Liquefied Natural Gas (LNG) in U.S. Energy Policy: Infrastructure and Market Issues
Released: 2006-01-31T00:00:00

Introduction

The United States is considering fundamental changes in its natural gas supply policy. Facedwith rising natural gas demand and perceived limitations in North American gas production, manyin government and industry are encouraging greater U.S. imports of liquefied natural gas (LNG). Recent activities by Congress, the Federal Energy Regulatory Commission, the Department ofEnergy, and other federal agencies to promote greater LNG supplies have included changingregulations, clarifying regulatory authorities, and streamlining the approval process for new LNGimport terminals. While forecasts vary, many analysts expect LNG to account for 12% to 21% oftotal U.S. gas supply by 2025, up from approximately 3% in 2005. If these forecasts are correct, U.S.natural gas consumers will become increasingly dependent upon LNG imports to supplement NorthAmerican pipeline gas supplies.

Recent measures before Congress seek to encourage both domestic gas supply and newLNG terminal construction. The Alaska Natural Gas Pipeline Act of 2004 (15 U.S.C. Â§ 720, et seq .)provides loan guarantees (Sec. 116) and other incentives for an Alaska gas pipeline. The EnergyPolicy Act of 2005 ( P.L. 109-58 ) includes various incentives for domestic natural gas producers(Title III, Subtitle E). The act also amends Section 3 of the Natural Gas Act of 1938, granting theFederal Energy Regulatory Commission (FERC) explicit and "exclusive" authority to approveonshore LNG terminal siting applications (Sec. 311c) among other provisions. Other proposals inthe 109th Congress, including H.R. 4318 , H.R. 3918 , and H.R. 3811 would lift federal restrictions on natural gas exploration and production on federal submergedlands of the Outer Continental Shelf. S. 1310 would authorize the expansion of a naturalgas transmission pipeline on federal lands in the Northeast.

While an increase in LNG imports is already underway, federal officials and Members ofCongress have been debating the merits and risks of U.S. LNG dependency. In April, 2005, forexample, President Bush stated that "One of the great sources of energy for the future is liquefiednatural gas.... We need more terminals to receive liquefied natural gas...." (1) In June, 2005 Department ofEnergy Secretary Samuel Bodman remarked that "LNG seems to offer a solution to ... the growingdemand for natural gas that we will see all around the globe." (2) In November, 2005 FederalReserve Chairman Alan Greenspan testified before Congress that "severe reaction of natural gasprices to the production setbacks that have occurred in the Gulf highlights again the need to ... importlarge quantities of far cheaper, liquefied natural gas (LNG) from other parts of the world." (3) Some in Congress havequestioned the implications of such a policy, however, drawing analogies to the consequences ofU.S. dependency on foreign oil and citing potential instability among foreign LNG suppliers. (4) Others have expressedconcern about LNG safety and vulnerability to terrorism. (5)

Specific questions are emerging about the implications of greater LNG imports to the UnitedStates. LNG has substantial physical infrastructure requirements and there are uncertainties abouthow this infrastructure would be integrated into North America's existing gas network. The potentialeffects of larger LNG imports on U.S. natural gas prices will be driven by the global LNG marketstructure, although that market structure is still evolving. Political relationships among countries inthe LNG trade may also change as LNG becomes increasingly important to their economies.

This report will review the status of U.S. LNG imports, including projections of future U.S.LNG demand within the growing international LNG market. The report will summarize recentpolicy activities related to LNG among U.S. federal agencies, as well as private sector plans for LNGinfrastructure development. The report also will introduce key policy considerations in LNGinfrastructure and market structure, highlighting current market information and key uncertainties. Finally, the report will identify key questions in LNG import policy development.

Background

Natural gas is widely used in the United States for heating, electricity generation, industrialprocesses, and other applications. In 2005, U.S. natural gas consumption was 22 trillion cubic feet(Tcf), accounting for 23% of total U.S. energy consumption. (6) Until recently, nearly all U.S.natural gas was supplied from North American wells and transported through the continent's vastpipeline network to regional markets. In 2003, however, due to constraints in North Americannatural gas production, the United States sharply increased imports of natural gas from overseas inthe form of liquefied natural gas (LNG). While absolute levels remain limited today, growth in LNGimports to the United States is expected by many analysts to accelerate over the next 20 years,reflecting growing domestic demand and expectations for a global expansion in LNG trade.

What Is LNG?

When natural gas is cooled to temperatures below minus 260Â°F it condenses into liquefiednatural gas, or "LNG." As a liquid, natural gas occupies only 1/600th the volume of its gaseous state,so it is stored more effectively in a limited space and is more readily transported by tanker ship. Atypical tanker, for example, can carry 138,000 cubic meters of LNG -- enough to supply the dailyenergy needs of over 10 million homes. (7) When LNG is warmed, it "regasifies" and can be used for the samepurposes as conventional natural gas.

