Last week on this blog, I explained how Dow Chemical’s chief rationale for restricting exports of liquefied natural gas (LNG) — the claim that gas used as a feed stock in domestic manufacturing adds more value to the economy than gas exported overseas – would also justify:

• Curbing Dow’s exports of chemicals, plastics, and electronic components to help domestic manufacturers of paints, cosmetics, pharmaceuticals, cell phones, laptops, and other finished goods become more competitive in the global marketplace.
• Empowering bureaucratic agencies to commandeer private property whenever they think the resource would add more value in the hands of some other firm or industry.

Dow CEO Andrew Liveris would no doubt cry bloody murder if Congress proposed to give Dow a dose of its own medicine and restrict the company’s exports in the “public interest.” Presumably, Mr. Liveris would also disavow any sympathy for confiscatory centralized economic planning, although that is in effect what he is advocating.

Other rationales Dow and its allies invoke to oppose “unfettered” gas exports include:

1. “Unlimited” gas exports could dramatically reduce the domestic supply of the natural gas liquids (NGLs) on which manufacturers depend as key feed stocks.
2. Long-term contracts to export liquefied natural gas (LNG) will “lock in” deliveries to foreign buyers, subjecting U.S. manufacturers to high risks of price shocks and supply disruptions.
3. Approving all LNG export applications that have been submitted to the Department of Energy (DOE) could result in ”half” of all U.S. gas produced being burned for the Btus in overseas power plants, pushing U.S. gas prices to Asian levels.

These are all false alarms. Let’s take them one at a time.

The angst that ”unchecked” exports of natgas to feed Japanese power plants will have dramatic impacts on the domestic supply of NGLs such as ethane, propane, and butane is baseless. Dry gas is what’s used for electricity. When natgas is produced, it often contains liquids, which are separated out in various steps along the path from the ground through the pipes and on to consumers. Those NGLs are then sold as their own unique product, and they typically fetch premium prices. This is why many producers are moving out of dry gas places like the Haynesville in Louisiana and Barnett in north Texas, as those formations are essentially just dry gas. They’ve moved on to Eagle Ford, Bakken, and parts of the Utica and Marcellus (among others) where there’s not just oil but also relatively high concentrations of NGLs. Key point: The NGLs are separated out before the dry gas is burned as electricity fuel, whether in domestic or foreign power plants.

One thing an increase in gas exports will indisputably do is increase investment in domestic gas production. That is good for consumers of NGLs. A report for the American Chemistry Council found that increasing shale development will benefit chemical manufacturers who use NGLs as feed stock, because increasing production means increasing supplies of NGLs. From the report:

America’s chemical companies use ethane, a natural gas liquid derived from shale gas, as a feedstock in numerous applications. Its relatively low price gives U.S. manufacturers an advantage over many competitors around the world that rely on naphtha, a more expensive, oil-based feedstock. Growth in domestic shale gas production is helping to reduce U.S. natural gas prices and create a more stable supply of natural gas and ethane.

Further development of the nation’s shale gas and ethane can drive an even greater expansion in domestic petrochemical capacity, provided that policymakers avoid unreasonable restrictions on supply.

As you’d expect from a market allowed to work, increased natgas production increases the supply of NGLs, which in turn puts downward pressure on NGL prices. Since gas converted to LNG would come mostly from new producing wells (that’s according to the Energy Information Administration), LNG exports would likely increase the available supply of NGLs.

As for long-term contracts, chemical companies can use them too to reduce exposure to price spikes in the spot market, and some already do. A recent example is Methanex, which decided to relocate a plant from Chile to Louisiana. Commenting on the potential price impact from exports, the CEO basically said he didn’t care because Methanex locked in a long term supply contract with Chesapeake. As reported in the Globe and Mail:

Debate is raging in the United States about whether the government should put limits on plans to build liquified natural gas facilities that would transform that country into a gas exporter from being a significant importer just a few years ago. An industry coalition of energy-consuming companies, such as Dow Chemical Co. and Hoechst Celanese Corp., argues that “unfettered” exports would drive up natural gas prices and rob U.S. manufacturers of a key advantage they enjoy against global competitors.

