Forbes Article

‘It was the best of times; it was the worst of times’ – never a truer word spoken for the gas industry. Whilst Chesapeake is fighting for its life in the US, spot gas prices are reaching all-time highs in Asia. In this ‘Tale of Two Cities’ you’ll get $2/MMBtu in New York (Henry Hub) and around $20/MMBtu in Singapore (Asian spot). The divorce between the Atlantic Basin and Pacific Basin couldn’t be any starker – the question is whether these spreads will incrementally narrow under inexorable laws of economics, or whether politics will throw a spanner in the works. Depending on how you answer this ‘convergence question’ will have dramatic implications for hydrocarbon asset prices in the years to come. Not to mention the contours of international energy relations.

‘Convergence’ makes most sense for the US of course – Chesapeake’s foibles merely mask a structural problem for American gas players; they are selling their gas for a pittance in the US when they could be making an absolute killing overseas, roughly to the tune of $1bn spreads a day in Asia. Whatever the economic merits of keeping ‘US gas for US consumers’ improving balance of payments, fast tracking coal to gas for emissions, as far as gas players are concerned, it’s still a damp squib. Great, they’ll get $5/MMBtu rather than $2/MMBtu with some unfortunate mothballing / defaults in between. Not exactly the giddy heights of Asian LNG.

        Doha's Double Hedge         Matthew HulbertContributor

        How Much Is Chesapeake Energy Really Worth?         Christopher HelmanForbes Staff

        New US Sub-Prime: Putting A Price On 'Chesapeake' Gas         Matthew HulbertContributor

Unfortunately for the US energy independence faithful, this is exactly what oil majors are eying for America – and it was Royal Dutch Shell that just let the cat out of the bag. Shell made things quite clear; if it was staying in the US, it means wets, it means looking at gas to liquids, but most of all, means LNG. Wheels have already been put in motion further north in Canada, where Shell, PetroChina, Kogas and Mitsubishi are lining up 12mt/y exports from British Colombia for Asian markets. That follows export licenses already agreed for British outfit, BG Group, and Apache through Kitimat LNG as well as the Alaskan North Slope plumping for LNG to monetise its 35tcf of proven reserves. Canada has no doubt that selling stranded to Asia is the only option it has on the table; it literally couldn’t give its gas away to the US if it tried.

The same penny is dropping in America. BG Group led the way with Sabine Pass off-take; Execlerate have tabled separate plans to build floating LNG plants off the Gulf Coast, while FERC has around 125bcm/y of LNG applications awaiting approval. ‘National flags’ don’t come into the equation, especially when you consider that Exxon Mobil already sells two-thirds of its products overseas; Conocco has been leading the charge to ship 10 million tons a year out of Freeport LNG. Assuming market consolidation is on the cards, US shale provides the perfect prize for cash-rich IOCs to capture: sign up low cost US supplies and sell then into very high value Asian markets, and do so off their own balance sheets. Sit on the acreage; aggressively lobby for LNG exports; pocket the difference. By way of lucrative footnote, domestic acreage is also coming in useful for international swap agreements overseas – call it Exxon-Rosneft 101.

The spanner in the works is political risk of course; how much gas will Washington allow to leave its shores? A couple of years ago you’d have said not much, but the fact the EIA has just downgraded recoverable shale reserves from 827tcf in 2011 to 482tcf in 2012 tells you all need to know. If the US wants to maintain its shale revolution, it badly needs prices to firm to make fields economically viable. LNG exports are a good way of doing that, at least to around $4-7Mmbtu. With some careful positioning, Washington could claim a political victory in the process; maintain the health of US shale (and American jobs) by making a virtue out of LNG export necessity. As far as US Energy Inc. is concerned, LNG isn’t a case of ‘if’, but when, how much and what pricing methods to use. 40 to 50 million tons a year by 2020 should be more than doable. That would make America the third largest LNG player in the world behind Qatar and Australia.

Europe will watch the debate with considerable interest – not just because the likes of BG Group have a 34% stake in total US LNG export capacity being developed, but because European hub prices currently sit mid-way between the US and Asia. European spot market liquidity has held up reasonably well thanks to Qatari supplies, but Doha is increasingly looking East, a dynamic that could leave Europe with its more traditional Russian, North Sea and North African pipeline mix. If American LNG doesn’t come good, North West European liquidity will dry up quicker than most think – with potentially serious price and dependency implications. Europe will inevitably fail to develop its shale reserves, not unless the states in question happen to be perched on the Russian border. Little wonder serious forecasts already think Europe will end up importing more US LNG by 2020 than it manages to frack in its own backyard.

