Russia and China have signed two large natural gas deals in the last six months as Russia turns its attention eastward in reaction to sanctions and souring relations with Europe, currently Russia's largest energy export market.
But the move has implications beyond Europe. In the department of everything is connected, U.S. natural gas producers may be seeing their dream of substantial liquefied natural gas (LNG) exports suffer fatal injury because of Russian exports to the Chinese market, a market that was expected to be the largest and most profitable for LNG exporters. Petroleum geologist and consultant Art Berman--who has been consistently skeptical of the viability of U.S. LNG exports--communicated in an email that Russian supply will force the price of LNG delivered to Asia down to between $10 and $11, too low for American LNG exports to be profitable.
Now, let's back up a little. U.S. natural gas producers have been trying to sell the story of an American energy renaissance based on growing domestically produced gas supplies from deep shale deposits--now being exploited through a new form of hydraulic fracturing called high-volume slick-water hydraulic fracturing.
The problem has been that overproduction and low prices--now only a fraction of the $13 per thousand cubic feet (mcf) at the peak in 2008--have undermined the financial stability of the natural gas drillers. Here's why: Natural gas from shale, referred to as shale gas, is generally more expensive to produce than conventional natural gas and will require that natural gas prices go much higher than they are today--from around $4 per mcf almost certainly to over $6 per mcf and perhaps more to pay the costs of bringing that gas out profitably.
But at that price, U.S. LNG is no longer competitive in Europe. And now, because of the Russian-Chinese natural gas pipeline deals, it may no longer be competitive in Asia. Those are the two largest markets for LNG. Without them it is doubtful that the United States will be exporting much LNG--except perhaps at a loss.
Here's the problem: To convert U.S. natural gas to liquefied natural gas, put it on specially built tankers and ship it to Europe or Asia will cost about $6 per mcf. If the price of U.S. natural gas averages around $6 per mcf, the total landed cost of U.S. LNG will be the cost of the gas plus the cost of converting it and shipping it, that is, around $12 per mcf.
The most recent landed prices for LNG to Asia as reported by the Federal Energy Regulatory Commission were $10.10 per MMBtu* for China, $10.50 for Korea and $10.50 for Japan. For Europe the numbers are even more sobering: $9.15 for Spain, $6.60 for the United Kingdom, and $6.78 for Belgium. All amounts are U.S. dollars.
These are probably reflective of spot prices rather than long-term contracts, and they are down due to softening energy demand that may be the result of an economic slowdown in Asia and Europe.
But, they give an indication of how difficult it will be for U.S. LNG to compete on the world market. LNG prices may well improve, but buyers of LNG typically sign cost-plus contracts. In the United States that would be the cost of Henry Hub natural gas (traded on the New York Mercantile Exchange) plus the cost of liquefaction and transportation. With no assurances--and a good deal of evidence to the contrary--that Henry Hub gas will remain at current prices (around $4) for the long term, it's difficult to see how there will be many long-term buyers of U.S. LNG.
One wonders under such circumstances just how many of the 14 proposed U.S. LNG export terminals will actually be built.
Having taken the long way around, let me return to the Russian-Chinese natural gas pipelines and their significance in this drama. Gazprom, the Russian natural gas giant that will actually deliver the gas, valued the earlier deal in May at around $10.19 per MMBtu. The latest deal has no announced value, but one analyst believes the Chinese will be asking for around $8 per MMBtu. Even if the Chinese end up accepting a price closer to the previous deal, some 17 percent of the Chinese natural gas supply will be coming from Russia when the pipelines are complete several years from now. And that will likely anchor the price of Chinese LNG imports between $10 and $11 per MMBtu, making the price too low to be reliably profitable for U.S. LNG exporters.
The implication is that today's soft prices for imported LNG to China and the rest of Asia may become the norm in a few years just as America's LNG export terminals are about to become operational. If investors fund these terminals and the Russian-Chinese pipelines get built, there is likely to be some epic capital destruction on the American side of the Pacific.
There are other reasons to be skeptical about America's future as a natural gas exporter. The rosy predictions of the industry and the U.S. Department of Energy for domestic natural gas production from shale may be overblown according to a new report from the same analyst who foresaw the massive downgrade of recoverable oil from California's Monterey Shale. Despite rising domestic natural gas production, the United States remains a net importer of natural gas. Natural gas imports accounted for about 10 percent of U.S. consumption through August of this year.
(Full disclosure: I worked as a paid consultant to help publicize the report mentioned above. But, as longtime readers know, since 2008 I've been skeptical about the wild claims of a long-term U.S. bonanza in oil and natural gas due to shale deposits. This report offers the first comprehensive analysis based on industry data and is produced independent of industry influence or money. Anyone with a stake in the industry or in U.S. energy policy should read it.)
It's possible that some U.S. LNG export projects may move forward in any case. If the buyers for this LNG sign long-term, cost-plus contracts as described above, those buyers will be in for a big surprise when U.S. natural gas prices rise. And those exports will create something of a self-reinforcing feedback loop by raising overall demand which will hoist domestic prices even higher for U.S. natural gas--even more so if there is not as much U.S. production as is currently being projected. If U.S. natural gas production remains at or below the level of domestic consumption, the United States could be faced with the rather bizarre prospect of having to import high-priced LNG from some countries to fill the gap created by LNG export shipments committed to others.
Higher U.S. natural gas prices will be a double-edged sword for those concerned about a cleaner energy future. U.S. natural gas producers and renewable energy companies will simultaneously rejoice if exports raise prices appreciably--producers because their financial fortunes will turn more positive and renewable energy companies because renewable energy will become more competitive with higher priced natural gas. Environmentalists, however, will gasp in horror as profitability rises enough in the shale gas fields to justify ever greater encroachments on the American landscape.
And, U.S. politicians who favor LNG exports may ultimately find themselves pilloried by consumers who must pay those higher prices and environmentalists who abhor the environmental costs--even as those politicians watch the campaign contributions flood in from a grateful shale gas industry.
*MMbtu stands for 1 million British thermal units, a measure of heat content. Mcf, of course, means 1,000 cubic feet. This much natural gas contains almost 1 million Btus--975,610 to be precise. And so, the two measurements are often used interchangeably when comparing price though they are not precisely equivalent.
UPDATED: November 17, 2014 to include information on U.S. natural gas imports.