What about those “premium Asian LNG markets” …

Turns out the “premium” revenues are consumed by higher costs …

The proponents of the Valdez LNG project often talk about “premium Asian LNG markets,” and the ability of those markets to help Alaska cope economically with declining oil production. The theory is that revenues from LNG sales to Pacific Rim markets will produce sufficient revenues to offset the impact of declining (and ultimately, ending) oil production. Among other things, this logic is used to justify the continuation of the ACES (“Alaska’s Clear and Equitable Share”) tax structure, by arguing that even if ACES causes producers to stop investing in new oil development, the Alaska economy will be fine because the Valdez LNG project will result in replacement revenues from sales of gas.

The argument always has created a sense of unease. Generally speaking, Asian LNG markets operate at price levels above those in the Lower 48. The analysis, however, has not captured the entire story. Pipeline facilities and LNG liquefaction plants are expensive to construct and operate. As the economic consultants to the State summarized when comparing the Valdez LNG project to the Trans Canada’s proposed AGIA (“Alaska Gasline Inducement Act”) pipeline to the Lower 48, LNG projects both have higher capital costs and significantly greater fuel consumption that comparably size pipeline projects. As a result, the unanswered question has been are the “premium” Asian LNG prices sufficient to absorb the higher costs of the Valdez LNG project and still produce revenues comparable to those produced from oil.

The answer turns out to be no. In an effort to assess whether a Valdez LNG project would produce net revenues sufficient to offset the impact of declining oil production this page has developed and started reporting the estimated netbacks to Alaska if either the AGIA pipeline or the Valdez LNG project were operating today. The results, using yesterday’s closing prices as an example, are reflected in the following chart.

Estimated Alaska North Slope Netback Values

The red indicates the net loss that producers – and thus, the State as royalty owner – would suffer if the AGIA and Valdez LNG options were operational today. The detailed basis for these calculations is available at https://bgkeithley.com/category/basis-for-calculating-alaska-oil-gas-values/, but because of the surprising result, a quick analysis of the Valdez LNG option is worth further mention.

It is true that the initial price for LNG delivered to Pacific Rim markets is higher than that currently being achieved in Lower 48 markets. For example, yesterday’s closing price for gas delivered to the AECO Hub in Alberta (the initial delivery point for gas transported through the AGIA pipeline) was Canadian $3.25/MMBtu (or, using yesterday’s currency rates, US $3.08/MMBtu). Converting to a common basis for comparing gas to oil, that equates to a value of $17.86/barrel of oil equivalent (“BOE”). On the other hand, according to the LNG prices reported by the Oil & Gas Journal adjusted for the costs of shipping previously estimated by the State, the price of LNG delivered to Japan currently is in the range of $9/MMBtu (or around $52/BOE), a “premium” of roughly 275% over prices that would be received for comparable sales of gas at the AECO Hub.

Why, with that advantage, does the netback from the Valdez LNG option end up in the red and close in value to the estimated netback using the AGIA outlet? The reason is that the costs of getting gas from the Alaska North Slope to the Pacific Rim LNG market is significant.

Those costs come basically in three pieces – shipping, the costs of the facility necessary to convert gas to LNG (to be built in Valdez), and the costs of the pipeline to get the gas from the North Slope to Valdez.

While the costs of shipping are not trivial – during the AGIA process the State’s consultants estimated the costs at roughly $1/MMBtu (or $5.80/BOE) – they are not the source of the problem. By far, the greatest share of the costs is incurred in moving the gas from the North Slope to Valdez, and then converting the gas to LNG in preparation for shipment.

In its recent Open Season materials, the Alaska Pipeline Project (TransCanada’s AGIA pipeline proposal) estimates the cost of moving the gas from the North Slope to Valdez at varying rates, depending on the type and length of commitment shippers are willing to make. Incorporating reasonable estimates of the type and length of commitments that shippers are likely to make to a Valdez LNG option, a reasonable estimate of the cost of the pipeline transportation to Valdez is in the range of $3.10/MMBtu (or $18/BOE).

The costs involved in the liquefaction facility in Valdez are even more significant. Based on the estimates made by the State’s consultants during the AGIA review – which, in turn, were based on the estimates previously developed by the Bechtel engineering firm and provided by the Alaska Gasline Port Authority – the costs of a liquefaction facility of the size that the Port Authority talks about now are in the range of $4/MMBtu (or $23.20/BOE). And, the costs do not end there. A significant amount of gas is consumed and lost in the process of transporting the gas to the liquefaction plant and once there, chilling the remainder to the extent required to liquefy the gas. The State’s consultants estimated the total loss at 15.8% of the volumes initially produced in the field, which at current prices represents an additional value loss of approximately $1.25/MMBtu (or $7.30/BOE).

The net result is that, while gas delivered to the Asian LNG market certainly commands a premium price over gas delivered to the Lower 48, once the costs of reaching the Asian market are taken into account, the net value to Alaska is roughly the same. At current prices prevailing in both markets, the netback to the North Slope is a roughly equivalent loss.

What messages are in those results for Alaska going forward?

There are three. The first is that, even though on its face the Pacific Rim LNG option appears attractive, once the costs of the Valdez LNG option are considered the results turn out generally about the same economically for Alaska as the AGIA pipeline option. The second is that, if Alaska continues to pursue an LNG option, serious consideration should be given to using the existing LNG facility on the Kenai instead of centering the focus on building a new facility at Valdez. A significant share of the loss in value under the existing LNG proposal is due to the fact that Valdez LNG option requires the construction of a new facility. The existing Kenai facility would not involve the same construction – and costs.

The most important message, however, is that gas is not a substitute for oil. In terms important to Alaska state government and the economy, gas comes nowhere close to providing the same economic lift as oil. The rate at which oil is declining can be offset with additional investment. See “Alaska’s Future: It’s the oil …,” Alaska Dispatch, http://alaskadispatch.com/voices/tundra-talk/5929-alaskas-future-its-the-oil (Jul. 10, 2010). From the perspective of the Alaska economy, there is much more benefit to spending time thinking about how to increase the investment levels in continued oil development than continuing to spend time on the various gas options.