U.S. LNG Export as a Source of Alternative Energy for Japan

By Anonymous

In class we studied how “FUD” (Public fear, uncertainty, and doubt) and regulatory bureaucracy can serve as impediments to opportunities for innovation such as Transatomic’s nuclear reactor. The same impediments can also serve as facilitators of alternative energy options for other nations.

It is an opportune time for the U.S. to export LNG to Japan because of the administration’s focus on job creation, low-carbon fuels, and balancing domestic production with demand. From Japan’s perspective, the threat of a recurring Fukushima nuclear disaster has been a source of public fear, which has caused the government to increase imported LNG. Due to Japan’s limited supply of domestic natural resources, it has been dependent on other nations to supply its energy needs. (See Exhibit 1) More than 95% of gas demand is from LNG imports. LNG remains an attractive source of energy to replace nuclear due to the Japanese government policy of reducing GHG emissions. However, a growing concern is the higher import costs of LNG from $9/MMbtu in 2011 to $16/MMbtu in 2012. Historically the LNG contracts have been linked to oil prices but more recent contracts have been more long-term in nature and linked to Henry Hub prices. The value proposition of the U.S. LNG contracts lies in the lower price relative to competitors and the transportation flexibility in helping utilities meet the uncertainty of demand.

Exhibit 1:

Exhibit 2:

While the economics of LNG export to Japan seem appealing for the U.S., several risks must be taken into account:

1) Regulatory Risk: There is a double obstacle to obtain the license to export LNG to Japan because it requires non-FTA export approval and FERC approval. As of August 28th, 2014, only nine companies have received both approvals in the last two years. Not only is FERC submission prohibitively expensive (>$100 million) but the non-FTA license is up to the discretion of the DOE depending on deemed commercial viability. The regulatory rules surrounding the approval process are also constantly being revised.

2) Environmental Risk: Many states have placed moratoriums on shale gas drilling due to concerns over impact of hydraulic fracturing on drinking water. The EPA is conducting a study on the actual environmental effects. Regardless of the outcomes, fracing will remain a politically charged issue that will weigh on policy makers’ decisions on exporting natural gas.

3) Price Risk: The DOE is studying the effects of LNG export on U.S. gas prices and economy. The results of the study will determine future approvals for non-FTA licenses. ICF has conducted a similar study and concluded positive impacts on the U.S. economy. (See Exhibit 3) While ICF estimates minimal increases in gas prices, the risk of gas prices dramatically increasing would have a detrimental effect on the U.S. economy. High gas prices will undermine the U.S. manufacturing advantage due to cheaper gas.

4) Geopolitical Risk: If Japan resumes operation of nuclear reactors again, LNG demand will drop. Also, increased competition from Russia, Qatar, and Australia could cause excess supply in the global markets. (See Exhibit 2) The competitors may increase domestic production causing prices to fall, reducing U.S. pricing advantage (JCC differentials with Henry Hub).

Exhibit 3:

 

Sources:

http://www.eia.gov/countries/cab.cfm?fips=CH

http://www.eia.gov/countries/cab.cfm?fips=JA

http://www.nytimes.com/2014/09/11/world/asia/japanese-nuclear-plant-declared-safe-to-operate-for-first-time-since-fukushima-daiichi-disaster.html?_r=0

http://www.ferc.gov/industries/gas/indus-act/lng.asp

http://www.api.org/policy-and-issues/policy-items/lng-exports/us-lng-exports-impacts-on-energy-markets-and-economy

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About macomberjohnd

HBS Finance faculty interested in sustainability in the built environment including devices, structures, townships, and cities.

4 Responses to “U.S. LNG Export as a Source of Alternative Energy for Japan”

  1. The points you raise regarding the risks of US LNG exports to Japan are interesting. I do agree that the LNG export situation with Japan poses some threats. But I have a slightly different take on the geopolitical and price risks raised:

    Regarding geopolitical risk, it would be interesting to explore whether any loss of demand from Japan could be compensated by demands from other regions. Europe is an obvious candidate for US natural gas given its need to move away from Russian supply in the current environment of economic sanctions.

    This leads me to your point on price risk, which I believe to be limited based on:

    i) the length of the regulatory process to gain non-FTA permission. Approvals from the DoE and the FERC must be obtained,

    ii) an LNG project takes around three years and is a very expensive proposition including huge upfront costs of building LNG terminals. Such hurdles, combined with the current regulatory uncertainty, should discourage many potential applicants for non-FTA export licenses,

    iii) the U.S. government is acutely aware of the opportunities arising from a large source of cheap energy at home – for the economy, for jobs and for energy independence.

