The Case for LNG Exports: Low Production Costs and Attractive Global Prices

In my previous article, we saw how an escalating global demand for natural gas creates an argument for its export. But that alone won't make U.S. exports profitable. There are other major factors that should be taken into account.

One such important factor is the cost of natural gas production. Countries that can produce natural gas cheaply hold a huge advantage.

How the Middle East is minting money...
For an analogy, we only need to look at crude oil. Middle Eastern countries have vast conventional reserves, and can produce them cheaply. According to The Economist, extraction costs in Gulf countries range between $3 and $5 per barrel . With today's global crude oil prices over $100 per barrel, their margins are huge.

...and how we can do the same with natural gas.
A similar story is brewing in the United States natural gas. Technological advances have brought about a paradigm shift in the exploration and production landscape. Hydraulic fracturing of shale rock changed the game, leading to horizontal drilling and pad-based drilling. Due to these innovations, production costs for shale gas have fallen, resulting in a glut of natural gas far outstripping demand. If current dynamics of supply and demand change and prices move north, then low-cost producers like Ultra Petroleum (NYSE: UPL  ) , Southwestern Energy (NYSE: SWN  ) and Chesapeake Energy (NYSE: CHK  ) stand to make solid profits.

Ultra Petroleum currently produces natural gas for about $2.80 per mcfe . For Southwestern Energy, production costs for the most recent quarter stood at $2.25 per mcfe , while Chesapeake currently drills for about $3.33 per mcfe . Range Resources (NYSE: RRC  ) operates at a slightly higher cost, extracting gas for $3.75 per mcfe .

Natural gas prices have partially recovered from last year as producers have deliberately stalled production -- thus reducing supply -- due to unfavorable economics. However, the recovery so far hasn't been too impressive.

Source: Energy Information Administration

Looking ahead, the forecast supply demand dynamics don't look likely to lead to higher natural gas prices. According to EIA's International Energy Outlook 2013, the United States is expected to grow its natural gas production by 1.5% annually, while its consumption rate will only increase by 0.73% annually .

Why we should export natural gas
In 2010, the United States produced 21.2 trillion cubic feet, or tcf, of natural gas, while in the same year it consumed 23.8 tcf. Further, in 2040, the nation is expected to produce 33.1 tcf, while consumption will only rise to 29.5 tcf . The following chart brings out the glaring difference in expected demand and supply:

Source: International Energy Outlook 2013

We can see that by 2020, U.S. natural gas production will overtake total consumption. By 2040, production will outstrip consumption by a whopping 3.6 tcf.

Source: International Energy Outlook 2013; Author's calculations

But, knowing today's market conditions, natural gas prices derive no real benefit from overall demand and supply. Unless there is an increasing demand for natural gas that hasn't been factored in already, the whole business model for natural gas producers seems to be at stake. Even low cost producers, including Ultra Petroleum, Range Resources and Southwestern Energy, have already written down their assets, taking in substantial losses, at least on paper.

Simply put, we are looking at a strong case to export natural gas.

How profitable would natural gas exports be?
Elsewhere around the world, there's huge demand supported by attractive prices. The following chart from BP provides a comparison between U.S. natural gas prices and their European and Japanese counterparts:

Source: BP.com

It's obvious that prices in Europe and Japan have become highly attractive in recent years. The Federal Energy Regulatory Commission (FERC) provides us an insight into how attractive LNG look from an investment perspective right now. The following chart  shows estimated LNG prices for October across regions:

Source: Federal Energy Regulatory Commission; Waterborne Energy, Inc; Prices in $/MMbtu

Low cost natural gas production has seen supply far outstrip demand domestically -- however, like the Middle Eastern oil producers, there's no reason why the United States cannot capitalize on natural gas exports. LNG exports should hugely benefit the economy.

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