.
University of Groningen Ministry of Economic Affairs;
Faculty of International The Netherlands
Economics and Business DG for Energy and Telecom
Masters’ Thesis Department of Coordination,
Strategy and International Affairs
Price Convergence in the Global LNG Market?
Author: W.A. Fischer
Student Number: s1271490
Email: W.A.Fischer@student.rug.nl
Phone: 0031645038469
Executive summary
Preface
My interest for LNG was spurred during the end of my studies, when I was searching for a suitable research subject. I encountered the three proposals for the LNG terminals in Holland, and looked at the investments required, and was surprised that I wasn’t aware of this market. Therefore, I decided to research this market, and during my research, my interest for LNG was fuelled, as it is a highly international and capital intensive market, with strong growth projections. My objective was to write a research that is relevant and a topic of current interest, as I was determined to write a research that would not disappear in a drawer of a desk somewhere. Therefore, I wrote a research proposal for the Ministry of Economic Affairs, and fortunately, my research proposal was welcomed. I conducted a research for a period of 7 months at the Ministry of Economic Affairs, Directorate General of Energy and Telecom, at the department of Strategy, Coordination and International Affairs.
While writing this, I fortunately can conclude that my research did not end up in a drawer, as I presented my results for a group of 40 industry experts at the 5th of February, including my supervisor from the University of Groningen, Professor Jepma, participants from the Ministry of Economic Affairs, the Office of Energy Regulators, ING, Shell, Vopak, and Clingendael. Afterwards, we concluded the meeting with a discussion between the participants, about the role of LNG in international gas markets and the role of LNG in the Dutch gas market. During my period at the Ministry of Economic Affairs period, I had many opportunities for collecting the right information and meeting the right people, and I would like to thank my supervisor for providing me these opportunities. Also, I would like to thank my supervisor, Bert Roukens for the many meeting we had, discussing the structure and the content of my research. Hereby I also would like to thank my supervisor at the University of Groningen, Professor Jepma, for his expert views on LNG and the gas markets in general. I also really could appreciate our flexible meetings for my research, at for example train station HS in The Hague, discussing my research, together with a cup of coffee. I also would like to thank my room mates at the Ministry of Economic Affairs, Annemieke Schouten and Erik Janssen, for answering my questions and discussing issues in the energy markets. Also, I would like to thank Christoph Toenjes from Clingendael, for discussing my research structure. Finally, I would like to thank James Jennsen, Ralph Dickel, Mike Grillot, Bruce Bawks, and all the other people that helped me with my research by providing the right information, by discussing the LNG markets, or by helping in any other way.
Table of Content
1 Introduction ...9 1.1 Reading Guide ...12 2 Theoretical background ...13 3 What is LNG ...17 3.1 History of LNG...183.2 Technical aspects of a LNG project...20
3.2.1 Liquefaction ...21
3.2.2 LNG transport ...22
3.2.3 LNG Regasification...23
3.3 Financial Aspects...24
3.4 LNG VS Pipeline Gas ...25
3.5 Competition from Pipeline gas ...28
4 LNG Supply ...29
4.1 Introduction ...29
4.2 LNG Suppliers ...31
4.2.1 Pacific Basin Exporters ...32
4.2.1.1 Indonesia...32
4.2.1.2 Malaysia...33
4.2.1.3 Australia...33
4.2.1.4 Brunei ...35
4.2.1.5 United States ...35
4.2.2 Projected LNG Exporters in the Pacific basin ...35
4.2.2.1 Russia...35
4.2.2.2 Peru...36
4.2.3 LNG Exporters in the Atlantic basin...37
4.2.3.1 Algeria ...37
4.2.3.2 Nigeria ...38
4.2.3.3 Trinidad & Tobago...38
4.2.3.4 Libya...38
4.2.3.5 Egypt...39
4.2.4 Projected LNG Exporters in the Atlantic Basin...39
4.2.4.1 Venezuela...39
4.2.4.2 Angola...39
4.2.4.3 Equatorial Guinea...40
4.2.4.4 Norway ...40
4.2.5 LNG Exporters from the Middle East ...41
4.2.5.1 Qatar ...41
4.2.5.2 Oman ...42
4.2.5.3 Abu Dabi (UAE) ...42
4.2.6 Potential Exporters in the Middle East...42
4.2.6.1 Yemen...42
4.2.6.2 Iran...42
5 LNG Demand ...47
5.1 World Gas demand ...47
5.2 Demand for LNG ...48
