The Critical Need to Examine More Carefully The Role of Liquefied Natural Gas (LNG) In Meeting Future U.S. Energy Needs - Part 1

Posted on May 17, 2005
Posted By: Andrew Weissman
 
As a result of soaring oil prices, the U.S. currently is more focused on energy issues than at any time since the 1970’s. While higher oil prices are the immediate catalyst for this interest, however, dependence upon imported oil is not the only or even necessarily the most important energy-related threat to the U.S. economy.

Instead, over the past several years, the U.S. has experienced even steeper increases in the price of natural gas -- increases that recently have again begun to accelerate in tandem with increases in the price of oil.

In the first 12 weeks of this year, for example, both the price of West Texas Intermediate crude oil and prices for physical delivery of natural gas in the Day Ahead market at Henry Hub in Louisiana (one of the most important trading hubs in the U.S.) increased by more than 30 %:

Over the past 36 months, however, the price of natural gas has increased even more sharply than the price oil:

More recently, electricity prices also have begun to increase, particularly at the wholesale level. Unless natural gas prices fall significantly, even steeper increases are likely this coming summer.

This is because in the summer months gas-fired electric generating units increasingly are the marginal source of supply in every Region of the country. As a result, even in Regions in which electricity is generated primarily by lower-cost coal or nuclear units, the market clearing price for electricity in the wholesale market in the summer months increasingly is determined by the cost of operating gas-fired plants.

Need to Comprehensively Reassess U.S. Energy Policy

As increased attention is being given to the need to reassess U.S. energy policy, therefore, it is essential that we develop a strategy to help minimize further increases in the cost of electricity and natural gas, as well as to minimize our dependence upon imported oil.

As shown in Table 1 below, direct use of natural gas and generation of electricity --in which natural gas is playing an increasingly important role -- currently account for 56.3 % of total fuel use in the U.S.:

This is almost 1.5 X total U.S. use of oil (less than 3 % of which is used to generate electricity).

Further, while almost 70 % of oil use is in the transportation sector, the cost of natural gas and electricity has a particularly significant impact on the ability of U.S. industry and U.S. farmers (who grow crops using fertilizer manufactured from natural gas) to compete in world markets.

For many years, the U.S. enjoyed adequate supplies of reasonably cost electricity and natural gas. This access to reasonably priced energy provided a major competitive advantage to U.S. industry and played a significant role in helping to minimize inflation.

In recent months, however, the clear trend has been for the pricing of all major energy sources in the U.S., including natural gas and the wholesale market price of electricity, increasingly to be driven by increases in the price of oil (in the case of electricity, because of the relationship to the price of natural gas).

This trend, if allowed to continue, is likely to have far-reaching consequences for the continued health of the U.S. economy, potentially magnifying several-fold the adverse impact of any further increase in the price of oil. If oil prices increase to $ 65 per barrel, for example, rather than an adverse impact of $ 80 billion per year on the U.S. economy, the net drain ultimately could become nearly 3 X as great (i.e., a quarter of a trillion dollars per year or more).

As a result, the growth rate of the U.S. economy could fall sharply and the ability of U.S. industry to compete in world markets could be seriously impaired.

We face an urgent need, therefore, to develop a comprehensive strategy to assure reliable, low cost supplies of electricity and natural gas – as well as to limit our dependence upon imported oil.

Reasons for Focusing on Liquefied Natural Gas (LNG)

This paper will not attempt to address comprehensively all of the issues which should be considered in developing a comprehensive energy strategy for the U.S. Instead, it has a more modest goal.

Specifically, the paper will focus on one particularly important issue: the potential role of increased imports of Liquefied Natural Gas (LNG) in meeting our future energy needs.

Further, even with respect to this issue, the objective of this paper is limited: to outline certain specific issues and questions which may be important to consider in assessing the extent to which the U.S. should rely on increased imports of LNG to satisfy the future energy requirements of the U.S. economy.

In focusing on this issue, the author of this paper wishes to make clear that he believes that increased imports of LNG can, should and almost certainly will play an important role in meeting future U.S. energy needs.

As the paper will discuss, there is an urgent need to increase the energy supplies available to the U.S. economy. Further, there is no question that significant new supplies of LNG can be developed and delivered to the U.S. market over the next 7 to 10 years.

To date, much of the debate in the U.S. regarding LNG has focused on potential concerns regarding the potential safety of delivering LNG into U.S. ports and the possible impact of these safety issues on the ability to site new delivery terminals, particularly in or near urban centers.

Issues regarding LNG safety certainly deserve to be considered carefully.

The industry’s track record in shipping LNG, however, is solid and the available evidence tends to indicate that the safety concerns relating to shipment of LNG are no greater than for a number of other substances routinely transported into U.S. harbors.

