On May 20, the Department of Energy authorized Cheniere Energy Inc. to export U.S.-produced natural gas from its Sabine Pass terminal in Louisiana to any country with import capacity. Cheniere is now the first company in the Lower 48 states to be granted this permission. The company's next step is to obtain approval from the Federal Energy Regulatory Commission to build a $6.4-billion facility that can liquefy the gas so that it can be shipped abroad.

Even though the DOE's approval was widely expected, and export capability will not be operational until 2015 at the earliest, Cheniere's stock surged 31% on the announcement, amid losses in both the energy markets and broader equity indices. The S&P 500 fell 0.77% and the Amex Oil Index declined 0.17% that day, although shares of the independent natural gas producers seemingly took direction from Cheniere, with the S&P E&P Index gaining 1% as they outpaced their crude-oil-levered counterparts.

The surge in Cheniere's shares notwithstanding, did the market get ahead of itself with its enthusiasm for natural gas-linked equities?

The earnings potential and, in turn, the equity performance of gas E&Ps have been pressured over the past two years by low futures prices, which collapsed under the immense shale-gas-drilling success that created a boom in supplies. One premise behind the recent relative outperformance of natural gas stocks is that with Cheniere's export ability, domestic gas E&Ps will have more end markets, and the gap between cheap U.S. gas prices and higher global prices will narrow.

Demand drivers

The liquefied natural gas (LNG) market is driven by user demand from Europe and Asia, with the main suppliers located in the Middle East/North Africa, Asia Pacific and Australia. Although these international suppliers are more proximate to the biggest end markets, U.S. gas could compete, even factoring in shipping, fuel and liquefaction costs. The reason: U.S. natural gas futures trade at a significant discount—approximately 30%—to global gas prices, which are indexed to global crude oil prices. U.S. gas prices have recently dipped as low as $4 per million Btu, while global gas prices have ranged from $10 to $25 per MMBtu.

The proposed U.S. LNG export terminals (there are three others beside Cheniere's) can price liquefaction services low enough to make U.S. gas attractive to Asian buyers, while still making U.S. projects economic. This is because the U.S. terminals are mostly brownfield development projects that will build on existing infrastructure. The costs of developing these projects are estimated to be about 20% to 30% lower than greenfield liquefaction facilities abroad. According to Cheniere, natural gas can be profitably liquefied and shipped from the Sabine Pass terminal to Europe for $7.15 to $9.90 per MMBtu (for a conservatively estimated margin of $2.85), and to Asia for $8.95 to $11.70 (for a margin of $1.05).

Cheniere already has several tentative supply deals with potential customers in Europe and Asia. With the DOE approval finalized, the company expects the majority of these pacts to convert to binding 20-year contracts.

European countries are keen to diversify their sources of energy away from Russia, especially following past conflicts that have resulted in supply disruptions during frigid winters. On May 30, Lithuanian Energy Minister Arvydas Sekmokas said the price offered by Cheniere for gas supplies would be at least 25% lower than what his country pays to Russia's Gazprom.

Additionally, as more countries reduce their use of nuclear power in the wake of the tragedy in Japan, there will be a greater need for gas supplies. A mere nine days after Cheniere received its approval, the German government announced plans for a permanent shutdown of eight nuclear power plants that contribute 40% of the country's nuclear capacity. Germany also said that it will close all remaining plants by 2022.

Japan, the world's top LNG importer, could import yet more supplies, as it rebuilds amid reduced nuclear capacity. "We are interested in the movements in the U.S. market and keeping an eye on developments there. More supply is always good news for buyers, and flexibility of supply is getting more important," said Sunao Nakamura, managing director of Tepco Trading Corp., speaking at an LNG conference in Singapore in early March. Tepco is the trading arm of Tokyo Electric Power Co., Asia's biggest utility.

While Europe and Asia are the largest regional markets for LNG, another possible destination for U.S. gas is South America. Several countries there are already net importers and the planned Panama Canal expansion might help U.S. supply to access these markets.

In theory, the possibilities for export abound. Yet, one wonders if world demand can keep pace with growing supplies as new shale resources are explored for in Europe and Asia and as overseas LNG projects accelerate. In April, the DOE estimated that Poland alone had 5.3 trillion cubic feet (Tcf) of shale gas, equal to more than 300 years of its yearly gas usage. France is thought to have comparable amounts of shale gas, though the country is leaning toward banning hydraulic fracturing.

Further, the other U.S. terminals, Freeport, Lake Charles and Cove Point, await permission to export domestically produced gas, while Canada's Canaport and Kitimat projects are also in the works.

What impact would a robust export market have on U.S. natural gas prices? If all the planned projects come online, liquefaction capacity in North America could exceed 6 billion cubic feet per day, or 10% of current production, according to Morgan Stanley estimates. If that happened, would domestic users need to pay more for power, and would that offset any comparative advantages in the bid to convert utilities from coal to natural gas? And if prices are not stable, would buyers be leery of long-term contracts? Without long-term contracts, these plants might be mere swing suppliers.

The success of North American LNG exports rests on many unpredictable factors, including the wide spread between global and domestic natural gas prices. The past decade saw a host of LNG regasification and import facilities built based on concerns about impending gas shortages in the U.S. and Henry Hub prices of $14 per MMBtu. This proved to be a losing bet for many companies, which were left with idle terminals and depressed stock prices. While some current forecasts call for sub-$3 gas on Nymex in the latter part of 2011, two vital questions remain: Will world supply outpace demand, and, in turn, what effect will this have on the spread between U.S. prices and global prices for a notoriously erratic commodity?