Global Natural Gas: Market in Transition The Impacts of U.S. LNG Exports

1. Global Natural Gas: Market in Transition The Impacts of U.S. LNG Exports Presentation to the Australian American Chamber of Commerce 6th Annual Energy Conference Kenneth B Medlock III James A Baker III and Susan G Baker Fellow in Energy and Resource Economics, and Senior Director, Center for Energy Studies, James A Baker III Institute for Public Policy Adjunct Professor, Department of Economics Rice University January 30, 2014 James A Baker III Institute for Public Policy Rice University

2. Natural Gas Demand • Baker Institute CES forecast of natural gas demand by country, 1992-2040 • An Asia-focused future? USA Saudi Arabia Russia Japan India China

3. International Price and the Incentive to Trade • Note change in regional price relationships post-March 2011? • Unexpected demand shocks have had an influence. • It is reasonable to expect the JKM premium will subside Price data from Platts; LNG Oil-Index author’s calculation

4. Shale Drives Change in the U.S. • Well-specific EURs can vary within a shale play substantially • Ultimately, profitability matters, as there is little debate about resource scale • Some wells are profitable at $2.65/mcf, others need $8.10… median is $4.85. EUR 2.83 bcf 1.51 bcf 0.93 bcf

5. Will there be growth in Foreign NCV Supply (Shale)? Maybe, but the US is Unique. • Stable and conducive regulatory and institutional frameworks. • Resource Access – mineral rights ownership; acreage acquisition; resource assessments; environmental opposition; etc. • Market Structure – transportation regulation (unbundled access vs. incumbent monopolies) and bilateral take-or-pay obligations vs. marketable rights; existence of infrastructure; pricing paradigms; etc. • Many other issues face shale development. • Water– use in production; water rights and management; flowback options (recycle and/or treatment and disposal) and native infrastructure; concerns about watershed protection (casing failures and fracture migration); etc. • Other issues – earthquakes related to injection of produced and treated water; long term effects of methane escape; concerns about contamination from produced water; ecological concerns over land use and reclamation; etc.

6. Understanding the Potential Impacts U.S. LNG Exports • Several factors are important to understanding the current international spot price in Asia, such as • short term deliverability constraints, • the effect of exports on markets abroad, and • the effect of more trade on the contracted market • US LNG exports will put significant pressure on international pricing paradigms. • In 2012, LNG trade was just over 30 bcfd. Filings exceed 30 bcfd, and approvals to non-FTA countries is over 6 bcfd. • Greater liquidity will alter the market in a substantial way. • Seeing benefits of low cost supply, EU is pushing for FTA recognition. This will pressure existing supply relationships, particularly in Central Europe.

7. One impact: changes in price volatility • Economic theory predicts the more fungible (or tradable) a commodity is, the lower its price volatility, all else equal. • Thus, LNG exports from the US could result in lower price volatility, both domestically and abroad. This will help facilitate demand growth.

8. US LNG and a Global Paradigm Shift • Export capacity will be built on the expectation that rents from arbitrage will “pay” for the fixed cost. • But, it is possible that some terminals will not earn the ex-ante required rate of return, contingent on the off-take agreement and who bears risk. • US LNG export capacity could be used for seasonal arbitrage. If seasonalprice differences among the regional markets are sufficient, US exports will be profitable during those periods. • LNG exports from the US will link global markets to storage in the US. Thus, liquidity will spill over and contribute to very different market paradigm.

9. Questions/Comments