The US is an LNG ‘sink’

The following was taken from a document prepared by Morgan Stanley, finacial advisors on the global oil and gas industry and which was presented at an energy conference last week at the Trinidad Hilton.      

We believe the US LNG market is one of the most promising in the world, for four important reasons.
1. The growth outlook for natural gas demand is strong in the US assuming moderate pricing. Natural gas is the fuel of choice to drive future growth in North America. However, it must be at a reasonable price. Increased demand over the past decade has been driven largely by combined cycle generation, and the ever present environmental and security issues surrounding alternatives like coal, nuclear and hydro-electric power. Three years ago many industry observers saw annual natural gas demand rising from 21.8 tcf in 2001 to almost 30 tcf by 2010.
Today, this is in severe doubt as rising prices and falling supply are actually reducing demand. A low-cost clean alternative would promptly reverse this trend, in our view, making the US end market one of the most promising in the world.
2. Indigenous production in the US has reached its plateau.
We expect US production by 2010 to be flat at best from a current level of 19 tcf per year, with further declines likely. We believe the US indigenous gas supply has the potential to shrink by approximately 1-3 percent per year going forward. Production costs continue to increase, and incremental production has rapid decline rates. LNG offer an alternative with significantly lower costs and limited decline rates.
3. There is limited competition from pipeline gas. Currently, the US imports around 3.8 tcf per year of gas from Canada (roughly 7 percent of demand). We believe that Canadian production is increasingly subject to the same diminishing returns as US production and will decline slightly.  However, additional gas could come to the US market through two potential pipeline alternatives. These are the 1 bcf per day (0.4 tcf per year) Mackenzie Delta pipeline and the 4 bcf per day (1.4 tcf per year) Prayeth Bay Pipeline. We expect regulatory filings for the Mackenize Delta pipeline this year, and we assume construction will begin in 2004, to be completed in 2009. We are less optimistic on the Prayeth Bay pipe, as it requires gas prices above US$4 and significant government subsidies in order to justify its cost of US$6-8 billion. In the best case scenario, construction on this pipeline would be completed in 2011, in our view. This would leave LNG imports as the main source of natural gas to compensate for declining US production. The call for LNG supply in this scenario could be roughly 2.5 tcf per year by 2010, or roughly 10 percent of the US gas market. We think roughly half of this would be imported by expansion of the current four US terminals, while the rest could be imported by four greenfield terminals.
4. The outlook for natural gas prices in the US is very robust. Due to the supply/demand outlook described above, Morgan Stanley’s US E&P analyst Lloyd Byrne has recently increased his 2003 Henry Hub forecast from US$4.65/mcf to US$5.50/mcf and his normalised Henry Hub price from US$3.50/mcf to US$3.75/mcf. On our estimates, US$3.50/ mcf would already be sufficient to import LNG into the US from anywhere in the world. Brownfield LNG expansion is already occurring.

Current plans exist to increase US import capacity at existing facilities from around 0.8 tcf per year (2.3 bcf per day) to around 1.4 tcf per year (3.9 bcf per day). We provide details on the process in Exhibit 41. As can be seen in Exhibit 43, we estimate that by 2010 the brownfield and greenfield developments combined will increase total import capacity to a theoretical level of around 2.8 tcf per year by 2010 (assuming 100 percent utilisation). It is, however, worth noting that, because of both technical and commercial reasons, it is difficult to run these facilities at 100 percent capacity. The largest ever annual volume imported into the US occurred in 1979, when 252 bcf were imported into Evertt and Lake Charles. These terminals had combined annual capacity at the time of 389 bcf. Hence, even in the year of highest imports, the average operating rate of these two terminals averaged 65 percent. In our supply analysis, we assume that terminals can be run at 80 percent of nameplate capacity, given operational improvements and excellent economics.

A new FERC ruling has made re-gas investments more attractive for the supermajors despite the attractiveness of the US market, the supermajors have been reluctant to commit capital to building re-gas capacity, largely because of regulations that prevented guaranteed access to the facilities and relatively low, regulated return. In December 2002, however, the Federal Energy Regulatory Commission (FERC) revised its authorisation policy for LNG import terminals, which we believe will trigger a change in the US LNG market.
The recent decision brings about two main changes.
• It removes regulation of returns. For existing terminals, returns are capped at a meagre 13 percent ROE. This is well below the returns available on most liquefaction projects, for example. We believe that owners of new re-gas capacity near consumption areas should now be able comfortably to earn double-digit returns.
• It removes the open-access requirement.
Previously, FERC required LNG import facilities to be open to all importers, in order to prevent discrimination by the terminal owner. It now allows LNG terminal operators to have full control of their own import capacity.
We expect four new greenfield LNG terminals to be fully operational by year-end 2010

Due to the attractiveness of the US LNG market, a large number of projects have been proposed to increase import capacity. According to one overview published by the EIA in January 2003, as many as 17 new re-gas plants are currently under consideration, which could theoretically add 5.4 tcf of annual capacity. We expect, however, that not all of these will be built. As we will argue in the next paragraph, we think that eventually there will be room for about six to eight additional terminals targeting the US market. However, given the long time lags involved in developing and constructing such plants, and the complicated regulatory environment, we estimate that only four will be constructed by year-end 2007. As it usually takes two to three years for these plants to ramp up production, we expect they’ll be adding 4 bcf per day (30 mtpa) by 2010.