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LNG Moves In On Western Markets

What are the potential market impacts of LNG importation in the Western United States?
Fortnightly Magazine - April 15 2003

currently under way is the Kern River Gas Transmission Co. 2003 expansion. The $1.26 billion expansion project will more than double the capacity of the Kern River system to a total daily capacity of 1.7 billion cubic feet. These pipelines will continue to be the primary supply for the needs of the California energy market.

An additional important aspect of the supply portfolio is the possibility of an LNG terminal in Baja California, Mexico. Five separate project sponsors have announced plans to construct terminals in the region: Marathon Oil, Sempra/CMS, Royal Dutch Shell, ChevronTexaco, and El Paso/Phillips. Each of these proposed projects represents a potential new supply source of 500 to 1,000+ mmcf/d.

California History

Until the early 1990s, no interstate pipeline companies operated within California. That changed with the completion of the Kern River and Mohave pipelines. Initially conceived in the late 1980s, when California was concerned there would not be enough interstate pipeline capacity to meet expected gas demand growth for the state, these two pipelines were primarily developed to transport gas for the enhanced oil recovery market in Southern California.

At about the same time, three other pipelines were performing significant expansions. All this development led to more than 2 bcf/d of new capacity to the state between 1992 and 1994. Demand did not materialize as expected, and a glut of pipeline capacity went unutilized, dropping annual average utilization from Southwestern regional basins from 84 percent to 66 percent in the period of 1990 to 1996.

The resulting excess pipeline capacity led to a period of extreme conflict between end users, firm capacity holders, pipeline owners, policy-makers, and regulators over who should be responsible for the costs associated with the stranded investment. Some of these issues continue to be litigated today. Figure 2 shows the basis differential between Henry Hub and Southern California prices during this period.

As can be seen from the data, basis differentials were under extreme pressure during this period, dropping from the +$0.50 to $0.75 range before pipeline capacity increased to -$0.25 to $0.35 range after capacity expansion. This is nearly a $1.00 drop in the California market versus Henry Hub. Although this may appear to have been good in the short term for users in the region, market participants eventually have to recover these investments, and they have been hesitant to repeat this experience. This probably contributed to the issues around the winter 2000-2001 that saw California border prices reach $60/mmBtu.

Alliance Pipeline

Alliance pipeline began construction in 1999 and entered commercial operation on Dec. 1, 2000. Alliance is capable of transporting more than 1.3 bcf/d. Alliance operates from Western Canada and terminates in the Chicago area with existing North America natural gas transmission infrastructure. This increased the flow from Western Canadian supplies into the heart of the Midwest markets by 29 percent. How did the markets respond? Basis differentials have continued to climb in the region despite the increase in supply.

Potential Impact of LNG Development and Market Strategies

Overall gas supply in the continental United States and Canada will be adequate to