Made in America - the economic impact of LNG exports from the United States


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Made in America - the economic impact of LNG exports from the United States

  1. 1. Made in America The economic impact of LNG exports from the United States A report by the Deloitte Center for Energy Solutions and Deloitte MarketPoint LLCDeloitte Center for Energy Solutions
  2. 2. Contents 1 Executive summary 4 Overview of Deloitte MarketPoint Reference Case 8 Potential impact of LNG exports 11 Responses to raised concerns about LNG exports2
  3. 3. Deloitte MarketPoint applied its integratedNorth American Power, Coal, and World GasModel to analyze the price and quantity impactsof LNG exports on the U.S. gas market. Given themodel’s assumptions, the World Gas Model projectsa weighted-average price impact of $0.12/MMBtuon U.S. prices from 2016 to 2035 as a result of the6 Bcfd of LNG exports. The $0.12/MMBtu increaserepresents a 1.7% increase in the projected averageU.S. citygate gas price of $7.09/MMBtu over thistime period. The projected impact on Henry Hubprice is $0.22/MMBtu, significantly higher thanthe national average because of its close proximityto the prospective export terminals. The projectedprice impacts diminish with distance away from theGulf. Distant market areas’ projected price impactsare less than $0.10/MMBtu. Focusing solely on theHenry Hub or regional prices around the exportterminals will greatly overstate the total impact onU.S. consumers.The results show that the North American gasmarket is dynamic. If exports can be anticipated,then producers, midstream players, and consumerscan act to mitigate the price impact. Producers willbring more supplies online, flows will be adjusted,and consumers will react to price change resultingfrom LNG exports. Made in America The economic impact of LNG exports from the United States 3
  4. 4. Executive summaryDeloitte MarketPoint LLC (“DMP”) is pleased to provide anindependent assessment of the potential economic impactsof LNG exports from the United States. Exporters might Deloitte MarketPoint applied itsbenefit from selling to foreign buyers, but how would suchexports adversely impact domestic consumers of natural integrated North American Power,gas? Increased competition for supplies and acceleratedresource depletion will likely raise domestic prices, but Coal, and World Gas Model toby how much? Will the level of exports being considered analyze the price and quantityraise prices enough to cause economic damage as someobjectors contend? After all, natural gas is a depletable impacts of LNG exports on the U.S.resource, and what is exported is made unavailable todomestic uses. Under the assumptions outlined in this gas market.paper, we shall see that the magnitude of domestic priceincrease that results from export of natural gas in the formof LNG is likely quite small.Some arguments in support of or objecting to LNG Vital to this analysis, the WGM represents fundamentalexports center around whether there are adequate producer decisions regarding when and how much reservesresources to meet both domestic consumption and export to add given the producer’s resource endowments andvolumes. That is, does the U.S. need the gas for its own anticipated forward prices. This supply-demand dynamic isconsumption or does the U.S. possess sufficiently abundant particularly important in analyzing the impact of demandgas volumes to provide for both domestic consumption changes (e.g., LNG exports) because without it, the answerand exports? In our view, this question only begins to will likely greatly overestimate the impact of demandaddress the export issue because simple comparisons changes by not adequately considering supply dynamics.of total available domestic resources to projected future Indeed, producers will anticipate the export volumes andconsumption are insufficient to adequately analyze the resulting increased prices to make production decisionseconomic impact of LNG exports. We believe the real accordingly. LNG exporters might back up their multibillionissue is not only one of volume, but more of price impact. dollar projects with long-term domestic supply contracts, butIf price is not significantly affected, then scarcity and even if they do not, producers will anticipate and incorporateshortage of supply are not significant issues. the demand growth in their production decisions. Missing this supply-demand dynamic is tantamount to assumingDMP applied its integrated North American Power, Coal, the market will be surprised and unprepared for the volumeand World Gas Model (“WGM” or “Model”) to analyze the of exports and have to ration fixed supplies to meet theprice and quantity impacts of LNG exports on the U.S. gas required volumes. Static models assume a fixed supplymarket.1 The WGM projects monthly prices and quantities volume (i.e., productive capacity) during