5.2.1 Demand for LNG in the Pacific Basin ...50
5.2.2 Atlantic Basin...52
6 Trade Flows...59
7 LNG Characteristics that shape the market...60
7.1 Market Characteristics ...60
7.2 Total LNG supply costs, transport costs and the impact on supply and demand...65
7.2.1.1 Transport costs of LNG to the US Gulf Coast ...66
7.2.1.2 Transport costs of LNG to Europe ...67
7.2.1.3 Transport costs of LNG to North East Asia...68
7.2.1.4 Transport costs of LNG to the US West Coast ...69
7.3 Contracting ...70
7.4 The emergence of a new market structure?...73
7.5 Renewed market positioning. ...77
7.6 Spot market trading...78
8 LNG Pricing ...80
8.1 Theoretical background...80
8.1.1 Gas pricing in the gas consuming markets around the world...83
8.1.2 The North American gas markets ...84
8.1.3 The UK Gas market...86
8.1.4 Continental Europe’s gas market ...88
8.1.5 Market Characteristics of Asian Markets ...89
8.2 Methodology...91 8.3 Results ...92 8.4 Conclusion...98 9 Recommendations ...100 10 References: ...104
List of Tables
Table 4-1: LNG Suppliers in 2006 ranked by region & output ...31Table 5-1: Projected gas demand growth in bcm...47
Tabel 5-2: LNG importing countries in 2005 ...48
Tabel 5-3: Potential LNG importers by region ...48
Table 5-4 Worldwide Liquefied Natural gas demand projections in bcm ...49
Table 7-1: HHI and C4 index in 2005 and 2011...63
Table 8-1: Country data used for data analysis by region ...91
Table 8-2: Descriptive statistics, from eviews. Values are in $/MMBtu ...92
Table 8-3: Short term LNG in 2004 ...95
List of Figures
Figure 1-1 Historic LNG and Gas Pipeline markets ...10Figure 1-2 International LNG trade is connecting markets ...11
Figure 2-1 Economic fundamentals in the gas market ...16
Figure 3-1: Growth of LNG by importing region ...19
Figure 3-2 Growth by exporting region...20
Figure 3-3: The LNG Chain...21
Figure 3-5; World LNG shipping capacity & number of ships ...23
Figure 3-6: CAPEX distribution in percentage...24
Figure 3-7: Competition between Pipeline gas and LNG (based on 30 bcm/year capacity)....27
Figure 3-8; Cost comparison between inland pipe and LNG at flat territory...28
Figure 4-1: Proven reserves of gas at the end of 2005 ...30
Figure 4-2 Current and expected liquefaction capacity in 2011 in Pacific Basin in bcm. ...37
Figure 4-3 Current and expected liquefaction capacity in 2011 in The Atlantic Basin. ...40
Figure 4-4: Economic value of gas in Iran ...43
Figure 4-5 Current and expected liquefaction capacity in 2011 in The Middle East...44
Figure 4-6 Current and expected LNG producing capacity...44
Figure 4-7 LNG producing capacity per region in 2005 ...45
Figure 4-8 LNG producing capacity per region in 2011 ...45
Figure 4-9: Growth in LNG gas production-2002-2007 ...46
Figure 5-3: Demand projections for LNG between the different consuming regions...50
Figure 5-4 Global LNG regasification capacity, 2003 ...58
Figure 5-5 Strong demand growth for LNG between 2005 and 2015 (in bcm) ...59
Figure 6-1 World inter-regional Natural Gas trade by type, reference scenario; WEO 2006, IEA ...59
Figure 7-1: Overall costs and transportation costs to the US Gulf Coast Terminal...67
Figure 7-2: Overall costs and transportation costs to Spain ...68
Figure7-3: Overall costs and transportation costs to Japan ...69
Figure 7-4: Overall costs and costs of LNG transport to the US West Coast...70
Figure 7-5: contract chains ...72
Figure 7-6: Spot transaction in LNG of the world over time...79
Figure 8-1: Relationships through LNG...81
Figure 8-2: Gas price developments in the US market...86
Figure 8-3 The S Curve used in LNG pricing in Japan, based on JCC...90
Figure 8-4: LNG Import prices 1992-2006...94
Figure 8-5: Correlation between the LNG consuming markets in the EU, Asia and the US ...95
Figure 8-6: Price differentials between Asia and EU LNG import prices...97
Figure 8-7: Price differential between Asia and US import prices ...97
1 Introduction
Currently, the security of supply of energy and the resulting diversification strategies for European countries are important subjects for many policy makers. The Netherlands as a leading gas country in Europe is having a forefront position with regard to gas market developments. Even though the Groningen Gas field is planned to be depleted in 2025 The Netherlands is planning to remain a leading player in the North European gas market and LNG (Liquefied Natural Gas) could play an important role in this development.
