Streetwise Professor

When playing Spin the Bottleneck with my students I say to look at what lies between the price of a transformed and untransformed commodity to identify the bottleneck. In my earlier post on the gaping spread between European (and Asian) LNG prices and the price of US gas (which is on the margin for both destinations) I noted two possible constraints: shipping and liquefaction capacity.

Well, it ain’t shipping.

There is a surfeit of LNG shipping capacity. So much that LNG shipping is effectively free between the US and Europe (down from $273K/day in December). Yet the spread remains very wide. So the binding constraint is definitely liquefaction capacity, in the US in particular. Those who have the rights to that capacity–notably firms that entered into contracts with the likes of Cheniere or Freeport that buy gas at the US price and pay a contractually fixed liquefaction/tolling fee–are coining it. They capture the bulk of the existing spread between TTF or UK Balancing Point prices and Henry Hub. (The LNG companies are benefitting only to the extent that they reserved some of their capacity for their own trading, which is rather de minimis).

So in the short run liquefaction capacity is quite valuable. The question is what will its value be over the longer term? Will current events convince enough financiers to provide capital for a large expansion of US capacity? Given the long gestation period of these projects it is a hard issue for banks and equity to analyze.

One thing to note. Another thing I discuss extensively in my classes is the importance of government/regulatory bottlenecks. Such bottlenecks may be a constraint on expansion of US LNG capacity. Many of the projects under development do not have the requisite federal permits. The Biden administration is unlikely to grant more. Thus, like taxicab medallions in NYC, existing permits likely have a substantial scarcity value–thanks to a government-created bottleneck.

This has interesting implications for financing of US LNG projects. Financiers of a given project face less risk of a glut of capacity coming online in a few years, and this should make them more willing to finance already permitted projects. But, of course, they are taking on political risk by doing so: might a new administration change course post-2024? Or might political pressure induce a change in course by the current administration? There are already a lot of political risks in investing in anything fossil-fuel related (attributable to climate hysteria). This is a US LNG-specific risk.