each time periodover a 30-year time horizon based on rigorous adherence to and therefore are prone to overestimate the price impact ofaccepted microeconomic theories. It includes disaggregated a demand change. Typically, users have to override this lackrepresentations of North America, Europe, and other major of supply response by manually adjusting supply to meetglobal markets. The WGM computes prices and quantities demand. Instead, the WGM uses sophisticated depletable 1 In this document, “LNG exports” refers to the volumesimultaneously across multiple markets and across multiple resource logic in which today’s drilling decisions affect of exports from the threetime points. Unlike many other models which compute prices tomorrow’s price, and tomorrow’s price affects today’s Gulf Coast terminals that haveand quantities assuming all parties work together to achieve drilling decisions. It captures the market dynamics between applied for a license to export LNG.a single global objective, the WGM applies fundamental suppliers and consumers.economic theories to represent self-interested decisions madeby each market “agent” along every stage of the supplychain. More information can be obtained from DMP.1
  5. 5. Shale gas production has grown tremendously over the Given the model’s assumptions, the WGM projects apast several years. However, there is considerable debate weighted-average price impact of $0.12 per million Britishas to how long this trend will continue and how much thermal units (MMBtu) on U.S. prices from 2016 to 2035will be produced out of each shale gas basin. Rather as a result of the 6 Bcfd of LNG exports. The $0.12/MMBtuthan simply extrapolating past trends, the WGM projects increase represents a 1.7% increase in the projectedproduction-based resource volumes and cost, future average U.S. citygate gas price of $7.09/MMBtu over thisgas demand, particularly for power generation, and time period. The projected impact on Henry Hub pricecompetition among various sources in each market area. is $0.22/MMBtu, significantly higher than the nationalIt computes incremental sources to meet a change in average because of its close proximity to the prospectivedemand and the resulting impact on price. export terminals. The projected price impacts diminish with distance away from the Gulf. Distant market areas’Based on our existing model and assumptions, which we projected price impacts are less than $0.10/MMBtu,will call the “Reference Case,” we developed a second such as the New York and Chicago areas. Focusing solelycase, which we will call the LNG Export Case, to assess on the Henry Hub or regional prices around the exportthe impact of LNG exports. Both cases are identical except terminals will greatly overstate the total impact on the U.S.for the LNG export volumes. In the LNG Export Case we consumers.represented 6 billion cubic feet per day (“Bcfd”) of LNGexports, approximately equal to the total volume of the The results show that the North American gas market isthree LNG export applications at Sabine Pass, Freeport, dynamic. If exports can be anticipated, and clearly theyand Lake Charles LNG terminals. Since the WGM already can with the public application process and long leadrepresented these import LNG terminals, we only had to time required to construct a LNG liquefaction plant, thenrepresent exports as incremental demands, each with a producers, midstream players, and consumers can actconstant of 2 Bcfd demand, near each of the terminals. to mitigate the price impact. Producers will bring moreComparing results of this second case to the Reference supplies online, flows will be adjusted, and consumers willCase, we projected how much the exports would increase react to price change resulting from LNG exports.domestic prices and affect production and flows.Given the model’s assumptions, the WGM projects aweighted-average price impact of $0.12/MMBtu onU.S. prices from 2016 to 2035. Made in America The economic impact of LNG exports from the United States 2
  6. 6. Gas prices in the Eastern U.S., historically the highest priced region in North America, could be dampened by incremental shale gas production within the region. Eastern bases to Henry Hub are projected to sink under the weight of surging gas production from the Marcellus Shale. The Marcellus Shale is projected to dominate the Mid-Atlantic natural gas market, including New York, New Jersey, and Pennsylvania, meeting most of the regional demand and pushing gas through to New England and even to South Atlantic markets. Pipelines built to transport gas supplies from distant producing regions — such as the Rockies and the Gulf Coast — to Northeastern U.S. gas markets may face stiff competition. The expected result is displacement of volumes from the Gulf which would depress prices in the Gulf region. Combined with the growing shale gas production out of Haynesville and Eagle Ford, the Gulf region is projected to continue to have plentiful production and remain one of the lowest cost regions in North America.3