Over the past 5 years, trade flows in the world wide LNG industry have increased by 29% (+ 40bcm), while the liquefaction capacity increased by 48 Billion Cubic Metres (bcm) per year, and the LNG fleet has grown by 75%. Major new trade flows are connecting previously distinct regional markets and a global LNG market seems to be emerging. Because of these developments the LNG industry currently is subject to very high growth rates and enormous capital investments around the world. A clear example of this is the investment boom in Qatar, a country that accommodates 15% of world gas resources in the world and is ambitious in becoming the largest LNG exporter in the world. Currently, Qatar is capable of producing of 25.5 bcm, and they are planning to quadruple their capacity to 104.7 bcm in 2010. The global LNG market’s trading volume size was 188.81 bcm in 20051, and the market liquidity is expected to be more than doubled, to 372.6 bcm in 2015.2 This strong growth could be realized through the development of large liquefaction projects in Indonesia, Nigeria, Australia, and Qatar. Because of the enormous capacity increase the LNG market will be subject to forces that could shape the market in a new way. This research will describe the current developments in the LNG market and its consequences.
The inspiration for this research is because of recent developments in the Dutch gas market. At the moment there are 4 serious propositions for LNG re-gasification terminals in The Netherlands, three in Rotterdam, namely GATE, Liongas and a recent proposal by Taqa, the NOC from Abu Dhabi. The fourth proposition is the north of The Netherlands, in Eemshaven. The development of these supply options can contribute to the positioning of Holland as a Gas Roundabout, and this is an aspiration of the Netherlands whereby The Netherlands will functions a an important hub for gas transport in a liberalized North Western European gas market. This research will contribute to the decision making process for these terminals as well as the general understanding of the global LNG market by exploring the implications of the recent developments in the global LNG market.
LNG is playing an increasingly important role in the energy supply strategies since it provides the market with increased transport flexibility. This is because LNG can be shipped around the world compared to the limited supply flexibility through pipelines. Also, LNG can monetize gas reserves that cannot be reached by pipelines due to geographical limitations, and it therefore can offer supply from different supply sources and this diversifies the gas purchasing portfolio. The flexibility potential of LNG can contribute to the development of spot markets and LNG also can be an opportunity to new entrants for entering the market, as it is difficult to enter the gas markets. Due to the flexibility of supply by boats, LNG can play an increasingly important role in geopolitical energy supply strategies. In the international energy market geopolitical issues are an increasingly important aspect of energy because of the fact that the Western world increasingly will have to rely on a few large suppliers instead
1 BP Statistical Review of Energy, June 2006, Trade movements 200, p 30
of many different suppliers for fossil fuels. The principal markets in North America, Europe and Asia are facing a supply challenge since the import dependence for gas will increase in the coming decades. Especially Europe will face a big challenge since its gas import dependency in 2015 is expected to be 70%.3
In addition to the supply challenge, we can observe a clear tendency towards increased nationalization in the global energy markets, and therefore we observe a greater importance of National Oil Corporation (hereafter NOC’s). Looking at a few examples such as the recent developments in Russia, with regard to the Sakhalin project, or the developments in the energy sector in Venezuela shows that the energy market increasingly becomes intertwined with geopolitics. Therefore, security of supply is a major political challenge and LNG can play a contributing role in the security of supply. Historically, gas flows, were dominated by geography, as the major pipeline connections determined the gas flows and LNG served as a complementary fuel transported in the region of production, as can be seen at figure 1.
Figure 1-1 Historic LNG and Gas Pipeline markets Source: Wood Mackenzie presented at IGU 2006
A strong increase in international LNG trade results in the development of more interconnected gas markets. This increased internationalization developed in the last decades, due to strong growth in LNG, and this growth is expected to continue as demand for LNG is very high, and many LNG producing facilities are being built around the world. The effect of this increase in international LNG trade can be observed in figure 1.2.
Figure 1-2 International LNG trade is connecting markets Source: Wood Mackenzie presented at WGC 2006
This figure shows the increased connections and the resulting internationalization between the previously distinct gas markets. Industry experts that are active in the international gas market argue that it is important and preferable that the LNG market will integrate into one big market. This market is characterized by LNG flows on a global scale, a competitive environment and a global price level where supply meets demand on an efficient level. In this way, security of supply for gas can be accomplished by deep liquid markets that are predominantly shaped by supply and demand in a competitive environment that is based on reciprocity. This would contribute significantly to the security of energy supply. It is questionable to what extend the market will evolve towards this shape, as there are many factors that are developing in favour or against an increase in flexibility, global integration and increased competition. On the one hand we see the combination of higher average natural gas prices, lower LNG costs, rising gas import demand, an active arbitrage market, the increase in supply sources, the doubling of the LNG tanker fleet in 2010 and the desire of gas producers to monetize their gas reserves. These factors contribute to the development of a global LNG market.4 Also, the increased interest for carbon emission reductions increases the demand for gas and consequently for LNG as it is a highly efficient fossil fuel.
