The Department of Energy in the U.S. recently approved a liquified natural gas (LNG) export project. The Freeport LNG Terminal in Texas has been allowed to export natural gas to countries that do not have a free trade agreement with the U.S. The terminal is expected to start exporting natural gas by 2017, at a rate of up to 1.4 billion cubic feet per day. Since natural gas is liquified for ease of transportation, these terminals are required to liquify and regasify the natural resource at exporting and importing locations respectively. 
- How Much Capital Will ConocoPhillips Spend Geographically In 2016?
- How Have Plummeting Crude Oil Prices Impacted Merger And Acquisitions In The US Oil And Gas Industry?
- Why Are We Bullish On ConocoPhillips?
- Why Is OPEC An Important Determinant Of Crude Oil Prices?
- How Will ConocoPhillips’ Revenue And EBITDA Grow Over The Next Five Years?
- How Has ConocoPhillips’ Revenue And EBITDA Changed Over The Last Five Years?
Although, the project still needs approval from the Federal Energy Regulatory Commission, it can be seen as a positive sign for energy companies such as ConocoPhillips (NYSE:COP), Chevron (CVX) and others producing large quantities of natural gas. We expect to see higher natural gas price realizations for these companies as natural gas exports from the U.S. are expected to drive domestic prices higher.
Supply Shock Due To The Unlock Of Shale Reserves
The large scale commercial implementation of ‘fracking’ techniques has led to a glut of natural gas supply in the U.S., which drove prices to their lowest level of almost $2 per 1,000 cubic feet in 2012. Just to give some perspective, the LNG export terminal in Texas that received a green light from the Department of Energy recently, was actually meant to be an import terminal. This was when the U.S. had still not realized a feasible way of tapping the abundant resource from impervious shale rocks.
Interestingly though, according to the U.S. Energy Information Administration (EIA), 95% of the total natural gas consumed in the country in 2011 was produced domestically. Not only this, the availability of shale gas is expected to keep U.S. independent of foreign supply for many years to come, as the EIA expects domestic production of natural gas to rise 44% by 2040.
Exports To Fuel Higher Natural Gas Prices
Due to the shale gas supply shock discussed above, the prices of natural gas in the U.S. are significantly lower than the rest of the world. While the Henry Hub natural gas prices in the U.S. continue to stay close to $4, the prices in Japan and European Union have been trading over $14 and $12 per 1,000 cubic feet respectively. This stark difference in prices makes a solid case for export of natural gas from the U.S. to Asia and Europe, even after considering the net impact of transportation costs.
However, the Department of Energy has been gauging relative benefits of allowing natural gas exports versus ensuring long term competitive advantage for U.S. based industrial and manufacturing companies, which comes inherently with lower cost of a widely used raw material such as natural gas. Therefore, a go ahead to the Freeport LNG terminal has sent a signal that the government agency sees benefits from exporting natural gas, outweighing its potential negative impact on domestic industrial growth.
Energy Companies Stand To Benefit
The recent announcement has helped reduce uncertainty over the Department of Energy’s stance on natural gas exports. This has led to increased expectations on approval of other applications pertaining to similar projects pending with the government. It was also reflected in a 4% jump seen in June 2015 natural gas future contracts following the announcement.
Higher exports will lead to higher domestic prices in the U.S. as increased international trade will narrow the price differential across geographies. However, it should be noted that the feasibility of exports is directly proportional to the size of price differential. So, the amount of exports allowed by the U.S. government will largely determine the cap on domestic prices.
Energy companies are set to benefit from this move, as higher gas prices in the U.S. will imply higher average price realizations for these companies. We expect average natural gas price realized by Chevron to increase to almost $7 per 1,000 cubic feet over the forecast period, primarily due to rising global energy demand and favorable pricing trend developing in the U.S., for the reasons mentioned above.Notes: