The Question of US LNG Exports

This post was written by Kenneth B. Medlock III, the James A. Baker, III, and Susan G. Baker Fellow in Energy and Resource Economics at the Baker Institute Energy Forum.

The US Senate has taken up a review of the licensing and permitting of exports of liquefied natural gas (LNG).  The issue was addressed in a hearing of the Senate Energy and Natural Resources Committee on November 8, 2011 in Washington, DC. The testimonies of the witnesses and video of the proceedings is available at the Senate Committee website. Of primary concern are the implications for domestic natural gas prices that exports may have, and the associated implications for reliable and affordable natural gas for domestic consumers. At the core of this issue is the elasticity of domestic supply.  In other words, how large is the domestic natural gas resource base and at what cost can it be extracted?  A large resource base is necessary, but not sufficient, for a relatively small resultant impact from exporting LNG. Sufficiency for the prospect of a small price impact requires that a vast quantity of the large resource base be profitable at relatively low cost.  Thus, understanding both quantity and cost is critical to this matter.

During the past decade, innovative new techniques involving the use of horizontal drilling with hydraulic fracturing have resulted in the rapid growth in production of natural gas from shale.  Certainly rising shale gas production has contributed to lower domestic natural gas prices. This, in turn, has led various interests to promote greater use of natural gas in power generation through substitution opportunities with coal, and renewal of industrial demands that had previously been fading. In addition, there has been interest in creating new demands, such as the use of natural gas in transportation particularly as the price of crude oil remains substantially higher than the price of natural gas on an energy equivalent basis.

It goes without saying that developments in shale gas production have changed the natural gas supply picture in North America substantially.  This, in turn, has turned expectations of increasing reliance on imported LNG – that were so pervasive just ten years ago – upside down. The LNG import terminals that were constructed are now scarcely utilized, and the prospects that the United States will become highly dependent on LNG imports in the coming years have receded, with proposals now emerging for exports of LNG from North America.  Indeed, shale gas production in the United States has increased from virtually nothing in 2000 to over 10 billion cubic feet per day (bcfd) in 2010, and a recent Baker Institute analysis indicates it could rise to 50 percent of domestic production by the 2030s.

On the critical concern of LNG exports, there are several key factors that (a) determine whether or not they occur and (b) the impact, if exports do occur, on domestic prices.  These factors are (i) the elasticity of domestic supply, (ii) the elasticity of foreign supply, (iii) the exchange rate, and (iv) the cost of exports. The basic economic lesson to recall on this point is that only in a unique case of inelastic domestic supply will domestic price rise substantially. Moreover, only if foreign supply is very elastic will the US price rise to the current international price, which is the concern generally voiced by opponents of LNG exports.  In all other cases, the price adjustment resulting from exports will occur in both the foreign and domestic market, with the degree of change in each market heavily dependent on the relative elasticities of foreign and domestic supply.  In general, if domestic supply is very elastic, then domestic price will not change very much, while foreign price will, particularly if foreign supply is capacity constrained relative to foreign demand.  So, the issue of price impact is very much determined by both domestic and international factors, which is a point that seems to be lost on the majority of those looking at this issue. In other words, the communication on price is a two way conversation.

For more detail on this issue, please see the written testimony on the Baker Institute Energy Forum website.