  7. 7. Overview of Deloitte MarketPointReference CaseThe WGM Reference Case assumes a “business as usual”scenario including no new CO2 emission regulations forpower plants and no new regulations for hydrofrackingoperations in shale gas production. U.S. gas demandgrowth rates are consistent with the U.S. EnergyInformation Administration’s (“EIA”) Annual Energy Outlook(“AEO”) 2011 projection, except for power generationwhich is based on the DMP electricity model. (There is nointended advocacy or prediction of any events. Rather,we use these assumptions as a frame of reference. Theimpact of LNG exports could easily be tested against otherscenarios, but the overall results would be rather similar forreasons articulated later in this document.)In the Reference Case, natural gas prices are projected to Figure 1. Comparison between projected Henry Hub and NYMEX futures pricesrebound from current levels and continue to strengthen $12over the next two decades, although nominal prices do not WGM $10 projectionreturn to the peak levels of the mid-to-late 2000s until after2020. In real terms (i.e., constant 2011 dollars), benchmark $8 $/MMBtu (Nominal $)U.S. Henry Hub spot prices increase from an annual average $6 NYMEX futuresof $4.15 per MMBtu in 2011 to $6.00 per MMBtu in 2020, October 17, 2011 $4before rising to $7.16 per MMBtu in 2030 in the Reference $2Case. Our Henry Hub price forecast for 2011-2035 averages$6.23. Bear in mind that this is the Reference Case which $0 Jan-13 Sep-12 Sep-13 May-13 Sep-22 May-12 Sep-21 Sep-20 Jan-12 May-21 Sep-19 Jan-21 Sep-18 May-22 Sep-17 May-18 Jan-20 May-20 Jan-14 Jan-18 Jan-22 Jan-15 May-19 May-14 Jan-16 Jan-17 May-17 Sep-14 May-15 May-16 Jan-19 Sep-15 Sep-16includes no LNG exports. Henry Hub NYMEX (October 17)Escalating real prices by an annual inflation rate (estimatedat 2.0%2), yields nominal prices which can be compared toNYMEX futures prices. The WGM projection of monthlyHenry Hub prices is compared to NYMEX futures prices asof October 17, 2011 in Figure 1. Prices are shown in nominalterms (i.e., dollars of the day including inflation). Near-termprojections are fairly consistent, but in the longer term,projected prices from the WGM rise significantly higherthan the NYMEX futures prices. On an annual average, theprojected prices are a dollar higher than the NYMEX futuresprices in the longer term. 2 Average consumer price index over the past 10 years according to the Bureau of Labor Statistics. Made in America The economic impact of LNG exports from the United States 4
  8. 8. The WGM projects the U.S. power sector to increase by about 50%over the next decade, accounting for nearly all of the projected futuregrowth. Based on assumptions in the WGM, gas will become thefuel of choice for power generation.One possible reason why the WGM forecasts prices higher question of LNG export than if we had assumed a lowerthan market expectation (i.e., NYMEX futures) is because gas demand. The higher gas demand will push projectionthe WGM’s forecast of gas demand for power generation is of price and quantity impacts of LNG export to be moreconsiderably higher than the publicly available EIA forecast. “conservative.” However, the real issue is not the absoluteBased on our electricity model projections, we forecast price of exported gas, but rather the price impact resultingnatural gas consumption for electricity generation to drive from the LNG exports.North American natural gas demand higher during the nexttwo decades.As shown in Figure 2, the DMP projected gas demand Figure 2. Diverse projections of the U.S. gas demand for power generationfor U.S. power generation is far greater than the demand 30predicted by EIA’s AEO 2011, which essentially forecasts 25no change. The WGM projects the U.S. power sector toincrease by about 50% (approximately 10 Bcfd) over the 20next decade, accounting for nearly all of the projected 15 Bcfdfuture growth. Based upon assumptions in the WGM, 10gas will become the fuel of choice for power generationfor a variety of reasons, including: tightening application 5of existing environmental regulations for mercury, NOx, 0and SOx; expectations of ample domestic gas supply 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030at competitive gas prices; and the need to back up Deloitte MarketPoint projection EIA AEO 2011intermittent renewable sources such as wind and solar toensure reliability. Like the EIA’s AEO, our projection does notassume any new carbon legislation in the Reference Case. Figure 3. DMP North American representation North American Coal North American GasOur electricity model, fully integrated with our WGM and British Columbiacoal model, contains a detailed representation of the Western Canada Prarie Canada AlbertaNorth American electricity system including