ThE council oF sTaTE govErnmEnTs

FEB 2013

CAPITOL rEsEarch
energy & environment

Liquefied Natural Gas and the Great Export Debate

The abundance of domestic natural gas in the United States at historically low prices presents policymakers, regulators and advocacy organizations with a new challenge: Should this resource be exported to other high-priced foreign markets or should it be protected and used as a strategic asset for energyintensive industries? Proponents of exporting liquefied natural gas tout the benefits of reducing the nations trade deficit and the substantial amount of construction and operations jobs associated with a terminal facility. Further, they contend the currently low domestic price and large supplies of gas sitting in storage act as a disincentive for future gas production. Supporters of increased exports argue that however imperfect the free-market may be to some specific industries or constituencies it ultimately is a better allocator of resources that will bring the most widespread economic benefits to consumers. Some in industries dependent on natural gas for their manufacturing processes consider the notion of exporting domestic energy sources unwise and even dangerous. Others suggest it could diminish the expansion of natural gas as an alternative transportation fuel, and believe increased exports will lead to more environmental degradation or will exacerbate problems associated with increased greenhouse gas emissions. A long-awaited report issued in December 2012 by the U.S. Department of Energy found the U.S. was projected to gain net economic benefits from allowing LNG (liquefied natural gas) exports, but it has not quelled the ongoing debate from detractors that worry about sending more natural gas overseas.1 State policymakers should expect to see increasing interest from Congress and advocacy organizations as the queue for export projects under consideration by the Department of Energy expands.

U.S. Natural Gas Pricing Basics and Liquefaction

The Council of State Governments

The natural gas industry is highly competitive and involves thousands of producers, local distribution companies, marketers, industrial consumers, electric utilities and interstate pipeline companies. With so many different types of buyers and sellers involved,

investors often use options to sell natural gas on the spot marketa market for buying or selling commodities or foreign exchange for immediate delivery and for cash paymentor through long-term contracts, which are offered to customers by marketers. These contracts also can involve financial instruments like hedging to avoid unexpected price spikes or future shortages to minimize economic losses. The most active and highly traded point for natural gas is the Henry Hub, located in Erath, La., which is connected to more than a dozen intrastate and interstate pipelines that connect energy to markets across the country. The Henry Hub also serves as the delivery point for futures contracts traded on the New York Mercantile Stock ExchangeNYMEXwhich effectively makes it the natural gas pricing center for North America. Buyers and sellers actively trade contracts on the spot market every day, which requires a certain amount of gas to be delivered on an agreed upon date. Futures trading, which is done on the NYMEX exchange, requires the seller to deliver and a buyer to physically receive gas at a contractually agreed upon price in a specified future month at the Henry Hub with a delivery price determined under the contract.2 The rapid expansion of natural gas development from shale formations through increased usage of hydraulic fracturing and horizontal drilling has had major implications for domestic supply and markets. According to the Energy Information Administrations 2013 Annual Energy Outlook, natural gas production is expected to increase by 44 percent to 33
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trillion cubic feet by 2040; with nearly all the increase attributable to shale gas.3 Like many other commodities, natural gas prices are significantly impacted by economic growth, which can spur consumption and supply and demand factors including seasonal energy usage during peak winter and summer months for heating or cooling. Prices for natural gas in the U.S. historically have been very volatile, especially in a period of high demand. During the aftermath of hurricanes Katrina and Rita that ravaged the energy infrastructure of the country in 2005, prices reached $16 per million British thermal units in the U.S. spot market.4 By comparison, the Henry Hub price on April 20, 2012, was $1.82 per million British thermal units. The prospect of the United States being a potential exporter of liquefied natural gas is a new phenomenon. As recently as 2009, the Energy Information Administration predicted that the U.S. would be dependent on foreign sources for natural gas supplies for decades. The vast majorityroughly 94 percentof natural gas exported in the U.S. is currently done so via pipeline.5 In order to move large quantities of natural gas in an efficient manner suitable for overseas markets, the natural gas must be converted into a liquid state or liquefied natural gas (LNG) through a process called liquefaction. Once the gas has been cooled to extremely low temperaturesat -260 degrees Fahrenheitit reduces the volume to 1/600th, thereby allowing tremendous amounts of storage on specially designed ocean vessels or tankers. These vessels arrive at regasification terminals where the natural gas is transformed back into a gaseous state and then moved through a pipeline distribution network to markets or placed in a storage facility.