The physical infrastructure of LNG includes several interconnected elements as illustratedin Figure 1 . In producing countries, natural gas is extracted from gas fields and transported bypipeline to central liquefaction plants where it is converted to LNG and stored. Liquefaction plantsare built at marine terminals so the LNG can be loaded onto special tanker ships for transportoverseas. Tankers deliver their LNG cargo to import terminals in other countries where the LNGcan again be stored or regasified and injected into pipeline systems for delivery to end users. ThisLNG infrastructure requires large capital investments. In addition to gas field development costs,a new liquefaction plant costs approximately $2-$3 billion, and an import terminal costs $500million to $1 billion. One LNG tanker costs $150-$200 million. (8)

Figure 1: LNG Supply Chain

Source: Oil & Gas Journal. Nov. 10, 2003. p64.

Due to the high capital costs of LNG infrastructure, LNG trade has traditionally relied uponlong-term fuel purchase agreements in order to secure project financing for the entire supply chain. Of over 160 major LNG supply contracts in force around the world as of June 2005, well over 90%had a contract term of 15 years or longer. (9) While these contracts have increasingly incorporated someflexibility by accommodating extra LNG deliveries, for example, or allowing shipments to bediverted, they have only allowed for a limited supply-demand response compared to other globalcommodities markets.

U.S. LNG Import Experience and Projections

The United States has used LNG commercially since the1940s. Initially, LNG facilitiesstored domestically produced natural gas to supplement pipeline supplies during times of high gasdemand. In the 1970's LNG imports began to supplement domestic gas production. Between 1971and 1981, developers built four U.S. import terminals: in Massachusetts, Maryland, Georgia, andLouisiana. (10) Dueprimarily to a drop in domestic gas prices, however, two of these terminals quickly closed. Importsto the other two terminals remained small for the next 30 years. In 2002, U.S. LNG imports wereonly 0.17 Tcf, less than 1% of U.S. natural gas supply. (11)

Figure 2: U.S. Natural Gas Wellhead Price ($/Mcf)

Source: Energy Information Administration. Natural Gas Weekly Update . Jan. 19, 2006.

United States demand for LNG has been increasing dramatically since 2003. This growthin LNG demand has been occurring in part because North American natural gas production appearsto have plateaued, so it has not been able to keep pace with growth in demand. As a result, U.S.natural gas prices have become higher and more volatile. As Figure 2 shows, gas prices at thewellhead have risen from around $2.00/Mcf through most of the 1990s to an average above$6.00/Mcf and a peak above $10.00/Mcf in 2005. (12) At the same time, international prices for LNG have fallenbecause of increased supplies and lower production and transportation costs, making LNG morecompetitive with domestic natural gas. (13) While cost estimation is speculative, some industry analystsbelieve that LNG can be economically delivered to U.S. pipelines for approximately $2.50 to$3.50/Mcf. (14)

Forecasts by the Energy Information Administration (EIA), National Petroleum Council, andother groups project expansion in U.S. LNG imports over the next 20 years. Specific LNG forecastsvary based on methodology and market assumptions, but most expect LNG to account for 12% to21% of U.S. natural gas supplies by 2025. (15) EIA's reference forecast projects U.S. LNG imports to reach 4.13Tcf in 2025, which equates to approximately 16% of total U.S. gas supply for that year, upsubstantially from the 2005 market share of about 3%. (16) Figure 3 details projected U.S. LNG imports relative to othernatural gas supplies in EIA's forecast.

Figure 3: Projected U.S. Natural Gas Production and Imports (Tcf)

Source: Energy Information Administration. Annual Energy Outlook 2006. Dec. 2005. Table A13.

Global LNG Market Development

Projections of accelerated growth in U.S. LNG demand reflect a general expansion in theglobal natural gas market. According to the EIA's most recent international forecast "natural gas isexpected to be the fastest growing component of world primary energy consumption." (17) EIA projects global naturalgas demand to rise by an average 2.3 percent annually for the next 20 years, with "the largestincreases ... projected for the transitional economies of Eastern Europe and the former Soviet Union... and for emerging Asia," much of it to fuel electricity generation. (18) A significant part of thisglobal gas demand growth is expected to be met by new supplies of LNG. Long-term projectionsof global LNG growth vary, but most major energy companies and industry analysts expect globalLNG demand to roughly triple by 2020, from 6 Tcf in 2003, to 18 Tcf or more in 2020. (19) According to EIAprojections, 18 Tcf would account for approximately 13% of global natural gas consumption in2020. (20)

LNG Safety and Security

Natural gas is combustible, so an uncontrolled release of LNG poses a hazard of fire or, inconfined spaces, explosion. LNG also poses hazards because it is so cold. Because LNG tankersand terminals are highly visible and easily identified, they may also be vulnerable to terrorist attack. Assessing the potential risk from LNG releases is controversial. A 1944 accident at one of thenation's first LNG facilities, for example, killed 128 people and initiated public fears about LNGhazards which persist today. (21) But technology improvements and standards since the 1940'sappear to have made LNG facilities safer. Between 1944 and 2006, LNG terminals experiencedapproximately 13 serious accidents, with two fatalities, directly caused by LNG. (22) Since international LNGshipping began in 1959, tankers have carried 40,000 LNG cargoes without a serious accident at seaor in port. (23) In January2004, however, a fire at an LNG processing facility in Algeria killed an estimated 27 workers andinjured 74 others. (24) The Algeria accident raised new questions about LNG facility safety and security.

