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Chesapeake Energy (NYSE: CHK ) earlier this week released its financial results for the fourth quarter. The results highlighted the shift in the company's portfolio from being natural gas-heavy to oil-heavy. Chesapeake has been focusing more on oil production as gas prices fell sharply due to the shale boom. The supply/demand imbalance could be removed if the U.S. allows more natural gas exports. The U.S. has been reluctant to do this, but recent geopolitical events have presented an opportunity to proponents of natural gas exports to press their case more aggressively.
The shale boom
The shale boom in the U.S. has completely changed the dynamics of the global energy market. It has also aided the U.S. economic recovery. Chesapeake was one of the companies that bet heavily on the shale gas revolution. However, when supply outpaced demand, gas prices in the U.S. fell to record low levels, making several natural gas projects unviable. As a result, Chesapeake, which is highly geared due to all the acquisitions it made during the boom, has been shifting focus to oil. In 2013, Chesapeake's oil production rose 32% year over year, compared to a 3% decrease in natural gas production.
Natural gas prices surged recently, hitting a five-year high of $6.493 per million British thermal units (mBtu). But the sharp rise was mainly due to the extremely cold weather in the U.S. In the last two days, natural gas prices have come down sharply, falling below $5 per mBtu. More importantly, longer-term natural gas prices are expected to remain around this level. While $5 is well above the record low levels natural gas prices hit in April 2012, it is a level at which oil and gas companies do not have a lot of incentive to undertake new gas projects. This explains Chesapeake's shift to oil production. This could change of course if the U.S. decides to shift its natural gas export policy.
Despite the shale revolution, the U.S. has so far been reluctant to export natural gas. Under current regulations, natural gas can be exported to countries that have free trade agreements with the U.S. Currently, only 20 countries have free trade agreements with the U.S. Exporting to the rest requires approval from the Department of Energy (DOE), which is given on a case-by-case basis. Currently, there is a significant demand for gas from several countries without free trade agreements, including China, Japan, India, and those in the European Union (EU). The DOE only approves export projects if the deal would be in the U.S. national interest, which makes getting an approval a cumbersome process. So far the DOE has only approved six export projects since 2011, the most recent being Sempra Energy's (NYSE: SRE ) Cameron liquefied natural gas (LNG) project in Louisiana.
Meanwhile, opposition to natural gas exports has come from unexpected quarters, Dow Chemical (NYSE: DOW ) being one. The company believes that cheaper natural gas offers U.S. manufacturers an advantage and this should not be given away by removing restrictions on natural gas exports. But, proponents of natural gas exports argue that the U.S. is not likely to give away its advantage. A study on LNG exports conducted by NERA Economic Consulting and commissioned by the DOE showed that domestic gas supplies and prices won't be affected significantly by natural gas exports. The argument in favor of expediting natural gas export project approvals not only makes sense from an economic perspective, but it also makes sense from a geopolitical perspective.
The turmoil in Ukraine over the past month, which has led to the ouster of its President Viktor Yanukovych, gives a strong reason to the U.S. to remove restrictions on natural gas exports to countries with which it does not have free trade agreements. The crisis began after Yanukovych abandoned an agreement that would have strengthened Ukraine's ties with the European Union (EU) and instead opted for closer cooperation with Russia. However, the deal with Russia was opposed by Ukrainians, who felt that their country should move closer to the EU. The protests finally led to Yanukovych's ouster. However, the crisis is far from over.
Russia continues to back Yanukovych, and the ousted President also has support in eastern and southern Ukraine, where there are ethnic Russians. The Russians have opposed the EU's support to the interim President in Ukraine. But this is a delicate issue for the EU. The region relies heavily on Russian gas, and in the past, Russia has cut off supplies to the EU. While gas exports from Russia into the EU have not been threatened so far, if the conflict escalates, there is a threat to regular gas supply Russia. This is where the U.S. could come in.
The U.S., with its abundant shale gas, can help the EU in reducing its reliance on Russian imports. Even after taking into account all the transportation, infrastructure, and storage costs, U.S. natural gas can easily compete with Russia's in terms of price. In my opinion, EU countries would be even willing to pay a slight premium for U.S. natural gas if it ensures energy security. It also serves American geopolitical interests. A recent paper from the U.S. House of Representatives Committee on Energy and Commerce also highlights the fact that natural gas exports will bring geopolitical benefits to the U.S. Given the situation in Ukraine, this is the best time for proponents of natural gas exports to press their case.
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