sion for siting an LNG import or export terminal. The terminal must be deemed in the public interest and any authorized exports must be to a country where the U.S. has an existing free trade agreement. Exports to countries with free trade agreements are deemed in the public interest under the Natural Gas Act and approved applications are considered without modification or delay. All applications to countries without a free trade agreement require the DOE to post a notice of application in the federal register for public comments, protests and motions to intervene, and must include an evaluation to determine if it is consistent with the public interest. Additional federal agenciesincluding Homeland Security and Transportationplay an important oversight role in the design, operation and construction of a facility. The federal consultation process can be even more expansive through an evaluation under the National Environmental Policy Act to determine potential environmental impacts requiring formal documents like Environmental Impact Statements.7 States can exercise considerable regulatory control over LNG facilities through the Coastal Zone Management Act to determine if a project fits within its approved coastal management policies. Without a certification from the state where the facility is proposed that it does in fact concur with its coastal plan, the Federal Energy Regulatory Commission would not grant construction approval. Projects also must comply with a states water quality standards especially if there are discharges in navigable waters or discharges of dredged or fill material in addition to permitting requirements under the Clean Air Act.8 Natural gas prices outside the U.S., especially in Europe and Asia, are often indexed to the price of oil. Qatar, the worlds largest exporter of LNG and Russia, through its state-controlled entities like the natural gas giant Gazprom, prefers to tie customers to long-term export contracts indexed to the global price of oil, or Brent crude oil, which is often much more expensive than U.S. prices. As of Feb. 11, 2013, Brent crude oil futures settled at $118.13 a barrel while U.S. futures were $97.03 a barrel.9 Since 1960, the Gas Exporting Countries Forum has operated as a de facto version of OPEC, where members try to set supply and demand management fundamentals for global natural gas markets. The 13-member organizationwhich includes Algeria, Bolivia, Egypt, Equatorial Guinea, Iran, Libya, Nigeria, Oman, Qatar, Russia, Trinidad and Tobago, Venezuela and the United Arab Emiratescontrol more than 60 percent of worlds gas reserves.10 Critics of Russian President Vladimir Putin have expressed concern that his regime often uses its leverage as the largest natural gas supplier to Europe in a coercive fashion during energy price disputes. In a high-profile event that drew international condemnation, then-Prime Minister Putin directed Gazprom to shut off supplies to pipelines crossing Ukraine, which transport 80 percent of the gas used in Europe.11 According to an article in the The Wall

Economic and Global Policy Implications

Export Rules and Federal Regulations

The Natural Gas Act prohibits the importing or exporting of natural gas, including from or to a foreign country without receiving prior approval from the Department of Energy.6 The act also gives exclusive authority to the Federal Energy Regulatory Commis2