On the other hand, there are many factors that are working against this development such as the high costs of LNG transportation, the necessary long term ‘anchor’ contracts for the large investments and the resulting inflexibility. So basically, many developments shape the market while it is growing strongly so therefore it is uncertain to what extend the LNG market characteristics will change.
The purpose of this research is to determine if we can expect increased flexibility in the global LNG market and if the market is moving towards a more competitive shape than the status quo. Theoretical models predict that in this case, in integrated markets, the prices for homogeneous goods such as LNG from different suppliers should move in the same direction. The price differentials should only represent differences in transportation costs. Currently, the LNG market itself shows very little resemblance to its ostensible parents, the world oil market
and the various liberalized onshore natural gas market, but LNG could play an important role in the change of the traditional regional isolation of the gas industry. Therefore we can recognize the LNG market as a truly global market.5 In this research, I will determine what the current market characteristics of the LNG market are, what factors are shaping the market and what the implications of these developments could be. This will enable us to gain insight in the current strongly developing LNG market and will contribute to optimal decision making.
My research will be divided into two parts. The first part will focus on the general characteristics of the LNG market, and will determine the fundamental factors that are shaping the LNG market. I will research to what extend flexibility in the LNG market can be expected due to developments in the LNG market. I will conclude this part by determining the current market shape by using economic theory and simple statistics. The second part of my research will focus on LNG pricing. In this part, I will empirically test to what extend the global LNG market is becoming more flexible by moving towards a more competitive shape, I will test this by determining the degree of which the law of one price can be applied to this market to this market. This will be tested by using regression analysis, using worldwide LNG import prices from January 1992 to February 2006 to see if price convergence occurs. If price convergence occurs, then the law of one price will be applicable to the global LNG market.
1.1 Reading Guide
This research provides a comprehensive overview of the global LNG market. As it is extensive, it is not necessary to read all material. Therefore this part describes the several chapters, so that you can decide whether to read it or not. I will begin the first part by describing economic theories that apply to the gas market in general so that we have a theoretical framework for analysing the LNG market. This is an essential part as it puts the LNG market into an economic framework. Then, taking these theories into account, I will continue with a review of LNG, introducing LNG, by describing the history and the technical characteristics, the financial aspects of LNG, and the competitiveness compared to alternative energy carriers and gas transported through pipe lines. In these parts I will describe the current situation and the developments that can contribute to increased flexibility in the global LNG market. This part is optional, and partly background material. Depending on your knowledge about LNG, it will be interesting to read. For specialists, its relevance will be limited, while for people that are new to LNG, it will be valuable.
I will then continue by looking at the key players in the market and I will describe the different characteristics of the highly divergent consuming markets in the world. The interaction of supply and demand is fundamental in the global LNG market and the role of supply and demand and flexibility is described. This part is also optional, and it relevance depends on the specificity of your information requirements. The graphs at the end of the sub chapters show a concise overview.
After setting the stage of the LNG market by having described the general characteristics and its influence on flexibility, I will continue by a more comprehensive analysis, by describing the fundamental factors that shape the LNG market in a distinct way. I will use economic theory and statistics to determine the market characteristics and I will explain the role of these
factors in detail. The purpose of this part of my research is to determine to what extend an increase in flexibility in the LNG market can be expected and what the new developments and the consequences for the market characteristics are. This part is fundamental for a good understanding of the LNG markets.
After looking at the fundamental market characteristics that shape the LNG market, I will empirically test if the LNG market indeed is increasing in flexibility by moving towards a more competitive shape, by testing the law of one price
This automatically leads us to my research question; is the LNG market becoming more flexible, and is the LNG market therefore moving towards a more perfectly competitive shape, instead of the current oligopolistic shape? In order to answer this question, I will use the economic theory of the law of one price. The law of one price will be tested by an empirical analysis using regression analysis for price convergence between the several LNG consuming markets in the world. I will analyse monthly LNG import pricing data from all importing countries over a period of 14 years between 1992 and 2006. This analysis will determine to what extend price convergence in the global LNG market is occurring and therefore if the global LNG market is moving towards a more competitive shape. If this indeed is the case, then the law of one price should be applicable.
After this empirical analysis, I will look at the results and based on the results, I will conclude to what extend price convergence occurs in the LNG markets. Then, I will discuss the implications of the results, with regard to market characteristics, geopolitics, and competition. I will finish my thesis by providing my own view and some recommendations and I will discuss the results of my research in relation to the developments in the Dutch gas market. This part is fundamental for reading as it answers my research question and puts the results into perspective.
2 Theoretical background
I will start my research with a theoretical background on the gas markets structure by describing the economic theories that apply to the energy markets in general and the gas market specifically. This will enable us to put the Liquefied Natural Gas market, hereafter LNG, into perspective, when analysing its market structure.
with investment opportunities in other sectors. To be able to attract the capital, a certain level or returns on investments is required. The characteristics just described are very general, and the gas sector has many distinct characteristics that distinguish the market from other general commodities like grain. I will briefly discuss these characteristics and the accompanying economic theories.
