11

OUR EMERGING DILEMMA IN LIQUEFIED NATURAL GAS

Frank Clemente Ph.D.Senior Professor of Social Science & Energy PolicyPenn State Universityfac226@psu.edu814-237-0787

2

We were forewarned about the consequences of the first “Dash to Gas”

1997: “if Lower-48 proved gas reserves are reported to EIA with reasonable accuracy, and inferred reserves as assessed by the Department of the Interior prove generally reliable…by early in the next century, natural gas will have become more of an energy problem than an energy solution” (Joseph Riva, Colorado School of Mines)

3

Concerns about LNG are not misplaced

1. “U.S. gas productive capacity, like oil, is now in permanent decline”. (Daniel Yergin, CERA, 2005)

2. “The North American markets are now dependent on the growth of liquefied natural gas. If we don’t get LNG, we don’t have a plan B”. (Michael Zenker, CERA, 2005)

3. “Six wildcard nations will ultimately determine the size of world LNG markets – Russia, Iran, Nigeria, Venezuela, Algeria and Libya”. (LNG Express , 2007)

4. “pricing for LNG is being forced towards oil-price parity…China’s recent decision to contract for long term LNG at market prices… may be a turning point” (UBS,2007)

5. “the US is the market of last resort for LNG…we will get the gas Europe and Asia don’t need” (Goldman Sachs, 2008)

4

Our Emerging LNG Dilemma

1. Since 2000, the U.S. has built a vast fleet of natural gas (NG) power plants and over 5 million NG heated homes.

2. Production in the lower 48 states provides almost 85% of our NG but has declined since 2000.

3. Increased demand amidst declining supply has dramatically escalated NG prices for all consumers, including families and industry.

4. Thus, we have built a NG infrastructure where new demand must increasingly be met by sources of NG outside the lower 48.

5

Our Emerging LNG Dilemma (cont’)

5. Canada provides 13% of our NG but will be of little help. Canadian production peaked in 2004 and demand for NG in oil sands development is rapidly growing.

6. The Alaskan Pipeline may or may not be built, but flow is not projected before 2020 and prices will be high.

7. By default, we have made a risky bet on our ability to import Liquefied Natural Gas (LNG) to meet growing demand.

8. There are huge reserves of NG in the world (over 6,000 TCF) but much is “stranded” in remote areas away from existing infrastructure and will be expensive to extract and transport.

6

Our Emerging LNG Dilemma (cont’)

9. Further, much of the world’s NG is concentrated in risky or hostile nations – Russia, Iran and Venezuela have over 45%.

10. Actual LNG supply will fall short of optimistic expectations because liquefaction plants have been cancelled or delayed across the world.

11. And, since Europe and Asia are also increasingly dependent upon NG, the competition for the LNG that is available will be intense.

7

Our Emerging LNG Dilemma (cont’)

12. Prices will be higher than previously projected because major producers such as Qatar are linking new LNG contracts to the price of oil.

13. As the most distant market from virtually all major sources, the U.S. will be forced to pay the highest price.

14. In effect, for the first time in history, the reliability of our electric supply system will be dependent upon decisions made in foreign nations.

88

Reserves of NG are Just As Concentrated As Oil

Top 5 Countries Control 60% of the Resource

Rest of World36%

Russia27%

Iran15%

Qatar14%

Saudi Arabia4%

Syria4%

Rest of World41%

Iraq10%

Iran11%

Kuwait9%

Saudi Arabia22%

Venezuela7%

Oil NG

Source: BP

99

The Steady Drumbeat of Global Natural Gas Demand

•Source: EIA 2007

79

88

104

116

129

141

70

80

90

100

110

120

130

140

Tri

llio

n C

ub

ic F

ee

t (T

CF

) P

er

Ye

ar

1995 2000 2005 2010 2015 2020

“Global demand for LNG could outstrip supply by up to 20 million tonnes a year [by] 2015” Donald Voelte, CEO Woodside Petroleum.

