U.S. LNG Exports: The Continuing Evolution of Natural Gas, America s Game Changer

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1 June 5, 2013 Practice Groups: Oil and Gas Liquefied Natural Gas Energy Energy, Infrastructure and Resources U.S. LNG Exports: The Continuing Evolution of Natural Gas, America s Game Changer By David L. Wochner and Sandra E. Safro Published in The PIOGA Press, June 2013, Issue 38, the monthly newsletter of the Pennsylvania Independent Oil and Gas Association. A few short years ago, companies in this country were competing for licenses to import liquefied natural gas ( LNG ) 1 into the United States. Today, we stand in a position to completely reverse that to become a net exporter and to use our abundant resource to provide our allies with a clean, reliable energy source LNG. However, before a single molecule of natural gas may be exported from the United States, the entity seeking to export must obtain a license to do so from the U.S. Department of Energy ( DOE ). Under the Natural Gas Act ( NGA ), the DOE must grant an application to export natural gas to nations with which the United States has a free trade agreement ( FTA nations ). 2 By contrast, the NGA sets up a rebuttable presumption in favor of applications to export natural gas to countries with which the United States does not have a free trade agreement ( non-fta nations ). In the case of applications to export to non-fta nations, under the law the party opposing the export has the burden of proving that the proposed export is not in the public interest. If the opposing party cannot meet that burden, the proposed export will be considered to be in the public interest, and DOE must grant the application for a license. It is in this area exports of LNG to non-fta nations where the majority of the exports debate has been focused. Two years ago, in May 2011, DOE issued the first license to export LNG to non-fta nations to Cheniere Energy's proposed Sabine Pass Liquefaction project. 3 In the time between DOE s order authorizing the Sabine Pass application and today, DOE has received nearly 20 applications to export LNG to non-fta nations. In light of these applications, DOE implemented a de facto moratorium on the issuance of any new non-fta export authorization pending the results of two studies that DOE commissioned on the economic impacts of LNG exports on the U.S. economy: a microeconomic study performed by the Energy Information Administration ( EIA ) and a macroeconomic study performed by NERA Economic Consulting (collectively, the LNG Export Study ). The stated intention was to determine, broadly speaking, the likely impacts of larger scale exports of LNG on the U.S. economy. In December 2012, DOE invited public comment on the LNG Export Study, with an initial comment period ending January 24, 2013, and a reply comment period ending February 25, Natural gas is converted from a gaseous to a liquid state when it is cooled to approximately -260 F. In a liquid state, natural gas takes up approximately 1/600 th the volume it occupies in a gaseous state. This decreased volume facilitates the marine transportation and storage of natural gas. 2 The United States currently has FTAs requiring national treatment for trade in natural gas with Australia, Bahrain, Canada, Chile, Colombia, Dominican Republic, El Salvador, Guatemala, Honduras, Jordan, Mexico, Morocco, Nicaragua, Oman, Panama, Peru, Republic of Korea, and Singapore. Of these countries, the Republic of Korea is the only major LNG importer. FTAs with Israel and Costa Rica do not require national treatment for trade in natural gas. 3 Sabine Pass Liquefaction, LLC, DOE/FE Order No. 2961, at 28 (May 20, 2011).

