Cheniere Energy just announced a significant downsizing of their operations, cutting their staff by more than 50% and announcing that they are attempting to outsource their gas marketing functions. Their president, Stan Horton has departed and just this morning, the company announced it was being forced to liquidate some of its shares to meet margin calls by concerned brokers. This is a pretty dramatic turn of events for the company that had staked its future on an ever increasing demand for LNG in the North American market. In fact this comes about a week after the first cargo arrived at their newly constructed Sabine Pass terminal. In addition to the Sabine Pass facility, the company is also building new LNG terminals at Corpus Christi and Cameron Parish, La., along with several pipelines to move the gas from the facilities onto the interstate grid.

So what went wrong? LNG seemed a pretty good bet a few years ago. With declining natural gas production in the US and growing demand fed by new gas fired generation coming on line, LNG seemed to be well positioned to serve are the fuel of choice to meet the growing needs of the market. In fact, the FERC is still touting LNG, saying as recently as last month that “the basic need for LNG in the United States remains strong.” It all looked good early in 2007 when LNG imports reached an all time high in the US. However, by the end of the year, imports had fallen to their lowest level since 2002.

Source: 2007 State of the Energy Markets Report - FERC

LNG is facing a very complex market. Higher natural gas prices, which are an absolute necessity for LNG to be economic, have in fact had some negative impact on its viability. When gas started to move up above $6 and showed consistent strength at that level, more dollars were poured into drilling for gas, with the number of rigs exploring for gas in North America more than doubling from 2002 to 2007, up from 600 to more than 1400. This increased drilling has lead to 5 bcfd increase in production since the Jan 2006, which has contributed to effectively capping natural gas prices in the US at $8 for most of that period. Only recently have we seen those prices break out about that range with a colder than expected winter leading to hard draws on storage. Most forecasts say that the price should fall back as storage is brought back up to “normal” ranges and we should see prices moderating around $8 to $8.50 for the rest of the year.

Looking at the graph above, there is clearly seasonality in the North American LNG market. This seasonality is brought about by the nature of trading LNG on a global basis, much like crude. In North American, the natural gas market is highly self-contained and mature, with an extensive infrastructure of pipelines from producing fields to markets and a large number of massive storage fields. This complex infrastructure has been well designed to ensure adequate year-round supplies of gas, keeping the lights on and the heaters burning during the coldest months when demand outstrips production. This infrastructure also helps keep prices somewhat level through-out the year, wringing out much of the seasonality that would occur without the benefit of storage. However, the European gas market does not have the benefit of the same levels of storage. Their supply and delivery system is more “just in time”, meaning most of the gas brought into the region is burned as soon as it arrives, with little going to storage during the summer months. Gas produced in the North Sea and imports from Eastern Europe and Russia command premium prices during the winter as demand is high, but throttle back in the summer as the gas can’t find a home.

It’s only during this down summer period that US buyers can be competitive in the global LNG market, picking up spot cargos from ships that had been plying the seas between places like Algeria and the UK in winter months.

Cheniere certainly didn’t build their business plans around utilizing multi-hundred million dollar facilities for only half the year. Unfortunately, I don’t see any near term change for the company, as global markets continue to view LNG as a more strategic fuel than does the US. Japan, a country that relies on a combination of nuclear and LNG to supply their energy needs continues to be a heavy buyer in the market as they work to bring nuclear capacity back on-line after the 2006 earthquake. Europe continues to grow more uneasy about the reliability of Russian gas supplies and is pushing ahead with expansion of the regions LNG import capacity.

Longer term, certainly, there is no question that natural gas production in the US will start to decline and fail to meet our needs, opening the door for LNG to play a role year-round. However, until that happens, those that bet on LNG in the short-term are going to continue to feel the pain.

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