Japan first imported U.S. liquefied natural gas (“LNG”) from the Kenai facility in Alaska in 1969. Kenai is now mothballed and Alaska officials have asked ConocoPhillips to consider resuming exports. But the real story comes from the second-largest U.S. state: Texas, as well as its neighbor Louisiana. In both states, LNG facilities that were originally slated to bring gas into the U.S., but lost that opportunity after the shale revolution dramatically increased U.S. natural gas output, now seek a new lease on life as LNG export stations. Cheniere, Sempra LNG and Freeport LNG aim to bring their plants on the Texas and Louisiana coasts into commercial production starting 2016/2017, and could eventually export more than 40 million tonnes of LNG annually, making the U.S. one of the world’s largest suppliers of the fuel.
Japan’s Energy Dilemma
These new LNG supplies are music to the ears of Japanese power plant operators as the country continues to struggle with radiation leaks and other problems at the Fukushima power plant damaged by the March 2011 tsunami. As of September 15, 2013 Japan had shut down its entire nuclear reactor fleet, which formerly produced 30 percent of the country’s electricity. LNG demand has risen substantially as a result. Now, Japanese power companies must sometimes pay as much as $20 per million BTU for LNG imports – around twice the cost of delivering gas from the U.S. Gulf Coast – because there are no other energy sources large enough to quickly replace lost nuclear power.
Japan has enough coal-fired power generation capacity to power more than 6 million homes during peak summer demand, but there won’t be any more large coal plants coming online until 2023 and the country must also power a massive industrial and commercial sector and keep electricity prices low enough for Japanese businesses to stay competitive in the global market. This leaves expanding gas-fired generation capacity and burning more LNG as the only viable large-scale options to keep the lights on and the economy humming.
Indeed, Japanese power companies are on pace to consume around 90 million tonnes of LNG in 2013, which will likely account for approximately one third of global demand. To help secure LNG for this massive market, Japanese investors are scouring the globe. They are even looking at projects such as Novatek’s Yamal LNG development in northern Russia, despite the fact that when pack ice closes the Northern Russian sea route to LNG tankers, Yamal lies more than 25,000 km by sea from Japan. Japan’s leaders clearly realize that energy security comes in part from diversity of supply. But Japanese buyers also prefer to obtain LNG supplies from a stable region without pirates or terrorists, one where Japanese investors can buy gas reserves in the ground, and where LNG purchases will deepen already tight strategic and economic bonds with a vital ally.
This brings us from Tokyo to Texas and the Gulf of Mexico. The U.S. offers Japan a stable LNG source with a much more secure physical, economic and political environment than any other Asia-focused global LNG exporter. American LNG supply potential grows out of a number of geological, geographic and legal/regulatory advantages.
First, the U.S. has world-class unconventional gas reserves that were proven and demarcated during the 2008-2011 phase of the shale revolution. Second, it has dozens of sophisticated producers who, if the market looks favorable, can quickly ramp up supply to support additional LNG projects beyond those already under construction. Third, producers enjoy access to a truly national gas pipeline grid that makes gas fungible and means that production increases anywhere in the U.S. can quickly be translated into greater exportable gas supplies. Fourth, the many underutilized U.S. LNG import terminals can be converted into liquefaction facilities at a much lower cost than building LNG export plants from scratch, as competitors in Australia and other areas must do.
Fifth and finally, the Panama Canal expansion will facilitate U.S. LNG trade with Japan and other Asian consumers. LNG exports from the U.S. can move through the expanded Panama Canal and either directly to Japan or to Singapore LNG’s trading hub, located only roughly a week’s sail from the Tokyo area. LNG cargoes were not previously carried through the Panama Canal, but the expanded Canal, slated to open in 2014, will be deep and wide enough to accommodate more than 85% of the existing and prospective global LNG tanker fleet, thus opening a new trade route between exporters in the Gulf of Mexico and Caribbean and the Asian market.
