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Despite development challenges, LNG capacity is destined to play a bigger role in the U.S. energy mix.

When MidAmerican Energy announced its plans to build a pipeline to bring stranded Alaskan natural gas into the lower-48 states, the U.S. energy industry stood up and took notice. If successful, the project will bring the largest infusion of gas that this country has seen in many years-and not a moment too soon.

U.S. gas demand continues rising, even as production at North American gas fields has plateaued. Bridging the supply-demand gap will require an estimated 10 billion cubic feet (bcf) of new gas supplies per day by 2010.1 The Alaskan pipeline could meet nearly half of that demand.

But gas won't begin flowing through that pipe until 2010 at earliest, and U.S. customers can't wait that long. Without significant new gas sources opening up, demand will begin to exceed the available supply sometime between 2006 and 2007. In the worst-case scenario, prices would skyrocket, forcing industrial gas users out of business, threatening the economy, and fueling a political firestorm. It's an ugly picture, no matter how you look at it.

Fortunately, significant new gas sources-and not just from Alaska-are opening up. The catch, of course, is that most of these sources are much further away than Alaska's North Slope. They're in places like Indonesia, Qatar, and Russia. And the only practical way to transport gas across such distances is to liquefy it, ship it in LNG tankers, and offload it at regasification terminals.

Not long ago, liquefied natural gas (LNG) was considered too expensive for the U.S. market. But technology advances have reduced the costs of producing LNG, and the price of gas in the United States has risen to the point that now LNG can compete alongside domestic natural gas. As a result, billions of investment dollars are flowing into LNG infrastructure to serve the U.S. market ().

Getting that infrastructure built, however, is proving to be anything but easy.

Site Snags

Siting LNG facilities is fundamentally difficult because numerous factors must converge to make a location usable. LNG regasification plants must be located at tanker-friendly seaports near a major gas pipeline. Yet they also need a lot of elbow room for safety and security reasons, which further narrows the list of appropriate locations.

Siting and permitting can be a drawn-out process, because this country has little experience with these facilities. Only four major LNG regasification terminals are operating in the United States today, so regulators may not be fully prepared to deal with a flurry of new applications. And disputes over state versus federal jurisdiction might cause further difficulties ().

As if these issues weren't challenging enough, the LNG industry suffered a serious setback recently when an LNG liquefaction plant in Algeria exploded. Although the cause of the tragedy is still being investigated (), the incident has added fuel to the fire of local opposition.

recently discussed siting issues with Tony Marsh, a managing director with the marine and energy division of Marsh USA Inc. in Houston; Amos Aviden, a principal vice president with Bechtel; Robert Ineson, a director with Cambridge Energy Research Associates (CERA); Jim Trifon, managing consultant with Wood Mackenzie; and Jacob Dweck, a partner and head of the LNG group at Sutherland Asbill & Brennan LLP.

Fortnightly: What are the biggest siting difficulties facing LNG facilities?

Tony Mayer, managing director, Marsh USA Inc.: NIMBY (not in my backyard) is a real stumbling block. No one wants a major LNG terminal near their industrial facility, or certainly near a residential area.

We've seen hydrocarbon incidents happen before. These are extremely volatile substances, and if they are not treated safely you have the potential for a tremendous explosion that could have far-reaching, third-party effects. That is the nature of the beast.

The main issue is the proximity of one facility to another, and the potential for an event to spread. The doomsday scenario would be for an incident to spread to an entire shipping terminal, and strain emergency resources.

Fortnightly: But is LNG fundamentally more dangerous than other petroleum or chemical substances, which we've become accustomed to living with every day?

Tony Mayer: They have different issues. With a crude-oil tanker the big issue is a pollution spill, and with an LNG tanker you don't have that risk. But you do have explosive potential. Like many petrochemical and refining facilities, care must be taken with LNG in terms of overall security.

Robert Ineson, director, Cambridge Energy Research Associates (CERA): LNG by itself doesn't burn. You need a mixture of gas and oxygen, in a narrow range, for it to burn. I have seen fires with these things. One is called a pool fire, which almost looks like you have a combustible thing floating on a liquid. How dangerous it is depends on how big the pool is. Many of the safety measures are intended to reduce the surface area of the fuel. If there is a leak, only a small area is exposed to the atmosphere.

Then there is concern about gas clouds. As it warms it will evaporate, and a gas cloud is potentially dangerous.2

One thing not commonly appreciated is that the natural gas infrastructure in this country is everywhere. Pipelines are all over the place, and we've become accustomed to them. LNG is just natural gas in another form, and some of the things that we haul around in trucks are more dangerous.