A number of technical studies since the terror attacks of September 11, 2001, have beencommissioned to reevaluate the safety hazards of LNG terminals and associated shipping. Thesestudies have caused controversy because, due to differences in analytic assumptions, some havereached inconsistent conclusions about the potential public hazard of LNG terminal accidents orterror attacks. In an effort to resolve these inconsistencies, the Department of Energy commissioneda comprehensive LNG hazard study from Sandia National Laboratories. The Sandia report, releasedin December 2004, determined that a worst-case, "credible" LNG tanker fire could emit harmfulthermal radiation up 2,118 meters (1.3 miles) away. (25) Although, the report concluded that "risks from accidental LNGspills ... are small and manageable," it also concluded that "the consequences from an intentional[tanker] breach can be more severe than those from accidental breaches." (26) Both proponents andopponents of new LNG terminals have cited the Sandia findings to support their positions. Thecontroversy continues.

LNG Policy Activities of the Federal Government

The federal government has been actively promoting increased LNG imports. Through newregulation, administrative actions, and legislation, federal agencies and Congress have tried to fosterLNG capital investment, streamline the LNG terminal approval process, and promote global LNGtrade.

FERC Regulations. The Federal EnergyRegulatory Commission (FERC) grants federal approval for the siting of new onshore LNG facilitiesand interstate gas pipelines, and also regulates prices for interstate gas transmission. (27) In December, 2002, theFERC exempted LNG import terminals from rate regulation and open access requirements. Thisregulatory action, commonly called the "Hackberry decision" allowed import terminal owners to setmarket-based rates for terminal services, and allowed terminal developers to secure proprietaryterminal access for corporate affiliates with investments in LNG supply. (28) These regulatory changesgreatly reduced investment uncertainty for potential LNG developers, and assured access to theirown terminals. (29) InFebruary 2004, FERC streamlined the LNG siting approval process through an agreement with theU.S. Coast Guard and the Department of Transportation to coordinate review of LNG terminal safetyand security. The agreement "stipulates that the agencies identify issues early and quickly resolvethem." (30) FERC alsoannounced a new branch devoted to LNG within its Office of Energy Projects. (31)

Between 1999 and 2005, FERC approved the reactivation of the two idled U.S. LNGterminals, and subsequently approved the expansion of the four existing import terminals in thecontinental United States. In September, 2003, FERC approved the Cameron LNG project inHackberry, LA, the first new LNG import terminal to be sited in the continental United States in over25 years. (32) Thecommission has since approved eight additional terminals (in Texas, Louisiana, and Massachusetts),and as of January, 2006 has received 12 additional terminal siting applications. (33) In 2004, FERC alsoapproved the construction of two new gas pipelines connecting Florida to proposed LNG importterminals in the Bahamas. (34) The terminals and pipelines approved to date by FERC couldincrease total U.S. LNG import capacity to approximately 7.0 Tcf per year.

Offshore Terminal Regulations. In November,2002, Congress passed the Maritime Transportation Security Act of 2002 ( P.L. 107-295 ), whichtransferred jurisdiction for offshore LNG terminal siting approval from the FERC to the MaritimeAdministration (MARAD) and the U.S. Coast Guard (USCG). According to the Department ofEnergy, the act

... streamlined the permitting process and relaxedregulatory requirements. Owners of offshore LNG terminals are allowed proprietary access to theirown terminal capacity, removing what had once been a major stumbling block for potentialdevelopers of new LNG facilities.... The streamlined application process ... promises a decisionwithin 365 days.... (35)

The proprietary access provisions for offshore terminals are similar to those set by FERC for onshoreterminals to ensure equal treatment for both kinds of facilities. In November, 2003, the MARADand USCG approved the Port Pelican project, the first offshore LNG terminal ever to be sited in U.S.waters. The agencies have subsequently approved Energy Bridge (January, 2004) and Gulf Landing(February, 2005), two additional offshore LNG projects. All three terminals would be located in theGulf of Mexico. Their combined annual capacity would be approximately 1.2 Tcf. As of January,2006, the agencies were reviewing seven additional offshore terminal applications, two off theCalifornia coast, four in the Gulf of Mexico, and two off the coast of Massachusetts.

Congressional Activities. In 2005, Congresspassed and President Bush signed the Energy Policy Act of 2005 ( P.L. 109-58 ). The Energy PolicyAct is generally seen as promoting new LNG terminal development in several ways. As noted earlierin this report, the act resolved certain state-federal jurisdictional disputes by granting the FERCexplicit and "exclusive" authority to approve onshore LNG terminal siting applications (Sec. 311c).The act also codifies the "Hackberry decision"discussed above (Sec. 311c). The act designates theFERC as the "lead agency for the purposes of coordinating all applicable Federal authorizations" andfor complying with federal environmental requirements (Sec. 313a). It also establishes the FERC'sauthority to set schedules for federal authorizations and establishes provisions for judicial review ofFERC's siting decisions in the U.S. Court of Appeals, among other administrative provisions (Sec.313b). The act also requires FERC to promulgate regulations for pre-filing of LNG import terminalsiting applications and directs FERC to consult with designated state agencies regarding safetyconsiderations in considering such applications. It permits states to conduct safety inspections ofLNG terminals in conformance with federal regulations, although it retains enforcement authorityat the federal level. The act also requires LNG terminal operators to develop emergency responseplans including cost-sharing to reimburse state and local governments for safety and security costs(Sec. 311d).