Japanese Buyers Sign Up
U.S. LNG exporters, who will begin putting gas to market in large-scale in 2016/2017, have already agreed to supply Japanese buyers with at least 7.4 million tonnes per year of LNG, equal to about 8.5% of the total LNG volume Japan is likely to burn in 2013. Tokyo Electric Power Co., one of Japan’s largest LNG consumers, committed in February 2013 to purchase 800,000 tonnes per year of LNG from the Cameron LNG project in Louisiana over a 20-year period beginning in 2017. In September 2013, Texas-based Freeport LNG signed an agreement with Toshiba to provide 2.2 million tonnes per year of LNG for 20 years. In conjunction with prior agreements of the same size signed with Osaka Gas and Chubu Electric Power Co., this means that Freeport has now committed to supply at least 6.6 million tonnes per year of LNG to Japan. Japanese purchases of U.S. LNG look set to increase substantially and the LNG volumes contracted for could double within a year, to 15 million tonnes per year.
The LNG from both Cameron and Freeport will be priced based on the Henry Hub benchmark. At the Henry Hub, many natural gas sources compete against each other on price. This “gas-on-gas” pricing is likely to offer a significant discount versus the traditional oil-linked pricing system other LNG exporters use for sales into Japan. Indeed, Japanese energy advisors believe importing LNG from the U.S. can shave billions of dollars off the country’s fuel import bill each year.
So what does this emerging Texas-to-Tokyo energy axis potentially mean for the global LNG market? Perhaps the most profound influence comes on the pricing front. U.S. cargoes will be priced based on Henry Hub prices, where gas from different sources competes for buyers. LNG suppliers such as Qatar, Australia and Indonesia, by contrast, typically price their gas through contracts that use crude oil prices as a reference point. In contrast to the oil price-based LNG contracts, Henry Hub features gas prices that, in per BTU terms, have been much lower than those for crude oil over the past several years.
Having substantial LNG supplies from the U.S. available to Asian consumers will effectively inject the lower U.S. natural gas price into the global LNG market. By 2025, global LNG demand could exceed 400 million tonnes, and more than 10% of the LNG supply fulfilling this demand could come from the U.S., which would mean U.S. LNG could exert significant effects on global LNG pricing structures. If Japanese (and to a lesser extent, Korean) LNG buyers continue seeking gas-on-gas pricing in new LNG supply contracts, the emergence of U.S. supplies will exert a disproportional effect on LNG pricing in many important emerging gas markets, especially China, where consumers may increasingly seek gas-linked, rather than oil-linked, pricing on future import deals for both pipeline gas and LNG.
In addition, substantial volumes of U.S. LNG will likely be sold into the short-term and spot markets. This means additional liquidity that, if combined with flexible new LNG trading models such as Singapore’s, could catalyze the emergence of a much more flexible global LNG market that helps keep prices lower and facilitates greater use of clean-burning gas in Asia and other growing markets.
For Japan, the bottom line is that U.S. LNG supplies can provide a stable and affordable energy source that not only enhances Japan’s energy security, but tightens the economic and strategic bonds between two vital Asian allies. The U.S. for several years was de-linked from the nascent global gas market because the shale revolution exploded, U.S. demand for LNG imports dried up and there was no export infrastructure to move surplus U.S. gas into the world market. This state of affairs is changing rapidly, and Japan is first in line to benefit.
Japanese power companies and U.S. oilmen are forging a trans-Pacific energy partnership whose primary constraint in the years to come will be whether the U.S. decides to use more of its surplus gas domestically for manufacturing and chemical production or instead decides to export it as LNG. The emerging LNG relationship also lays the foundation for Japan to purchase U.S. crude oil if Washington eventually allows oil exports alongside the gas exports it has already approved.
Traditionally, the U.S.-Japan relationship has been about national security and trade. Now, with the ability of U.S. LNG suppliers to help underwrite Japan’s long-term energy supply security, a critical new dimension has been added.