Fortnightly: Why, then, is it facing such strong local opposition? And how should companies respond to that opposition?

Amos Aviden, principal vice president, Bechtel: There are legitimate and not-legitimate perceptions about the risks involved with LNG. I believe LNG is very safe, and it has an outstanding safety record. But in places where LNG terminals are not acceptable to the public at large, they will face a battle.

Robert Ineson: Any hydrocarbon has some danger associated with it. You take steps to manage it adequately, and 40 years of experience with LNG has been instructive in understanding what measures must be taken. One thing companies do is to look for an exclusion zone with a large swath of land around it, so if gas vapor escapes and catches fire or explodes, there would be no one to be hurt by it. The other approach is containment, where you build a concrete bunker around it to contain gas leaks.

The largest concentration of LNG regasification terminals in the world is in Tokyo, a very densely populated city. They are familiar with it and have gotten accustomed to it. But there will be places where people are just not going to be able to get past the safety issue.

Jim Trifon, managing consultant, Wood Mackenzie: There are a number of issues a developer has to look at when siting a plant. Is the port big enough? How does it relate to the pipeline infrastructure? Can the site handle this facility? Where is it in relation to the population?

Exxon Mobil is putting the Mobile Bay [Ala.] project on the back burner. The local folks don't want it, and the company has determined it's not worth fighting for. The site has a variety of concerns.

Amos Aviden: Another class of terminals is proposed for offshore sites. No offshore receiving terminals yet exist for LNG, but similar terminals do exist for crude oil, LP gas, and other products. The technology and operations on the marine side are similar, and they should be just as safe and reliable as onshore terminals. But they tend to be more expensive.

Mayer: Major NIMBY issues are avoided when you site the facility offshore. There is still the potential for an explosion, but it would be some distance offshore.

Fortnightly: Will the explosion at Skikda, Algeria, set back LNG project development in this country?

Jim Trifon: We don't think it's going to be a very big roadblock. It will, however, be part of the various roadblocks that the industry will have to overcome through education, etc. We just need to get people used to seeing LNG come in on tankers.

Jacob Dweck, partner and head of the LNG group at Sutherland Asbill & Brennan LLP: Because projects are subject to both public and government scrutiny, and because authorities are trying to create a framework to account for all reasonable risks, attention appropriately focuses on all sorts of incidents, including the tragedy at Skikda. In order to properly assess the impact of the Skikda event for any site or proposal, we need to understand what happened and why. The incident should be given a thorough investigation and analysis. It's important that we do not turn the incident into a symbol of the risks posed by LNG, or conversely, dismiss it out of hand as an accident that can only occur at an old and operationally deficient facility. Only then can we learn the lessons that it has to teach us in assessing new facility proposals in the United States.

Fortnightly: What about permitting? Are developers facing a permitting quagmire?

Dweck: The federal government is continuing to adopt policies that make LNG more available, such as fast-track certification processes, and through the recognition that offshore facilities require a different, and possibly less stringent, permitting regime. The [Federal Energy Regulatory Commission] has recognized that regulating LNG facilities the same way that you regulate pipelines is not a feasible way to attract capital.3

Show Me the Money

The economics of LNG constrains financing options. Gas infrastructure in general, and LNG facilities in particular, are highly capital-intensive projects, requiring years to develop. Before investing in production and liquefaction, gas producers typically want their output committed under long-term contract.

On the other hand, the U.S. gas industry has evolved into a highly liquid trading market. In such a market, long-term contracts are considered an expensive way to secure gas supplies.

In the midst of this apparent dilemma, LNG project developers have a limited number of financing options available-and they all involve lots of equity, or at least a set of firm, long-term contracts with creditworthy companies.

Within these limitations, developers are getting creative about how to structure their projects. To discuss these approaches, Fortnightly interviewed Keith Meyer, president of Cheniere LNG; Darcel Hulse, president of Sempra Energy LNG Corp.; Otto Granli, vice president for Atlantic Basin LNG with Statoil in Norway; and Rob Bryngleson, vice president with Excelerate Energy LLC. Ineson of CERA and Dweck of Sutherland, Asbill & Brennan added their observations as well.

Fortnightly: How are LNG regasification plants and tankers being financed in the face of the apparent economic mismatch? Must projects have a gas producer as an equity stakeholder, as seems to be the case for most advanced projects?

Keith M. Meyer, president, Cheniere LNG: We own a 30 percent interest in the Freeport, Texas, facility. Most of the capacity is now subscribed by Dow Chemical and Phillips. We expect to have a significant foundation customer for each of our projects, and it's logical that the customer would be a large party with equity gas … that is, with its own product to bring to market. We'd welcome that, but it's not a requirement.