Key Issues in U.S. LNG Import Policy

Federal actions are facilitating greater U.S. LNG imports, and the private sector is respondingwith plans for new LNG facilities. Nonetheless, concerns are emerging about the infrastructureneeds of LNG, the future structure of global LNG trade, and the relationship between the UnitedStates and other LNG market participants.

Physical Infrastructure Requirements

To meet U.S. LNG imports of 4.13 Tcf in 2025 as projected by the EIA would requiresignificant additions to North American import terminal capacity. Along with expansions at fourexisting terminals, six to ten new import terminals would be needed. LNG developers haveproposed over 30 new terminals with a combined import capacity far exceeding what would likelybe needed the meet the projections ( Figure 4 ). (36) These developers include multi-national corporations with thefinancial resources and project experience to develop such facilities. At issue is where theseterminals would be built, how they would be integrated into the nation's existing gas infrastructure,and how they might be secured against accident or terrorist attack.

Figure 4: Existing and Proposed LNG Import Terminals in North America

Source: Federal Energy Regulatory Commission (FERC). "Existing and Proposed North American LNG Terminals."

Office of Energy Projects. Washington, DC. Jan. 23, 2006. http://www.ferc.gov/industries/lng/indus-act/terminals/exist-prop-lng.pdf

Terminal Siting. Choosing acceptable sites fornew LNG terminals has proven controversial. As noted earlier in this report, federal agencies haveapproved the siting of ten new terminals in the Gulf of Mexico as well as two new Florida pipelinesfor proposed terminals in the Bahamas. But many developers have sought to build terminals nearerto major consuming markets in California and the Northeast, as Figure 4 shows. Developers haveproposed terminals near consuming markets to avoid pipeline bottlenecks and to minimizetransportation costs. In 2003, soon after LNG deliveries to the Cove Point resumed, natural gas forthe local Maryland market was priced well below conventional gas supplies transported by pipelinefrom the Gulf of Mexico. (37) If new terminals are built far from key consumer markets,delivered gas might cost more than if LNG terminals were built locally.

As of January, 2006, federal agencies have approved only one new LNG import terminaloutside the Gulf of Mexico, in Massachusetts. Such near-to-market terminal proposals havestruggled for approval due to community concerns about LNG safety, effects on local commerce, andother potential negative impacts. LNG terminal opposition is not unlike that experienced by someother types of industrial and utility facilities. Due to local community opposition, LNG developershave already withdrawn terminal projects recently proposed in California, Maine, North Carolina,Florida, and Mexico. Other terminal proposals in Rhode Island, New York, New Jersey and Canadaare facing stiff community opposition. In Alabama, a state assumed by many to be friendly to LNGdevelopment, community groups have effectively blocked two onshore terminal proposals and havecalled for LNG import terminals to be built only offshore. (38)

In some cases state and local agencies are at odds with federal agencies over LNG terminalsiting approval. For example, Delaware's environmental secretary has blocked the development ofan LNG terminal on the Delaware-New Jersey border ruling that part of the terminal would extendinto Delaware's waters and violate Delaware's Coastal Zone Act. (39) The United StatesSupreme Court has appointed a special master to resolve the dispute. (40) In January, 2005,Massachusetts and Rhode Island filed petitions in federal court to reverse FERC's approval of anLNG import terminal to be sited in Fall River, Massachusetts. (41) In 2004, the CaliforniaPublic Utilities Commission (CPUC) sued FERC in federal court over FERC's assertion of solejurisdiction over the siting of an LNG terminal in Long Beach. The CPUC dropped its suit, however,after the passage of P.L. 109-58 mooted its arguments.

Local opposition for LNG terminals has been strong in the Northeast, which has aconstrained gas transmission infrastructure. Northeast gas prices are higher than in other parts of thecountry. In Maine, for example, the monthly average wholesale price of gas delivered betweenOctober, 2004 and October, 2005 was $12.09/Mcf, compared to $8.27/Mcf in Louisiana. (42) Were the same pricedifferential to hold in the future, Maine consumers would have to pay $3.81/Mcf, or 46 percent, morefor LNG delivered to Louisiana rather than the Maine coast. Many factors like weather, pipelinetariffs, and new natural gas supplies from Canada could significantly change relative prices. Nonetheless, if recent regional pricing patterns persist, displacing a handful of proposed LNGterminals from consumer markets to the Gulf of Mexico could cost regional gas consumers billionsof dollars in extra pipeline transportation charges. On the other hand, siting new terminals in morereceptive locations could help bring them into service more quickly, and could still exert downwardpressure on gas prices while alleviating community safety concerns.

Pipeline Infrastructure. LNG supplies to theUnited States have been such a small share of the total market that they have had little discernibleinfluence on the development of North America's gas pipeline network. If projections of U.S. LNGgrowth prove correct, however, LNG terminals may have more impact on pipeline infrastructure inthe future. As additional LNG import capacity is approved, how new terminals will be physicallyintegrated into the existing pipeline network becomes a consideration.