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Street Journal, Gazprom routinely charges European customers more than four times more than its Russian customers for its gas on top of the long-term contracts that must be signed.12 The large price differentials between domestic natural gas prices and global prices for natural gas, the potentially onerous contracts and practices of dominant gas exporting companies, and growing energy demand in Asia have piqued the interest of U.S. companies sitting on large supplies of gas to look for new strategic opportunities in overseas markets. Though the macroeconomic implications for exporting LNG are far from certain, one widely cited study conducted by the economic consultancy company ICF International estimated that one export facility alone could potentially reduce the U.S. trade imbalance by up to $7.1 billion a year and provide more than 14,000 job-years in long-term facility operation employment.13 Another highly publicized study by Michael Levi with the Council on Foreign Relations estimated that if additional U.S. spare natural gas capacityroughly 6 billion cubic feet per daywas exported, it would mean an additional $3.2 billion a year for the nations economy and 60,000 jobs.14 Thus far, the only facility to have received all its federal export permits is the Sabine Pass Liquefaction Project owned by Cheniere Energy Partners. Located in Cameron Parrish, La., the facility is estimated to move up to 800 billion cubic feet of gas per year for more than 20 years based on its current customer contracts. Ironically, the Sabine Pass project sits atop existing infrastructure originally planned for an LNG import facility. After Cheniere Energy spent billions for a site retrofit, the project is expected to begin operations in 2015.15 Despite the potential economic possibilities, there is no universal agreement that exporting natural gas will be the boon its supporters believe it can be after all the costs and regulatory steps are factored into the economic calculus. The most challenging factor to consider is the cyclical swings in natural gas market prices and shipping costs associated with LNG. Since U.S. natural gas prices reached its nadir in April 2012, prices have rebounded significantly, albeit at levels considered inexpensive compared to historic price trends. Further, the cheap U.S. price does not factor in the additional premiums added into export contracts for any gas that may be lost during the liquefaction process in addition to liquefaction fees at import terminals and shipping costs which can add an additional 85 cents to nearly $3.00 to the actual price of the gas depending if the cargo is headed to Europe or Asia.16 The federal permitting process also can cost more than $100 million and may take anywhere from 12 to 18 months to complete, and potential export facilities are extremely expensive to construct, with prices averaging roughly $7 billion.17

porting LNG has amplified an already intense public policy debate. Interest groups and energy policy experts alike were anxious for its publication as it could signal the direction the administration could take on existing projects awaiting regulatory approval. The study was largely positive about the benefits and impact exporting liquefied natural gas would have for the economy, stating, Across the scenarios, U.S. economic welfare consistently increases as the volume of natural gas exports increased. This includes scenarios in which there are unlimited exports. The reason for this is that even though domestic natural gas prices are pulled up by LNG (liquefied natural gas) exports, the value of those exports also rises so that there is a net gain for the U.S. economy measured by a broad metric of economic welfare or by more common measures such as real household income or real GDP (gross domestic product).18 Many industries using natural gas and their related trade associations were highly critical of the studys findings. The Industrial Energy Consumers of Americawhich includes a broad swath of companies in the fertilizer, steel, aluminum, chemicals and plastics industryissued a statement claiming the study used outdated demand assumptions and greatly underestimated the impact of increasing electricity prices that would result from increased exporting.19 Numerous energy-intensive industrial facilities across the country rely on natural gas as an essential building block and feedstock to produce a dizzying array of products, including steel, glass, paper, clothing, paints, fertilizer, plastics, antifreeze, dyes, photographic film,

Pushback from Industry, Environmental Groups and Congress

The publication of the Department of Energys long-awaited study on the economic effects of ex-

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medicines and explosives. The chemicals industry is enjoying a small renaissance with new facilities like the multi-billion dollar Shell Appalachian Petrochemical Project, located in the Marcellus Shale region of Pennsylvania largely because of ample supplies of relatively inexpensive natural gas. Typically, the largest cost for many of these types of industrial facilities is energy; with Chinese wages rising roughly 20 percent per year, some economic analysts are predicting it will be as economical to manufacture goods domestically as it will in China by 2015.20 For outspoken critics like Dow Chemical CEO Andrew Liveris, unfettered exporting of a finite and strategically valuable commodity like liquefied natural gas makes little sense. He was quoted in the Detroit Free Press during a February 2013 hearing before the Senate Energy and Natural Resources Committee as saying, America would sacrifice this once-in-a-generation opportunity. ... Its very easy to see why other nations want our gas. Whats harder to see is why wed be willing to (export most of it).21 Numerous environmental organizations have expressed their opposition to increased LNG exports, with well-known groups like the Sierra Club launching anti-export initiatives as part of their Beyond Natural Gas campaign. Although many individual groups have varying perspectives, their opposition to LNG exports generally stems from concerns that it would lead to increased natural gas drillingmost notably the process of hydraulic fracturingand the release of more greenhouse gases or air pollutants associated with the exploration process. In a November 2012 report critical of the federal regulatory process, the Sierra Club argued that the environmental impact with the physical construction of export facilities has been largely ignored. It stated, If DOE (the Department of Energy) does not change course, huge volumes of natural gas will be produced and exported without any consideration of how this massive