This 2020 ‘lead time’ is important for  Europe, not just because it’s going to take some time for US LNG trains to gather speed, but because the first wave of exports will predominantly go to Asia. Japan has been in the headlines post-Fukushima boosting short term demand, but the real prize remains China. Gas demand has been going up 5% year on year, while LNG shot up 31% once China’s fifth import terminal went online. That’s closely followed by India where LNG remains a strategic priority given the impossibility of getting pipelines into Delhi via Pakistan or Afghanistan. Although both nations are actively developing domestic shale reserves, (China has earmarked no less than 30bcm capacity), America should have little problem taking Asian market share, particularly if it provides greater flexibility on take or pay contracts to hedge long term price risk.

Indeed, the mere prospect of US LNG is Asia is already creating major problems for Middle East and Russian players trying to sell gas (LNG or pipeline) on an oil indexed basis. Australia is in no better shape; despite headline figures of 80mt/y of LNG by 2018 (i.e. the world leader), cost inflation is rife and coal bed plays are looking more costly to develop than originally thought. International players are still investing in Australia (ironically as a double hedge against US LNG flopping), but given that Australian LNG docks into Asian ports for around $17-$18MM/Btu, any softening of prices could leave current (and prospective) LNG projects in the red.

That might sound problematic for future supply prospects, but it’s also extremely interesting when we consider that Chenerie’s Sabine Pass output will be sold into South Korea at $8/MMBtu. Sure, Chenerie is more desperate than most to secure long term supply contracts to ease domestic credit constraints give its junk status (CCC+), but it actually took its pricing cue in Asia from deals brokered by BG Group. The ‘general’ formula is to set a minimal $3/MMBtu (i.e. Henry Hub) capacity leasing charge as default payment if gas isn’t lifted, with a 115% mark up to bridge differentials on actual deliveries. Obviously it’s very early doors to call a decoupling of international gas prices from oil (Japanese Crude Cocktail (JCC)) in Asia towards ‘Shanghai Spot’ for gas in China, but at the very least, we can expect the likes of Qatar, Russia, Australia (and even Canada) to be more flexible on contractual terms / oil indexation if they want to secure Asian markets and stymie a Pacific Basin price war. It’s either that or they’ll hold out on sales, and hope US LNG doesn’t pan out. When the market gets razor tight, get Asian governments to sign on the oil indexation line.

Fair enough, traditional producers are probably safe to assume that bigger American beasts won’t be nearly as generous as Cheniere have been on terms, but if further US developments such as Cove Point, Lake Charles or Jordan Cove retain even notional links to underlying Henry Hub prices (plus mark-ups), then traditional oil indexation pricing methods could be in deep trouble. Long term contracts remain crucial for getting stuff built, but pricing references within them would be far more dynamic. It could also mean more LNG capacity is reserved to feed genuine spot markets rather than the 10-15% typically used in developments today.

No one is saying this equates to international gas price parity just yet – not by a country mile; the spreads between US domestic prices and Asian spot will remain huge. But the logic of any global commodity market is to develop a single price rule across vast geographical locations. Physical assets go from low price markets to high yield plays – over time, arbitrage does it work: You end up with price parity. That’s probably why BG Group isn’t particularly bothered about being so flexible over take or pay clauses on long term contracts. If Asia eventually ends up oversupplied, whatever BG fails to sell in the East, it will get similar prices for on European hubs, and perhaps even one day, in New York.

As scary as that might sound, given that anything up to 250mt/y of LNG might make its way onto global markets over the next twenty years from every point on the compass – Nigeria, Indonesia, Israel, PNG, Mozambique, Equatorial Guinea – you name it, now would seem a good time to organise the gas world on global gas fundamentals. The next five to ten years will largely determine which direction we’re heading, but liquid markets are good for fungibility, they are good for supply and good diversity of sources. And it’s US LNG that could tip the balance towards those interests.

        Doha's Double Hedge         Matthew HulbertContributor

        How Much Is Chesapeake Energy Really Worth?         Christopher HelmanForbes Staff

        New US Sub-Prime: Putting A Price On 'Chesapeake' Gas         Matthew HulbertContributor

Traditional petro-state would be put on the back foot; gas would finally break its oil indexation shackles, new market designs would development. US deliveries would also help to put the transatlantic energy relationship back on track for the more market minded, at least once the ‘hidden hand’ has done what it should do first; let US majors make loads of money in Asia before things globally level out. American natural gas has the potential to change the world – the only question that remains, is whether US politicians will let glorious global convergence play out.