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<title>Liquified Natural Gas: What IS It All About?</title>
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<p align="left"><font face="Arial"><strong><small>About The Author:</small></strong></font></p>
<p align="left"><font face="Arial"><!--webbot bot="HTMLMarkup" startspan --><A name=olsoinfo><!--webbot bot="HTMLMarkup" endspan --></font><font size="2">Joseph
P. Mathew is the President of Hybrid Energy Advisors, Inc. Hybrid Energy
Advisors, Inc., based in Houston, TX, </font><span lang="EN">
<font size="2">provides independent business advisory services to the
natural gas industry and related markets. Their advisory services include
business development, risk management, asset and corporate valuation and
optimization analysis, corporate, project and public finance, general
industry research and analysis, and corporate credit risk analysis.</font></span></p>
<p align="left"><font size="2">For more detail, please visit their website
at
<a href="http://www.hybrid-advisors.com/" style="color: blue; text-decoration: underline; text-underline: single">
www.hybrid-advisors.com</a> or contact Hybrid Energy Advisors, Inc.
directly by e-mail at
<a href="mailto:[email protected]" style="color: blue; text-decoration: underline; text-underline: single">
[email protected]</a> or call 713-666-9007.</font></p>
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<font SIZE="6"><p><b>Liquified Natural Gas:<br>
What <i>IS</i> It All About?<br>
</b></font><b><i>Joseph P. Mathew<br>
President<br>
Hybrid Energy Advisors, Inc</i><span style="font-size: 12.0pt">.</span></b><strong><br>
</strong><font face="Arial" size="2">(<em>originally published by PMA OnLine
Magazine: 2003/01</em>)</font></p>
<p><font FACE="Palatino" SIZE="2"> </p>
</font>
<p class="MsoNormal" style="text-align:justify">The natural gas industry
is in constant evolution. A few general observations in the current market
are:<i> </i></p>
<ul style="margin-top: 0in; margin-bottom: 0in" type="disc">
<li class="MsoNormal" style="text-align: justify"><font face="Arial"><i>
greater projected natural gas-fired electricity generation capacity<br>
</i></font></li>
<li class="MsoNormal" style="text-align: justify"><font face="Arial"><i>
relatively small amount of natural gas storage to provide price buffers<br>
</i></font></li>
<li class="MsoNormal" style="text-align: justify"><font face="Arial"><i>
increasing projected demand for industrial, commercial and residential
users<br>
</i></font></li>
<li class="MsoNormal" style="text-align: justify"><font face="Arial"><i>
unpredictable weather patterns<br>
</i></font></li>
<li class="MsoNormal" style="text-align: justify"><font face="Arial"><i>
various demand-driven transportation capacity constraints<br>
</i></font></li>
<li class="MsoNormal" style="text-align: justify"><font face="Arial"><i>
higher marginal cost of procuring reliable natural gas supply</i></font></li>
</ul>
<p class="MsoNormal" style="text-align:justify">Given the confluence of the
above observations, the United States is going to feel increasing upward gas
price pressure, all other things being equal.</p>
<p class="MsoNormal" style="text-align:justify">So what can mitigate this
effect? The answer is new natural gas supply and its reliable
transportation to consuming markets. Although the answer appears simple,
the process of getting to a viable solution requires intensive study of
supply alternatives. One source is liquefied natural gas, or LNG.</p>
<p class="MsoNormal" style="text-align:justify"><u><b>LNG Backgrounder<br>
</b></u>LNG is typically created using a three-step process. First,
subterranean gaseous-form natural gas is �frozen� into a liquid state
through a complex cryogenic process (called �<i>liquefaction</i>�) involving
temperatures as low as -275 degrees Fahrenheit. Second, after the gas is
liquefied, it can be stored in cryogenic holding tanks or pumped directly
from the cooling vestibule into special insulated transportation vessels,
such as railcars, trucks, or ships. Third, upon delivery of the vessel to
its final destination, LNG is pumped from the vessel into either another
cryogenic storage tank for later delivery or directly into a re-gasification
unit that uses sea water or air to reheat the LNG in order to convert it
back into gaseous natural gas. Once this LNG turns into gaseous gas, it is
pumped through a pipeline system that leads to an ultimate market.</p>
<p class="MsoNormal" style="text-align:justify">It sounds fluid, but usually
is not quite as simple. Raw natural gas can be �heavy� (also called �wet�
or �hot� gas) with various higher carbon molecules. These heavier particles
create a higher heat content (ranging from 1,090-1,320 btu/cf) than
permissible by many pipeline distribution standards. Although this heavier
form of gas can be frozen, stored and shipped, the extra heat content may
have to be �stripped off� prior to entering another distribution system to
conform to the gas heat standards of the pipeline network.</p>
<p class="MsoNormal" style="text-align:justify">In the United States, state
public utility commissions (PUCs) oversee gas pipeline heat content
standards. It is estimated that the average heat content of current
distributable gas in the United States is approximately 1030-1060 btu/cf. </p>
<p class="MsoNormal" style="text-align:justify">Any gas disseminated into a
system that does not conform to these independent standards will not be
permitted into the inherent system without the heavier particles being
stripped (through a process called �<i>fractionation</i>�) or diluted with
inert gas. This process adds an additional cost to the overall project.