There appears to be little question, therefore, that increased imports of LNG potentially can play an important role in meeting increased U.S. energy needs, at least in those circumstances in which it is possible to obtain supplies: (i) from reliable suppliers; (ii) pursuant to firm, long-term commitments; (iii) made directly to end users of natural gas, generators or Local Distribution Companies (LDC’s); (iv) with guaranteed, commercially binding commencement dates for deliveries; (v) at reasonable prices; (vi) that are not indexed to the price of oil; and (vii) pursuant to contracts that provide adequate protections for purchasers in the event suppliers are unable to make delivery.

At the same time, while there is no question that LNG has an important role to play in future U.S. energy strategy, there is a critical need to examine more carefully than any federal or state Agency appears to have examined to date the extent to which the U.S. should rely on LNG vs. other alternative domestic sources of energy supply available to the U.S. market.

This urgent need to evaluate other available sources of supply arises for several reasons:

  • First, the choices which are made over the next few years regarding how to meet future U.S. energy needs will have far-reaching economic repercussions for the U.S. economy. These repercussions are likely to be long-lasting in nature, since LNG purchases typically involve commitments intended to last for at least 20 to 25 years. Given the huge financial commitments required, as a practical matter, once these commitments are made, they may largely preclude the U.S. from deploying alternative energy strategies for many years.

The U.S. Energy Information Administration’s (EIA’s) most recent long-term forecast, for example, Annual Energy Outlook 2005 (AEO 2005), estimates that over the next 20 years, total annual imports of LNG will grow from 2004 levels of 649.1 BCf per year (approximately 2.9 % of the total current U.S. natural gas market) to 6.37 Trillion Cubic Feet of year – an increase of 881 %:

This is a staggering amount of energy.

While increased imports of LNG are expected to come from several Regions, by way of comparison, in BTU equivalent terms, 6.37 TCf is approximately 20 % greater than the total amount of oil the U.S. imported from the Middle East in 2004 (which last year was just under a billion barrels). A decision to import quantities of fuel of this magnitude, if implemented, could have huge adverse impacts on the strength of the U.S. economy, the U.S. balance of payments deficit and the value of the dollar.

Supplying this amount LNG will require the construction of a number of massive new LNG supply projects, expected to be located principally in the Middle East and West Africa. The cost of constructing these projects is likely to total at least $ 100 to 125 billion. A portion of this amount (perhaps 10 to 15 %) will be spent on delivery terminals and re-gasification facilities located in the U.S. Most of the required capital expenditures, however, will be for new production facilities and liquefaction facilities in the host country (the most expensive component in the supply chain) or for the construction of the specialized tankers required to ship LNG (generally by ship manufacturers in Asia).

These expenditures are expected to be financed based upon long-term, 20 to 25 year supply contracts, supported by purchase commitments by end use purchasers in the U.S. for the portion of the output of these projects delivered to the U.S. market. While the price terms for these contracts have yet to be determined, given current prices for natural gas and likely future trends, over the 20 to 25 year life of these contracts, total required payments for the portion of the supplies delivered to the U.S. could easily total between $ 1 trillion and 4 trillion in $ 2005.

If EIA’s recent forecast proves to be accurate, by as soon as 2010, the net adverse impact on the U.S. balance of deficit of increased imports of LNG is likely to total at least $ 1 billion per month (i.e., $ 12 billion per year). By 2025, depending upon the final price terms, this figure could easily increase to $ 50 to 125 billion per year:

The potential 2025 contribution of LNG imports to the U.S balance of payments deficit is potentially 1 to 2 X the current total U.S. balance of trade deficit, which is at an all time record level (viz., $ 58.3 billion for January of 2005, the most recent month for which data is available).

Even for a country with a $ 13 trillion per year Gross Domestic Product (GDP), these are staggering figures. Over the 20 to 25 year life of these new supply projects, the required payments by U.S. purchasers are likely to total more than the budget for the entire federal government (with over 2.5 million employees) in any one year.

Even at the low end of the $ 1 to 4 trillion range (again, measured in $ 2005), the total outflow of dollars would exceed the total net U.S. balance of payments deficit for the past decade; at the high end of the range, it would exceed the aggregate net balance of payments deficit in U.S. history.

Over time, turning to another type of imported fuel (other than imported oil) to meet a large portion of this country’s incremental energy needs, rather than attempting to develop alternative, U.S.-based sources of supply will result in the loss of at least tens of thousands -- and possibly hundreds of thousands -- of American jobs.

Further, supporting the construction of $ 100 billion or more in infrastructure elsewhere in the world rather than here in the U.S. and, over a period of years, sending $ 1 trillion or more in revenues overseas will have huge implications for federal, state and local tax revenues and for the value of the U.S. dollar.

