Pipeline to Nowhere?

Last week the news headlines blazed on about the proposed natural gas project in Alaska between Exxon, Conoco and Trans-Canada to build a pipeline over 800 miles long to run from Alaska's North Slope on to Asia.  Talk was of the 15,000 jobs to be created and the revenues to be rewarded for the 10-year endeavour. Richard Bass argues in Forbes that exporting LNG to Asia would be helpful to the North American gas market.  Maybe we should think this one through a little.

The price most often associated with the U.S. natural gas market is the daily price at Henry Hub in Louisiana. The NYMEX division at CME Group bases their most popular natural gas futures contract on this delivery point. The price has been a little under the weather, to say the least, when looking at historical prices.  This is due mainly to the rather lofty supply of "dry gas" in storage. Dry gas is generally the output that you get from wells in the Gulf of Mexico and onshore wells that only output natural gas.

For the last few years much has been made of the drilling in shale areas. New technology has made these areas reachable for the drilling of oil and gas, in the form of natural gas liquids. Once extracted, a residual by-product of this "wet gas" happens to be more "dry gas". 

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The oddity in all this is that natural gas liquids are priced in the form of price-per-barrel, as oil is.  The price of wet gas tends to track overall petroleum prices a little better than dry natural gas does.  So, as the price of oil stays above $90 per barrel, it pays to keep drilling shale for oil and "wet gas".  Producers would continue to sell "dry gas" almost down to the price of $zero as it is not the main target.  Supply continues to build even as rig counts for natural gas plummet.

Natural gas also is what industry folk call "a lower 48-state commodity", meaning it's pretty much land-locked to the U.S. We have the capacity to import gas in the form of LNG.  We just do not have much capacity to export LNG.

Here's the punchline: spending $65 billion (probably much more) to send Alaskan natural gas to Asia will not do much for anybody south of Canada.  North Slope natural gas will probably rise in price to merge toward the Asian price of about $17/mmBTU (don't worry about what that means), but Henry Hub may still linger in the $3.00-5.00 range for as long as oil stays over $80.  Also, at that price for the pipeline, and assuming a 27-year straight write-down, that's going to cost about $8mm/day during production. That's to accommodate production of about the equivalent of 350 NYMEX futures contracts per day (3.5 billion cu. feet). That works out to an added cost of about $2.20 per NYMEX equivalent, which seems expensive at current prices of $3.50.

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Why are we in such a hurry to sell a natural resource to Asia to capture a fast arbitrage?  The point is not lost; after all, a profit is a profit.  Yet, maybe we can turn what appears to be a sorry state of affairs for the natural gas patch into a boon for industrial production. As labor costs in Asia rally and their consumption engine continues to grind on, maybe there is opportunity here to use a low cost energy (read; manufacturing) supply combined with a hard-hit domestic labor market and produce something to export.  The logistics really come down to labor costs and with unemployment the way it is maybe there's negotiable room here.  Maybe Exxon should hold off on adding to their natural gas portfolio and add some joint ventures in the industrial area and make use of a cheap source of energy as a competitive advantage (ghost of John D.?).  Just an idea…

By. Michael Doyle