Fractionation can occur either upstream or downstream, but is usually
contingent upon which location is most cost effective, politically sound,
environmental-friendly or where there may be access to a viable purchasing
market for the fractionated heavier gas. Fractionated gas products can
either be marketed or injected back into the ground. Any marketing and
sales of this heavier gas can serve as a revenue enhancement of or a
contra-expense item to the total project. </p>
<p class="MsoNormal" style="text-align:justify"><b><u>The LNG Opportunity<br>
</u></b>Historically, the price of LNG has been prohibitive when compared to
United States gas prices. Costs of delivery ranged in the $2.50 to $3.00/mmbtu
range (not including the netback price to the owner of the stranded gas
reserves from which the gas was initially purged). Assuming a $1.00/mmbtu
netback to such owner, a total deliverable gas price of around $3.50 to
$4.00/mmbtu could possibly be attained on a cost basis. </p>
<p class="MsoNormal" style="text-align:justify">In the 1970�s and 1980�s,
physical gas prices had spiked in the United States, feeding fears of gas
shortage. This phenomenon inspired the construction of four major LNG
import re-gasification terminals, all on the United States East Coast
(Everett, MA, Elba Island, GA, Cove Point, MD, and Lake Charles, LA in total
constituting approximately 3 bcf/day of installed capacity). </p>
<p class="MsoNormal" style="text-align:justify">However, deregulation led
producers of gas to become motivated to explore and develop newer, easy
access gas reserves in the mountain states and the Gulf Coast, flooding the
market with excess gas inventory. This was exacerbated by Canadian policy
changes that allowed increased gas exports, in effect emigrating additional
low-cost gas from the Western Canadian Sedimentary Basin to compete for
demand in the United States. The result was a gas supply �bubble� which
kept prices very low for quite some time. How times have changed.</p>
<p class="MsoNormal" style="text-align:justify">Last year, the Department of
Energy�s Energy Information Administration (EIA) anticipated medium-term
Henry Hub gas prices to range from $3.25/mmbtu to $3.50/mmbtu, and long-term
gas prices to be close to $4.00/mmbtu.</p>
<p class="MsoNormal" style="text-align:justify">In analytically forecasting
natural gas prices, one can label the expected gas price a �dependent�
variable and the underlying fundamentals as �independent� variables that
influence the dependent variable. Using quantitative techniques, Hybrid
Energy Advisors, Inc. (HEAI) predicted in the spring of 2002 that Henry Hub
financial prices, the dependent variable, would range between $3.35 and
$4.10 through the winter months of 2002/2003. They also calculated ten-year
price forecasts of $2.25-$2.80/mmbtu during the summer months and
$3.70-$4.25/mmbtu during the winter months. HEAI believes that ten-year city
gate prices of gas on the West Coast and Midwest United States will trade
approximately equivalent (�flat�) to Henry Hub prices, and upper East Coast
prices to trade at approximately 45-65 basis points (cents/mmbtu) above
Henry Hub prices. These forecasts include a greater gas import as a
percentage of total domestic gas. HEAI believes that by the year 2010,
approximately 6-8% of the total US gas supply will come from LNG produced
from foreign stranded gas reserves.</p>
<p class="MsoNormal" style="text-align:justify">Today the total cost of LNG
production has been quite streamlined and reduced to approximately $2.00/mmbtu
due to competition and improvements in technology. Much of the technology
