(UtiliPoint - Mar. 26)

By Ken Silverstein Director, Energy Industry Analysis

The debate over constructing liquefied natural gas plants in California and elsewhere has caused an explosive reaction. The divisive nature of the subject prompted Calpine Corp. to pull out of a deal. And it has pit federal regulators against state authorities. Despite the angst, such imports are expected to play a role not just in California but also in the United States and the rest of the world in the coming decades.

With the demand for natural gas expected to outstrip domestic supplies and new reserves being discovered globally, liquefied natural gas (LNG) will become more prominent. At the right price, that fuel source can be transported here so that producers can earn adequate returns. BG, for example, has made much headway in this area—a fact noted by Commerzbank. It says the oil giant's 11 percent earnings growth projections are attributed partly to its LNG operation that it describes as “nimble and farsighted.”

“We want to make sure if there are safety challenges we preemptively and proactively address them and at the same time build public confidence,” says Energy Secretary Spencer Abraham, at a recent forum on LNG.

LNG cools natural gas to a temperature of minus 260 degrees Fahrenheit until it becomes liquid and occupies 1/600 of its gaseous volume. Large tankers are then used to ship the LNG to major markets. It now accounts for five percent of the world's gas consumption and the biggest exporters are Indonesia, Algeria and Malaysia while Japan is the largest importer of the fuel source. Oil executives have predicted that LNG will surpass petroleum as the world's main fuel source by 2025 and will make up 20-25 percent of the total gas demand in the United States. That's compared to one percent today. It's no wonder then that 30 LNG terminals are currently at various stages of development in North America.

The discussion over LNG is now driven by two factors: potential returns and safety considerations. The latter is what has lately dominated the news. Calpine said it backed out of building a plant in Eureka, Calif., because the local community and its leaders were adamantly opposed. It said it values community relations and didn't want to operate under such conditions. The same debate is now occurring in Fall River, Mass. The fear that those communities have is linked to a recent explosion at a LNG facility in Algeria that killed 23 people.

Still, the Department of Energy says that the United States wants to import more LNG from Indonesia and Australia to the West Coast. It's necessary, the DOE says, because of pipeline constraints and natural gas production limitations. The West Coast is therefore an “optimal” location for more LNG facilities. The tone of the discussion has risen to the national level, as the Federal Energy Regulatory Commission issued an order on Wednesday that said siting and construction of LNG import terminals rests exclusively with the federal government—a claim that the California Public Utilities Commission has challenged.

“We acknowledge the legitimate concerns of the CPUC regarding matters of safety and security and give our assurances that the evaluation of the proposed project will include thorough and rigorous review of these issues,” FERC wrote.

Terrorist Threat

So, economics is now colliding with security concerns, particularly from terrorists. But developers say that the threat is overplayed. Concern has spread because citizens fear that the ships to transport the fuel source would become targets or that the LNG would escape and then congeal above their neighborhoods. But some experts say that LNG vapor is lighter than air and not the same potential hazard as petroleum-based products. Meanwhile, the carriers that transport the fuel are durable and tough.

If regulators and developers are able to overcome public doubts, then the extent to which it will be used as a fuel source depends on the returns that producers earn as well as the rigors of the permitting processes. It takes about a $3.50-$4.00 per MMBtu natural-gas market price to support development of LNG assets. Current natural gas prices exceed $5 per MMBtu. Because the costs tied to LNG are high, it will take long-term contracts to ensure that they get built. That's the word from Algeria's minister of energy, who said recently that the spot market does not provide sufficient guarantees to invest the capital needed for LNG projects.

The risks are apparent but the drumbeat for LNG continues. Qatar just announced what it says will be the world's largest LNG processing plant. It will produce 4.7 million tonnes per annum with India expected to be the primary patron.

Similarly, El Paso Corp. is developing an offshore technique that will eliminate the need for land-based terminals to take liquid forms of gas and turn them back into vapor. The liquid will be transported by ship to a point offshore, where special onboard facilities would regasify it. A mooring buoy would link the ship to an underwater pipeline for transportation to shore. El Paso is developing an offshore system to eliminate concerns over environmental issues and possible terrorism, both of which are often objections to land-based terminals. Still, that project and other similar ones have met with opposition from environmentalists and others who say they could hurt marine eco-systems and be the cause of dangerous explosions.

"LNG could go a long way to satisfying this country's demand for natural gas," says Jack Harrington, a partner with Fulbright & Jaworski in Washington, D.C., who is working on a number of LNG projects. "To get there, existing terminals must be reactivated or expanded and there must also be new construction." Land-based facilities are proven safe, he adds, although he finds El Paso's concept "attractive." Ship-based terminals, though, have no LNG track record and may take longer to develop because the engineering period may be drawn out.

Center Stage

Producers are eager to find new markets for their gas that is not going to local markets. But to bring this idea to fruition, more capital is needed. And investors want some assurances. The field has attracted major companies including ExxonMobil, ChevronTexaco, Shell Gas and Power, BP and Sempra Energy. At least $100 billion in new investment is needed over the next decade, says Shell Gas and Power.

If the permitting process remains thorough but is quickened, then many of the proposed plants could get built. At the same time, the current price of natural gas probably can't be sustained but it is unlikely that such costs will dip below the threshold at which LNG would become uneconomical, experts say. If those prices did, however, that would harm the effort to boost LNG imports. The long-term trend, however, is toward greater use of natural gas to fire electric generation. And the supplies and the infrastructure to get natural gas there are tight. That's why LNG has taken center stage.

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