production increase will affect communities across the country.22 Congressional critics like the chairman of the Senate Energy and Natural Resources Committee, Sen. Ron Wyden of Oregon, have urged the federal government to slow down its consideration of granting additional approval for natural gas exports until the environmental and domestic economic ramifications are more fully understood. In a November 2012 press release, Wyden said the Natural Gas Acts automatic approval of exports to countries with free-trade agreements with the U.S. needs to be reconsidered. It could harm the nations ability to achieve energy independence, combat pollution and preserve the environment, and improve the economic competitiveness of American manufacturers, Wyden said.23 Massachusetts Congressman Ed Markey has expressed very strong objections to the conclusions of the Department of Energy study specifically and to exporting natural gas in general. In response to the studys findings he sent a letter to Energy Secretary Steven Chu stating, the minority of Americans with significant ownership stakes in natural gas productionthe wealthywill likely see benefits from exporting, while for the majority of Americans, higher energy bills and diminished job prospects means reduced economic well-being.24 There is evidence of potential correlation, according to the Energy Information Administration, federal estimates, that expanded natural gas exports could increase residential electricity prices between 2 to 3 percent and up to 7 percent for industrial customers, depending on the amounts and pace of gas that is exported.25 Despite the strong rhetoric from detractors, state leaders should recognize there is substantial bipartisan support in Congress for exporting LNG, with more than 100 members of the House of Representatives signing a January 2013 letter to Chu saying, In the wake of the DOE report and the realities of todays natural gas market, we believe now is the time to expand domestic exportation of LNG. We respectfully urge the Administration to advance without delay through comment period and toward approval of export permits to non-Free Trade Agreement (FTA) countries.26 A group of bipartisan senators also has introduced legislation that would extend the current preferential treatment for export projects to countries with free trade agreements to NATO allies and Japan to further cement energy security ties and reduce the influence of resource rich countries like Iran and Russia.27

Next steps

The federal government has at least 15 projects on its docket for consideration. If all were approved, it would total more than 29 billion cubic feet per day in natural gas exportsa prospect most energy and Wall Street analysts believe is highly unlikely considering the political and economic challenges that would arise with exporting approximately one-third of the nations domestic consumption. Following the issuance of the Department of Energys macroeconomic report, an initial public comment period
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was established that ended in late January 2013. A series of reply comments from the administration will be due at the end of February 2013 for each of the projects up for review. The Department of Energy has said it will act on each of the export projects at the end of the comment period on a case-by-case basis that have met the Federal Energy Regulatory Commissions pre-filing process, and its decisions will be based on the departments much-publicized economic study.

