Blog Post

The Economic Case for Natural Gas Exports

This is the second post in a Common Resources series on U.S. Natural Gas Exports. See Nathan Richardson's post introducing the issue.

American natural gas is historically cheap, while prices remain high elsewhere, especially in Asia. This makes exports of U.S. liquefied natural gas (LNG) look very attractive. Companies have moved to take advantage of this opportunity by seeking permits to build export terminals (or adapting import terminals) and to export LNG—energy firm Chenniere recently received FERC and DOE approval for a new export facility, and others are in the pipeline.

Although a meaningful volume of exports would not actually materialize for another five years, there is vocal opposition. Environmental groups claim exports will lead to more fracking, with associated environmental risks. Gas-dependent industries claim exports would raise prices and choke off a hoped-for manufacturing renaissance. Some in Congress have heard and share these calls: a Democratic minority report proposes blocking most new exports. Who is right? Should the U.S. permit the export of natural gas?

First, some background on the international gas market. Currently, worldwide LNG exports are about eight percent of worldwide natural gas production and rising rapidly. Leading exporters include Qatar, Malaysia, Indonesia, and Australia. Leading importers are Japan, Korea, and Spain. China, for now, remains among the less significant importers although that situation is widely expected to change as the country’s modernization continues apace. This still-emerging international LNG trade is striking in that that it commands prices dramatically higher than US exporters appear likely to offer. Japan’s most recent landed LNG price was about $12/mcf. Allowing for an estimated $5/mcf cost for liquefaction, shipping, and regasification, the market outlook favoring US suppliers seems persuasive in the short-term.

From an economics perspective, international trade of U.S. natural gas, like the virtues of free trade generally, has to be viewed as positive. Simply put, it improves overall global welfare and, for the most part, that of all the countries engaging in trade. But things may not be so simple. It is fair to ask whether the U.S. will be helped or hurt on net by permitting such trade, and on what time scale.

If exports did not lead to increased U.S. natural gas prices, the economic benefit would be unambiguous. Our rate of re-industrialization would be unchanged, the use of gas in the electricity and transportation sectors would be unaffected, and our economy would be better off. Environmental consequences aside, therefore, the debate is about price—or, more accurately, the responsiveness of supply and demand to price (and, to some extent, about equity). If supply is very responsive to price, then price pressure from exports is offset by increased supply. And if demand is very sensitive to price, then rising prices choke back demand, limiting the price rise but possibly leading to increased demand for substitutes, like coal use in power stations, as some environmental groups contend.

Studies have examined the possible impact of LNG exports on the U.S. economy. DOE’s Energy Information Administration (EIA), for example, has modeled a range of export scenarios out to 2025. EIA predicts exports could add from 10 to 26% to gas prices during that period, on top of a modest increase independent of exports. A rough mid-point of 15% increase (over prices otherwise prevailing) by 2020 is not entirely trivial but not alarming. Even after this increase, U.S. natural gas prices would be well below oil prices on an energy-equivalent basis, and far below their pre-shale gas peak of 10-15 years ago. A recent Brookings study summarizes other analyses which find smaller price impacts from exports than the EIA study. While we can’t vouch for the economics of these studies, the underlying reason for such a low increase in prices may well be the ability of the shale gas development industry to respond to higher prices.

When it comes to America’s seemingly lop-sided advantage in the world LNG trade, one should be cautious about drawing overly firm conclusions. Several factors limit the reach of this advantage. First, other big exporters have locational advantages in shipping LNG (such as Australia to Japan and Qatar to Europe)—although opening up the Panama Canal to bigger ships in 2015 will help in the Asian market and gas in Australia may be more expensive than in the U.S. Second, most international LNG transactions and contracts have, until now, been linked to oil prices, producing a relationship rapidly becoming wildly unrealistic, with pressures building to renegotiate . Third, although most analysts believe that $2/mcf gas is not sustainable; forecasting how high U.S. natural gas prices will go in the future is devilishly tough, being based on highly uncertain geological, economic, and regulatory factors. The last of these is particularly unclear as, for example, EPA moves to limit coal in the power sector (thereby increasing gas demand) and regulate shale gas emissions under the Clean Air Act (thereby increasing costs). In short, while America’s competitive advantage in the international LNG trade is unlikely to vanish, the future extent of that advantage should not be judged by the current price differentials.

There are always reasons for one sector or another to fight free trade. In this case, with the complex interplay of domestic supply and demand for natural gas, the world price of oil, and the international demands and supplies of gas, there is a compelling case for the marketplace determining the degree to which U.S. natural gas leaves our shores. Domestic supplies are large enough and probably elastic enough to limit price increases from levels seen in previous bubbles, although the growing dependence of the power sector on natural gas is cause for concern.