The United States of Liquified Natural Gas

2016 could prove to be a pivotal year in America’s history for a reason that few Americans currently appreciate. At Cheniere Energy’s Sabine Pass property in Cameron Parish, Louisiana, America exported its first cargo of domestically produced liquefied natural gas (LNG) from the contiguous United States in over 50 years.

Before year end 2017, Dominion Energy’s LNG plant in Cove Point, Maryland is scheduled to be up and running. More than a dozen similar plants are in the works around the country, preparing to liquefy natural gas by cooling it to –160°C, can it in giant tankers and ship it around the world.

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And these are merely the first wave of LNG plants built to take advantage of low-cost gas from the US shale revolution. According to the Financial Times, at capacity these plants will be able to export about 9bn cubic feet of gas a day, or about 12 per cent of the production of the US. The US, since 2009, is the largest producer of natural gas in the world, so this level of export is globally significant.

An economic development of this magnitude is disruptive and it will take time for the market forces of supply and demand to reach enough equilibrium that buyers and sellers can participate without fear of jarring turbulence.

Today turbulence is particularly acute because these first shale-era LNG plants were planned according to pre-shale economics, where giant buyers of the LNG signed long-term output contracts with the builders of the plant and took substantial price risk.

With so much new LNG capacity being developed, however, the prices contemplated in some of the contracts are no longer tenable and contracts are being renegotiated. The Financial Times reported that Petronet LNG, an LNG importing firm sponsored by the government of India, successfully renegotiated its LNG contract with Dominion Energy and a similar contract with an Exxon subsidiary in Australia.

Another source of short-term turbulence in a market traditionally based on output contracts is the development of a spot market, which is growing rapidly. In the year 2000, only about 5% of the world’s LNG was sold on a spot basis with short term contracts. Today this number is over 25% and should continue to grow as LNG usage grows.

The availability of a spot market makes simple long-term output contracts with binary price risk less prudent for would- be buyers. This is hindering the short term ability to raise capital for LNG plants based on the security of these contracts. However, a spot market makes long-term hedging easier for all market participants and is proof positive that this market is maturing.

As with other mature commodities, very soon the financial logistics of matching demand and supply in LNG will have the benefit of deep global futures, options and spot markets. Long term output contracts will be adjusted to take into account such markets and LNG plants will be built based on a new and growing global market, not the patronage of a few giant customers.

On the supply side, shale oil drilling companies, which produce significant quantities of natural gas, are already facing pointed criticisms from investors who are insisting that growth in production must be balanced with the need to show profit on investment. According to a Wall St. Journal report on October 6, 2017, Invesco Ltd., which has more than $900 billion in assets under management, has pressured several company boards to link executive pay to return on capital rather than production growth. Investment advisory firm Sailing Stone Capital Partners has taken similar actions.

The Journal reports that these investor demands have been recognized and that some of the biggest producers have promised to pay for new investments and dividends only with cash from operations.

Based on this expectation, natural gas production from shale exploitation will likely continue to surge into 2018 and thereafter be driven by market demand rather than the quest for new supply. Even if current managements take liberties with the timing of the performance of these promises, market forces outlast transient managements and will ensure that these promises are ultimately kept.

About Chris Donnelly

Christopher J. Donnelly, is an experienced attorney, bond analyst and fixed income strategist, with years of experience in structured finance, distressed bonds and bond related litigation in a variety of industries and the emerging markets. He is a graduate of Rutgers University (BA), The University of Pennsylvania (JD) and New York University, (LLM in Taxation). Chris is a Managing Director of Straacom, LLC and can be contacted at Straacom provides strategic research, analysis and communications for publication and on assignment for private clients.

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