Mr. Floren said Methanex has no intention of getting involved in a political debate in the United States, adding that the company expects to pay off the capital cost of moving its Chile plants in less than four years, and that exports of LNG will not ramp up before then. But he said the 10-year supply deal with Chesapeake is critical insurance against an unexpected spike in gas prices down the road.

In his oral testimony, Dow CEO Andrew Liveris fretted that if DOE approves all the LNG export applications it is considering, producers could ship “half” of America’s natgas “bounty” overseas, driving prices to Asian levels. This alarming scenario has no basis in reality. Several factors will constrain natgas exports — the cost of constructing export facilities, the moderating effect of exports on Asian gas prices, and competition from foreign suppliers. In addition, increased demand due to exports will boost domestic production, which will limit increases in domestic prices. Here’s what experts are saying:

Daniel Yergin, President IHS CERA –

Many LNG projects for the United States have been announced. These would be expensive facilities to build — $10 billion or more. Only a handful, in our view, are likely to end up being financed and built. The reason is both cost and the scale of global competition. Currently, 95 million tons of new annual capacity around the world are either under construction or have been committed, which is equivalent to fully a third of existing capacity. Capacity in the U.S. that might be coming into a market late in this decade or early in the next will have to compete with new supply from existing exporters, such as Australia, and the new sources, such as off-shore East Africa and the Eastern Mediterranean. Moreover, western Canada is likely to become a major exporter of LNG to the main markets in Asia. This competition will create a global market offset on how many projects are actually built.

Thomas Choi, Natural Gas Practice Leader, Deloitte LLP –

US LNG exports are unlikely to cause US prices to rise to levels of importing regions. Just because US markets are connected to import markets does not mean that US prices will rise to the level of import countries. The cost of LNG liquefaction, shipping, and regasification provides a large price wedge between prices in the US and import markets. . . . Given how dynamic the North American gas market is and the abundance of US gas supplies available at similar cost levels, our model projects modest price impacts at our assumed export volumes.

Dr. Charles Ebinger, Brookings Institution –

Under the most reasonable assumptions (in this case assuming 6 bcf/day of exports), most reports forecast that natural gas prices will be between 2 and 11 percent higher in 2035 than if the U.S. did not export LNG. There are a number of factors that insulate domestic prices from dramatic increases in price as a result of exports. First . . . there is a market-determined limit on how much the United States can economically export, depending on domestic prices, the international gas market, and the global market for competing fuels. Second, the size of the resource base is substantial, an important factor because the EIA estimates that roughly 63% of the gas required to meet demand for LNG export will come from increased domestic production. Finally, the domestic natural gas sector is very efficient and producers are able to respond rapidly to marginal increases in the domestic price.

David Montgomery, NERA Economic Consulting –

As DOE officials themselves explain, it is easy to apply to DOE for a license and necessary to have one in order to start the approval process at the FERC. But only three projects have officially begun the FERC process, and no expert familiar with the industry expects even a small fraction of the total capacity that has made application to DOE will be built in the next decade. . . . First, there will always be a difference of $6 to $8 between Asian prices and U.S. prices, since that represents the cost of inland transportation, liquefying, shipping, and regasifying natural gas to get it from the U.S. to Japan or Korea. Asian buyers have no incentive to buy gas in the U.S. if it is not cheaper than their prevailing domestic price by that amount. Assuming that current, larger LNG pricing differentials will persist in a world in which LNG exports increase at a rapid rate ignores everything we know about supply and demand, and is the fallacy that has led to the demise of many bubbles of energy investment.

Kenneth Medlock, James A. Baker Institute, Rice University –

According to a recent Baker Institute study, commercially viable shale gas resources have rendered the domestic supply curve to be very elastic. This means that even modest changes in price will result in significant changes in production. So, the capacity for the US market to absorb large increases in demand without significant upward pressure on price is large. In fact, the central tendency of prices is now projected to be between $4.50/mcf and $5.50/mcf over the next few decades. . . .The paper goes on to argue that (a) the impact on US domestic prices will not be large if exports are allowed, and (b) the long term volume of exports from the US will not likely be very large given expected market developments abroad.