First of all, the gas industry is characterized by a high degree of risk related to resource development and a high degree of investment specificity all along the energy chain from production to consumer. The required amount of investment capital is relatively large and the investments are generally speaking specific to a site or a special link in the chain, therefore increasing risk. The consequence of the specificity of the investments is discussed in the transaction cost theory and this theory is stated in the well known article by Roald Coase ‘The Nature of the Firm’.
The aim of this paper was to find answers to the general research question; why there is so much economic activity taking place outside of the market mechanism, having in mind the efficiencies of the competitive market? In other words; why do firms exist? His findings were that the reality seems to deviate from what economic theory alone would suggest. This is because in firms, market transactions that are influenced by the price system are replaced by centralized decision making. This decision making would imply that there are more costs of using the market than previously believed. Such costs, which are incurred in making an economic exchange, are known as transaction costs. Transaction costs include the time and expense of negotiating, writing and enforcing contracts; they include the adverse consequence of opportunistic behaviour and the costs of trying to prevent such behaviour. Examples of these costs are the costs of discovering what relevant prices are, the costs of bargaining, the search and information costs, etc.6 Therefore, he states that free economies are not only ruled by markets and price setting, since hierarchically organized firms also can have strong influence in the markets. The transaction cost theory claims that free economies will tend towards an optimum of overall transaction costs to deal with elements of uncertainty, opportunism by the players and asset specificity. An example of this is that a firm decides to outsource a specific activity if internalizing this activity becomes too expensive relative to buying it on the market due to transaction costs. On the contrary, if risk management costs of using the markets are too high the activity could be internalized by horizontal or vertical integration by for example using long term contracts. This optimization depends and develops with technological and institutional development.
The fact that vertical integration occurs in reality shows that there are market failures since it is more efficient to internalize an activity instead of buying it from independent suppliers on a free market. The degree of vertical integration is determined by the requirements of the economy in production and the economy in the governance process, or as Williamson points out in the book The Economic Institutions of Capitalism, economizing in transaction costs.7 In the gas sector, the specificity of the investments is particularly large. The relatively high costs of gas storage, and transportation costs between different locations are substantially higher for gas than for oil. These characteristics work against the use and creation of market places as it is relatively costly to match supply and demand. This increases the asset specificity and risk profile. Therefore these theories predict that due to the relatively high transaction costs because of the relatively high risk and investment specificity vertical
6 Besanko et al., 2004
integration and the use of long term contracts are favoured instead of free markets in the gas market.
The second economic theory that can be applied to the gas market is the theory developed by British Economist David Ricardo. He developed the concept of Ricardo rent and his theory states that the cost differences given by the quality of the production site and by its location relative to the market result in different rents, called Ricardo rents. His theory is based on the example of farming and cattle raising, but the same theory can be applied to the mining in the gas market. When producing gas, the production ultimately depends on the quality of the production site. Costs of developments differ from field to field, because of on-shore or offshore development, or the size of the fields. Also, the location of the field generally speaking imposes specific distances to the consuming markets. These characteristics are fundamentally different from manufactured goods, since these goods can be bought by everybody on the market, and the production site can be chosen freely. The differences in production costs for manufactured goods are mainly because of differences in the technology and the organisation used to produce the goods. However, these characteristics do not apply to the gas market and therefore the gas market gives rise to Ricardo’s rent.
Another fundamental characteristic in the gas market is the finiteness of the resources. If we apply Ricardo’s rent theory on this, the claim would be that the resources are not really limited and the market has to move from easy to exploit resources to the more difficult and costly resources, thereby increasing the Ricardo’s rent. Therefore, it is just a question of capital spending on technological development. However, this theory is too restricted and a theory that opposes Ricardo’s theorem is Hotelling’s Theorem, developed by the well known US economist and statistician Harold Hotelling. In his theorem, he assumed the finiteness of a given resource and he defined the net price path as a function of time while maximizing rents when extracting a finite resource.
Hotelling’s Theorem states that in an efficient exploitation of a renewable and non-augmentable resource, the percentage change in net-price per unit of time should equal the discount rate in order to maximize the present value of the resource capital over the extraction period.8 The resulting price path will give rise to economic alternatives when the finite resource is depleted. In the gas market, this theorem is used in the decision making process of companies about investments and depletion of gas field, which will use some discounted cash flow analysis. This theorem gives rise to the depletion premium and shows what a resource owner will get for the depletion of a finite resource. On the other hand, it also shows what the consumer is willing to pay beyond the marginal costs of production, due to the limited supply. This limited supply may be temporary as investments can remove supply bottlenecks, but this decision is made by the resource owner. Because of the concentration of the resources in the gas market, only a few players are able to make these decisions, thereby acting as in an oligopoly. This is represented in the following figure.
