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Think the Shale Gas Boom Is a No-Brainer for Investors? Think Again

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LNG is the newest political football, and it will have to pass muster in Washington, DC, before investors can benefit.

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For the past 40 years, those in the US have been regaled by politicians about the need to rid the nation of the dependency on foreign oil, all the while operating a foreign policy built solely around the securing and maximizing of the flow of said foreign oil to the US. Now that Energy Return on Energy Invested (ERoEI) has become a topic of real interest, and the structural price for a barrel of oil equivalent (BOE) is firmly in the $100 per barrel range, the unlocking of various unconventional or tight supplies of oil and gas are not only economically viable, but are creating a production glut that current infrastructure cannot keep up with. This has resulted in the crash of US natural gas prices and the widening of the price spread between West Texas Intermediate Crude and Brent Crude.

These massive changes in US production are causing massive changes within the greater energy market. It's created a massive arbitrage between the US and the rest of the liquid natural gas-using world, so much so that pressure is mounting to allow exports of LNG, which would be a huge boon to global growth, allowing that cheaper energy to disperse through the global market and keep a lid on LNG prices. Normally, something like this would be a boon to the world at large, but political reality is far different than market reality. As always, the two are in direct conflict with each other.

Cheniere Energy (NYSEAMEX:LNG) has the only permitted LNG export terminal in the continental US under construction. All others, including refitting of existing LNG import terminals, are on hold and being held, nominally, by the US Department of Energy. Even Cheniere's permit is a restricted one, only allowing it to export 2.2 billion cubic feet per day – a level arbitrarily decreed to not be detrimental to the national interest – and only to nations without a free trade agreement with the US.

Cheniere has tried to fight this restriction by citing it as a violation of the US' agreement with the World Trade Organization as well as General Agreement on Tariffs and Trade (GATT), but a recent court decision held that those treaties do not supersede standing US legislation. In essence, the 1938 Natural Gas Act's provision giving the Department of Energy the power to set the rules on natural gas exportation is still in effect, and the burden of proof regarding exports not being in the national interest lies with the exporter, not with the DoE.

This is a convenient dodge for the court as it then allows the DoE to be completely suborned by political pressures emanating from Washington, DC. And since the rest of the world wants the US' liquid natural gas because companies like Cheniere or Exxon Mobil (NYSE:XOM) – one of those who have applied for a terminal refit permit – can provide it to them at a significant discount to the current market price, the amount of political capital bound up in the granting of these export licenses is, frankly, almost beyond comprehension. Cheniere's restricted license is worth $3.2 billion US per year at $4.00 per million BTU.

Politically, selling this need to restrict these exports to the American people will be one of the few things the US Congress will not have to work hard to do. In fact, allowing significant exports of natural gas, given the general distrust of Big Oil among US voters, would be the harder sell for Congress because it will primarily be looked at as them being in the pockets of the oil companies selling domestic energy to the highest bidder, and further, not serving the people whom they are supposed to represent. Senator Ron Wyden (D-Oregon) as Chair of the Senate Energy and Natural Resources Committee is dead set against allowing anything that will allow the price of natural gas to rise. It does not matter that he is economically illiterate. He has power and he intends to use it.

The producers will expand and contract supply to maintain the long-term average price of natural gas – around $4 per million BTUs. We've been seeing this over the past year as wells have been shut down and the price has risen off of its floor below $2. So, there is little doubt that supply can be expanded to meet demand levels for potential export. Price and long term supply are clearly not credible issues. The US is sitting on the world's second-largest natural gas reserves, behind China and more than enough supply for 50+ years of production. Moreover, reserve estimates are rising faster than production is depleting them at current prices. Given this political gridlock, I would be expect a pullback in natural gas futures to $3.00.

But that said, make no mistake, I expect the DoE will grant the export licenses over time. The issue will be how much tribute to the Obama administration and the Democratic Party will be extracted in the process in order to secure their retention of the White House in 2016 as well as for the upcoming mid-term elections in 2014. With the trio of LNG terminals being green-lit in Kitimat, BC, the US will have to move fast or lose some potential customers for its gas. A full license is worth hundreds of billions of dollars in revenue, well worth the $15-20 billion investment in the LNG terminal itself and any ancillary payments to grease the political skids.

The problem is that the market for LNG production and export in the US will be completely controlled and metered out not for maximal profit potential of the companies doing the exploration, transportation, liquefaction and storage, but for the politicians who claim the authority to tell them what is best for their business. Cheniere is currently trading on the potential that the suits in Washington will open up the market, but at this point it has the ability to pick winners and losers, and in the initial rounds, Cheniere has lost decisively.
No positions in stocks mentioned.
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