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The Global LNG Gamble

The Geopolitical Risks of LNG
Fortnightly Magazine - March 2005

that overseas energy producers have on the U.S. economy. "The problem is that nearly three-fourths of proven reserves are found in the Middle East and areas near there," says James Woolsey, former director of the Central Intelligence Agency, and now a vice president with Booz Allen & Hamilton and a policy advisor to the U.S. Secretary of Defense. "This creates real geopolitical risk. Importing natural gas helps to diversify sources, and there may be alternative ways to deal with the problem. But it is something one wants to pay attention to."

The consequences of inattention to these risks might be large or small, depending on what kind of disruptions might occur. In any case, until the industry develops mechanisms for dealing with such risks, utilities might find they are vulnerable to the very price shocks LNG imports are intended to avert.

Choke Points

Until now, global supply risks have received little attention in the LNG debate. In large part, this is because such risks generally are seen as an unavoidable fact of life.

"This is just the real world we are living in," says Don Mason, a commissioner on the Ohio Public Utilities Commission, and chairman of the National Association of Regulatory Utility Commissioners (NARUC) gas committee. "I agree there could be long-term disruption problems, but we run into those situations now. Certain gas fields don't produce as successfully as expected, for example. It is something to be concerned about, but that's why it is important for the United States to be diversifying the LNG supply, so we are not dependent on any one area."

Such diversification, however, might prove elusive; while oil tankers sail to and from dozens of ports around the world, the LNG trade is constrained to a handful of routes connecting relatively few terminals.

"This isn't going to be a globally traded market in the foreseeable future," says Gavin Law, head of the global LNG team at Wood Mackenzie in Edinburgh. "Going forward we expect the spot market may stretch to 15 or 20 percent of the trade in certain years, but the bulk will be traded on a long-term basis. Even most majors cannot invest the huge sums in the necessary infrastructure unless they know where the gas is going."

In a few cases, integrated energy companies might be prepared to accept merchant risk and simply market imported gas in the U.S. interstate pipeline network. But these instances will be the exceptions rather than the rule. "These projects are so expensive and they take so much time to build, very few companies do it alone," says Alan Herbst, a principal with Utilis Energy and a course director with the Oxford Princeton Programme. "LNG project sponsors look to spread the risk, and they are involved through the entire supply chain."

A significant barrier for LNG project developers is price uncertainty. Selling LNG into the U.S. market is not like selling to Japan or Taiwan, where no viable alternative exists. In the United States, LNG must compete against indigenous gas resources. And while the best projections suggest gas prices