A final thought. What would Mr. Liveris say if Congress were actually to consider restricting Dow’s exports on the theory that it is in the “public interest” to lower “feed stock” prices for final goods manufacturers so they can export more of their high “value-added” products?

He’d probably argue — correctly — that the proposal is short-sighted and self-defeating. Restricting U.S. chemical industry exports might create a temporary glut and lower prices, but the policy would quickly boomerang. As Dow, Celanease, Eastman, and Huntsman lost sales, profits, and market share, they would also lose investment and asset value, and production would decline. U.S. paint, cosmetic, pharmaceutical, and fertilizer companies would find themselves more dependent on imported chemicals. The imports would be pricier not only because of transport costs but also because the foreign suppliers would face less competition from Dow and other U.S. chemical manufacturers.

The same logic, of course, applies to coercive restraints on exports of U.S. natural gas. If increased gas production benefits chemical companies, then they should be the first to oppose any policy that reduces gas companies’ incentive to produce. Limiting the oil and gas industry’s ability to compete in the global marketplace would do exactly that.

Dow Chemical CEO Andrew Liveris has been making waves of late with congressional testimony and a Wall Street Journal oped advocating restrictions on U.S. exports of liquefied natural gas (LNG).

To oppose “unfettered,” ”unlimited,” or “unchecked” LNG exports — in other words, to fetter, limit, and check the freedom of gas producers to sell their own products — Dow formed a business group called America’s Energy Advantage (AEA). Other members include Alcoa, Eastman, Huntsman, and Nucor.

AEA’s rationale for restricting gas exports (to quote Liveris’s oral testimony) is that when gas is not exported but instead is used to manufacture products, it creates “eight times the value” across the entire economy. That claim derives from a Charles River Associates (CRA) study sponsored by – drum roll, please – Dow. According to CRA, using gas as a manufacturing input trounces gas exports in terms of job creation, GDP growth, and trade-deficit reduction. Therefore, AEA argues, Congress and/or the Department of Energy (DOE) should constrain LNG exports in the “public interest.” AEA also warns that higher gas prices from increased overseas demand could destroy tens of thousands of manufacturing jobs and kill the U.S. manufacturing renaissance. AEA claims it is not opposed to all LNG exports, it just wants a “balanced” approach.

Economist Craig Pirrong (a.k.a. the “Streetwise Professor“) deftly pops this rhetorical balloon:

I am adding a new entry to my list of phrases that put me on guard that someone is trying to con me: “balanced approach.”. . . . In Obamaland, “balanced approaches” mean large tax increases now, and hazy promises of spending cuts in some distant future. In Liveris’s oped, “balanced” means imposing restrictions on exports of natural gas to lower the cost of his most important input. Funny, ain’t it, that things seem to tip the way of those advocating “balanced approaches”? In other words, if it helps me, it’s fair and balanced!

The whole thing is galling. Even if Liveris were correct and gas turned into chemicals generates “eight times” the economic value of gas sold abroad, such third-party assessments should have no bearing on how companies dispose of their own property. As American Enterprise Institute scholar Mark Perry points out, AEA companies did not invest a dime to develop fracking and horizontal drilling technology, construct the wells, or hire the rig workers, yet they presume to decide what happens to the gas after it’s extracted from miles under the Earth. Not unlike the Supreme Court’s Kelo decision, AEA’s implicit premise is that central planners have the right, nay the duty, to commandeer private property whenever the resource would add more value in someone else’s hands.

But do Liveris and AEA really believe the rationale they’re pushing, or only when it cuts in their favor? Here’s an easy way to tell. Dow, Alcoa, Eastman, Huntsman, and Nucor primarily manufacture intermediate goods, not final goods. As natural gas is an input to them, so their products are inputs to still other companies. AEA-produced chemicals, plastics, electronic components, aluminum, and steel reach the consumer only after other manufacturers “add value” by turning those “feed stocks” into paints, cosmetics, fertilizers, pharmaceuticals, computers, cell phones, automobiles, and so on.

So by AEA’s logic, the government should restrict exports of chemicals, aluminum, and steel to hold down domestic prices and make U.S. manufacturers of final goods more competitive. The “public interest” demands it! I’ll bet my salary against Liveris’s that he will never, ever agree that sauce for the goose should also be sauce for the gander.