Darcel Hulse, president, Sempra Energy LNG Corp.: We will use our internal cash flows to finance construction of our facilities. The projects are structured so they can be debt-financed, but we don't need that financing in place to construct the plants.

Sempra does not have any production. With these plants, we will take gas and market it in North America for those who don't have a marketing presence. Or, for those entities that have marketing capabilities, we offer a service that is purely capacity in our facility, much like capacity in a pipeline.

Otto Granli, vice president for Atlantic Basin LNG, Statoil: The financing issue may vary from country to country. In Norway, we finance our infrastructure on our balance sheet, so it's not project financed. That is the cheapest way for companies with the necessary credit to finance such projects. But it depends on what partners you have, and what country you are in.

In the United States you have a liquid market, and as long as you are able to deliver and sell gas according to the terms and conditions of that market, you just assess that risk compared to your alternative outlets. This is not a problem for the industry as a whole, but it could be a problem for companies that can't support their obligations with the necessary credit rating.

Rob Bryngleson, vice president, Excelerate Energy LLC: Our project is all equity financed. We are backed by George Kaiser, owner of Kaiser Francis Oil Co. in Tulsa. The facilities are on the record as costing between $60 million and $65 million for the buoy, riser, platform, and subsea pipe. The cost of the tanker ships hasn't been disclosed, but it's pretty much the market price, with some additional equipment onboard.

Fortnightly: What would help to bring more flexibility to financing options?

Robert Ineson, CERA: The whole idea of merchant capacity is feasible, and it makes sense if you've got supply lined up before you begin construction. That's what you do in the merchant role. There will be a strong driving force toward a more liquid market.

The term "take-or-pay" causes an involuntary shudder. We are still facing the reality that most public utility commissions are reluctant to go along with long-term contracts. They feel they've been burned by them in the past, and they are now extremely wary. And if regulators are wary, utilities are concerned about being second-guessed.4

Meyer, Cheniere Energy: What I would like to see is for some of the larger industry customers and utilities in this country to take their future into their own hands a little more with LNG, and to directly contract for terminal capacity. In so doing, they would have access to all the world's supply, as opposed to just the supply from the company that took the terminal capacity.

When Dow stepped in and took the terminal capacity at Freeport, we had a lot of calls from large industrials that were interested in how they could participate in some of that capacity. We expect to see more interest in long-term access to LNG supplies.

Fortnightly: Will this ultimately evolve into a more liquid market for LNG?

Dweck: Certain folks in this industry say this is a production-destination type of business, which leaves little room for a spot market. But my view is that in time there will be enough vessels built, and there will be enough capacity in the United States that you will have more spot cargoes coming in.

There are some constraints on the development of a spot market. The whole notion of a value chain suggests linking liquefaction capability and trapped gas abroad with a home regasification facility, because so much money is tied up.

But to have a spot market you don't need 50 percent of the market. You need 5 or 10 percent to impact the way the commodity is sold. I see that evolving in time.

Meyer: I see global arbitrage happening, and more shipping options are opening up. There is a spot market, but not to a great extent. You have some spot capacity at all of the U.S. terminals, and there are volumes out there for that. In fact, a lot of the volume going into Lake Charles has been spot. But you won't see it being a major part of the LNG trade.

Granli: NYMEX is a liquid market, and as long as you are able to deliver and sell gas according to the terms and conditions of NYMEX, you can assess the risks of that market against your alternative outlets. This is not a problem if you have the credit rating necessary to support your performance in the market. Of course, there is a big difference between prices in the United States and other markets, where LNG is sold on terms related to other energy sources in those markets.

Statoil already is marketing gas in the United States from Trinidad and Algeria, through Cove Point. We have control of the entire chain, and we are in the markets for the long run. We will bring in equity gas from Snø?vit (Statoil's 190-bcm gas field under development in the Barents Sea) beginning in 2006, and that is a comfort to long-term buyers. This is the basis for our presence in the United States, and the way we will approach supplying the U.S. market in the future.

Gaining Momentum

Clearly numerous issues complicate LNG development in America, but powerful forces are marshaling to make it happen. Politicians and regulators, spurred by the prospect of a potential energy crisis, seem increasingly interested in paving the way for LNG projects. Oil and gas majors, eager to supply the demands of a growing economy, are poised to absorb much of the market-price risk. And entrepreneurial players are getting increasingly creative about facility design and siting.

Over time, as LNG capacity increases, arbitrage markets will evolve. Gas supplies will be diverted to locations of greatest need, allowing LNG to help correct supply-and-demand dislocations in many places around the world.