REFERENCES
1 Macroeconomic Impacts of LNG Exports from the United States. NERA Economic Consulting on behalf of the US Department of Energy. December 3, 2012, p. 1 http://www.fossil.energy.gov/programs/gasregulation/reports/nera_lng_report.pdf 2 Understanding Natural Gas Markets. American Petroleum Institute, November 2006, p. 19-20. http:// www.api.org/oil-and-natural-gas-overview/exploration-and-production/natural-gas/~/media/9D185 9A08BE44BBFAF5264148AE8ACF6.ashx 3 US Energy Information Administration, Annual Energy Outlook 2013 Early Release. December 5, 2012, p. 2 (Figure 3). 4 The Federal Energy Regulatory Commission, High Natural Gas Prices: The Basics. February 1, 2006, p. 2. http://www.ferc.gov/legal/staff-reports/high-gas-prices.pdf 5 Congressional Research Service, US Natural Gas Exports: New Opportunities, Uncertain Outcomes. Michael Ratner, Paul Parfomak, and Linda Luther. November 4, 2011, p. 5. http://www.fas.org/sgp/crs/misc/R42074.pdf 6 The Natural Gas Act, (15 U.S.C. 717b) http://fossil.energy.gov/programs/gasregulation/2011usc15.pdf 7 Ibid, p.12. 8 Federal Energy Regulatory Commission, State Rights in Authorization of LNG Facilities. June 28, 2010. http://ferc.gov/industries/gas/indus-act/lng/state-rights.asp 9 Brent Crude Settles Lower as Euro Zone Concerns Weigh. Reuters/CNBC, February 11, 2013. http://www.cnbc.com/id/100448958 10 Natural Gas Exporting Group Seeks Coordination on Pricing. Bloomberg, December 22, 2012. http:// www.bloomberg.com/news/2012-12-22/natural-gas-exporting-group-seeks-coordination-overpricing.html 11 Europeans Shiver as Russia Cuts Gas Shipments. NBC News, January 7, 2009. http://www.nbcnews.com/id/28515983/ 12 A New Foreign Policy for Gazprom. Andrew Peaple, Wall Street Journal. January 29, 2013. 13 Economic Impact Study of Construction and Operations -Dominion Cove Point LNG. ICF International, October 2011, p. 139-140. http://www.fossil.energy.gov/programs/gasregulation/authorizations/2011_applications/11-128-LNG.pdf 14 A Strategy for US Natural Gas Exports. Michael Levi, Council on Foreign Relation. June 2012, p.14. http://www.hamiltonproject.org/files/downloads_and_links/06_exports_levi.pdf 15 LNG Export Economics: A Look at Frontrunner Cheniere. Peter Kelly-Detwiler, Forbes. December 5, 2012. http://www.forbes.com/sites/peterdetwiler/2012/12/05/lng-export-economics-a-look-atfrontrunner-cheniere/ 16 Dont Be Surprised if U.S. Gas Export Profits Leak Away. Liam Denning, Wall Street Journal. August 12, 2012. http://online.wsj.com/article/SB10000872396390444900304577581360777564888.html 17 Exports of American Natural Gas May Fall Short of High Hopes. Clifford Krauss, New York Times. January 4, 2013. http://www.nytimes.com/2013/01/05/business/energy-environment/exports-of-usgas-may-fall-short-of-high-hopes.html?pagewanted=all&_r=0 18 Macroeconomic Impacts of LNG Exports from the United States. NERA Economic Consulting, p. 6. http://www.fossil.energy.gov/programs/gasregulation/reports/nera_lng_report.pdf 19 DOE NERA LNG Export Study Flawed. Industrial Energy Consumers of America press release, January 24, 2013. http://www.ieca-us.com/wp-content/uploads/01.24.13_DOE-NERA-LNG-Export-StudyPress-Release.pdf 20 As Chinese Wages Rise, US Manufacturers Head Back Home. David Conrads, Christian Science Monitor. May 10, 2012. http://www.csmonitor.com/Business/new-economy/2012/0510/As-Chinesewages-rise-US-manufacturers-head-back-home 21 Dow CEO Warns Congress About Exporting Too Much Liquefied Natural Gas. Todd Spangler, Detroit Free Press. February 12, 2013. http://www.freep.com/article/20130212/BUSINESS06/130212063/DowChemical-CEO-warns-Congress-about-exporting-too-much-liquefied-natural-gas 22 Look Before the LNG Leap. Craig Segall, Sierra Club Staff Attorney, p. 25. http://www.sierraclub.org/naturalgas/downloads/LOOK-BEFORE-YOU-LEAP.pdf 23 U.S. Senator Ron Wyden, press release. November 2, 2012. http://www.wyden.senate.gov/news/ press-releases/wyden-us-should-reconsider-rubber-stamping-lng-exports-as-part-of-a-21st-centuryenergy-policy