Figure 2-1 Economic fundamentals in the gas market
This figure shows the supply and demand curve and the intersection of these two lines show the market clearing price in a free market. The effect of the Ricardo rent and the Hotelling rent can be observed in the figure. These results in a situation where demand exceeds supply, thereby creating higher prices than in then free market place. Gas markets are characterized by inelastic demand for gas as gas is essential for human and social activities. Only above a certain price, demand becomes more elastic, as it becomes profitable to switch fuels, if this is possible. The demand curve is becoming more elastic as the quantity increases and long term demand is automatically more elastic than short term demand. On the supply side, there are clearly capacity constraints. The supply curve is elastic below the capacity constraint but supply becomes very inelastic when the capacity constraint is reached. This result in the vertical supply curve as can be observed in the figure, and this is completely different in a perfectly competitive market where the supply curve is horizontal. If demand is higher than the capacity constraint, the prices rise and the resulting rents will go the producers as can be seen in the figure. This part is represented by the Hotelling rent box in the figure. The effect of the Ricardo rent is because of differences in production costs and this effect also can be observed in the figure.
A fourth characteristic that should be taken into account when analysing the LNG market is the characteristic that the exploitation of resources is dependent on two players, namely the resource owner, and this is generally speaking the government of the country with the resources, and the producing company that has a different economic objective and whose negotiation power changes during the life time of the exploitation project. In the beginning, the negotiating power of the companies is relatively large as risk capital is needed, but over time, the relative negotiation power of companies with governments changes when knowledge about the project increases and the further the investment is progressed. The goal of companies and governments are also different as governments want to maximize value on the long term, and companies are shorter term oriented as they have to satisfy shareholders and will tend towards faster depletion of the resources then governments. These issues are addressed by a theory called the principal agent theory.
which will affect the value of the asset. The theory focuses on the optimal design of contracts between the two parties and the difficulties that can arise under conditions of incomplete and asymmetric information when a principal hires an agent. Applied to cooperation between companies and government for the depletion of gas resources this means that the state or the NOC is the principal and the foreign contractor is the agent. If the foreign contractor is a consortium this could be regarded as a principal-agent problem with many agents.9 Difficulties can arise because of information asymmetry on subjects as technology, the resources, the investment risk, the marketing or the sharing of the income. Following modern contract theory, it is impossible to make complete contracts.10
However, in order to develop a contract as good as possible, two constraints must be met. The first constraint is called the participation constraint. This states that a suitable compensation should be given to the agent based on the opportunity costs of his resources and time so that the agent is willing to accept the offer. The second constraint is the incentive constraint. A principal must understand that the agent will take action most suited to its own preferences and this can give rise to the problem of hidden action. As pointed out above, due to information asymmetry difficulties can arise, as hidden actions might arise. Therefore the contract must be modified suitably to provide the agent with enough motivation to carry out the project that is beneficial for both parties. The optimal contract is chosen to yield the highest possible return to the principal, subject to the satisfaction of these two constraints. There are many contract forms in the gas industry with the aim to achieve the optima contract form such as concessions, leases, production sharing agreements and joint venture agreements.
In practise the composition of an optimal contract turns out to be very complex as can be seen in the recent developments in Russia with regard to the Sakhalin project. I will discuss the specific characteristics of contract for LNG later on in my research. The economic theories described in this chapter will serve as a reference when analysing the LNG market. These theories are generally applicable to energy markets and the gas market in specific. It is also is applicable to the LNG market, but LNg also has distinct characteristics. Therefore I will now continue my research by describing the factors that shape the LNG market, apart from theory. I will start with a general description of LNG, the cost structure and the competitiveness and after an overview I will describe the current and expected supply and demand.
3 What is LNG
First of all, I will describe the physics and general characteristics of LNG, so that we can get a clear understanding of the product discussed in this research. LNG is produced when natural gas is cooled to a temperature of -161°C at atmospheric pressure. At this temperature the gas condenses to a liquid so this explains the term LNG, Liquefied Natural Gas. Prior to the liquefaction process, the LNG will be treated to remove water, oxygen, carbon dioxide, sulphur compounds, and other components that will freeze under the low temperature needed for storage or be destructive to the liquefaction facility. Like the natural gas that is delivered by pipeline into homes and businesses, LNG typically contains more than 90% methane (CH4). It also contains small amounts of ethane, propane, butane and some heavier alkenes. The purification process can be designed to give almost100% methane.