environmental British Columbia Saskatchewan E. Canadaemissions for key pollutants (CO2, SOx, NOx, and mercury). Northwest Fort Union HuntingdonKingsgate Monchy Emerson Ontario Eastern NE Canada NPRB Iroguois Pacific NWThe integrated structure of the models is shown in Figure 3. Green Northern Appalachia/ Pacific NW Rocky N. Great Plains Midwest Niagara Mid Atlantic River Basin SPRB Pittsburg#8 Mtns ENCThe electricity model projects electric generation capacity Uinta Basin N Cal WNC Mtn Appalachia Central Appalachia EOR Off-shoreaddition, dispatch and fuel burn based on competition PGE Anadarko Southwest/ San Juan Atlantic New Mexico So. Cal SCG Southern Appalachiaamong different types of power generators given a host SDGE ESC WSC S. Atlantic Permian Basinof factors including plant capacities, fuel price, heat Gulf Coast/TX Mexico Gulf Coastrates, variable costs, and environmental emissions costs.This integration captures global linkages and also inter- WECC Bri t Co l WECC NPCC NPCC Al b e rta Qu e b e c Ca n a d a Ea t s M APP Ca n a d a NPCCcommodity linkages. Integrating gas and electricity is NPCC On ta ri o NEPCOL WECC No rth e a s t MROvitally important because U.S. natural gas demand growth WECC NVPP No rth M o n ta n a M APP NEPOOL WECC M APP US -Ea s t So u th we s t Pa c NW US -We s t 3 4 WECC M AIN NVPP WUM ECAR We s t NVPP Id a h o M ic higan So u this expected to be driven almost entirely by the electricity WECC Wy o mi n g M AIN M AAC ECAR Western CIS and Eastern WECC M APP M AAC MAAC US -So u th NIL We s t Ea s t COB WECC N Ne v a d a MAIN ECAR M AAC Europe Europe Ea s t So u th WECC ECAR N CA M AIN We s tsector, which is predicted to grow at substantial rates. WECC Uta h SOM VACAR WECC Co l o ra do No rth SPP WECC No rth Ba y CA En te rg y VACAR TVA SPP No rth Ce n tra l Ea s t WECC WECC TVA 8 Ctrl CA S Ne v a d a No rth / So u th VACARHence, the WGM projection will be less favorable to the SPP WECC So u th So u th S CA WECC En te rg y TVA Ne w M e x i co Ari z o n a Ce n tra l We s t So u th e rn Pacifi c Ce m tra l So u th e rn Ea st ERCOT WECC No rtl a 6 CM B So u th e rn 7 We s t FRCC Rim and En te rg y ERCOT So u th We s t ERCOT FRCC No rth Ce n tra l ERCOT Gu l f Middle East Mainland Australia ERCOT FRCC 2 So u th ERCOT So u th Asia Four Latin Entitlement NOx SOx CO2 Hg America 5 Hubs Af rica NOx SOx CO2 Hg North American Electricity and Emissions World Gas Model5
  9. 9. Buffering the price impact of LNG exports is the large Figure 4. U.S. gas production by typedomestic resource base, particularly shale gas, which weproject to be an increasingly important component of 80domestic supply. As shown in Figure 4, the Reference Case 70projects shale gas production, particularly in the Marcellus 60Shale in Appalachia and the Haynesville Shale in Texas Production (Bcfd) 50and Louisiana, to grow and eventually become the largest 40component of domestic gas supply. Increasing U.S. shale 30gas output bolsters total domestic gas production, which 20grows from about 64 Bcfd in 2011 to almost 80 Bcfd in 102018 before tapering off. 0 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Non-shale gas Other shale South Texas Fayetteville Marcellus Haynesville BarnettThe projected growth in production from a large domesticresource base is a crucially important point. Many upstreamgas industry observers today believe that there is a verylarge quantity of gas available to be produced in the shale one particular geographic point, the entire eastern part ofregions of North America at a more or less constant price. the United States reorients production and flows and basisThis would imply that they also believe that natural gas differentials change substantially. Basis differentials aresupply is highly “elastic,” i.e., the supply curve is very flat. not fixed and invariant to LNG exports or other demand changes. On the contrary, basis differentials adjust to LNGGas production in Canada is projected to decline over volumes and help ensure economically efficient backfillthe next several years, reducing exports to the U.S. and and efficient prices. The advent of large quantities of shalecontinuing the recent slide in production out of the gas in heretofore nonproducing areas will cause the basisWestern Canadian Sedimentary Basin. However, Canadian to those areas to fall. The increased supply also will makeproduction is projected to ramp up in the later part of this more gas available for export and help mitigate the pricedecade with increased production out of the Horn River increases due to exports.and Montney shale gas plays in Western Canada. Furtherinto the future, the Mackenzie Delta pipeline may begin Most notably, gas prices in the Eastern U.S., historicallymaking available supplies from Northern Canada. Increased the highest priced region in North America, could beCanadian production makes more gas available for export dampened by incremental