24 Congressman Ed Markey, Letter to Secretary Steven Chu. December 14, 2012. http://democrats. naturalresources.house.gov/sites/democrats.naturalresources.house.gov/files/documents/2012-12-14_ Chu_NERA.pdf 25 US Energy Information Administration, Effect of Increased Natural Gas Exports on Domestic Energy Markets. January 2012, p. 16. http://www.eia.gov/analysis/requests/fe/pdf/fe_lng.pdf 26 Letter to Secretary Steven Chu in support of LNG exports. January 23, 2013. http://billjohnson.house.gov/uploadedfiles/1-24-13_final_doe_nera_lng_letter.pdf 27 U.S. Senator John Barrasso, press release. January 31, 2013. http://barrasso.senate.gov/public/ index.cfm?FuseAction=PressOffice.PressReleases&ContentRecord_id=91e781a6-a662-3e05-2f6dbd5c549dbe3c

Brydon Ross, CSG Director of Energy & Environmental Policy | bross@csg.org

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Applications to Export Domestic Liquefied Natural Gas

Project Name sabine Pass liquefaction, llc Freeport lng Expansion, l.P. and Flng liquefaction, llc lake charles Exports, llc carib Energy (usa) llc Dominion cove Point lng, lP Jordan cove Energy Project, l.P. cameron lng, llc gulf coast lng Export, llc gulf lng liquefaction company, llc lng Development company, llc (oregon lng) sB Power solutions inc. southern lng company, l.l.c. Excelerate liquefaction solutions i, llc golden Pass Products llc cheniere marketing, llc main Pass Energy hub, llc cE Flng, llc Waller lng services, llc Pangea lng (north america) holdings, llc magnolia lng, llc Trunkline lng Export, llc gasfin Development usa, llc Total application amount

Location cameron Parrish, louisiana Freeport, Texas lake charles, louisiana gulf coast Texas, Florida calvert county, maryland coos Bay county, oregon cameron Parrish, louisiana Brownsville, Texas Pascagoula, mississippi Warrenton, oregon atlantic/gulf coast offshore vessels savannah, georgia calhoun county, Texas sabine Pass, Texas corpus christi, Texas offshore louisiana Plaquemines Parrish, louisiana cameron Parrish, louisiana ingleside, Texas lake charles, louisiana lake charles, louisiana cameron Parrish, louisiana

Quantity of Gas (billion cubic feet/ day) 2.2 Bcf/d 1.4 Bcf/d 2.0 Bcf/d "0.03 Bcf/d: FTa 0.01 Bcf/d: non-FTa 1.0 Bcf/d "1.2 Bcf/d: FTa 0.8 Bcf/d: non-FTa 1.7 Bcf/d 2.8 Bcf/d 1.5 Bcf/d 1.25 Bcf/d 0.07 Bcf/d 0.5 Bcf/d 1.38 Bcf/d 2.6 Bcf/d 2.1 Bcf/d 3.22 Bcf/d 1.07 Bcf/d 0.16 Bcf/d 1.09 Bcf/d 0.54 Bcf/d 2.0 Bcf/d 0.2 Bcf/d

FTA Application Status (a) approved approved approved approved approved approved approved approved approved approved approved approved approved approved approved approved approved approved approved Pending approval Pending approval Pending approval 29.41 Bcf/d

Non-FTA Application Status (b) approved under review under review under review under review under review under review under review under review under review n/a under review under review under review under review n/a under review n/a under review n/a n/a n/a 24.80 Bcf/d

Source: Department of Energy (As of January 11, 2013) http://www.fossil.energy.gov/programs/gasregulation/reports/summary_lng_applications.pdf (a) FTA= Applications to export to Free Trade Agreement countries (b) Non-FTA= Applications to non-Free Trade Agreement countries

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