At that point LNG will emerge as more than a bit player on the global energy stage; it will begin to fulfill a vital role in balancing energy markets and providing a flexible option for companies' energy supply portfolios.

Endnotes

  1. Balancing Natural Gas Policy-Fueling the Demands of a Growing Economy (2003), National Petroleum Council, http://www.npc.org/reports/ng.html
  2. The great-granddaddy of all LNG accidents occurred in 1944 in Cleveland, when an LNG spill caused a giant gas cloud that exploded, destroying numerous buildings and killing 128 people.
  3. In teragency Agreement Among the Federal Energy Regulatory Commission, the United States Coast Guard and Research and Special Programs Administration for the Safety and Security Review of Waterfront Import/Export Liquefied Natural Gas Facilities, http://www.ferc.gov/industries/gas/indus-act/LNG-Safety-Agreement.pdf.
  4. According to W. Robert Keating, commissioner with the Massachusetts Department of Telecommunications & Energy, the NARUC Gas Committee is considering whether to issue a set of LNG policy recommendations for state regulators-including how to treat long-term contracts for LNG from a ratemaking perspective.

Liquid Assets

LNG developers are living in exciting times. Investment opportunities are burgeoning, but projects face an array of challenges.

"LNG has real potential to play a more significant role in this country's future energy mix," says W. Robert Keating, a commissioner with the Massachusetts Department of Telecommunications & Energy, and chairman of the National Association of Regulatory Utility Commissioners (NARUC) Gas Committee.

"It appears very competitive, and whether you are a regulated entity or not, you're going to have to pay serious attention to it."

Keating contributed to last year's National Petroleum Commission (NPC) study that projected LNG imports would grow to supply 14 percent to 17 percent of U.S. gas demand by the year 2025, up from 1 percent in 2003. Making this happen will require tens of billions of dollars to be invested in LNG infrastructure.

"We will need 10 to 12 import terminals by 2010, with 10 to 12 Bcf per day of capacity," says Darcel Hulse, president of Sempra Energy LNG Corp. in San Diego. Sempra estimates that between $5 billion and $14 billion will be invested in North American regasification facilities through 2010. At last count, 46 proposed LNG terminals were in various stages of development around North America, from the Pacific Coast to the Caribbean. Only about one-fourth of them actually will be needed, so developers are racing to get their projects permitted and financed first (). Projects fall into three main categories:

Regasification capacity represents only one part of the LNG value chain. When all the links are included, from exploration through regasification, 1 Bcf/day of LNG capacity requires about $4.5 billion to $6 billion in total capital investment (). Much of that investment already has been made, particularly at the exploration and production end of the chain. But gas producers are making major new investments in liquefaction plants and LNG tankers to serve the U.S. market's growing demand.

Demand Destruction

Investors that are pouring money into LNG capacity are counting on U.S. gas prices remaining fairly high-in the $4 to $5 range, generally speaking. While all the pertinent studies support these expectations, three key wild cards affect the LNG opportunity.

First is the 4.5 bcf/day pipeline being developed to bring Alaskan North Shelf gas to the lower 48 states. Theoretically, this pipeline would reduce the supply-demand gap in 2010 by about 40 percent. But some analysts see the pipeline stabilizing the long-term opportunity for LNG in the United States, and vice-versa.

"We don't see an exclusivity between LNG and the pipeline," says Robert Ineson, a director in CERA's North American natural gas practice. "There is a bit of irony here, but your downside risk is reduced if you have built a large LNG base, because your gas supply is easily transportable. You have a larger market and it's more efficient for everyone." In short, increasing U.S. access to global gas sources would tend to reduce price volatility in the market generally. This would protect prices in the United States from falling too far, because if they did then LNG tankers would be diverted to more lucrative markets. This might put pressure on some terminals in the short term, but in the long term it would allow greater stability in U.S. gas prices.

The second wild card is the phenomenon known as demand destruction. In other words, demand for gas is destroyed when consumers stop using gas for whatever reason. Industrial users that rely on natural gas as feedstock are particularly important.

"High gas prices could drive those industries offshore," says Darcel Hulse, president of Sempra Energy LNG Corp. "In the short term they can ride it out, but if prices stay high for a sustained period, those industries will move closer to gas sources, and they will ship finished products from overseas."

Industrial consumers are most vulnerable to gas price shocks, and in general the U.S. industrial sector has been shrinking. Indeed, demand destruction is more than a theory of what might happen. It already has happened, and to what degree it will continue remains uncertain.

"A lot of the industrial demand that would be sensitive to gas prices has already been affected," Ineson says. "We have seen significant reductions in industrial demand since it peaked in 1996, and although there are nuances in each industry, continued migration offshore would be consistent with what we've seen."