shale gas production withinto the U.S. The North American natural gas system is highly the region. Eastern bases to Henry Hub are projected tointegrated so Canadian supplies can generally access U.S. sink under the weight of surging gas production frommarkets when economic. This increase in available gas for the Marcellus Shale. The Marcellus Shale is projected toexport to the U.S. could be supplemented even more if the dominate the Mid-Atlantic natural gas market, includingAlaskan Gas Pipeline were to penetrate Alberta, but that New York, New Jersey, and Pennsylvania, meeting mostwould likely not happen within the time horizon of this of the regional demand and pushing gas through to Newscenario and is thus not considered. England and even to South Atlantic markets. Pipelines built to transport gas supplies from distant producing regions —Increasing production from major shale gas plays, many of such as the Rockies and the Gulf Coast — to Northeasternwhich are not located in traditional gas-producing areas, U.S. gas markets may face stiff competition. The expectedis projected to transform historical basis relationships result is displacement of volumes from the Gulf whichduring the next two decades. Varying rates of regional would depress prices in the Gulf region. Combined withgas demand growth, the advent of new natural gas the growing shale gas production out of Haynesville andinfrastructure, and evolving gas flows may also contribute Eagle Ford, the Gulf region is projected to continue to haveto changes in regional basis, though to a lesser degree. This plentiful production and remain one of the lowest costis a very important point as well. If LNG is exported from regions in North America. Made in America The economic impact of LNG exports from the United States 6
  10. 10. Given our basic assumptions, the WGM projects LNG exports will cause a volume weighted- average price impact of $0.12/MMBtu on U.S. citygate prices from 2016 to 2035 as a result of the assumed 6 Bcfd of LNG exports out of the three Gulf Coast terminals. The $0.12/ MMBtu increase represents a 1.7% increase in the projected average U.S. citygate gas price of $7.09/MMBtu over this time period. The projected increase in Henry Hub gas price is $0.22/MMBtu during this period. It is important to note the variation in price impact by location. The WGM projects that the impact at the Henry Hub will be much greater than the impact in other markets more distant from export terminals.7
  11. 11. Potential impact of LNG exportsGiven our basic assumptions, the WGM projects LNG By the time you move to downstream markets, such asexports will cause a volume weighted-average price Illinois, New York, and California, the projected priceimpact of $0.12/MMBtu on U.S. citygate prices from 2016 impact is generally about $0.10/MMBtu or less. If weto 2035 as a result of the assumed 6 Bcfd of LNG exports weight the price impact in each market by the volume ofout of the three Gulf Coast terminals. The $0.12/MMBtu gas demand, we can compute a weighted average priceincrease represents a 1.7% increase in the projected impact for the U.S. of $0.12/MMBtu.average U.S. citygate gas price of $7.09/MMBtu over thistime period. The projected increase in Henry Hub gas This analysis illustrates the interconnectivity of the Northprice is $0.22/MMBtu during this period. It is important to American system and the need to analyze not only Henrynote the variation in price impact by location. The WGM Hub and other price points near export terminals, butprojects that the impact at the Henry Hub will be much prices throughout the U.S. in order to fairly gauge thegreater than the impact in other markets more distant impacts from LNG exports. Analyses that focus just onfrom export terminals. Henry Hub prices will likely overstate the impact.To put the impact in perspective, Figure 5 shows the price Figure 5: Impact of LNG exports on average U.S. citygate gas pricesimpact on top of projected Reference Case U.S. averagecitygate prices over a 20-year period. The height of both $9.00bars represents the projected price with LNG exports. $8.00 $7.00The WGM’s projected price impact might not be as large $6.00as some might expect because that is not what they $5.00 $/MMBtuobserve in the short term. For example, even a 1 Bcfdincrease in demand during a peak winter day can cause $4.00spot prices to shoot up. $3.00 $2.00However, in this analysis we are considering long-term $1.00impacts, when changes in supply and demand canbe anticipated. Unlike short-term markets, in which $0.00 2016-20 2021-25 2026-30 2031-35 2016-35supply and demand are both largely fixed, both supplyand demand are far more elastic in the long term. Reference ImpactProducers can develop more reserves in anticipationof demand growth, such as LNG exports. Indeed, LNGexport projects will likely be backed by long-term supply Figure 6: Price impact varies by