LNG terminals may affect pipeline infrastructure in two ways. First, new terminals andterminal expansions must be connected to the interstate pipeline network through sufficient"takeaway" pipeline capacity to handle the large volumes of imported natural gas. Depending uponthe size, location and proximity of a new terminal to existing pipelines, ensuring adequate takeawaycapacity may require new pipeline construction. For example, the owner of the Elba Island, GAterminal intends to build a 191-mile pipeline to transport additional gas volume from the terminal'splanned expansion. (43) Energy experts have expressed concern, however, that interstate pipeline capacity may not besufficient to handle future LNG supplies without substantial new pipeline additions. (44) The availability of pipelinecapacity directly affects pipeline transportation costs, so it is an important consideration in evaluatingthe economics of LNG versus traditional pipeline supplies in specific markets.

Second, if gas imported as LNG cannot move freely through interstate pipeline systems,consumers may not realize the lower prices that result from additional gas availability. One industryobserver remarked, "without more infrastructure, gas may face the kind of glut plaguing the electricutility industry, with too much generating capacity and too few connections." (45) For this reason, some LNGdevelopers advocate building LNG terminals in traditional gas producing regions, where pipelinenodes are located. According to one industry executive, "it doesn't make a lot of sense to build aterminal and then have to build a huge pipeline." (46) Others argue that the most costly constraints in the gas pipelinenetwork are at the ends of the pipelines, not the beginnings. Gas is expensive in Boston, forexample, because there are few pipelines supplying the region -- a transportation constraint thatwould not be alleviated by pumping more gas into pipelines in the Gulf of Mexico. As one seniorFERC official has reportedly remarked, "putting more and more LNG plants in the Gulf, while itmay be good for the overall gas supply situation in this country, won't do a whole lot for the regionalgas needs of New England." (47) It is not clear, therefore, whether adding LNG supplies totraditional producing regions would be less costly for consumers than building in-market terminalsand adding to regional pipeline capacity.

In addition to requiring sufficient takeaway capacity, LNG terminals likely will influencepipeline network flows. Major U.S. pipeline systems were designed primarily to move gas fromtraditional producing regions (e.g., Gulf Coast, Appalachia, Western Canada) to consuming regions(e.g, Northeast, Midwest). If most new LNG capacity is built in the Gulf of Mexico, then traditionalgas flows would be maintained. If a number of new terminals are built in consuming regions,however, they may change historical gas transportation patterns, potentially displacing traditionalproduction and changing infrastructure constraints. Among other potential impacts, some analystshave suggested that new LNG terminals will result in "less market leverage and probably lower cashflows" for some existing pipelines because new LNG supplies may be able to reach consumermarkets by alternate routes. (48) Predicting the overall effects of long term changes in gas flowsis a complex problem, although such changes may have important implications for current pipelineutilization and for future pipeline investments.

Interchangeability. LNG consists primarily ofmethane, but it may also contain significant quantities of other hydrocarbon fuels, such as ethane,propane and butane. The quantity of these other fuels in LNG affects the overall heat content in theLNG and varies depending upon its source. In markets outside the United States, LNG containsmore non-methane fuels and, therefore, has a higher heat content than traditional U.S. natural gassupplies. LNG with a high heat content can cause problems when imported into the United Statesbecause it may damage pipelines and natural gas-fired equipment (e.g., electric power turbines)which are designed for a lower heat content. There are a number of potential technical solutions toLNG interchangeability problems, such as stripping out the non-methane fuels, blending the LNGwith domestic natural gas, and "diluting" the LNG with nitrogen. (49) These solutions mayinvolve significant added expense to LNG processing, however, which could be reflected in highernatural gas prices. The FERC has been working with natural gas trade associations to establishappropriate national policies for natural gas interchangeability and quality. The FERC has addressedsome interchangeability issues on a case by case basis, and has proposed more general regulationson natural gas quality and interchangeability, but the commission's expressed preference is that thegas industry and gas quality stakeholders reach their own consensus on interchangeability. (50)

Safety and Physical Security. To protect thepublic from an LNG accident or terrorist attack, the federal government imposes numerous safetyand security requirements on LNG infrastructure. The nature and level of risk associated with LNGis the subject of ongoing debate among industry, government agencies, researchers and localcommunities. (51) Whatever the specific risk levels are determined to be, they could multiply as the number of LNGterminals and associated tanker shipments grows. Likewise, the costs associated with mitigatingthese risks are also likely to increase. To the extent these costs are not borne by the LNG industry,they may represent an ongoing burden to public agencies such as the Coast Guard, law enforcement,and emergency response agencies.