    It seems that as the US government, I would be incentivized to maintain low gas prices.

  2. The premise here is a “geopolitical risk” that demand for LNG will decrease and that supply will increase, creating excess supply of natural gas in the market. I however do not think that situation is likely to materialize, at least not in the near term.

    While shale gas deposits continue to be discovered in new countries and technically recoverable resource estimates continue to grow, production of those resources has not substantially materialized. Many developers thought it would be easy to replicate the success of the US shale gas industry abroad, but there were several unique conditions that fostered that success that are hard to replicate e.g., favorable regulatory conditions, land right ownership structures, and availability of oilfield services. In addition, the geology in each region is different, and countries like China with huge natural gas deposits have found the technical challenges of extraction hard to overcome. As a result, supply will continue to be limited.

    Simultaneously, demand for natural gas continues to grow. In addition to Japan’s growing need, China plans to grow their natural gas consumption from 4% to 10% of total energy by 2020, while substantially increasing their demand base during that time. As Alex pointed out, Europe is also seeking new sources of natural gas as they diversify away from Russian sources.

    As a result, I think a gap between supply and demand for natural gas will remain in the short to medium term and, as the author stated, there is a huge opportunity for the US to fill that gap in demand with LNG exports.

  3. I wanted to add some more background information as fuel for thought:

    1. In addition to its lack of natural resources, Japan also has two electricity grid systems making it difficult to transmit power within the country, thus making LNG even more attractive. (https://en.wikipedia.org/wiki/Electricity_sector_in_Japan)

    2. The majority of current planned ports for LNG export for the U.S. are actually through Mexico. This is due to the political challenges of having these huge ports based in anywhere in States. (http://www.forbes.com/sites/judeclemente/2014/08/30/49/)

    Japan has been an importer of LNG for a long time and will likely continue to be a big market for LNG consumption – however, it might be of best interest for Japan to diverse its energy sources, and they perhaps have already been doing so. For example, Hydrogen (http://www.bloomberg.com/news/2014-07-30/japan-bets-on-hydrogen-s-potential-to-diversify-energy-sources.html). If the shipping cost of LNG can be reduced successfully, China would also be a huge market for U.S. exports, with similar transportation processes and a bigger demand.

  4. Thanks for the interesting post. While the US LNG is not the cheapest in the market (cost is approx. $10.5 per MMBtu including liquefaction and transportation), Japan is currently excessively paying for its LNG supplies (~$16-17 per MMBtu), straining the Japanese economy and resulting in its trade deficit. This in turn gives the US a great advantage to break into the Japanese market as the country struggles for cheaper sources of energy to balance its economy. However, as you’ve mentioned, there is obviously the risk of prices going down as supply increases but this is assuming that the demand remains steady or even declines as Japanese nuclear power plants are brought back online, which I think is unlikely to happen as long as Japan secures cheaper natural gas.

    Secondly, given that more than 60% of Japan’s LNG imports are based on oil-indexed spot market prices that are more volatile, a long term contract with US LNG suppliers will protect Japan from excessively overpaying for natural gas and also safeguard the US from going into a price war with competing countries whose LNG prices are tied to the oil markets.

    Finally, I agree that the key risk will be in the domestic natural gas market prices. As a Natural Gas Partners spokesperson mentioned in the recent HBS Energy Conference, “prices may go up to $6 or even $7 per MMBtu” as the US exports LNG. At this price point I imagine that, unlike the current trend of dropping natural gas drilling activity (rig counts), more companies will be eager to drill for natural gas especially if the oil prices remain as low as they are today. Combined with increased efficiencies, this increased activity should balance any domestic natural gas price surge, keeping it under a tight leash.

    Sources:
    http://www.bloomberg.com/news/2014-04-01/a-little-less-rich-qatar-gas-dominance-challenged.html
    http://www.foreignpolicy.com/articles/2014/01/15/japans_nuclear_hangover
    http://www.foreignpolicy.com/articles/2014/02/11/the_geopolitics_of_gas_exports
    http://www.americansecurityproject.org/ASP%20Reports/Ref%200116%20-%20The%20Geopolitical%20Implications%20of%20U.S.%20Natural%20Gas%20Exports.pdf
    http://www.bloomberg.com/news/2014-09-30/u-s-gas-boom-turns-global-as-lng-exports-set-to-shake-up-market.html

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