location (average 2016-35)contracts, as well as long-term contracts with buyers.There will be ample notice and time in advance of the $0.25exports to make supplies available. The price impact isthen determined by how supply costs will change as a $0.20result of more rapid depletion of domestic resources. $/MMBtu $0.15As previously stated, the projected impact of LNG exportson price varies by location, as shown in Figure 6. The price $0.10impact attenuates with distance from the LNG exportterminals. The impact is greatest at the Henry Hub, situated $0.05near all of the export terminals, about $0.22/MMBtu onaverage from 2016 to 2035. The impact at the Houston $0.00Ship Channel is nearly as much, about $0.20/MMBtu. Average U.S. Henry Hub Houston Ship Channel Illinois New York California Made in America The economic impact of LNG exports from the United States 8
  12. 12. Figure 7 shows the aggregate U.S. supply curve, including the price impact is fairly small. The massive shale gasAlaska and all types of gas formations, assumed in the resources have flattened the U.S. supply curve. It is theWGM. It plots the volumes of reserve additions available shape of the aggregate supply curve that really different all-in marginal capital costs, includingfinancing, return on equity, and taxes. The marginalcapital cost is equivalent to the wellhead price necessary Figure 7. Aggregrate U.S. natural gas supply curveto induce a level of investment required to bring theestimated volumes on line. The WGM includes over 100 $8.00different supply nodes representing the geographic $7.00and geologic diversity of domestic supply basins. Thesupply data is based on publicly available documents and Marginal Capital Cost ($/MMBtu) $6.00discussions with credible sources such as the United StatesGeological Survey, National Petroleum Council, Potential $5.00Gas Committee, and the Department of Energy’s EIA. $4.00The area of the supply curve that matters most is the $3.00section below $6/MMBtu of capital cost because $2.00wellhead prices are projected to fall under this level $1.00during most of the time horizon considered. These arethe volumes that are projected to be produced over the $0.00 0 200 400 600 800 1000 1200 1400 1600 1800next couple of decades. The Reference Case estimatesabout 1,200 trillion cubic feet (Tcf) available at wellhead Cumulative Reserve Additions (Tcf)prices below $6/MMBtu. To put the LNG export volumesinto proper perspective, it will accelerate depletion of thedomestic resource base, estimated to include about 1,200Tcf at prices below $6/MMBtu in all-in capital cost, by Figure 8: Impact of higher demand on price2.2 Tcf per year (equivalent to 6 Bcfd). Alternatively, the2.2 Tcf represents an increase in demand of about 8% $8.00to the projected demand of 26 Tcf by the time exports $7.00are assumed to commence in 2016. The point is not to Increased Marginal Capital Cost ($/MMBtu)downplay the export volume, but to put exports into $6.00 Demandperspective versus the overall available supply base. The $5.00results of this analysis demonstrate that the magnitude ofthe assumed total LNG exports is substantial on its own, $4.00 Price Impactbut not very significant relative to the entire U.S. resource $3.00base or total U.S. demand. $2.00In the WGM, supply and price are inextricably linked. $1.00With regard to the potential impact of LNG exports, theabsolute price is not the driving factor but rather the shape $0.00 0 200 400 600 800 1000 1200 1400 1600 1800of the aggregate supply curve which determines the priceimpact. Figure 8 depicts how demand increase affects Cumulative Reserve Additions (Tcf)price. Incremental demand pushes out the demand curve,causing it to intersect the supply curve at a higher point.Since the supply curve is fairly flat in the area of demand,9
  13. 13. If that is the case, leftward and rightward movements in Finally, there is a small increment, 1%, coming from LNGthe demand curve (where such leftward and rightward imports. Having both LNG imports and exports is notmovements would be volumes of LNG export) cut through necessarily contradictory since there is variation in pricethe supply curve at pretty much the same price. Flat, elastic by terminal (e.g., Everett terminal near Boston historicallysupply means that the price of domestic natural gas is has much higher prices than the Gulf terminals) and byincreasingly and continually determined by supply issues time. The WGM projects seasonal arbitrage of global(e.g., production cost). Given that there is a significant LNG flows. U.S. LNG imports are expected to be higherquantity of domestic gas available at modest production during summer periods as LNG shippers take advantagecosts, the export of 6 Bcfd of LNG should not significantly of plentiful storage capacity and large summer load forincrease the price of domestic gas because it should not power generation in the U.S. and weaken during