Posted by: bmeverett | March 7, 2014

US Natural Gas Exports and Ukraine

The recent crisis in Ukraine has prompted calls for increased US natural gas exports to reduce the Russian pressure on Ukraine and Western Europe. On balance, this crisis may encourage us to take some sensible steps here. Common sense suggests that the US should develop its extensive natural gas resources, and economics tells us that that natural gas should flow to its highest value use, whether domestic or export markets. We need to be careful, however, not to overstate what we can do in the European, and particularly in the Ukrainian gas markets.

Ukraine currently imports about 1 trillion cubic feet (TCF) of natural gas every year from Russia. Since the break-up of the Soviet Union, Russia has sold this gas at a discount, presumably to keep a hook in Ukraine’s economy. Since last December, the Russian price to Ukraine was about $7.50 per thousand cubic feet (MCF), an attractive price, given that the average import price into the EU has been running about $11.50 per MCF. This discounted price, however, has been further sweetened by Russia’s allowing Ukraine to run a tab on its gas imports, accumulating a debt currently estimated at around $1.5 billion.

Before we consider the policy implications, a few general comments about the global natural gas market. First and foremost, oil is easy and inexpensive to transport while gas is not. A barrel of oil can be shipped from any coastal location in the world to any other coastal location for $3/barrel or less. With oil prices at over $100/barrel, the transportation cost is only a small share of the delivered price. Oil can be poured into tankers under ambient temperature and pressure conditions, while natural gas must be moved (a) through pipelines, (b) in liquefied form which requires liquefaction facilities, special cryogenic ships and regasification facilities or (c) chemically converted into liquid fuels. All of these methods are very expensive with new projects costing in the tens of billions of dollars. Unlike oil, the delivered price of natural gas depends heavily on distance from potential suppliers.

Second, the world has a large number of discovered natural gas fields which are not under development because the infrastructure is not in place. The industry calls this “stranded” or “static” gas. We know it’s there, but there’s no market willing to commit to its purchase. Much of this resource base is in the Middle East, the Caspian and Central Asia. The constraint on gas supplies is infrastructure investment, not resource availability.

The Ukrainians’ problem is not the lack of access to natural gas supplies, but their desire to maintain cheap supplies of Russian gas. The key strategic issue is whether the Ukrainians are willing to pay more for gas in order to get themselves out from under the thumb of the Russians. Let’s assume for the moment that the discount for Russian gas is about $4 per MCF. With imports of about 1 TCF, the discount is about $4 billion per year. There are about 45 million Ukrainians, so the Russian discount is roughly $100 per person. According to World Bank data, per capita income in Ukraine is about $3,900, so the discount is about 2.5% of the average Ukrainian’s income.

If Ukraine wants to reduce its dependence on Russian gas, the US is probably not the place to start. Odessa is about 7,700 ocean miles from Houston – a long haul for LNG tankers. The Turkish LNG hub is only 450 miles from Odessa. Potential Israeli or Egyptian export terminals are only about 1,400 miles away, and Yemeni natural gas is less than 3,000 miles away. The question is whether Ukrainians will be willing to pay the price. Moving from a subsidized price to a market price is critical for Ukraine’s future. Either they are independent from Russia or they are not. None of the regional LNG suppliers will subsidize Ukrainian gas consumption, and the US shouldn’t either. If the Ukrainians choose to move forward with non-Russian gas supplies, it will take some time and lots of infrastructure investment. Here the West can help with political and financial support.

Western Europe’s problem is similar. The EU currently consumes about 16 TCF of natural gas annually of which 4 comes from Russia via pipeline. The EU can reduce their dependence on Russian gas by negotiating LNG contracts with other suppliers in the Middle East and Africa. Qatar, which has almost inexhaustible supply of natural gas, is about 4,900 miles from the Adriatic terminals. Nigeria is a similar distance from Northwest Europe. The US is a competitor for the European natural gas market, but it’s by no means an easy reach. Houston is 5,600 miles from Northwest Europe. Although US natural gas prices are currently below historic levels at less than $5 per MCF, Nigeria has gas currently being flared, i.e., zero value gas, and gas can be produced in Qatar for less than $1 per MCF. Each major US LNG export project that comes on line could sell roughly 1 TCF/year – a significant market player, but not exactly enough to overwhelm the European market and push the Russians out. Again, the issue is how much, if anything, the Europeans will pay to reduce their dependence on Russia.

By all means, let’s develop our gas and take advantage of export sales when they make commercial sense. Let’s be careful, however, about threatening Putin. The US currently has natural gas reserves of about 300 TCF, most of which we will consume ourselves. Russian gas reserves are currently 1,165 TCF, and their consumption is only about two-thirds of ours. They are likely to remain a much more powerful player in the gas market than we are.


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