Finally, by definition, the fact that the infrastructure is located elsewhere in the world also increases the risk that supplies from time to time will be interrupted or that production facilities initially built based upon commitments by U.S. purchasers ultimately will fall into other hands of or be diverted to supply the needs of other customers.

None of this means that massively increasing our dependence upon imports of LNG is necessarily a mistake.

Instead, there may be offsetting benefits that are sufficient to justify a massive increase in our dependence upon another type of imported fuel (in addition to imported oil) or ways to minimize at least some of the potential risks of a heavily LNG-dependent strategy for meeting future U.S. energy needs.

It does suggest, however, that before a commitment is made to massively increase U.S. dependence upon LNG, there should be a thorough and careful examination of the risks and benefits of LNG vs. potential alternative domestic sources of supply that may have the potential to better serve the overall interests of the U.S. economy.

  • This is especially true since, essentially by default, a strategy of massively increasing U.S. dependence upon LNG is rapidly becoming the near-exclusive strategy for meeting incremental U.S. energy requirements for both natural gas and electricity. Absent a concerted effort to develop alternative sources of supply, therefore, if this strategy fails, for a period of many years, there may be no alternative source of energy available to meet a significant portion of the basic energy requirements of the U.S. economy.

If EIA’s most recent projections prove to be accurate, over the next two decades, even assuming the proposed new Alaskan natural gas pipeline is completed, increased imports of LNG will become the sole source of supply to meet almost 2/3rd’s of the expected incremental natural gas supply needs of the U.S. market (i.e., specifically, 65.4 %).

If the proposed Alaskan natural gas pipeline is not completed for any reason or is delayed substantially beyond its current projected in-service date (which EIA estimates is likely to be no earlier than 2016), the U.S. will be dependent upon increased imports of LNG for an astounding 87.7 % of its incremental supplies of natural gas.

Quite literally, therefore, our current energy strategy – to the extent we have one – leaves us critically dependent upon our ability to drastically increase imports of LNG as potentially nearly the sole incremental source of supply of natural gas, other than natural gas that might be brought into the lower-48 States from Alaska, available to meet home heating requirements and to provide fuel and feedstock to U.S. manufacturers.

In addition, except for natural gas from Alaska starting in 2016 or some subsequent year, it is potentially nearly the sole source of incremental fuel for the country’s gas-fired generating units, which now account for more than 40 % of total generating capacity in the U.S.

If the expected increase in supplies of LNG fails to materialize for any reason, therefore, – i.e., either because worldwide LNG production capability is not ramped up as quickly as the proponents of a heavily LNG-dependent strategy currently hope, or because we are unable or unwilling to site new delivery terminals in the U.S. or because China or some of our European allies or any other country outbids us for the limited amounts of newly-available supplies that we hope will become available during the next 10 to 15 years, we may be left with no fuel available to expand the output of our existing fleet of gas-fired units.

As a result, since our nuclear units and many of our largest and most efficient existing coal-fired units already are running at full capacity, we may be left without an alternative strategy in place to meet the incremental electricity needs of our economy. For a period of time, therefore, the growth of the U.S. economy may largely come to a halt.

  • There is no reason, however, why we need to be trapped in this position. Instead, there almost certainly are other means available to meet our incremental energy requirements. These options are likely to be less expensive, in pure dollar terms, and almost certainly would be preferable strategically and from the overall standpoint of the U.S. economy. These options are not likely to be available in a timely manner, however, unless efforts begin soon to develop and implement a comprehensive national energy strategy that provides for the development of alternative, domestically-based sources of supply on an urgent, “highest-priority-possible” basis.

The alternative means of meeting our future energy needs include more intensive efforts than have been proposed to date to accelerate energy conservation, renewable energy and development of on-shore and off-shore domestic sources of natural gas.

In addition, they also include a potential all-out, crash effort to speed the development and deployment of coal gasification, both to provide fuel for new electric generation facilities and to provide an alternative source of supply for some of the gas-fired power plants that have been constructed over the past 5 years.

Many of these alternatives could prove to be far less costly than importing LNG, especially in a global market in which it has become increasingly likely that LNG prices will be indexed to the price of oil (as already often is the case for sales for LNG to purchasers in other countries), at a time when the price for oil could spiral out of control at any point.

These alternatives potentially could avoid an unneeded drain of $ 1 trillion or more on the U.S. balance of payments, during a period in which there is an urgent need to reduce the current sky-rocketing U.S. balance of payments deficit and to strengthen the U.S. dollar.

In addition, they all share the further benefit that the jobs and infrastructure required to provide these sources of fuel all would be located in the U.S., providing tens of thousands of permanent new U.S.-based jobs and increasing federal, state and local tax revenues.

