Published: November 16, 2010
Sometimes the most
important impact on a raw material commodity comes less from its
actual extraction and more from how product is introduced into
Indeed, that is becoming the next major development in North
American natural gas. The expansion in liquefied natural gas
(LNG) exports may well hold the key to turning a glut into
The LNG process cools gas into a liquid form, allowing it to be
stored and transported via tanker. The liquid is then "regasified"
on the other end and injected into existing pipeline systems.
This provides for the development of genuine spot markets, since
the movement of gas is no longer limited by how far pipelines
The prospect of a long-term
natural gas surplus has caused some to ask whether the
additional volume coming on-line will simply depress prices. As
I have mentioned here several times, this is not a question of
conventional, freestanding gas reserves. This is all about
unconventional production - primarily shale gas - and where it
is likely to be increasing overall availability.
With the gas glut turning into a more permanent energy fixture
in North America, the market will progressively become (even
more than currently) one in which production will primarily meet
regional needs, with contract swaps acting to offset differences
We will be moving into a very different way of balancing the
market. Henceforth (and probably for decades to come) that
balance will be affected by the knowledge that there is more
supply than required, and it's easily able to move into the
In short, unlike crude oil - where we are beginning to see very
early signs pointing to the development of a supply-constricted
environment - gas will provide a supply-expansive environment.
The regulatory changes I recently discussed are certain to spur
on the accelerating transition from coal to gas and renewables
for electricity generation. And that will require additional
gas, as will its expanding use in the production of
petrochemicals. A cold winter will also drain stockpiles. In
storage volume, we are currently well below the levels at this
time last year (although those were record levels). Nonetheless,
gas out of the ground - but not in the market - still occupies
most of the pipeline capacity in the U.S.
And that simply points toward a continuing surplus.
The Advantage of Two North American Plays
Once we consider the impact beyond fulfilling local
requirements, some plays will have greater benefits than others.
Two are particularly noticeable in North America, and we have
discussed both of them in the past.
The first is the rapid development of the Big Horn, Montney, and
related basins in western Canada. The second is the Marcellus in
Pennsylvania, New York, Ohio, and West Virginia.
Both of these are quite likely to provide volume more cheaply
than some other basins.
In a surplus condition, cheaper volume will displace more
expensive - especially when you consider broader geographical
applications (inter-regional trade). Both North American
reserves, therefore, should see increasing drilling, even when
prices in the market as a whole are going down and drilling is
And that is the case currently. Despite natural gas contract
prices below $4 per 1,000 cubic feet, production and rig usage
are increasing in both the Marcellus and western Canada.
But what does this do to the profitability of production
companies and pipeline operators? Doesn't feeding a glut always
lead to a downward pressure on prices and a decline in
Not when a positive spread between production costs and market
prices can actually be improved upon. And that's done simply by
moving the gas to locations where the demand is so great it
provides a premium on the return expected.
The development will benefit gas sourced from both conventional
and unconventional North American basins.
But first, the current cost-pricing spread. The new shale and
tight gas sources in British Columbia and Alberta are providing
the likelihood of prices at a $1 to $1.25 discount to Henry Hub
(the Louisiana location at which pricing for NYMEX gas contracts
is determined). There are some additional costs for transport to
distribution points, but recently completed spur lines to the
TransCanada Mainline pipeline allow the gas to enter large
In the Marcellus, wells are coming in cheaper than anticipated.
The average well spud this year will come in profitable, at less
than $3.60 per NYMEX contract, with a rising percentage coming
in significantly below that level. Unlike western Canada, the
Marcellus has the advantages of much closer proximity to end
users and an increasing network of pipelines to serve both
throughput and storage.
The concern, however, remains that the enormous amount of volume
that both basins could put on-line would still flood the market
and depress pricing, regardless of the additional demand for
electricity generation or how cold our winters become.
Enter LNG... and two gigantic markets seeking additional gas for
which they will pay a premium over North American prices.
Where the Demand Is
Asia needs the increased volume of natural gas to fuel its
expansion. Europe needs it to wean itself from reliance on
conventionally pipelined (and overpriced) Russian Gazprom OAO
(PINK: OGZPY) volume.
Canada already has decided to move the new gas volume from
western Canada to the Kitimat LNG terminal on the Pacific coast
of British Columbia for export to Asia. Kitimat is scheduled to
come into operation in late 2014. Already, there is a near
certainty that its capacity will be doubled.
European requirements combine well with the rapidly expanding
volume coming out the Marcellus. And on that count, there is
Cove Point, Maryland.
Already in operation, Cove Point is the largest LNG facility on
the U.S. east coast. As the need collapses for LNG imports into
the United States - another result of our ongoing gas surplus -
don't be surprised if this terminal begins reversing operations
to export volume. This is tailor-made to provide a major outlet
for additional production from the Marcellus.
LNG trade is no flash in the pan. It is becoming the single most
important advance in balancing the global gas market. Currently,
86 gasification or regasification terminals exist worldwide;
there are another 246 in planning stages or under construction.
That means, as additional volume comes out of the ground in
western Canada, the Marcellus, or other basins in the United
States, it will be shipped to higher-paying markets abroad.
Welcome to North America: the new Saudi Arabia of energy.
-- Kent Moors
Note: This article originally appeared on