pertaining to lower-cost land-based terminals and offshore and ship-board
re-gasification units are still relatively unproven. However, major energy
industry players and engineering firms do not foresee problems with the
design and implementation of these methods.</p>
<p class="MsoNormal" style="text-align:justify">Therefore, assuming a
netback of $1.00/mmbtu, the total delivered price of approximately $3.00/mmbtu
can now be theoretically achieved. This LNG price is almost $1.00/mmbtu
less than a decade ago. When comparing this new price to industry average
price forecasts for Henry Hub and East and West coast city gates, LNG can
certainly be considered an economical source of natural gas supply.</p>
<p class="MsoNormal" style="text-align:justify"><b><u>Major supply and major
demand zones<br>
</u></b>New technologies in LNG and the upward gas price trends are creating
the opportunities for re-gasification terminals to spring up in a variety of
areas. These areas include the United States East and West Coasts,
Northwest Mexico, Italy, Germany, England, Spain and even emerging markets
such as China and India. Asian counterparties such as Japan, Korea and
Taiwan, who have historically constituted approximately 70% of demand in the
LNG market, are also building new terminals.</p>
<p class="MsoNormal" style="text-align:justify">The gas supply to meet
expected growth in LNG demand is from stranded gas reserves associated with
crude oil production that historically did not have much hope of coming to
market. These reserves are typically owned and operated by many major
worldwide energy companies. Longstanding production zones include Algeria,
Libya, Nigeria, Qatar, Malaysia, Australia, Brunei, Indonesia and the United
States (Alaska, Cook Inlet). Many proposed new areas of liquefaction
include Norway, Trinidad & Tobago, Venezuela, Bolivia and various countries
of the Middle East. </p>
<p class="MsoNormal" style="text-align:justify">The ideal economic scenario
when evaluating which terminal projects make sense are contingent upon
studies related to where and how much gas demand is going to be, where the
supply will come from, and how much gas to produce.</p>
<p class="MsoNormal" style="text-align:justify"><b><u>Not so Fast<br>
</u></b>While natural gas consumption growth rates are expected to increase
over the next twenty years by 50% as compared to a current level of 65 bcf/day,
the solution to providing the supply to satiate such growth is not quite as
transparent as just evaluating the face-value economics of alternative
sources.</p>
<p class="MsoNormal" style="text-align:justify">In any energy infrastructure
project, due diligence on regulatory, permitting, and environmental factors
is quite important. A hiccup in procuring the necessary political
approvals, permits and rights-of-way can be devastating to the economics and
viability of a project. Projects have been known to come to a dead halt,
much to the chagrin and expense of the lead project developer and production
consortium, over matters such as residential noise or particulate pollution,
wildlife endangerment, political vacillation, or just plain general
nuisance. </p>
<p class="MsoNormal" style="text-align:justify">LNG re-gasification
terminals are viewed as large, obstructive and generally displeasing to the
eye for local residents and businesses. Although designs to bury such large
facilities underground have been forthcoming, general apprehension related
to the �don�t build in my backyard� philosophy still emphatically exists.
One mitigant to that problem is sighting the terminal off-shore or aboard
the LNG transport ship itself, far from residential or commercial areas.
