So You Want to Build a Natural Gas Sector

Investors aren't too excited about natural gas these days.

The lack of enthusiasm is understandable, with front-month NYMEX natgas prices having sagged below $4/mcf.

But another group globally seems to be looking at gas with mounting interest. Governments.

A few data points. The Ukrainian government said today it will encourage foreign companies to explore for gas in the Black Sea shelf. The government said such gas development would be "a major improvement in our energy security."

This seems to be a developing theme. The government of Trinidad and Tobago announced this week it is suspending development of the $600 million Alutrint aluminum smelter. Previously it was envisioned that Alutrint would be fueled by Trinidad's abundant natural gas reserves, providing an affordable solution to the energy-intensive aluminum smelting process.

Explaining the move, the government noted that it has serious concerns as to whether aluminum-making is "the optimal use of our gas." Domestic consumption and LNG export may be higher priorities.

Peru is yet another case in point. The nation's first liquefied natural gas export facility came online in June, and is now on track to ship 4.4 million tonnes of liquefied gas per year.

But the development has caused a storm of protest, with some Peruvians objecting that gas is being shipped to other countries without provisions to ensure adequate supply for domestic users. The government is now looking carefully at its next moves in relation to the country's growing gas industry.

The message is: gas is still valued and strategic, no matter how low prices get. A commodity that fires industry and heats homes is a critical one.

The question will be, how do governments ensure supplies? Draconian controls don't work. Argentina has tried this, putting price controls and export restrictions on gas in order to secure low-cost domestic supply. The result has been that no one drills for gas in Argentina. Leading to flagging output and the need to actually import gas from neighboring nations (at high prices).

Instead, governments need to find ways that producers can make a profit while selling locally.

One way is with intelligent export quotas. Allow producers to sell a profitable amount of gas to higher-price foreign markets, subsidizing the portion sold to the domestic market. This requires government and companies to work together to determine where the breakeven price is, and what sales mix will get them above the mark.

Some nations are building this into their production sharing contracts. With the government taking a portion of produced gas, which can then be sold locally at state-mandated prices. Again, this is a good solution, provided that government take is at a level that still allows producers to make money (and thus stay in business).

It can get more creative. How about allowing producers to pay their corporate taxes with gas-in-kind? Which the government can then give back to the people.

This discussion is picking up globally. We'll see what solutions result.

By. Dave Forest of Notela Resources