2 On May 17, 2013, twenty-four months after it issued an order authorizing LNG exports from the Sabine Pass LNG Terminal, DOE issued Order No. 3282, authorizing the Freeport LNG Terminal ( Freeport ) in Quintana Island, Texas to export LNG to non-fta nations ( Freeport Order ). 4 This order makes Freeport the second terminal in the Lower 48 to secure such authorization. The Freeport Order is significant because DOE not only analyzes Freeport s application, but the agency also analyzes the results of the LNG Export Study and the initial and reply public comments on the LNG Export Study. Overall, DOE s Freeport Order is a net positive for the 19 pending applications at DOE seeking authorization to export LNG to non-fta nations and likely for future applicants. The order demonstrates a firm understanding of the global gas market and, coupled with recent statements from DOE officials, appears to indicate a more accelerated pace for future orders. Importantly, DOE notes in the Freeport Order that significant LNG exports and the rapid reversal of the natural gas market are new phenomena that are very likely to change over time. Consequently, DOE intends to continue to monitor market developments that could tend to undermine the public interest in grants of successive applications for exports of domestically produced LNG to non-fta nations. DOE now has done the heavy lifting in terms of the actual analysis of economic factors surrounding exports of LNG from the United States. While DOE still will need to take into account the cumulative impacts for each incremental terminal it reviews, it seems to have demonstrated in the Freeport Order that it has substantial data to rely on to justify its decision regardless of how many applications come before it. I. Freeport Order Will be Challenged To start, it is important to note that DOE repeatedly has recognized that its order will be highly scrutinized and likely will be challenged legally. Those who oppose LNG exports or have argued that DOE should limit the volume of exports allowed very likely will file a request for rehearing, possibly followed by a federal court appeal. The Freeport Order provides a thorough recitation and analysis of the record. DOE not only provides its own conclusions, but in several places cites administrative law cases that support its positions/decisions. This methodical and carefully drafted order can be viewed as a preparation for defense of an appeal. Under DOE s regulations, requests for rehearing are due Monday, June 17, If DOE does not respond to a request for rehearing within thirty days, its order will be considered final and can be appealed. DOE, however, can provide itself with additional time to consider and respond to a request for rehearing by issuing a tolling order within that thirty-day period. The tolling order is a procedural mechanism and does not provide substantive analysis of a request for rehearing, nor is it a definitive indication of how the agency ultimately will respond to a request for rehearing. Finally, once DOE issues a final order on rehearing, parties will have sixty days to file an appeal in the U.S. Court of Appeals for the D.C. Circuit. II. DOE Broadens Its Consideration under the Public Interest Standard DOE explains in the Freeport Order that it will take a measured approach in reviewing other pending applications to export LNG and laid out a detailed discussion of the factors it will be 4 Freeport LNG Expansion, L.P and FLNG Liquefaction, LLC, DOE/FE Order No. 3282, at 6 (May 17, 2013) [hereinafter Freeport Order ]. 2

3 considering when reviewing LNG export applications. In addition to the LNG Export Study and the initial and reply comments on it, DOE took the following other factors into consideration, including benefits of international trade; economic impacts of higher natural gas prices and potential increases in gas price volatility, and mitigation of same; cumulative impacts of multiple LNG export projects; and the viability of the overall export proposal. DOE s comments addressing the viability of a specific proposed export project are significant and provide a good indication of the factors that will drive DOE in a certain direction with regard to what terminals it authorizes. Specifically, DOE s reference to applicants ability to demonstrate that there are facilities that are capable of handling the proposed export volumes clearly highlights two key points: that DOE will give priority and/or preference to projects that are (1) brownfield terminals (i.e., existing import terminals), and (2) proceeding through the regulatory process at the Federal Energy Regulatory Commission ( FERC ) 5 for authorization. DOE also notes that it continues to subscribe to the principle set forth in its 1984 Policy Guidelines that the market is the most efficient means of allocating natural gas supplies. DOE s reaffirmation of the 1984 Policy Guidelines is a very positive development for LNG exports, since the Guidelines express a very strong preference for a market-based approach, and is one of the strongest indications in the order that DOE will continue to process and approve succeeding applications. It notes that agency intervention may be necessary to protect the public interest if there is insufficient domestic natural gas supply to meet domestic needs. III. DOE s Processing of Pending Applications Importantly, DOE finds that prior FTA authorizations are not a reliable predictor of the number and capacity of LNG export facilities that will ultimately be financed, constructed, and placed in operation. DOE concludes that prior FTA authorizations, therefore, do not undermine the assumptions of the LNG Export Study and thus will not impact its review of pending non-fta applications. In December 2012, along with its release of the LNG Export Study and solicitation of comments, DOE issued an order of precedence for processing the pending non-fta applications. 6 DOE officials have publicly stated that, at least for the short term, the agency will continue to process the pending applications in the previously announced order of precedence. IV. DOE Supports the LNG Export Study and, in Light of Current Conditions, Continued Exports Overall, the Freeport Order supports the conclusions of the LNG Export Study and continued exports of LNG. DOE finds that the conclusion of the LNG Export Study is that the United States will experience net economic benefits from the issuance of authorizations to export domestically produced LNG and that the LNG Export Study is fundamentally sound. The Freeport Order includes language in multiple areas that supports continued exports. For example: DOE takes on LNG export opponents arguments that natural gas confers a greater value on the U.S. economy when used in manufacturing than when produced for export and finds that more natural gas 5 Under the NGA, DOE has authority over exports of the natural gas commodity and FERC has authority over the siting, construction, and operation of the LNG export facilities. FERC s analysis includes a robust environmental review of proposed facilities under the National Environmental Policy Act. 6 DOE Order of Precedence Non-FTA LNG Export Applications, available at (last visited June 3, 2013). 3

