US LNG Exports: The Numbers May Tell a Different Story

If one were to believe the headlines, it sounds as if LNG shipments of American shale gas were a "done deal."

For one, The Guardian's recent headline goes "US shale gas to heat British homes within five years," in line with a deal stuck by Centrica. Just this spring, The New York Times' DealBook reported that "3 Foreign Companies Invest in U.S. Project to Export Liquid Gas," namely Mitsui and Mitsubishi of Japan, and GDF Suez of France. Meanwhile, according to a piece on StateImpact Pennsylvania, while now the US has only two LNG export terminals, 17 additional facilities are pending approval by the US Department of Energy.

But according to Ruud Weijermars, Founder and Principal Consultant, Alboran Energy Consultants, economically the numbers to export US shale gas as LNG may not add up.

He contends that buying parties for North American LNG would only be prepared to pay whatever the Henry Hub price is for natural gas plus the costs of liquefaction and transport.

"I believe that's about $3 added on, anywhere in the world basically, plus a little bit of profit for, in this case, Cheniere Energy Inc., or any other operator," he explains, referring to the company transforming its formerly intended LNG import terminal. "So as long as that price - the Henry Hub price plus the $3 add-on and maybe $1 profit - remains competitive with what is paid in Europe, for example, then such a contract makes sense for the buying party."

The question, he says, is, how much does it help American gas producers? He offers some more numbers.

"The break even price at the minimum is $6; it should probably be closer to $7 or 8. So when you take that as a bottom line, plus the contract construction, i.e. $8 plus $3 is about $12. Then you are hardly competitive with what the gas price is that's paid in Europe," explains Mr. Weijermars, who says that Russian gas is delivered to Europe via a long-distance pipeline through Central Europe for about $11.

"It is probably going up," he admits of the Henry Hub price. "According to an analysis we performed of well output, it will peak by the beginning of 2014 and then you'll see a realistic decline. That of course is going to effect price a bit earlier, so we see prices creeping up a little bit and that will continue, but as soon as there is a margin again, producers will push the price back to marginal production."

Still, of future American LNG exports, he says, "It's very expensive, the margins are small and it sounds attractive for all the buying parties as long as US producers are sticking to this very cheap production price. That's out of necessity, not because they want to but because the market is oversupplied at the moment."

He concedes that America needs to have another exit point for it gas to break out of its closed gas market situation. "There are several ways to do that: LNG export, export to Mexico and gas-to-liquids straightaway, which is what Shell wants to do."

Mr. Weijermars' main concern, however, is that there is very little room for intelligent debate about what he terms a "more modest vision" for America's unconventional gas.

"If we now look at the well decline, the rigs declining, the number of wells declining, there is a more negative scenario that says we may have declining gas output - what is the effect of that?"

According to him, that scenario is not covered by the National Energy Modeling System. "And I think that's because no one wants to hear a possible negative scenario, but I think it's the most realistic one. We're closer to a declining gas output situation for shale gas in the US than ever before.

"It's a completely different ball game from conventional production, where one sees a 50% margin on production," he continues. "That's very different today and I think that's something that we as an industry all have to get used to. It's just not in our systems: the common understanding that upstream production is no longer as profitable as it used to be. I see that everywhere, that the realization just hasn't sunk in as upstream has always been a very profitable part of gas production."

Of course, instead of sitting around and waiting to drill in the US, many unconventional explorers have been taking their show on the road, with domestic politicians counting their chickens before they are hatched by citing high potential production levels, like in Poland, where Mr. Weijermars notes that only about 40 wells have been drilled.

"So we will need to see. I think the extreme economic expectation, that we'll have cheap gas available is an expectation which we cannot fulfill with the technology we have today. I think that's too much driven by the over-hype in the media; companies will have to scramble to make a profit from whatever shale gas is being produced. That will be the main limitation on quick development unless governments are prepared to subsidize or if there's a price floor for the producers so they can basically produce without any losses, but then you have a different business model: you're stimulating the development of your natural resources strategically, stimulating jobs, industry with relatively affordable gas at $10/MCF - that's what you need as a minimum."

And now it seems that policymakers in Brussels are entertaining the argument that Europe is losing its competitiveness and so it must entertain the notion of pursuing unconventional gas.

"As you know we're now importing 50% of our natural gas from outside Europe: much from Russia, Northern Africa and Nigeria, a lot via long-distance pipelines, some of it via LNG. European internal production is declining very rapidly and by 2030 we could be at 80% import of gas and oil is much worse already, so there is a very strong concern about energy security. Whether shale gas is the solution, I'm not sure."

According to him, there are multiple scenarios.

"We need more pipeline gas for sure, more competition with Russian gas and there is also this hope that shale gas will be developed. But even according to the most optimistic scenario, it only adds a tenth of the total volume that we need - so shale gas is not going to help Europe a lot," he explains. "It just sends a signal. If there's a fractional contribution of production, it sends a signal to Russia. So far they're pretty laid back about it, but until that happens they'll negotiate with traders and are asking them to sign on to the Nord Stream project, which they'd like to have ready in 2018."

Gas traders in Europe, he believes, are choosing security of supply, with Nord Stream looking like a sure thing.

He says: "The other two are wild cards: LNG is unclear and shale gas is completely unclear. That's a risk you can't take as a trader, so they will sign on to long-term Russian gas supplies, enabling the financing of these two northern pipelines, which means that they'll likely stick with oil-indexed gas contracts."

All around, he says, the expectations for shale gas have been totally overblown and not founded on the economic fundamentals.

"If you're optimistic, you say 'fine we have a great development in the US with our cheap gas, are attracting industry - the petrochemical industry's coming back.' If you're only looking at these things, without looking at the full value chain as it's interconnected globally, then it looks good.

"But in the long run I think the the whole business fundamental is not as solid as it seems. The bottom line is, gas producers can only stay in business if they can recoup marginal cost; at the moment they are not. This is the reason why they're stopping gas drilling. That will recover at some stage, but it could perhaps cause supply interruptions."

Mr. Weijermars concedes that while his assessment may be pessimistic, the industry has a need to be realistic, professional and assess the viability of shale gas and explain exactly how things are. Despite those sentiments, he says, "I praise US entrepreneurship for going to that extreme, demonstrating the technological potential, resource potential development and the economic risks that you take when you do that."