pricing framework) the current projects will be very profitable despite the capital and operating cost blowouts being experienced and the impact of the strength of the Australian dollar on projects that will generate US dollar revenues.

With most of the projects in our region able to recover their cost of capital at around a $US50 a barrel oil price, there is a big margin for error built into the economics of the projects.

It would take a relatively near term and quite dramatic structural change in the market to undermine their viability, which explains why despite the blowouts in capital and operating costs there is still a queue of projects now on the drawing boards and likely to proceed.

It is unlikely that even if the US were to become a meaningful exporter of gas that the level of US exports would fundamentally reshape the balance between supply and demand in the Asia Pacific region because that would inevitably push up US domestic gas prices while pushing down export LNG prices, narrowing the arbitrage opportunity and making it more attractive to retain the gas within the domestic market.

In the long term new supply and/or the threat of new supply will discipline LNG prices and probably keep them lower than they might otherwise have been if not for the emergence of unconventional gas. The would-be US exporters, however, have to clear the significant political obstacles before they can have any impact on the market and even if they do there are some disciplines around the degree of impact they are likely to have.