Market Analysis

Crimea River of Natural Gas

What does Ukraine have to do with a 1938 US natural gas law?

The troubles in Crimea took another turn Friday, with Russian state-run energy giant Gazprom threatening to cut off Ukraine’s natural gas supply if the government doesn’t pony up $1.9 billion same-day—no small threat toUkraine or its European neighbors, which get about 15% of their LNG from Gazprom courtesy of a Ukrainian pipeline. But in an interesting twist, it comes as US politicians are considering loosening restrictions on natural gas exports to help ease Ukraine’s economic dependence on Mother Russia. If it happens, it wouldn’t help ease the current standoff, but over time, it would be a long-term positive for both sides. The Ukraine and Europe would get a cheaper, more stable LNG source, and US Energy firms would gain another source of revenues.

Russia has long used energy as leverage over its former Soviet satellite, which relies heavily on its giant neighbor for funds and supplies. It gets about 70% of its natural gas imports from the Motherland, making it heavily dependent on—and vulnerable to—Putin’s political whims. He had Gazprom cut Ukrainian supply in 2006 and in 2009, cutting off the EU’s supply in the process and causing prices there to jump 19%. Now, to turn the screws after what he sees as an illegal coup against the “only legitimate President,” Viktor Yanukovych (who actually resigned his post), President Vladimir Putin first dropped the discount Gazprom gave Ukrainian firms, and then came Friday’s threat: If Ukraine doesn’t pay its overdue bill for February, Gazprom flips the switch.

For a cash-strapped country like Ukraine, a $1.9 billion same-day bill is a tall order. The US and EU have agreed to supply $16 billion in combined loan guarantees and other financial assistance over the next couple years, but Ukraine still wouldn’t have had enough to pay all its bills even before Gazprom’s latest threat. Moreover, to end Putin’s stranglehold, Ukraine needs a viable long-term energy solution.

To some US politicians, that solution is now obvious: Enabling US firms to export some of the huge liquid natural gas (LNG) surplus to Europe and Ukraine. Pumping out about 84 billion cubic feet in December alone, the US expects to surpass Russia as the world’s leading natural gas producer this year. This also gives the US far more LNG than it can use—much of the natural gasses extracted as a byproduct of shale oil drilling are flared off. Exporting to Ukraine and a region encompassing about 23% of the global economy would help. But it’s currently illegal.

The Natural Gas Act of 1938, which regulates the resource to this day, requires any US firm wishing to export natural gas to get approval from the Federal Energy Regulatory Commission. The US’s free-trade partners have long-term approval by default, but any other potential partners face a long, slow approval process involving multiple government bodies. Then there is the matter of infrastructure. Only one LNG shipping terminal on the Atlantic is approved to export—and it won’t be ready until 2015. Five others are waiting for final approval just to start converting import terminals to export, and more than 20 more have submitted applications.

Whether the EU and Ukraine get fast-track export approval remains to be seen—politicians are politicians, after all. However, if this goes through, exporting US LNG to Europe would bring long-term benefits. Thanks to ongoing innovation in shale drilling technologies, US energy firms are able to produce LNG extremely cheaply and easily—and in much higher quantities than US citizens and businesses need. It has made US manufacturing even more competitive and energy increasingly more affordable for households and businesses alike, providing an overall tailwind. But for Energy firms, it’s not so great. Shale is a more expensive source to tap, and the supply glut weighs on prices and, thus, revenues. If firms were allowed to sell the excess overseas, where prices are significantly higher than in the US, they’d see much better profits. The Energy sector would finally gain from the technology it developed, fueling future investment, growth and jobs.

But many see this differently. They’re afraid widening demand for US LNG outside our borders would cause too much gas to leave the country, limiting domestic supply, raising prices and causing US firms to lose their competitive edge. True, prices may rise at first—but that doesn’t mean US firms or citizens would suffer. Nor is it terribly different from what would happen if the status quo remained—keeping surplus LNG in storage keeps prices down, which would eventually motivate energy firms to cut production, reducing supply and pushing prices up. Prices are a signal: A higher price tells energy firms to produce more to meet demand. If more production doesn’t fill that gap and prices continue rising, energy firms will try new innovations—like they did by expanding hydraulic fracturing and shale exploration last time energy prices skyrocketed—to lower them again.

Whether politicians will understand this and act remains to be seen. And the changes likely take quite a while to implement if they do. Freeing up natural gas exports would be a long-term positive for the US Energy sector, but natural gas’s supply glut likely weighs on revenues for the foreseeable future.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.