Although such new technologies regarding offshore and ship-board
re-gasification is being studied and developed by a variety of industry
players, the educating process required with political parties is an ongoing
and sometimes frustrating process.</p>
<p class="MsoNormal" style="text-align:justify">Guidelines regarding the
oversight, regulatory standards and environmental compliance of on-shore or
off-shore terminals are still in debate. In the United States, three of the
four import terminals are overseen by the FERC. Regulatory oversight can be
an issue to contend with as most merchant energy firms and pipeline
companies vie for ownership, control, and equity interest. For such market
participants, FERC jurisdiction impedes profitability and ease of management
control of the owners and its merchant gas off-take counterparties. Many of
the industry participants building and sighting these terminals contend to
the FERC that if they have the burden of finding, constructing, funding, and
permitting a terminal, they should not be subject to losing the economic
potential to sell such re-gasified gas into open market by subjecting the
capacity to a FERC-controlled �open-season�. After all, if one firm does
all of the work, why would that firm surrender the market opportunity to
profit from the off-take gas sales to another firm who has not incurred the
same �finders� costs? For many of these project leaders, equity ownership
of a FERC-jurisdiction terminal at a regulated rate of return is not
enough. They want the most facile way to attain the real �juice�. That is,
they prefer the sole ability to sell their upstream LNG into the interstate
domestic markets as gaseous gas and take merchant positions in key
locations.</p>
<p class="MsoNormal" style="text-align:justify">Two other LNG-related
non-operational risks that are worth mentioning at this time are terrorism
and/or accident risk and sovereign government risk.</p>
<p class="MsoNormal" style="text-align:justify">Firstly, the events of
September 11, 2001 will forever be marked in American and world history as
an indelible reminder that impedances to economies can come in a variety of
forms. Terrorism has been shown to be a more significant influence on
energy endeavors than ever before. With the threat of oil tanker, nuclear
reactor and LNG ship sabotage, political risk to sighting an on- or
off-shore re-gasification unit is high. Man-made or accidental explosion of
such a tanker can be catastrophic in the mind of the common person, and
although studies have shown that LNG volatility is much lower in its liquid
cooled form, the image of a giant vapor cloud can have devastating effects
on the human psyche and at the very least create an apocalyptic image that
few are willing to internalize.</p>
<p class="MsoNormal" style="text-align:justify">Secondly, since much of the
gas that is being liquefied comes from foreign and third-world countries,
sovereign risk can be quite disenchanting as compared to reliable,
high-credit, highly-liquid United States gas. Changing governments,
political coups, local customs, and draconian regimes can portend
inconsistent supply. Due to this factor, price concessions are usually made
in relation to United States-priced gas supply, however, the sovereign risk
inherent in such supply must to be evaluated concomitantly with the
discounted pricing.</p>
<p class="MsoNormal" style="text-align:justify"><b><u>Conclusion<br>
</u></b>The United States is in need of additional natural gas sources based
on forward fundamental supply/demand and price expectations. LNG appears to
be a very viable and constantly improving choice in this regard. While the
economic viability of LNG as a necessary gas supply-stack contributor as
compared to Alaskan, Gulf Coast or bicoastal gas can be pointed out,
political, sovereign and regulatory risk can impede the progress of such
beneficial projects and turn what was once a supply savior into a
bureaucratic roundabout.</p>
<p class="MsoNormal" style="text-align:justify">It is becoming more apparent
that the energy companies, United States government, FERC, and state public
utility commissions (PUCs) need to ally interests in figuring a pragmatic
goal in satisfying such projected United States gas demand growth. The
figures and analysis tell a convincing story of what is required to mitigate
impending natural gas shortfalls, but the real solutions need to be
prudently pursued by private enterprise and supported by rational local,
state and federal government legislation.</p>
<p class="MsoNormal" style="text-align:justify"> </p>
<hr color="#FFFF00">
<blockquote>
<p align="left"><font face="Arial"><!--webbot bot="HTMLMarkup" startspan --><A name=olsoinfo><!--webbot bot="HTMLMarkup" endspan --></font>Joseph
P. Mathew is the President of Hybrid Energy Advisors, Inc. Hybrid Energy
Advisors, Inc., based in Houston, TX, <span lang="EN">provides independent
business advisory services to the natural gas industry and related
markets. Their advisory services include business development, risk
management, asset and corporate valuation and optimization analysis,
corporate, project and public finance, general industry research and
analysis, and corporate credit risk analysis.</span></p>
<p align="left">For more detail, please visit their website at
<a href="http://www.hybrid-advisors.com/" style="color: blue; text-decoration: underline; text-underline: single">
www.hybrid-advisors.com</a> or contact Hybrid Energy Advisors, Inc.
directly by e-mail at
<a href="mailto:[email protected]" style="color: blue; text-decoration: underline; text-underline: single">
[email protected]</a> or call 713-666-9007.</p>
</blockquote>
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