These alternative domestic sources of supply also share, however, several other important characteristics:

  • For many of these alternatives (other than some conservation projects), even to implement a single project at a specific site may require a lead time of 3 to 4 years (and in some instances longer), to obtain necessary permits and financing and to fabricate and install the necessary equipment.
  • To implement these alternatives on the requisite scale, even longer lead times may be required -- even for major conservation initiatives.
  • Finally, as a practical matter, given the perceived risks, private developers are unlikely to risk large amounts of capital on these projects without strong assurances that federal and state governments will support the timely completion of these projects.

Unless we find a way, therefore, to move forward immediately with the development and implementation of a comprehensive new national energy program on an urgent, “highest, priority possible basis,” we almost certainly will instead simply continue to drift down the path we have been following for the past 24 to 36 months.

Specifically, essentially by default, the U.S. will become dependent upon the potential that it might be able to dramatically increase imports of LNG as the near exclusive means to meet its incremental energy needs for natural gas and electricity, both later this decade and throughout the next 20 years and commit itself to a whole new era of expanded dependence upon imported fuels, with LNG imports over a period of years potentially matching and then exceeding (in BTU equivalent terms) the current level of oil imports from the Middle East.

Further, this fundamental shift in energy strategy will have been allowed to occur without any rigorous analysis – or, for that matter, any meaningful analysis at all at either the federal or state level, of: (i) whether the massive increases in LNG imports that EIA currently projects for 2010, 2015 and subsequent years actually is achievable; (ii) how significant the risk is that we will fall short of these goals; or (iii) what the consequences might be if for any reason the level of LNG imports assumed in EIA’s estimates is not achieved.

Nor does there appear ever to have been any rigorous analysis – or indeed any analysis at all -- of what the alternatives might be to a heavily LNG-dependent strategy and the potential risks and benefits of these potential alternatives in terms of:

  • Reliability of U.S. energy supply;
  • The potential for severe price shocks and heightened price volatility in the U.S. natural gas and electricity markets;
  • Job loss or job creation in the U.S. economy;
  • The continued ability of U.S. industry and U.S. farmers (who depend upon the availability of competitively-priced fertilizer) to compete in world markets;
  • The U.S. balance of payments deficit; and/or
  • The future growth of the U.S. economy.

Further, at least to date, no effort appears to have been made to determine what the possible U.S. “fall-back” strategy if:

  • The global LNG market does not develop as rapidly as EIA currently hopes;
  • Other countries outbid the U.S. for available supplies; or
  • Supplies are interrupted due to political unrest, labor strikes, terrorist incidents, wars or any of the other factors that frequently interrupt international shipments of oil.

Instead, one of the most important policy choices we’ve ever faced literally is being made by default.

Please Note: This is Part 1 of a 3 Part series. Part 2 will be published tomorrow, May 18th and Part 3 on May 19th.

 
 
Authored By:
For any questions, comments or reactions, please don’t hesitate to contact Andy Weissman directly at Andy.Weissman@EnergyBusinessWatch.com or 202-589-2391. Visit our new web site at www.energybusinesswatch.com
 

Other Posts by: Andrew Weissman

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Comments

May, 17 2005

Andrew Weissman says

Author's addendum:

For more information regarding the supply constraints facing the U.S. natural gas market and actions that should be taken to meet the energy needs of the U.S. economy, please check out our web site at www.energybusinesswatch.com or e-mail me at aweissman@energyvg.com.

-- Andy

May, 21 2005

Murray Duffin says

I agree with Andy's estimate of $125+B to build the facilities to liquify and regasify 6.4 Tcf/yr of NG. To that amount we have to add the investment in tankers. The $250m/tanker frequently quoted was in 2003, before steel prices took off and did not include the cost of insurance, either during construction or after launch. We probably have to count on $350M going forward. An incremental 6.4 Tcf Of LNG at an optimistic 23 Bcf/yr/tanker from Qatar would need 280 tankers, or about another $100B. Depreciation and interest at 6% for 30 years would push production and delivery cost to above $5.00/kcf. Adding wellhead cost of gas would put the delivered cost well over $6.00/kcf. Does anyone believe that 30 year money at 6% interest would be available, especially for the tankers. The risk premium would likely call for not less than 10%. Greenspan just quoted Japanese/Korean prices of about $3.50/kcf as if that number would apply also in the USA. Those prices are for long term contracts, negotiated years ago, and for much shorter shipping routes. Importing 6.4Tcf of LNG/yr would cost not less than $50B/yr by 2015, and more likely near $70B. Murray

May, 21 2005

Len Gould says

You state, correctly,

"Finally, as a practical matter, given the perceived risks, private developers are unlikely to risk large amounts of capital on these projects without strong assurances that federal and state governments will support"

In otherwords, generation entities cannot build alternatives to cheap gas turbine generataion in a "free market" electrical system, without the necessary assurance of rate stability provided by regulation. The timing just seems TOO co-incidental, at least to a sceptic like me.

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