Could U.S. LNG Exports Beat Gazprom in the Race to East Asian Markets?

President Vladimir Putin has realized that his country’s gas industry has been heading in the wrong direction. At this week’s Eastern Siberian Oil & Gas Conference in Moscow, RusEnergy’s Mikhail Krutikhin said that Putin’s strong public warnings to Russia’s gas industry of a weakening Western vector at the end of October signaled this realization. The announcement is leading to a shift in strategy. Gazprom’s new task is to jump-start the implementation of the Eastern Gas Program.

Pipelines in East Asia
East Asia Pipeline Map

The race is on to complete critical infrastructure projects in Russia’s Far East to support the development of a new gas export center to East Asian markets. Seemingly, the negative effects of the American shale gas revolution and uncertain European demand for Russian gas has finally come to the attention of industry analysts. Gazprom and other Russian gas producers have little time to tap into the lucrative Asia-Pacific markets before global competitors, including Australia, Qatar, and the United States, position themselves as the region’s leading gas suppliers, according to officials at the conference.

But even if Gazprom is able to build the necessary infrastructure in the medium term, Krutikhin and others believe that the cost of the projects - the most pessimistic estimates are in the range of $127 billion dollars – means that Russia will likely end up subsidizing it’s gas exports to Asia, where the price of imported LNG might out-compete that of Russian piped gas.

“Russia wouldn’t be able to sell this gas for market price if the [Eastern Gas] program costs this much,” Krutikhin said at the conference. “Russia would already have to sell to China this gas lower than its production costs, subsidizing gas consumers in this country.” But the direction of global gas prices hinges on a lot of uncertain factors. Setting other questions aside for now, how real is the possibility that the United States will become a net exporter of LNG to markets that Gazprom is targeting in it’s Eastern Gas Program? My most recent article for OGE ended with this possibility. Could American LNG exports outpace Gazprom’s new project?

Several interesting reports released by the Harvard Business Law Review and Rice University’s Baker Institute for Public Policy have addressed the prospects of LNG export from the United States.

According to Rice University’s Kenneth Medlock, this issue must be considered within the context of international trade, where implications for domestic and international pricing for regional gas markets come into play. “Currently, in the U.S. alone there is over 17bcfd of [LNG] export capacity in various stages of proposal and development, which represents over 50 percent of current traded volume [globally],” Medlock writes in report U.S. LNG Exports: Truth and Consequence. “If even one-third of this capacity is built and placed into operation, it will dramatically alter the ability to supply the Asian market with natural gas.”

Still, according to Medlock, the long-term natural gas supply curve outside of North America indicates that global gas prices will likely drop in the future, bringing into question the economic benefit of U.S. LNG exports to the region. Prospects for shale development in Europe and Asia, mainly China, recent offshore finds in the Eastern Mediterranean and East Africa, and the rise of competing pipeline import projects from Russia and Central Asia (like South Stream and TANAP/Nabucco West), might lead to a global gas glut and downward pressures on gas prices. “To make matters more complex, supplies from Central and South Asia already or soon will enjoy pipeline links to China, and discussions continue regarding alternatives for Central Asian supply routes to Europe,” writes the professor.

In East Asia, after the March 2011 tsunami and phasing-out of Japan’s nuclear power plants, the regional gas hub price in Japan and Korea climbed to near-oil parity as a result of the need to replace indigenous nuclear fuel with imported gas. Under these conditions, “if one adds supply to a supply-constrained market, the price in that market will fall precipitously, all else equal,” according to Medlock. “In the case of the Asian natural gas market, supply will almost certainly be added – whether it is as LNG exports from the U.S. or other sources of supply via pipeline or LNG to Asian consumers – precisely because the high near-term price encourages such a response.”

Medlock concludes: “In general, regardless of the number of export licenses granted, U.S. LNG exporters face risks associated with exchange rate movements, the development of alternative foreign supplies, and the relative price impacts of introducing U.S. LNG volumes into a currently tight international LNG market. In fact… the apparent profitable export option from the U.S. market based on current market conditions is transitory, as current market conditions beget a supply response abroad that erodes current price differentials.”

Medlock’s remarks imply that Russia could become a leading supplier to Asian markets, contributing to the “transitory market conditions” that might preclude large-scale U.S. LNG exports to the region. But this also raises questions regarding Russia’s own long-term economic benefit of spending billions of dollars on the Eastern Gas Program. If the Asia Pacific region experiences a drop in gas prices due to an increase in imports from other suppliers (i.e. Australia, Qatar, etc.), will Russia receive enough revenue in the long-term to offset it’s enormous capital expenditures in the short-term?

That was one of the big questions raised at Wednesday’s forum in Moscow. Currently (in Russian), the following ideas on infrastructure development in Russia’s Far East are under consideration:

• Expand the Trans-Siberian Railroad to support a transit capacity of 100 million tons of goods per year (currently it can transport 16 million tons/year)
• Increase the 2011 Capital Expenditure Fund for the Development of the Far East and Baikal Region to 100 billion rubles
• Eliminate the federal income tax for new industries that invest no less than 500 million rubles in regional infrastructure projects
• And increase public-private partnerships for the development of the Far East

Stay tuned to OGE for further coverage of Russia’s Eastern Gas Program.

Ben Priddy
Central Asian Analyst

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