Cheniere-BG Deal Provides Pricing Answer, Prompts Questions

How robust is the demand for U.S.-sourced liquefied natural gas (LNG), and who besides BG Group will buy it?

Those are two of the key questions that Lafayette Herring and surely many others who closely follow the changing U.S. LNG scene are pondering now that UK-based BG Group will buy cargoes of the fuel from U.S.-based Cheniere Energy Partners. The deal will turn Cheniere's Sabine Pass LNG terminal in Cameron Parish, La., into an export facility.

"All participants in the LNG trade will pay close attention to this deal," said Herring, a consultant at Houston-based Waterborne Energy, which closely follows the global LNG and LPG markets. "There are planned or potential export projects across the globe which will ultimately compete on the basis of cost. Suppliers and buyers now have a clear market point as a reference for new supply options from the U.S."

On October 26, BG Group and Cheniere Partners announced an agreement under which the former will buy 3.5 million tonnes per annum (mtpa) of LNG from the latter at Sabine Pass. The 20-year sales and purchase agreement (SPA) hinges on the construction of two 4.5-mtpa liquefaction trains at the site by Cheniere's Sabine Liquefaction subsidiary. Cheniere envisions adding another two 4.5-mtpa trains at the site. Earlier this year, the U.S. Department of Energy granted Sabine Liquefaction authority to export up to 16 mtpa of LNG to countries with which trade is permissible.

The SPA marks the first LNG export deal of its kind in the U.S. Gulf Coast region, which is home to five of the 10 LNG terminals under Federal Energy Regulatory Commission jurisdiction. Aside from ConocoPhillips' Kenai LNG facility in Alaska, which is slated for retirement, no other U.S. LNG terminal currently exports the fuel. Major growth in natural gas production from shale formations is prompting the drive to dramatically increase LNG exports from the U.S.

A Reference

Herring, whose firm called the deal a "game-changer" earlier this week, explained that the SPA's purchase terms are telling. Under the agreement, Cheniere will be paid $2.25 per thousand British thermal units (MMBtu) sold and will sell the LNG to BG for 115 percent of the Henry Hub natural gas benchmark price. Herring points out the SPA clarifies something that until last week had confounded players in the global LNG market: the price of U.S.-sourced LNG. As this table shows, the daily Henry Hub spot price has remained in the $3.40 to $4.00 range for much of the past two months. On the day of BG and Cheniere's announcement, it was $3.65. Using that price from October 26 as an example, one can easily determine that the price of LNG from the U.S. is $6.45/MMBtu free-on-board (pre-shipping).

"The SPA's purchase terms of [1.15% HH + $2.25] reveal insight into the capital cost and the direct cost of energy, which are the core intrinsic costs—directly relating to the plant and its operations," Herring said. He added that other costs in the LNG trade include the cost of gas—very transparent in the U.S. market—and the cost of shipping, which corresponds to distance to market.

Using the Henry Hub pricing basis or structure for U.S. LNG export pricing also marks a new direction for the LNG sector.

"Clearly the LNG trade is gradually diversifying the supply basis structure away from the oil-based pricing, which is the long-standing fundamental pricing basis for LNG," Herring said.

In an analysis of the deal Waterborne released last Friday, Herring pointed out that BG will pay just under $35 million per month to Cheniere. Also, Herring's analysis found a $1.90 per MMBtu capital costs difference between LNG regasifaction and LNG liquefaction: the Sabine Pass terminal's regasification tariff is roughly $0.35 per MMBtu while the export fee is $2.25 per MMBtu.

From an economic standpoint, Herring finds the scope and scale of the liquefaction business particularly noteworthy.

"Regas terminals were a big deal in the U.S. market in terms of energy projects, most clearly in consideration of development budgets and capital budgets," he said. "Comparing now a $0.35 (per MMBtu) regas terminal tariff to the $2.25 tariff in the recent export SPA translates into a 540-percent increase in cost of service. The liquefaction/ export business is significantly 'grossed-up' with respect to the overall economics as compared to the regas or market demand side of the LNG value chain."

Also interesting is the fact that the SPA was made publicly available, which Herring said is virtually never done.

"I know of no other LNG company or project which has had the details of its commercial affairs publicly disclosed," Herring said. In Cheniere's case making the SPA public is not surprising, though.

Herring explained that Cheniere, as a publicly traded company, is bound by U.S. Securities and Exchange Commission rules to release all material financial obligations. It is important to point out, however, that what is material for Cheniere is quite another for BG Group; the former had a market capitalization of roughly $2.6 billion as of November 3 while the latter's market cap is much greater.

Who's Next?

Now that BG has stepped forward as the first customer of LNG produced at Sabine Pass, who will sign subsequent SPAs with Cheniere? Because BG has agreed to buy nearly 40 percent of the 9 mtpa that the planned liquefaction trains will produce in the first phase, industry watchers like Herring are curious to know which type of customer is next in line. Will it be another multinational like BG that would act as a middleman and sell it on the open market, or will it be an end-user such as an Asian utility that would buy LNG to generate electricity?

Given Sabine Liquefaction's authority to ultimately export up to 16 mtpa from the four planned trains, it is plausible that Cheniere is lining up other customers. Perhaps a more complete picture of the terminal's customer base will emerge in the coming weeks.

In terms of which company may be next to unveil plans to export LNG from the Gulf Coast, the focus may shift to Sempra Energy. On Thursday Dow Jones Newswires reported that Sempra plans to seek permission to add liquefaction capacity to its Cameron LNG regas terminal. According to the article, Sempra CEO Debra Reed acknowledged that her company was in talks with major potential customers and that it plans to seek DOE authorization "'in the very near future.'"

Enter the regulators?

Should demand for LNG exports from the Gulf Coast terminal prove to be robust, what tipping point would compel regulators to intervene and counter a perceived threat to the U.S. natural gas market? If the price of U.S.-sourced LNG would reach, say, $16/MMBtu, domestic natural gas customers would feel the pinch. At that point, or perhaps well before, regulators could step in and limit how much LNG can be auctioned off. Implementing such a ceiling could thwart the plans of other prospective U.S. LNG exporters.

Regulators have long permitted regas terminals based on how they serve the "public interest" by securing and stabilizing the U.S. energy market.

"Now, defining the public interest of selling domestically produced natural gas is a very different proposition," said Herring. "The U.S. will represent the only LNG-exporting nation that has a strong domestic demand for natural gas. Every other exporting nation has a stranded resource which the export of which does not create a challenge to domestic demand."

"The consideration now balances between free-trade obligations vs. price and demand competition introduced by foreign buyers," Herring continued. "Looking at the DOE's (U.S. Department of Energy's) language in the authorization orders, the DOE has the right to revisit the public interest determination in the future if market conditions change significantly from today. That is a risk."

Another unknown is what role, if any, the Jones Act might have in shaping the market for LNG sourced from the U.S. The law requires, among other things, that all goods shipped by water between U.S. ports be carried on U.S.-flagged and U.S.-owned vessels built in the U.S. and crewed by U.S. citizens and permanent residents. Given the likely higher costs associated with such requirements, the owner of a U.S. liquefaction facility might simply limit its LNG sales to foreign customers.

How the Jones Act would apply in the case of an LNG cargo shipped from, say, a U.S. Gulf Coast export terminal to a domestic regas terminal in the Northeast is not immediately clear at this time.

As the U.S. LNG export sector unfolds, answers to these and other questions will surely emerge.