The prospect of LNG exports from the US has been cause for both excitement and nervous anticipation in Asia, but the scenario is really far from a foregone conclusion, according to a special report from the Economist Intelligence Unit (EIU). The spanner in the works: Gas prices in the US, which have plummeted to well below the mark at which shale-gas drilling is profitable.
Most shale-gas producers, says the EIU in the report titled Independence Day, require prices of at least US$5/mBtu in order to break even in existing, low-cost plays. In new and less productive plays, the break-even price is higher--at around US$8/mBtu. Since March 2010, US gas spot prices have languished below the US$5 threshold, with the exception of a brief moment in June 2011. In other words, nearly all "dry" gas production--that is, at wells not bearing natural gas liquids (NGLs)--has been unprofitable for more than two years.
The infusion of capital needed to sustain these loss-making endeavours has come in part from joint-venture partners that have bought out leases from the pioneers of the shale-gas dash. The rest have come from debt. An analysis by the US-based research firm Bernstein Research last year found that capital expenditures on land acquisition and new drilling exceeded cashflow among 18 of the top shale-gas producers.
As a whole, the US gas industry is now taking on US$40 billion in new debt each year just to maintain current output, according to Arthur Berman, a gas expert. The Chief Executive of ExxonMobil, Rex Tillerson, put it succinctly when he told an audience at the Council on Foreign Relations, a New York-based think tank: "We are all losing our shirts today (on natural gas). We're making no money. It's all in the red."
The result is that the US oil and gas drilling industry has turned upside down. Producers focused on "dry" gas plays have become increasingly debt-laden, while those who hold leases in "wet" plays (formations rich in NGLs) have moved their rigs as quickly as possible to these more lucrative areas. In 2008, just as the shale boom was getting under way in earnest, 20 percent of rigs were drilling for oil and 80 percent were extracting gas. The reverse is true today.
On top of that, there is a demand-side logic that points to a lull in the expansion of shale-gas drilling. Domestic US gas demand, while growing, has lagged production substantially. Nearly all new demand is from the electricity sector, where the capacity to switch from coal to gas at will is limited. Construction of new gas-fired power plants, while happening, will take years.
Exporting LNG can remove some of the current glut of US gas--and allow firms to benefit from the US$14/mBtu that Asia is paying. But quite how much remains to be seen. Regulatory approval for the construction of LNG export facilities has not come easily, hindered by fears that exports would raise US gas prices due to convergence with overseas markets.
The economics are likely to get worse before they get better. As producers shift to wet plays, a glut of NGLs is emerging, leading to a sharp drop in prices. More fundamentally, US gas prices cannot be expected to stay below the cost of production, which is where they are now. For this reason, the EIU expects the market to go through a period of rebalancing. Low prices will lead to a dip in gas production by 2013. Tighter supply will in turn stimulate price rises, encouraging a pick-up in production. This will eventually create an excess of gas that could be sold overseas.
Whether US policymakers will be keen to export much of the country's supply of still relatively cheap gas is moot. It seems likely that the US will be shipping only a fairly modest amount of LNG, even in the latter years of this decade.
Asia will need to wait.
This is a partial summary of Independence Day: A Special Report on North America's Oil and Gas Boom, from the Economist Intelligence Unit (EIU). An independent business within The Economist Group, EIU also produces regular reports on the "liveability", and cost of living, of the world's major cities.