1010

Competition for NG/LNG Will Intensify

Projected growth in NG consumption by region, 2004-2020

1.9

5.4

6.67.0

10.7

5.3

1

2

3

4

5

6

7

8

9

10

11

TC

F

Asia Europe NorthAmerica

EurAsia Asia MiddleEast

“Korea needs to prepare for global LNG war”, "Han Moon-Soo, Korean Gas Company"

OECD Non-OECD

1111

The U.S. Bets On A Brave New World

Where new NG supply came from 1993 - 2006

Where new supply is projected to come from

2006-2019

•Source: EIA

“North America is setting itself to import LNG in large quantities” (IEA, 2007)

Domestic Production, 26%

LNG From Foreign Nations, 74%

Canada, 60%Domestic

Production, 17%

LNG From Foreign Nations, 23%

1212

Draining Trinidad First

0.3%

70%

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8%

Trinidad's share ofglobal NG reserves

Percentage of U.S.imports which were from

Trinidad last 5 years

Ryder Scott Petroleum Consultants recently indicated Trinidad’s proven and probable resources have declined 16% since 2004.

In 2007, National Petroleum Council reported Trinidad had the lowest R/D ratio of 17 exporting countries.

1313

We Will Look To Distant Sources and Pay a Premium

4

8

12

16

20

24

28

32

36

40

LN

G S

aili

ng

Da

ys

East Asia Europe U.S. Gulf U.S. East Coast U.S. West Coast

North Africa West Africa Middle East West Pacific

“The U.S. is the market of last resort for LNG” Credit Suisse Bank

Data adopted from Drewry Shipping and University of Texas

, 2007

1414

Three Nations Will Account for 62% of Global Incremental LNG Supply though 2015

Sources: Goldman Sachs; UBS

16% 20%26%

38%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

% O

f G

lob

al I

ncr

emen

tal

LN

G S

up

ply

T

hro

ug

h 2

015

Australia Nigeria Qatar Rest of World

“Qatar… is attempting to secure long term contracts that link pricing to be equal to or above crude prices” (Goldman Sachs, 2007)

15

The Risky Realities of LNG• “Once LNG cargoes hit the water, they’re going to the highest-price

market regardless of the type of contract you have in place”. (Bruce Williamson, CEO, Dynergy, 2007)

• “LNG importing countries in Asia and Europe rely on LNG imports…resulting in a willingness at times to pay prices exceeding those in the U.S. markets in order to have LNG cargoes diverted”. (EIA, 2008)

• “Molecules flow to dollars. Spain paid the equivalent of $14 last summer and the molecule went there and did not come here”. (James Duncan, Director, Conoco Phillips, 2006)

• “Turkey is paying record prices for liquefied natural gas cargoes after Iran slashed exports through a natural gas pipeline”. (Bloomberg News, 2008)

16

U.S. Will Pay the Market Price for LNG

• “The U.S. will have to compete with oil linked markets long term and U.S. prices are now expected to climb with oil.” (WoodMac, 2007)

• “U.S. prices will have to migrate to the top of the heating oil/resid band to keep USA netbacks competitive with western Europe”. (Tristone Capital, 2008)

• “ Korea Gas Corp and Qatar’s Ras Gas…20 year deal was signed in November for LNG at around $11…The price varies as oil prices rise or fall”. (Gulf Times, 2007)

• “if the North American market wants more LNG, prices will have to rise to closer to global levels” (First Energy Canada, 2008)

1717

EIA 2005 Outlook Set the Stage for Optimism

* Actual was only 631 BCF in 2005 and in 2007 was 774

750

1,300

1,800

2,670

3,555

4,330

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Bill

ion

Cu

bic

Fe

et

(BC

F)

Pe

r Y

ea

r

2005 2007 2009 2011 2013 2015

“Strong growth in LNG is expected to continue… with LNG’s share of net imports growing from less than 5 percent in 2002 to 39 percent… in 2010” EIA, 2004

In 2005 EIA projected these increases through 2015.

Source: EIA

18

Cavalier Optimism is Contagious and Ongoing

• 2004: “A tsunami of LNG tankers is headed toward U.S. ports”. (Hill Huntington, Stanford Energy Modeling Forum)

• 2005: “6 Tcf per year … of liquefied gas is pointed toward U.S. markets at delivered prices under $4.50”. (AGA/EEA 2006)

• 2006: “by 2010, U.S. imports [of LNG] will exceed the requirements of either Europe or Asia”. (EPRI)

• 2007: “Florida: LNG to the Rescue”. (CERA)

1919

Optimism All Around: LNG Prices Would be low and stable

3.50 3.753.50 3.50

3.00

3.503.20

2.50

3.00

3.50

4.00

4.50

5.00

5.50

6.00

6.50

7.00

7.50

8.00

Pro

jec

ted

Co

st

Of

LN

G $

/MC

F

U of Texas2003

Exxon 2003 Wood Mac2003

GasTechnology

Institute2004

DeutscheBank 2004

U ofColumbia

2004

Harvard2005

Supply is not resource limited – for inland prices [of] $3.50. The supply curve is flat for a long way (David Nissen, Columbia Univ. 2003)