LNG takes up about 1/600th of the volume of natural gas in its gaseous form and this is like shrinking the volume of a beach ball to that of a ping-pong ball. This makes it practical to transport and store and it is the only viable way to transport natural gas to places that are beyond the reach of pipeline systems. LNG's density is 45% that of water; it is odourless, colourless, non-corrosive and non-toxic.11 When vaporised it burns only in concentrations of 5% to 15% when mixed with air and neither LNG nor its vapour can explode in an unconfined environment. LNG has got a very good safety track record and had 35.000 LNG successful shipping. The commonly used measure for LNG volume is bcm, billion cubic metres, but mtpa, million ton per annum is also used. For pricing purposed, the measure Million Metric British Thermal Units (MMBtu) is used. 100 bcm is equal to 3530 billion cubic feet of gas, 73 million tonnes of LNG, and 90 million ton of oil equivalent. For pricing purposes later on in my research I will also state the MMBtu to bcm as gas prices are quoted in MMBtu. 100 bcm is equal to 3600 MMBtu.
3.1 History of LNG
The first evidence of LNG appeared in the US when Godfrey Cabot submitted a patent for a barge to carry liquid gas in 1914. Although there is no evidence that this was ever built, it proves that at the time the concept was technically feasible. Ship design activity commenced around 1954 with British, French and Americans working on designs for carrying gas.12 In 1961 Britain signed a 15-year contract to take less than 1 million tonnes per annum (mtpa) from Algeria, commencing in 1965. The first liquefaction plant in the world was commissioned at Arzew in Algeria to supply this contract with gas production coming from huge gas reserves found in the Sahara and this CAMEL project was the first commercial trade in LNG to the UK and France.13 By 1969 three more trades has started- an additional delivery from Algeria to France, one from Libya to Italy and Spain and one from Cook Inlet of Alaska to Japan. The latter one was the first Pacific project.
The first deliveries of LNG were relatively short halls from Algeria but this changed as the US also entered the market in 1972. The exports to the US started on a small scale but in 1978 deliveries for the much larger contracts began in 1978. The development of the early U.S. LNG projects took place during a period of unprecedented change in the international energy markets. The change in the markets was caused by the two oil price shocks, the widespread nationalisation of the international oil companies’ concession areas within OPEC and the restructuring of the North American gas industry.
Even though the LNG import to Europe continued to increase, the North American trade nearly collapsed, and the result was an end of the substantial growth expectations in the Atlantic basin trade. However, the LNG industry continued to grow substantially, but the balance of interest shifted towards the Pacific as Korea and Taiwan joined Japan as importers. The demand for LNG was growing strongly in Asia as between 1975 and 1996 the Asian pacific demand increased by an average of 3.31 BCM per year. This is comparable to 2.4 mmt
11Shell.com Gas and Power, LNG, what is LNG 12 The History of LNG, BP.com
(Million Metric Ton), and this is slightly more than a typical LNG train at the time. To compare, the U.S. and Europe demand increased with only 0.76 bcm per year.14 The shift can be observed in figure 3.1 that shows the growth of LNG by import region. From 1996 the Atlantic Basin demand took off, since it was growing on average with 3.97 bcm per year, compared to Asia’s growth of 4.22 bcm per year and therefore, on average the development of 2 LNG supply trains per year were needed to meet demand. This required an initial investment of roughly 5 billion dollars per year in the LNG industry.
Figure 3-1: Growth of LNG by importing region Source: Jensen Associates
Due to the fact that the Asian market demand continued to grow, the principal supplies were from the Asian Pacific region and more specific, from the countries Indonesia, Malaysia, Australia and Brunei. The first Middle East project from Abu Dhabi dates back to 1977, but there was no significant expansion until the large new projects from Qatar and Oman in the late 1990s. The slow growth in Europe and the U.S. markets restricted large new developments in the LNG industry in the Atlantic basin and trade was limited by supplies from Algeria and Libya. However, the start up of new liquefaction plants in Trinidad and Nigeria, as well as increased competitiveness of LNG supply from Qatar is resulting in high growth expectations for the Atlantic Basin as can be observed in figure 3.2.
14 Jenssen, J. 2004, The development of a global LNG market, Is it Likely? If so When? Oxford Institute for
Figure 3-2 Growth by exporting region Source: Jensen Associates
This figure shows that the Pacific basin suppliers dominated the LNG market, but since 1995 Middle East and the Atlantic Basin are quickly gaining market share. While the initial focus of the new Middle East supplies was on Northeast Asian markets, the emergence of Europe and North America as customers is illustrated in Figure 3.3. This figure shows an moderate increase in market share for Europe and the US but looking at contractual commitments between Qatar and the Atlantic Basin consumers, this market share is likely to grow strongly in the coming years.