Securing tanker shipments against terrorist attacks may be the most significant publicexpense associated with LNG. CRS has estimated the public cost of security for an LNG deliveryto the Everett terminal to be on the order of $80,000, excluding costs incurred by the terminalowner. (52) Marinesecurity costs at other LNG terminals could be lower than for Everett because they are farther fromdense populations and may face fewer vulnerabilities, but could still be on the order of $20,000 to$40,000 per shipment. If LNG imports increase as projected, the number of vessels calling at LNGterminals serving the United States would increase from 99 (0.17 Tcf) in 2002 to over 2300 (4.13Tcf) in 2025. (53) Atcurrent levels of protection, marine security costs would then be in the range of $46 million to $92million annually. (54) Recognizing the added security needs associated with the LNG trade, the Coast Guard's FY2006budget includes an additional $11 million in general maritime security funding over FY2005 levels. These resources are for new small response boats and associated crew to increase the Coast Guard'soperational presence and response posture, enforce security zones, and escort LNG tankers and otherhigh interest vessels. (55)

Congress included provisions in P.L. 109-58 requiring new LNG terminal applicants toinclude plans for security cost-sharing with state and local government agencies (Sec. 311d). Thepublic costs of LNG security also may decline as federally mandated security systems and plans areimplemented. Nonetheless, because the accounting of security costs is ambiguous and may be tiedto uncertain sources of federal funding, such as Department of Homeland Security grants, somepolicy makers remain concerned about LNG security costs and the potential diversion of CoastGuard and safety agency resources from other activities.

Supply Bottlenecks. Because U.S. LNG terminalsprocess large volumes of LNG, the potential for one facility to bottleneck supply might not berecognized. A disruption at a U.S. import terminal (or at an associated supplier's export terminal)could effect regional gas availability.

Hurricanes Katrina and Rita, which struck the Gulf of Mexico in 2005, forced the temporaryclosure of the Lake Charles LNG terminal and raised questions about the vulnerability to futurehurricanes of multiple new LNG import terminals in the same region. (56) In March, 2004, strikingworkers at an export terminal in Trinidad stopped all LNG operations -- interrupting shipments fromthe largest U.S. supplier and the sole supplier to the Everett terminal. Although the strike endedquickly and U.S. gas demand at the time was moderate, one gas trader stated that if the strike hadoccurred during the heart of winter it might have exacerbated already high Northeast gas prices. (57) Similarly, when LNGshipments to the Everett LNG terminal were suspended after the terror attacks of September 11,2001, markets analysts feared shortages of gas for heating and curtailments of gas deliveries toregional power plants in New England. (58)

Some industry analysts view the Gulf hurricanes, Trinidad strike, and September 11, 2001events as new supply risks the United States could face as LNG becomes a larger share of gas supply. Others view these kinds of events as ordinary supply uncertainties readily managed in other fuelmarkets. As one consultant stated,

they are not problems that should make the industry shyaway from developing LNG trade ... they are just problems that should make you consider how youare going to structure long-term LNG contracts and estimate what kind of premiums you are goingto pay over indigenous pipeline supply. (59)

The future sensitivity of U.S. natural gas markets to LNG terminal disruptions is difficult to forecastand will be driven by factors such as supply diversity and pipeline development. Nonetheless, theconcentration of incremental gas supplies among perhaps a dozen major import facilities may raisenew concerns about the security of U.S. natural gas supply.

Global LNG Market Structure

In his 2003 congressional testimony, Federal Reserve Chairman Alan Greenspan asserted thatincreasing LNG import capacity would create "a price-pressure safety valve" for North Americannatural gas markets which would be "likely to notably damp the levels and volatility of Americannatural gas prices." (60) Basic market economics suggest that increasing marginal gas supplies from any source would tendto lower gas prices. But the long-term effectiveness of LNG in moderating gas prices will besignificantly influenced by global LNG supply, the development of an LNG spot market, andpotential market concentration.

Global LNG Supply. The belief that LNG canserve as a "price-pressure safety valve" by setting a price ceiling on natural gas assumes thatsufficient LNG would be available at that price to satisfy all incremental gas demand. Otherwise, gas prices would be capped by potentially more costly North American production alternatives. Thequestion, then, is whether there will be sufficient LNG production abroad to supply incremental U.S.demand and sufficient global infrastructure to distribute it.

Table 1 summarizes basic characteristics of existing or potential LNG exporters. As thetable shows, 2005 global LNG production capacity currently operating totaled approximately 9.1 Tcfper year. Table 1 also shows an additional 15.8 Tcf of global capacity proposed for service by2015, with more proposals likely in the future. If all these proposed facilities were constructed, totalglobal production capacity could exceed 24 Tcf annually, exceeding EIA's projected global LNGdemand of 18 Tcf in 2020.

Global tanker capacity also appears to be keeping up with LNG demand growth. Currenttanker orders will add 130 ships to the current operating fleet of 191, increasing the overall numberof LNG vessels 250% from the fleet size of 127 tankers in 2001. (61) Based on these figures,there appears to be sufficient interest among existing and potential exporters to meet both short-termand long-term global LNG demand projections. It remains to be seen which of these export projectswill be constructed and how they will be integrated into the global LNG trade.

Table 1: Global Natural Gas Reserves and LNG ProductionCapacity

Sources: "World LNG Map: 2005 Edition." Petroleum Economist . 2005; "Major LNG Gas Projectsto 2015." Reuter's News . Jan. 5, 2006; Oil & Gas Journal , Vol. 103, No. 47. Dec. 19, 2005. EnergyInformation Administration; Trade press.

