	Introduction

This report analyzes the potential for liquefied natural gas (LNG) to become a flexible, dependable, source of natural gas supply for the U.S. market, while also setting a cap on natural gas prices. While adding the physical capacity to receive more LNG is important, significant changes in the structure and practices of the LNG market are also likely to be required before LNG might assume its projected economic role in U.S. energy supply. The evolution of LNG supply will contribute to the debate over the relative importance of the proposed Alaskan natural gas pipeline, expanded use of lands now off limits to exploration and production, and investments in technology to expand additional unconventional gas supplies. In 2005, over 85% of natural gas imported to the United States came from Canada via pipeline. Virtually all of the remaining projected natural gas imports are expected to be in the form of LNG. Whether LNG can provide a cap on U.S. natural gas market prices, or a floor below which prices are unlikely to fall, depends on the way the price formation process develops in the LNG market as well as the fundamental demand and supply balance. Price risk is managed through a price escalation clause in the SPA. However, if an SPA is not in place, as the size of production capacity increases, the risk associated with marketing ever larger quantities of LNG grows. Spot, as well as futures and derivative markets, allow market participants to manage risk, but in the traditional LNG market, quantities are set in the SPA and the producer's need to operate at full capacity to cover financing costs and generate a profit dictates contract terms. Supporting the supply chain would be the availability of financial capital to develop new projects, fund new tankers, and build new receiving terminals without the necessary collateral of an SPA. As a result of these origins, LNG prices have been derived from, and determined contractually by, the price of oil. Contract Provisions

The LNG market is showing signs of undergoing a transition. Since the traditional LNG market structure, largely intact today, is based on long-term contracts designed to ensure business stability, a number of changes would need to occur if a more competitive market structure is to evolve. Because increasing LNG supplies is only one of a number of ways to close the projected gap between U.S. natural gas demand and supply over the coming years, any decisions to encourage or discourage this particular source may have implications for other potential sources. Optimists point to the large quantities of stranded natural gas around the world and the plans to develop dozens of receiving terminals in the United States and might conclude that this source alone might close the demand and supply gap.
Natural gas consumption in the United States is expected to increase substantially over the coming decades primarily because of its usefulness in generating relatively clean electricity. Domestic supplies are projected to be unable to meet increasing demand because existing fields are yielding less production and new drilling efforts are not replicating past success rates. Pipeline imports from Canada are also projected to decline. Various alternatives exist that might close the demand and supply gap, with imports of liquefied natural gas (LNG) being touted as one of the most promising.
As a result of projected supply increases, much of the LNG debate and analysis has focused on the availability of the physical facilities needed to bring larger quantities of LNG into the United States. However, other changes in LNG market structure and practices are also likely to be needed before expanded quantities of LNG can be supplied at competitive market prices.
The traditional LNG market, which developed in the 1970s can be characterized as capital intensive and long term, with restrictive contractual provisions. Risk is managed through the sales contract, and the whole production chain is committed in advance to ensure economic viability of the project. Many of the characteristics of this market are inconsistent with a more competitive market environment.
The LNG market is only in the early stages of a transition which incorporates a viable short term spot market, price discovery through gas-to-gas competition, financial instruments to manage risk, competitive capital acquisition, open access of various links in the supply chain to insure efficient resource allocation, and an expanded set of producers and buyers. Full realization of the potential of LNG to provide a stable source of supply to U.S. markets, as well as providing a price cap to U.S. natural gas prices, awaits changes in market structure, investment in receiving terminals, as well as additional sources of supply.
The extent to which the LNG market develops market-based characteristics may determine the extent to which other sources of natural gas supply are needed. An Alaskan natural gas pipeline, development of restricted prospective resources, and developing advanced technologies to extract natural gas from unconventional sources may be considered as substitutes in closing the projected demand and supply gap.