4 is likely to be produced domestically if LNG exports are authorized than if they are prohibited. There is no one-for-one trade off between gas used in manufacturing and gas diverted for export. 7 DOE also states that it believes that the public interest generally favors authorizing proposals to export natural gas that have been shown to lead to net benefits to the U.S. economy. While there may be circumstances in which the distributional consequences of an authorizing decision could be shown to be so negative as to outweigh net positive benefits to the U.S. economy as a whole, we do not see sufficiently compelling evidence that those circumstances are present here. 8 DOE repeatedly finds that comments opposing Freeport s application fail to establish that Freeport s proposed exports will be inconsistent with the public interest, the test that opponents must satisfy. Due to DOE s robust analysis of the record and consistent rejection of those comments opposing or seeking to limit LNG exports, it seems reasonable to read DOE s conclusions on the sufficiency of these comments a bit more broadly to apply to other export applications in which all of the same negative comments have been filed. In fact, not only did DOE find that the opposition had not adequately demonstrated that exports are inconsistent with the public interest, but it could be argued that DOE actually affirmatively demonstrates in the Freeport Order that exports are consistent with the public interest. This affirmation should help DOE in its issuance of ensuing export authorizations for the pending applications. V. Supply, Demand and Gas Market Volatility In the Freeport Order, DOE also addresses concerns raised about impacts of LNG exports on domestic supply and demand, and natural gas market price volatility. DOE explains that, based on EIA s Annual Energy Outlook ( AEO ) natural gas estimates, proved reserves of natural gas, and technically recoverable resources, there are adequate natural gas resources to meet demand associated with the Freeport application. DOE notes, however, that these supply estimates change over time and that it will, therefore, continue to monitor them to inform future decisions. Given ongoing production in existing and new unconventional basins and as a result, the likely increases in technically recoverable reserves for the next few years at a minimum, this factor should continue to be a check in the positive column for LNG exports. DOE disagrees, on balance, that LNG exports will substantially increase the volatility of domestic natural gas. It explains that when domestic wholesale gas prices rise above the LNG netback price, LNG export demand is likely to diminish, if not disappear altogether. Also, in light of DOE s findings that natural gas reserves are adequate to support Freeport s proposed exports, DOE sees no reason why LNG exports would interfere with the market s supply response to increased prices. Nonetheless, DOE stated that it will continue to review market information and stated in its press release accompanying the Freeport Order that [a]s further information becomes available at the end of 2013, including the EIA s Annual Energy Outlook Report, the Department will assess the impact of any market developments on subsequent public interest determinations. VI. Environmental Impacts of Unconventional Production and LNG Exports One recurring issue raised by environmental organizations is the alleged impact on the environment from induced production upstream triggered by the proposed export projects. These arguments 7 Freeport Order at Freeport Order at 75. 4

5 have been raised both at DOE and at FERC. Notably, DOE made little or no mention of environmental groups attempts to link upstream unconventional production and hydraulic fracturing to LNG exports. Instead, DOE explains that parties who wish to raise questions regarding the environmental review must do so in the FERC proceedings addressing the actual import facilities. It is a positive development that DOE has held its ground on this environmental point and continues to defer to FERC and the robust environmental review that that agency undertakes for the export facilities. Importantly, FERC consistently has rejected the environmental community s efforts to link any alleged impacts from upstream production to proposed export facilities. While a number of challenges still remain, it appears that DOE and FERC will hold their ground on the efforts to link upstream production with LNG exports. Conclusion DOE s authorization of exports to non-fta nations from the proposed Freeport LNG export project should be considered a very positive development for the LNG industry. DOE s compelling use of supply and demand data and reliance on free market principles to reach a positive decision on LNG exports may indicate that the agency will begin issuing non-fta decisions on a more accelerated basis, and thus should signal to natural gas producers in the United States that an increasing number of global markets will be available for their game-changing resource. Authors: David L. Wochner david.wochner@klgates.com Sandra E. Safro sandra.safro@klgates.com Anchorage Austin Beijing Berlin Boston Brisbane Brussels Charleston Charlotte Chicago Dallas Doha Dubai Fort Worth Frankfurt Harrisburg Hong Kong Houston London Los Angeles Melbourne Miami Milan Moscow Newark New York Orange County Palo Alto Paris Perth Pittsburgh Portland Raleigh Research Triangle Park San Diego San Francisco São Paulo Seattle Seoul Shanghai Singapore Spokane Sydney Taipei Tokyo Warsaw Washington, D.C. Wilmington K&L Gates practices out of 48 fully integrated offices located in the United States, Asia, Australia, Europe, the Middle East and South America and represents leading global corporations, growth and middle-market companies, capital markets participants and entrepreneurs in every major industry group as well as public sector entities, educational institutions, philanthropic organizations and individuals. For more information about K&L Gates or its locations, practices and registrations, visit This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer K&L Gates LLP. All Rights Reserved. 5