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Liquefied Natural Gas: Transportation Fuel of the Future?

By Peter Staas on September 9, 2011

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Thus far, the majority of Royal Dutch Shell’s investments in liquefied natural gas (LNG) have focused on exporting the fuel from gas-rich regions to markets where the fuel commands a premium price.

On May 20, 2011, Royal Dutch Shell (NYSE: RDS.A) made its final investment decision on the world’s first floating liquefied natural gas (FLNG) vessel, an innovation that promises to open up a large number of stranded natural gas fields to development.

Advertised as the longest floating structure in the world, Shell’s first FLNG facility will span more than four soccer fields, weigh more than six times as much as the world’s largest aircraft carrier and tower seventeen stories above the water.

The hulking vessel will operate in Shell’s 100 percent-owned Prelude field offshore Northwest Australia, which was discovered in 2007 and is estimated to contain about 3 trillion cubic feet of natural gas equivalent reserves. Management expects the vessel to extract about 3.6 million metric tons per annum (mtpa) of liquefied natural gas, 1.3 mtpa of condensate and 400,000 mtpa of liquefied petroleum gas.

Shell estimates that the FLNG vessel will cost $3 to $3.5 billion per mtpa of LNG capacity, which amounts to a total cost of $10.8 to $12.6 billion.

This massive undertaking isn’t Shell’s first investment in Australian LNG projects that will export the fuel to Asian markets.

The firm in 2009 made a final investment decision on its 25 percent stake in Gorgon, a massive LNG export facility with a capacity of 15 mtpa on Barrow Island, offshore Western Australia that will process gas extracted from the subsea Gorgon and Jansz-Io fields. Shell also boasts a 26.5 percent non-operated stake in Woodside Petroleum’s (ASX: WPL, OTC: WOPEY) Sunrise LNG project and a 9.5 percent interest in the company’s Browse LNG project. In April 2011 Shell acquired a 6.4 percent equity stake in Chevron Corp’s (NYSE: CVX) Wheatstone LNG project, the first phase of which will have a combines capacity of 8.9 mtpa.

Shell’s willingness to invest in these capital-intensive prospects reflects rising demand for natural gas throughout Asia. For example, the Chinese government’s long-term plans call for gas to account for 10 percent of the country’s energy mix, one-third of which will be imported via pipelines or LNG.

Natural gas has been growing in popularity in China, particularly in power-generation facilities located near major cities. Concerns about air quality mean that many of the high-rise residences constructed during China’s recent housing boom are equipped for piped gas. Further migration to urban areas will only increase demand.

LNG imports will be part of the solution. China’s first re-gasification terminal opened in Guangdong province in 2006, and the country currently boasts three import facilities.

In addition to rising demand, Asia also offers favorable pricing dynamics. Not only are the long-term supply contracts favored by Chinese operators based on oil prices, but Japan and South Korean power companies also venture into the spot market during periods of peak demand. According to a recent report from Platts, strong competition among North Asian buyers pushed spot prices in the region to USD16.525 per million British thermal units.

However, Shell’s most recent downstream LNG venture will serve a market where there’s no shortage of natural gas: North America. On Sept. 7, 2011, the Super Major unveiled a plan to distribute liquefied natural gas (LNG) at select Flying J stations in Alberta, Canada. Third-party partners will deliver LNG to the truck stops until 2013, when Shell expects to develop the capacity to liquefy natural gas at its Jumping Pound gas complex (pending regulatory approval). Currently, this processing and fractionation facility provides Calgary-area utilities with fuel for their thermal power plants.

Shell also announced a co-marketing partnership with Westport Innovations (TSX: WPT, NSDQ: WPRT), a technology leader in the conversion of diesel fueled engines to either CNG or LNG. According to a press release, the two firms will leverage their individual strengths to present heavy-duty truck operators with an economically compelling reason to switch over to the technology.

Westport Innovations estimates that roughly 25,000 US vehicles run its CNG- and LNG-powered engines. Medium-duty vehicles such as transit buses and garbage trucks, which run on CNG, account for the majority of the firm’s sales. A joint venture with respected diesel engine manufacturer Cummins (NYSE: CMI) has helped immensely with market penetration, while the economics of a CNG-powered vehicle are an easy sell to fleets that operate from a central hub and don’t drive long distances.

However, the firm’s promising LNG technology for heavy-duty trucks that travel long distances has been a tougher sell. Not only do these complex systems cost about $60,000 more than a comparable diesel rig, but LNG is more expensive than CNG because of the added costs associated with liquefaction. Nevertheless, LNG still costs less than diesel fuel at the pump and emits up to 27 percent less carbon dioxide. The biggest challenge remains a lack of fueling infrastructure: Whereas the Dept of Energy estimates that the US has almost 900 CNG fueling stations, only 44 locations currently pump LNG.

Shares of Westport Innovations surged almost 20 percent after the partnership was announced and hit an all-time high. There’s a bit of déjà vu about these recent developments.

The company’s shares also surged from $19 in late March to $28 per share in early April after President Obama delivered a speech that highlighted natural gas as a crucial component of the nation’s energy independence. Don’t believe the hype. With a contentious election looming on the horizon and lawmakers focused on cutting spending, a transformational bill such as the New Alternative Transportation to Give Americans Solutions Act (NAT GAS Act) stands scant chance of passing.

This deal also follows on the heels of similar announcements from a few major North American gas producers.

For example, Chesapeake Energy Corp (NYSE: CHK) on July 11 announced the creation of Cheseapeake NG Ventures Corp, a venture capital fund that will invest up to $1 billion over the next 10 years in an effort to promote the adoption of natural gas-fueled vehicles (NGV). The fund also invested $155 million in newly issued convertible debt from Clean Energy Fuels Corp (NSDQ: CLNE), a company that specializes in developing fueling infrastructure for NGVs. Chesapeake Energy will also accelerate plans to convert all of its light-duty (LD) vehicles to run on compressed natural gas (CNG) and its heavy-duty duty trucks to run on LNG.

Natural gas producers are keen to demonstrate the cost advantages of switching heavy-duty trucking fleets to LNG and encouraging the build-out of fueling infrastructure. But this process will take some time to gain traction. Shares of Westport Innovations will pull back to reasonable levels once the hype subsides.

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