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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

meet demand over the next 10 to 15 years. Although production in Texas and the shallow-water Gulf of Mexico may be declining, these declines will be offset by additional imports for Canada. Any additional capacity and supply must therefore be at or below contemporary prices.

An LNG terminal in Baja California would probably receive gas from South America, which has a low wellhead cost. It would require large capital investments at the producing end in the form of gas pipeline to the port and liquefaction capability, as well as additional capital investment in ships and the Mexican terminal. Gas at the port would have few alternative delivery options.

Furthermore, the economics of the entire operation are partially driven by revenues anticipated from liquefaction byproducts. The cost structure of LNG thus involves high fixed costs and low variable costs further offset by a variable contribution margin from other products. If an LNG project is built and demand fails, LNG shipments would probably continue, which would be very destabilizing to regional gas prices.

Given the tendency of history to repeat itself in the natural gas industry, what is the best strategy to employ in this region? Regardless of whether an LNG terminal is built, there will be adequate supplies in North America. Consider the following base case:

  • There will be significant growth in natural gas demand in the Southwest.
  • There will be significant increase of pipeline capacity into this region.
  • One and possibly two LNG import terminals will reach fruition in the 2005-2010 timeframe.
  • Gas prices will remain stable.

The key risk to this outlook is that natural gas-fired power plant construction will slow, relative to forecasts. Certainly construction has already begun to lag, but some of that is probably incorporated into LNG developers' expectations. If the outlook continues to contract, either because of electricity market fundamentals, unavailability of credit to developers, or life extension (or even expansion) of solid-fueled plants, gas prices could collapse again.

If one or more LNG import terminals are to be established, they will have to be base-loaded to ensure consistent deliveries. That would imply that the existing pipelines would become the "swing" load suppliers. It is unlikely that any of the new projects would be willing to accept any of this risk so it would fall primarily to the older more established companies in the region.


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