Third, demand among the other major industrial gas consumers-power generators-will depend in part on how regulators view long-term LNG supply contracts in their ratemaking decisions."We need the support of the regulatory commissions and distribution companies so that all parties can benefit," says Keith Meyer, president of Cheniere LNG in Houston. "There is an opportunity today for large utilities in this country, but that opportunity will disappear if we don't keep the gas industry healthy. If we don't address the shortfall on the supply side, the demand side will fix it for us."

For their part, regulators seem to perceive the problem and are moving to correct it. The NARUC Gas Committee expects to address the issue of long-term contracts for LNG during its proceedings this year, with a possible set of policy recommendations to follow.

"Regulators need to look at LNG as part of the total fuel mix," says Donald L. Mason, a commissioner with the Public Utilities Commission of Ohio. "Sourcing LNG is similar to any other contract. If you are locking in prices similar to what indexed prices are showing, then it's a prudent decision. Right now, the numbers show that LNG provides a good alternative source of gas supply." -M.T.B.

Disaster in Algeria

When Unit 40 of the Skikda gas liquefaction plant exploded, the shockwave began a chain reaction that detonated two adjacent units, leveled nearby administrative buildings and shattered windows more than a mile away. More than 27 workers were killed, and dozens more were injured-many apparently as a result of inadequate emergency systems and procedures. Unit 40 itself suffered chronic technical problems due to design defects, according to a spokesman for Kellogg Brown & Root (KBR). KBR revamped three of the units at Skikda in the late 1990s, but not Unit 40, which was supposed to be shut down.

The dead were scarcely buried before activists began using the Skikda incident to illustrate LNG's hazards-despite the fact that the same explosion could not have happened at a modern regasification facility, which would not use a steam boiler like the one that exploded at Skikda.

"A liquefaction factory is much more complicated than a receiving and regasification terminal," says Otto Granli, vice president for Atlantic Basin LNG with Statoil in Norway. "The risks connected to a regasification terminal are not comparable with the liquefaction side. But we realize that incidents like this will scare people."

In response to such fears, developers are stepping up their public-education campaigns. Shell US Gas & Power, for example, launched a Web site with a streaming video program addressing LNG safety and security (http://www.shell-usgp.com/lngsasmain.asp).

Regulators also are reviewing safety considerations and studying the Skikda incident. In January the Federal Energy Regulatory Commission (FERC) offered its assistance to Algerian officials investigating the explosion at Skikda, but Algeria hadn't responded at press time in early March. Additionally, in February FERC entered an interagency agreement with the U.S. Coast Guard and the Department of Transportation to coordinate review of safety and security issues at LNG import terminals. -M.T.B.

FERC: A Preferred Venue?

The longstanding feud between state and federal authorities is heating up in the LNG industry. Developers of liquefied natural gas (LNG) terminals seeking a streamlined siting and permitting process-such as that being developed by Federal Energy Regulatory Commission (FERC) and other federal agencies-are encountering resistance from state regulators who don't want their jurisdiction usurped by the feds.

A current case involves an LNG terminal project at the Port of Long Beach in Southern California, being developed by Sound Energy Solutions (SES), a Mitsubishi subsidiary. The California Public Utilities Commission (CPUC) and the California Energy Commission (CEC) both filed motions to intervene in the project's application at FERC. (FERC Docket No. , filed Jan. 26, 2004)

"The CPUC informed SES … that SES was a public utility under California law," the CPUC motion states. "It would be necessary for [SES] to apply for a CPCN [certificate of public convenience and necessity] in order to operate its proposed LNG facility legally." Moreover, the CPUC states that SES must "apply for and receive" a CPCN before it begins construction. However, no such application was filed with the CPUC (as of press time), so in February, when SES filed for FERC's siting approval, the CPUC moved to intervene.

SES hasn't commented on the CPUC's assertions, but the commission's motion adopts a somewhat defensive stance regarding the efficiency and fairness of its permitting processes.

"The CPUC has an open mind on the issues and will consider all of the parties' positions in a hearing on SES's application," the motion states. And, "at the request of sponsors of proposed LNG projects along the West Coast, the CPUC set an expedited schedule so that the CPUC could issue a decision by the summer of 2004 on some of the main access issues."

FERC isn't commenting directly on the case. However, at a media briefing in early March, FERC Chairman Pat Wood noted that he spoke with CPUC Chairman Michael Peevey about his concerns in advance of the filing, but that FERC has a statutory obligation to examine the facility. "So stay tuned," he said.-M.T.B.

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