It apparently has not occurred to anyone at AEA that their agenda could backfire. AEA and CRA are preaching free-lunch economics, which never works as intended. They assume Congress or DOE can curb shale gas exports and nothing else about the natural gas industry will change. There will be no decline in investment and production. Supply will remain high and prices low. Ridiculous!

It’s bad enough groups like the Sierra Club seek to shut down fracking and, therefore, block LNG exports. But at least their agenda is internally consistent. Gas companies won’t frack what they can’t sell, so greens oppose LNG exports to restrict U.S. gas company sales and global market share. Dow, on the other hand, wants both more fracking and constrained exports. That does not compute. The AEA campaign adds to the gas industry’s already serious political risks. Actually empowering bureaucrats to make “value added” determinations of which U.S. firms get to compete in the global LNG market would likely reduce oil and gas industry investment in the production of Dow’s beloved “feed stocks.”

AEA also fails to consider the risks its agenda poses to the broader global trading system. The AEA proposal conflicts with Article XI:1 of the General Agreement on Tariffs and Trade (GATT), which prohibits adoption of quantitative restrictions on natural resource exports to promote or protect domestic processing industries.

In September 2010, the U.S. steel workers and other manufacturing unions petitioned the U.S. Trade Representative (USTR) to investigate China’s restrictions on exports of rare earth elements (among other trade-distorting policies). In June 2012, the USTR requested the World Trade Organization (WTO) to set up a dispute resolution panel to examine China’s export restraints. Earlier this week, the U.S., EU, and Japan filed a complaint with the WTO challenging China’s rare-earth export restrictions. Reuters notes that, “The EU, the United States and Mexico won a similar case against China in January concerning other raw materials.”  Chemical, steel, and aluminum workers take note: The U.S. cannot flout the same treaty obligations and trade principles we invoke without looking ridiculous and undermining the “rules-based free trade” in which Mr. Liveris professes to believe.

Ed Pirrong’s comment on this point is suitable for framing:

Here’s a balanced rule for you, Mr. Liveris: Producers can sell to whomever offers them the highest price.  Short. Simple. Easy to understand.  No bureaucrats required.  And to show what a broad minded guy I am, I propose that the rule be applied to Dow.

The CRA study commissioned by Dow is partly a critique of a NERA Economic Consulting study, prepared for DOE to help the agency review a host of LNG export license applications. NERA estimated the economic impacts of different levels of LNG exports for a range of scenarios assuming different levels of demand, supply, and price. NERA concluded:

Across all these scenarios, the U.S. was projected to gain net economic benefits from allowing LNG exports. Moreover, for every one of the market scenarios examined, net economic benefits increased as the level of LNG exports increased. In particular, scenarios with unlimited exports always had higher net economic benefits than corresponding cases with limited exports.

NERA economist David Montgomery offers a concise rebuttal to the CRA study in this Q&A document. Here I’ll excerpt two paragraphs that seem to me most relevant to the issues discussed above.

Is there any possibility of a contraction of manufacturing because of higher energy costs?
No, as prior NERA studies have shown, the real threat for manufacturing is growing government regulation, of which export restrictions would be another part. The one thing about LNG exports that is certain is that they will grow slowly, and that any difference they make will be a small change in the rate at which manufacturing expands. With the possible exception of a very small slice of the chemical industry [the nitrogen fertilizer industry which employed approximately 3,920 works in 2007], there is no chance that LNG exports could turn robust growth into decline.

Don’t the data show that 1 BCF [billion cubic feet] of gas in manufacturing generates more value than 1 BCF of exports?
Absolutely not, that is an error that any first year economics student would recognize. Value added in manufacturing is created by the labor and capital at work in the industry, not by physical inputs like natural gas. The value of natural gas is fully captured by the willingness of customers to purchase the natural gas – and if overseas purchasers are willing to pay more for natural gas than domestic producers from whom some gas might be bid away, then clearly natural gas generates more value as an export than when used domestically. That is the basis for NERA’s conclusions, not some revolutionary change in the structure of industry over the past few years.