Spot Market Growth. Some gas market analystsbelieve that a robust short-term or "spot" market for LNG is essential for U.S. importers to manageprice and supply risk, and to do business cost-effectively. An LNG spot market could allow forshort-term balancing of physical supply and demand. It could also offer greater LNG price discoveryand transparency, benefitting companies negotiating long-term LNG contracts and potentially servingas a more relevant index for LNG contract price escalators than traditional petroleum indexes. (62) A spot market might alsosupport financial trading and derivatives, important tools for managing price risk, especially duringperiods of volatile prices. (63)

In recent years, the global LNG market has seen limited, but increasing short-term trade.Short-term contracts accounted for 11% of global LNG transactions in 2005, up from less than 2%in 1998, and have already enabled physical market balancing. In 2005, for example, just afterHurricanes Katrina and Rita struck the Gulf of Mexico, Suez Energy (owner of the Everett LNGterminal) purchased a spot LNG cargo to meet its obligations to its New England customers. (64) In 2003-2004, SouthKorea purchased 36 spot cargoes of LNG to meet extra residential heating demand duringwinter. (65) In December, 2003, Indonesia sought four LNG cargoes from rival producers to meet delivery contractsfollowing production problems at its Bontang plant. (66)

Unlike petroleum markets where all prices are essentially short-term, analysts believe LNGtrade will stabilize with some mix of long and short-term contracts since infrastructure costs are sohigh. No new LNG liquefaction project yet has been launched without a long term contract. Thelikely size of an LNG spot market is difficult to predict, however at least one major exporter expects30% of global LNG capacity will ultimately trade on the spot market. (67) Coupled with projectionsof overall LNG demand growth, a 30% spot market share implies a tripling in spot market volumesby 2020. It is an open question, however, whether this volume of spot trade in LNG will materializeand if it will offer the full range of benefits realized in comparable commodity markets.

A concern related to LNG spot market development is the potential role of marketintermediaries. In the late 1990's, independent marketers like Enron and Dynegy emerged toparticipate in trading of natural gas, electricity, and other energy commodities. These marketparticipants increased market liquidity, selling risk management services to both producers andconsumers. Many marketers fell into bankruptcy, however, following the California electricity crisisin 2001 and subsequent scandals. A handful of major banks are beginning to pursue newpartnerships with LNG terminal companies (e.g., Morgan Stanley - Cheniere Energy) to facilitateLNG trading and marketing, but such partnerships have yet to fully develop. (68) It is unclear, therefore,which entities may ultimately succeed in providing the LNG industry with the capabilities neededfor a fully functioning market.

Market Concentration. Some industry analystsbelieve the future LNG market may be susceptible to concentration-related inefficiencies. They notethat only a limited number of buyers and sellers can effectively participate in LNG trade because thecapital requirements are so great. (69) Many analysts also believe that a relatively small number ofexporting countries are likely to account for the majority of LNG trade in the foreseeable future.

Based on LNG's similarity to the world oil trade, some observers are concerned about thepossible emergence of a natural gas export cartel analogous to the Organization of PetroleumExporting Countries (OPEC). One analyst remarked:

Might a few countries come to dominate the supply ofLNG and adopt policies harking back to the confrontational OPEC of the 1970's? An association ofsome kind among LNG exporters is likely. Many of them are also oil exporters, and the desire tocompare fiscal terms will be irresistible. (70)

In March, 2004, at the Fourth Annual Gas Exporting Countries Forum, 15 major natural gasexporters established an "executive bureau" to develop common policies and joint initiativesregarding natural gas exports. According to press accounts, some forum members viewed the bureauas "a major step toward creating an OPEC-like organization to regulate gas production." (71) Some analysts have alsopointed to apparent efforts by Russian gas company, Gazprom, "to sketch out the basic terms forbroad cooperation in the gas sector between Russia and Iran" the two countries controlling the largestnatural gas reserves in the world. (72) Other analysts are more skeptical of a potential natural gas cartel,citing the predominance of long-term contracts for LNG trade, divergent national interests, and otherfactors as barriers to collaboration. (73)

The ability of a cartel to play a similar role in gas as OPEC does in oil is debatable. OPECmember countries currently control over 75% of the world's proven oil reserves and approximately40% of global oil supply. (74) By comparison, OPEC members control approximately 50% ofproven world gas reserves and approximately 59% of global LNG production capacity projected for2015 (Table 1 ). When non-LNG sources are accounted for, however, OPEC countries' share ofglobal gas supply would be approximately 5% in 2015. Based on these figures alone, it is difficultto draw conclusions about the potential market power of an association of LNG exporters. It ispossible, however, that the diversity of LNG suppliers, and the competitive relationship betweenLNG and traditional pipeline gas could make the world LNG market somewhat different than thatof oil.

Global Trade and Politics. Continued growth ofUnited States demand in an integrated global LNG market may affect trading and politicalrelationships with key market participants. According to one estimate, by 2015 the United Statesmay be the world's largest LNG importer, accounting for 22% of global volumes ( Figure 5 ). SouthKorea, Spain, and the UK will also be importing large quantities of LNG, and may be joined bydeveloping nations including India and China, seeking greater imports for rapidly growingeconomies.

Figure 5: Global LNG Import Market Shares Projected for 2015

Source: Deutsche Bank Securities, Inc. "Global LNG: Exploding the Myths." July 22. 2004. p2.