(7.19) Cost of LNG in 2006

2020

Optimistic Supply Projections to 2008 From as Recently as Three Years Ago Never Materialized

- - - Latest EIA estimates for 2008 is 784 BCF

1,070 1,075 1,124

1,496

1,760

1,984

500

700

900

1,100

1,300

1,500

1,700

1,900

2,100

TC

F/Y

EMF2005

Woodmac2006

PIRA 2006

Jeffries2005

EIA 2005

AGA2005

“The Atlantic liquefied natural gas market faces the risk of oversupply.” "P. Sauquet, VP, Total, 2005"

2121

Optimism Still Persists: Projected Global Supply of LNG in 2015

All projections made in 2007

- - - Current LNG Supply

13.8

14.8 15.0

15.7

16.817.3

18.9

9

10

11

12

13

14

15

16

17

18

19

TC

F/Y

IEA Woodmac EEA/ICF El Pasu GlobalInsight

UBS Rice

2222

Optimism Dominates: Projected North American LNG Imports in 2015

- - - 2007 LNG Import Level = 784 bcf/d

7 7

9

11

13

14

15

16

4

56

7

89

10

1112

1314

15

1617

BC

F/D

EIA IEA Rice EMF EEA/ICS Transcanada Woodm ac CERA

"Flordia: LNG to the rescue" (CERA, 2007)

23

Increasing recognition of supply constraints

• “…the global LNG market points to a future where the supply demand balance becomes increasingly tight as new liquefaction projects suffer continuing delays”. (UBS, 2007)

• “Unfortunately, the supply of LNG around the world is not as plentiful as one would have thought”. (Jim Mulva, Conoco Phillips, 2007)

• Current bottlenecks in upstream production and liquefaction capacity are tightening”. (IEA, 2007)

• Liquefaction capacity is not growing at the same rate as … regasification capacity or global natural gas demand growth”. (CIBC World Markets, 2008)

2424

Reality Sets In: The Steady Decline inEIA Forecasts of U.S. Imports of LNG in 2008

Year Forecast Made For 2008 Imports

1,760

1,550

1,111

934784

200

400

600

800

1000

1200

1400

1600

1800

BC

F /

Y

2005 2006 2007 2008 (Jan) 2008 (Feb)

2525

The Sweep of Optimism Fades: EIA Forecasted Imports for 2015

0.83

4.33

2.51

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

2002 Forecast for 2015 2005 Forecast for 2015 2008 Forecast for 2015

LN

G I

mp

ort

s (T

CF

/Y)

42% reduction in forecast in 3 years420% increase in

forecast in 3 years

2626

Construction Costs of Liquefaction Plants are Rising Dramatically

Source: Jensen Associates, December 2007. Estimates by James Jensen

$275

$625

$1,110

100200300400500600700800900

1,0001,1001,2001,300

Co

st P

er T

on

of

Liq

uef

acti

on

Cap

acit

y in

Th

ou

san

ds

of

Do

llar

s

2000 2007 2012

Costs are increasing so rapidly that Jensen Associates have increased cost estimates twice since Dec 2007 (Sansom, 2008)

2727

Escalating Cost of Liquefaction Plants: Key Examples

$3.9B

$7.8B

$4.5B

$12B

$10B

$23B

2

4

6

8

10

12

14

16

18

20

22

24

Co

ns

tru

cti

on

Co

sts

in $

Bill

ion

s

Pluto (Australia) Pluto (Australia) South Pars (Iran)

Original Estimate Latest Estimate

“Costs are going up, and they are going up far faster than anyone expected” Andy Flower, former Senior Adviser to BP Global LNG

South Pars (Iran) Sakhalin II (Russia)

2828

Breakeven NG Prices for the Six of the Largest LNG Plants Under Construction or Proposed

* Source: estimated from UBS 2007

5.50

6.00

6.50

6.80

7.00

7.40

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

8.0

FO

B B

rea

ke

ve

n P

ric

e $

/mc

f

Brass Sakhalin II Pluto Gorgon Angola Gassi Touil

“New projects would now have marginal economies if sold at U.S. Henry Hub… of $7.25.” UBS, 2007