thedramatically increase the production cost of domestic gas. winter when European and Asian demands peak.The projected sources of incremental supply used to meet An important point to bear in mind is that the Norththe assumed export volumes come from multiple sources, American natural gas market is highly integrated and allincluding domestic resources (both shale gas and non-shale segments will work together to mitigate price impacts ofgas), import volumes, and demand elasticity. As shown in demand changes.Figure 9, the bulk of the incremental volumes come fromshale gas production. Including non-shale gas production,the domestic production contributes 63% of the total Figure 9: Projected sources of incremental volumeincremental volume. Net pipeline imports, comprisedmostly of imports from Canada, contribute another 19%. Impact of LNG exportsHigher U.S. prices would be expected to induce greater 17%Canadian production, primarily from Horn River andMontney shale gas resources, making gas available forexport to the U.S. The U.S. net exports to Mexico decline 1%slightly as higher cost of U.S. supplies will prompt moreMexican production and reduce the need for U.S. exportsto Mexico. Higher gas prices are also projected to trigger 53%demand elasticity so less gas is consumed, representing 19%about 17% of the incremental volume. Most of thereduction in gas consumption comes from the powersector as higher gas prices incentivize greater utilization ofgenerators burning other types of fuels. 10% Shale production Non-shale production Net pipeline imports LNG imports Demand elasticity Made in America The economic impact of LNG exports from the United States 10
  14. 14. Responses to raised concernsabout LNG exports In response to LNG export applications to the DOE made component of domestic supply and prices will reflect by several entities to date, some concerns have been raised production costs. Higher shale gas production cost estimates regarding the viability of exports and the impact they may do not necessarily mean that shale gas will not be produced have on the U.S. gas market. The opposing arguments to because prices will tend to rise in order to sustain their LNG exports center around two main points: (i) allowing development. exports will cause U.S. gas prices to rise to levels equal to world gas prices, and (ii) exports should be prohibited in Another factor that will help maintain the growth in order to suppress domestic prices because suppressing shale gas development is the huge amount of capital domestic prices is good for employment and the U.S. that companies, particularly the majors, have poured into economy. These two main points have prompted parties acquiring shale gas acreage and developing fields. The to raise more specific concerns and questions which we capital expenditures represent sunk costs and lower the will address one at a time. Based on the WGM analysis marginal cost of future production. That is, the incremental conducted and based on our knowledge and experience, cost of production is lower because part of the total DMP provides the following observations in response to cost has already been paid. Some examples of major these concerns. expenditures are: Concern: Contribution of shale gas to U.S. market • ExxonMobil paid $34.9 billion to acquire XTO, which could be grossly overestimated. specialized in shale gas development, and later purchased DMP Analysis: Abundant shale gas resources and two small shale gas exploration companies (Bloomberg, commitment by energy majors to develop those June 9, 2011). reserves will likely ensure strong future growth of shale gas production. • Chevron acquired Atlas Energy Inc. and its 622,000 acres in the Marcellus Shale for $3.58 billion and subsequently Despite the rapid growth in shale gas production during the purchased additional acreage from smaller operators past several years, there is still some degree of skepticism (Bloomberg, May 4, 2011). about how long the trend will continue. The EIA forecasts shale gas will comprise 47% of total U.S. production in • Shell acquired East Resources for $4.7 billion to double its 2035, more than double the 23 percent share in 2011.3 reserves of shale gas (Bloomberg, May 28, 2010). Our Reference Case forecasts that shale gas will become the dominant domestic source, hitting 50% as early as 2020. • Statoil signed deals with Chesapeake and Talisman for There is little debate over the massive volumes of shale gas. shares in jointed development of shale gas plays with The debate is really over the production cost of shale gas. these companies (Reuters, October 10, 2010). Some have estimated massive volumes to be available at very low prices (under $4/MMBtu). The shale gas supply Not only are these investments large, but the arrival of curves in the WGM are less optimistic and represent diversity majors signals a new era in the development of shale