In an integrated global LNG market, individual country energy polices may significantlyaffect LNG price and availability worldwide. In 2001 and 2002, for example, after the Japanesegovernment forced Tokyo Electric Power to shut down over a dozen nuclear plants for safetyreasons, Japanese utilities relied more heavily on fossil fuels for electricity generation. Accordingto the EIA:

the result was a significant increase in Japan's demandfor LNG, so that the majority of world spot cargoes were delivered to the Japanese market. Japan'sincreased reliance on LNG probably contributed to the reduction in short-term deliveries of LNG tothe United States... (75)

Japan's nuclear energy policies also affected South Korea, which depends on flexible spot LNGsupplies to meet winter heating demand. With LNG supplies in Asia suddenly scarce, South Koreahad to pay a substantial premium to attract spot cargoes originally destined for Spain. (76) In 2004-2005, Spainattracted numerous LNG spot cargoes "at the expense of the US" in response to record cold weatherand inadequate hydroelectric power supplies. (77) Despite record cold temperatures and record high natural gasprices after the Gulf hurricanes, U.S. LNG terminals were operating at less than 50% capacity inDecember, 2005. (78)

Trade with LNG exporters such as Iran, Nigeria, and Venezuela may also raise geopoliticalconcerns. According to one analyst, "question remains on the merits of increasing reliance onimported energy ... if supply sources are from a region perceived as politically unstable orinhospitable to U.S. interests." (79) In part to mitigate such risks, the DOE has been encouraging thedevelopment of LNG supplies in South America and West Africa rather than the Middle East. According to the former DOE Assistant Secretary for Policy and International Affairs, "DOE istrying to make countries like Equatorial Guinea as attractive as possible to investors while aimingto limit the countries' potential political instability through contract and regulatory reform." (80)

LNG trade may also be linked to broader trading and political relationships among key LNGpartners. For example, in the fall of 2004, China's interest in securing LNG supplies from Iran "putit in direct conflict with U.S. efforts to force Iran to renounce its ambitions to become a nuclearweapons state." (81) Ina 2004 meeting with U.S. Energy Secretary Spencer Abraham, the Prime Minister of Trinidadreportedly used his country's status as the largest U.S. LNG supplier to seek most favored nationstatus for Trinidad's energy exports, duty free U.S. access for all Trinidadian-packaged products, andU.S. aid to offset gas exploration costs. (82) Russia's brief withholding of natural gas supplies to Ukraine andparts of the European Union in January, 2006 in what was widely perceived as both an economic andpolitical dispute have raised additional concerns about political linkages among future natural gasmarket participants. (83) It is interesting to note that several European countries, including Italy, Ukraine, Poland, Hungary,Croatia, have since proposed the construction of new LNG imports terminals to reduce theirdependence on Russian pipeline natural gas supplies. Russia's plans to become a major LNGexporter may further complicate the global natural gas trade.

It is difficult to predict the nature of trading and political relationships either among LNGimporters, or between specific LNG importing and exporting countries over a 20-year time frame. Nonetheless, experience suggests that global LNG trade may introduce new risks and opportunitiesamong trading countries that warrant consideration in LNG policy debate.

Conclusions

As long as domestic demand outpaces North American natural gas production, the option ofdeveloping LNG import capacity appears economically attractive. Currently, LNG supplies 3% ofU.S. natural gas, but both industry and government project this figure to rise to as much as 21% by2025. Such an increase would pose a number of practical, immediate challenges, such as ensuringadequate production and import capacity, integrating LNG efficiently into the existing natural gassupply network, and securing LNG infrastructure against accident or terrorist attack. Publicopposition to LNG-related facilities and new trading relationships in an increasingly integratedglobal gas market will also bear upon the expansion of the industry.

As the practical challenges to LNG import expansion are addressed, the policy discussionturns to the long-term implications of increased LNG imports in the nation's energy supply. Intentionally or not, the United States may be starting down a path of dependency on LNG importssimilar to its current dependency on foreign oil. Such a dependency would represent a major shiftin the nation's energy policy, and may have far-reaching economic impact. Because U.S. naturalgas markets are regional, major consuming areas such as California and the Northeast might beparticularly affected.

Some energy analysts believe that U.S. dependency on imported LNG is inevitable; the onlyuncertainty is how quickly it will occur. Others disagree, promoting instead familiar alternativessuch as greater domestic gas production, switching to oil or other energy sources, and conservation. Recent measures before Congress affect LNG imports by providing incentives for domestic gasproduction and for new LNG terminal construction. If Congress considers the relative merits of LNGand other energy supply alternatives, three overarching policy questions may emerge.

Is expanding LNG imports the best option for meeting long-term natural gasdemand in the United States?

What future role, if any, should the federal government play in facilitating theongoing development of LNG infrastructure in the United States and abroad?

How might Congress mitigate the risks of the global LNG trade within thecontext of national energy policy?

The answers to these questions may flow from enhanced understanding of the infrastructure andmarket structure issues discussed in this report. With incomplete information and limited policyanalysis, LNG imports may look unrealistically attractive to some, but unreasonably risky to others. The reality probably lies somewhere in between. It may not be possible to predict the LNG future20 years from now, but choices made now can substantially affect that future.