TransCanada Corp.'s (TRP) fledgling liquefied natural gas business has suffered its second major setback in as many months, potentially grounding the company's ambitions to tap into the growing North American market.

New York Gov. David Paterson on Thursday rejected Broadwater Energy's proposal to build an LNG terminal in Long Island Sound, endorsing vehement opposition to the project from Connecticut officials and environmentalists.

"The regulatory process provides Broadwater a number of options going forward and we intend to fully review the decision and findings, then evaluate the project's next steps," John Hritcko, the consortium's senior vice president and regional project director, said in an emailed statement.

Broadwater Energy is a joint venture between TransCanada and Royal Dutch Shell PLC's (RDSA) Shell Oil Co.

The decision falls just two months after the struts were knocked out beneath TransCanada's only other LNG project, the Gros Cacouna venture with Petro-Canada (PCZ). The proposed C$1 billion Quebec terminal hinged on securing a long-term supply contract with OAO Gazprom (GAZP.RS), but this was thrown in disarray after the Russian energy giant scrapped plans for the LNG supply facility on the Baltic Coast. The project is currently under review.

Many analysts believe, however, both Cacouna and Broadwater are effectively dead in the water, which could see TransCanada's LNG business sputter to a halt. The Calgary-based company is looking to diversify into other industries from its position as the dominant player in the Canadian natural gas pipeline market, which makes for a logical move into LNG. Meanwhile, the outlook for natural gas prices looks strong, with more U.S. power generation switching to natural gas amid declining production.

Broadwater wants to build a US$700 million floating LNG vessel nine miles off the Long Island coast, which could supply New York City and Connecticut with 30% of daily demand via an existing pipeline. The Federal Energy Regulatory Commission has already approved the project despite opposition from Connecticut, which sparked U.S. Senate legislation reasserting state control over siting LNG facilities.

"The logic of opposition to the Broadwater project is questionable," TransCanada Chief Executive Hal Kvisle said earlier this year. Natural gas prices in New York City have spiked on a supply bottleneck, and the facility would go some way to alleviating that, he added.

TransCanada referred initial enquiries to Broadwater and didn't return further calls for comment.

But compared with the swift development of its North American power business, TransCanada's LNG plans have inched forward, and even abandoning them entirely shouldn't rattle investors, said Daniel Shteyn, a utilities analyst at Desjardins Securities.

"It would have been a good side business for them...but it's not a key driver," he said. "The market's not giving them any value for (the LNG projects) anyway."

Indeed, shares tracked the broader market higher, recently trading up 75 cents, or 2.1%, to C$37.19. This contrasts sharply with market reaction after TransCanada said it was buying National Grid PLC's (NGG) Ravenswood power station in Queens, a borough of New York City, for US$2.9 billion. Last Tuesday's announcement sliced nearly a tenth off TransCanada shares as investors questioned the high cost of the acquisition and the company's optimism about future returns.

Ravenswood will, however, boost TransCanada's power generation capacity to more than 10,200 megawatts. And these are currently producing assets, unlike the LNG proposals which had tentative start dates of 2010 for Broadwater and 2012 for Cacouna.

The fates of both these projects are off-putting, but TransCanada may not rule out LNG completely should a suitable opportunity arise, Shteyn said.

"Hal Kvisle and his team are quite opportunistic in nature - in a good way," he said. "But if another LNG project comes up, I think they'll think long and hard about whether it will culminate in a positive outcome."

Copyright (c) 2008 Dow Jones & Company, Inc.