gas. of shale gas plays, including some in “sweet spots” with very Unlike in the past when smaller independent companies low production costs, but more in higher cost areas. The worked shale gas fields in response to high prices, energy WGM supply curves were developed based on best available majors have the resources to remain committed to data and talking with leading supply experts from industry development through the vacillations of gas prices. They and governmental agencies. have staying power. Furthermore, they have the resources to invest in continued improvements of shale gas technologies The price forecast from the WGM based on the various and procedures. Their involvement will likely continue to3 EIA Annual Energy Outlook 2011 with Projections to 2035, assumptions reflects the long-run marginal cost of domestic drive down the cost of shale gas production, making more p.2. supplies and is higher in the long term than the current volumes available economically. forward price curves. Regardless of the exact share of total production, many expect shale gas to be an important11
  15. 15. Even if shale gas production does not reach the Figure 10: Impact of higher cost supply curveprojected levels because costs turn out to be higher than $8.00estimated, it does not necessarily mean that the impactof LNG exports would be much higher. Lower shale gas $7.00 Increasedproduction would likely be the result of the discovery of Demand Marginal Capital Cost ($/MMBtu) $6.00another, more economic, source of supply. Very important, Higher cost supplyit is the shape of the supply curve, rather than the absolute $5.00cost level, that determines the price impact. Figure 10 $4.00 Price Impactillustrates that simply having a higher supply cost estimate(i.e., shifting the supply curve up) does not necessarily $3.00imply a greater price impact from a demand change. $2.00Concern: High level of uncertainty that shale gas $1.00can be produced as modeled due to concerns $0.00including regulatory issues, access issues, and 0 200 400 600 800 1000 1200 1400 1600 1800environmental issues. Cumulative Reserve Additions (Tcf)DMP Analysis: Regulations will likely push bestpractices already adopted by leading companies andrestrict fracking in only the most sensitive areas.The U.S. EPA and a few states, primarily those without When employing best practices, hydrofracking operationspast history of large scale gas production, are examining have demonstrated to be safe and reliable. More stringenthydraulic fracturing (“fracking”) practices and considering regulations will most likely enforce adoption of bestnew regulations designed to ensure safe operations. practices in hydrofracking operations. As such, theyImprovements to fracking technology and its combined would not be expected to impose significant added costuse with horizontal drilling helped drive down the cost to those already employing best practices. If a ban onof shale gas production and turn it into an economic fracking is imposed, it is likely to be restricted to highlyresource. Fracking involves drilling a well and propagating sensitive areas, such as near sources of drinking water orfractures in the shale source rock by injecting large population centers. For example, New York’s Departmentamounts of fluid. The fluid is primarily water mixed of Environmental Conservation recently lifted a frackingwith sand and a small amount of chemicals. While ban on all but the most sensitive areas, leaving 85% of themost fracking operations have been performed without state’s Marcellus Shale open to drilling.4incident, some fear that accidental leakage of wastewater or uncontrolled fracturing might contaminate Furthermore, fracking regulations may likely be imposedgroundwater aquifers. Potential regulations might drive at a state level. Some major shale gas producing states,up the cost of hydrofracking or restrict areas for drilling. including Texas and Louisiana, have a long history of oil and gas production and may be unlikely to impose newAlthough tighter regulations might impose additional regulations on hydrofracking. These states have experiencedcost to shale gas development, it is unlikely that they an economic boom due to rapid growth in shale gaswould kill shale gas growth. The fracking process includes production in the Barnett, Haynesville, and Eagle Fordinstalling multiple layers of cement and casing to protect basins located in their states and are unlikely to restrictagainst leakage into groundwater and subsurface. future prospects with additional regulations. Therefore, 4 http://money.cnn.Furthermore, groundwater aquifers are typically located most shale gas operations are unlikely to be greatly affected com/2011/07/01/news/at much shallower depths than the production zone. by new fracking regulations. economy/fracking_new_york/ index.htm Made in America The economic impact of LNG exports from the United States 12