Currently, all of the LNG purchased in the United States is done so on the spot market. This puts LNG in head-to-head competition with domestic natural gas. That it is not how LNG will be bought by California’s natural gas utilities, who have CPUC approval to purchase LNG on long-term contract.

It is nearly impossible for LNG to be produced at a cheaper rate than domestic natural gas. There are two main reasons for this:

• The production cost of Pacific Rim LNG is higher than that of domestic natural gas. The cost of extraction in gas fields across the Pacific, cryogenic liquefaction of this gas in preparation for marine transport, marine transport in specialized tankers, and processing the LNG at the import terminal is much higher than extracting natural gas from gas fields in the Rockies, Canada, or the Southwest and sending it via pipeline to the West Coast.

• The average global price of LNG is historically higher than that of North American natural gas, and is even more volatile. This will likely be exacerbated by increased demand coming from China, India and other Pacific Rim countries that are industrializing while at the same time attempting to transition off of coal. Natural gas producing countries know this, and all signs indicate they will sell LNG at higher and higher prices. As an example of this, the Russian government has just mounted something of a hostile takeover of Shell Oil’s Sakhalin II project to ensure they receive a better price than they would if it were under Shell’s control.

The question, then, is why Californian (or Pacific Northwest) utilities would agree to buying natural gas that is more expensive for them. The answer is three-fold:

1. They stand to make a greater profit off of LNG. You’ll note that many of the investors into LNG infrastructure are the Western region’s major utilities: PG&E, So Cal Gas, SDG&E (the latter two through their parent company Sempra). By partnering in the ownership of this infrastructure, these private companies will earn an extra profit margin for all of the LNG throughput, profit that they do not receive when they purchase from already-established North American supply lines. The term in the business world is “vertical integration.” Thus, they have an incentive to shut off domestic supplies while purchasing foreign LNG through their own terminals and pipelines.In the case of Sempra Energy and Southern California that is exactly what is happening.Kinder Morgan Pipeline Co. proposed in 2003 to build a major pipeline from the Rockies to Southern California with tentative startup in 2006.This project would have competed directly with the Sempra LNG terminal now under construction in Baja California to serve Southern California.Sempra successfully convinced Kinder Morgan to form a partnership, turn this pipeline around, and send it to the East in the opposite direction of Sempra’s utility customers.The revised pipeline project, called Rockies Express, is now under construction.

2. These utilities are asking for their projects to be rate-based and/or that LNG be given preferential access to long-term ratepayer contracts under the rubric of “essential supply diversity.” This means they will pass on all of the costs they will incur to their ratepayers as a surcharge on their bill.This permission has already been granted in California.It is likely that when LNG contracts are negotiated with the utilities a stiff premium will be charged for “essential supply diversity,” such that consumers may in fact pay rates for LNG that are significantly above what they would pay for domestic natural gas.Californians continue to pay for exorbitantly overpriced 10-year power contracts signed in 2001 in a desperate attempt to end price gouging in the California power market.This is one example of consumers paying prices far above market rates for a long period of time. Consumers could be overcharged for LNG in a similar manner, as the California Public Utilities Commission has already stated as gospel – without holding any hearings or weighing any evidence - that the U.S. is running out of natural gas and that LNG is a necessary addition to the utility procurement mix to protect ratepayers.It is reasonable to anticipate that LNG provider will attempt to extract the maximum price for this supposedly critical piece of the ratepayer “protection,” regardless of what the market price of domestic natural gas happens to be.

3. Lack of effective regulation of U.S. natural gas markets has resulted in artificially high prices for domestic natural gas in recent years that give the impression that importing LNG would tend to drive down U.S. natural gas prices.LNG proponents make this argument by comparing the market price of U.S. domestic natural gas to the production cost of imported LNG.The production cost of domestic natural gas reaching the West Coast is well below the cost to import LNG. However, despite the lack of effective regulation of U.S. natural gas markets, the physical reality of warm winters and the attendant glut of domestic natural gas has driven natural gas prices down to levels that make importing LNG to the U.S. unattractive.LNG imports to the U.S. declined sharply from 2003 to 2006.The reason is LNG producers can get better prices for their product in Asia and Europe.

Through these three factors, utilities incur no risk, either from the volatility of LNG pricing, or the new costs associated with building new LNG infrastructure.