Figure 3-3 Middle East LNG producing capacity is expanding and shifts its export focus
3.2 Technical aspects of a LNG project
Figure 3-3: The LNG Chain Source: Deutsche bank, 2003
3.2.1 Liquefaction
The liquefaction process essentially functions like a giant fridge by cooling the gas to minus 160 degrees Celsius, so that the gas becomes liquid. The processing modules needed for this process are called trains and this part of the process is the most expensive part of the whole LNG chain. The costs of a typical LNG project is high because of remote locations, strict designs, safety standards large amounts of cryogenic material and a historic tendency to over design to ensure supply security since delays are very expensive. One of the arguments in favour of LNG’s competitiveness towards other alternatives is that the costs of liquefaction decreased by 50% in the last four decades.15 The cost developments in recent years can be observed in figure 1, which shows the increased competitiveness of LNG liquefaction costs compared to the US gas price.
Figure 3-4; Liquefaction costs per train, from 1969 up until 2005 Source: Deutsche Bank, Waiting for the cavalry, 2005
As a result of this, the optimal size of the train increased from 1 -1.5 mtpa to 4.5-5.5 mtpa and beyond. However, the large recent additions in supply capacity in Qatar are characterized by trains with the size of 4.7 mtpa and these trains are build with the latest technology and innovations, thereby creating highly competitive trains.16
The costs of an LNG plant are currently in the order of US$ 250/tonne/year for a one train plant. So for a liquefaction plant that produces 8.2 Million ton per annum (mtpa) the costs of construction are 1.5 to 2.0 billion dollars. Roughly half of that is for construction, 30 percent is for equipment, and 20 percent is for bulk materials. The liquefaction trains take up roughly half of the costs of operating an LNG plant, storage and loading facilities take up 24 percent utilities amount to 16 percent and other facilities account to the remaining 11 percent. The development of a second train results in improved unit costs by economies of scale and the cost of a second train lies around US$ 200/tonne/year.17 The costs of LNG projects are driven down significantly in the last decades due to economies of scale. However, factors such as the reduction of over-design margins, larger and fewer storage tanks, improved technology (such as gas turbines, larger axial compressors, multiple compressors, turbines on a single shaft), improved engineering techniques, better staff training and competitive lump sum bidding also contributed to the significant cost reduction of LNG projects.18 However, recent reports by Standard and Poor’s and by IEA suggest that cost overruns in large projects such as Sakhalin in Russia and Snohvit in Norway have occurred, because of engineering challenges. In general, it seems that the trend for lower costs along the LNG chain is not likely to continue much further.19
3.2.2 LNG transport
LNG is transported in expensive and specially designed ships that minimize loss and maximize safety. In the early days of the LNG industry, the MOSS design, developed by the Norwegian company Moss Maritime was mostly common. This ship was build with a spherical aluminum tank. Roughly half of the tankers nowadays are MOSS design, but this percentage is decreasing as the majority of the newly developed ships are of a membrane type since they are more efficient. Currently there are 206 LNG carriers in operation and the size of these ships has increased over time. The typical size of a carrier now currently in use is around 145.000 cubic metres (m3) of LNG. Further increases in size, are coming up due to rapid developments in recent years in the LNG carrier construction. At the end of 2001 the largest LNG carrier on order had a cargo capacity of 140.000 m3. Today, 35 of the 141 LNG on order have cargo capacities between 209.000 m3 and 270.000 m3. The first of these large vessels is to be delivered in October 2007 but the peak in delivery for ordered vessels will be in 2008.
17 The role of LNG in the European gas market , Clingendael International Energy Program, 2003 18 Poling, J. 2003, The Global Liquefied Natural Gas market; Status and Outlook, Energy Information
Administration, U.S. Department of Energy.
19 A detailed description of the LNG liquefaction process can be found at Statoil’s website:
The costs for a new LNG carrier with a capacity of 145.000 m3 ships is about US$170-190 million20, however, the price for a new carrier is also determined by the availability of building capacity in the shipyards. The demand for LNG carriers is very high at the moment, due to high growth expectations and therefore the costs of the construction of LNG carriers rises sharply. The growth of the LNG fleet in recent years has been spectacular and the LNG fleet is expected to continue to grow significantly. This can be observed in figure 3.5.
Figure 3-5; World LNG shipping capacity & number of ships
Source: Energy Sector Enquiry, European Commission, January 2007 & Ernst & Young
This growth can be explained by three factors. The first factor is already discussed to a certain extend and this is the cost reduction for new ships. The second reason for the growth is induced by the strategy of LNG exporting and importing companies which both integrate the full LNG chain and this strategy contributes to increased flexibility in the market so I will elaborate on that later on in my research. The third reason is the increase in orders from independent companies which see a crucial value of the transportation link. The IEA expects that the growth will continue.21 At the beginning of 2010, the total LNG fleet will number a minimum of 326 ships. Qatar alone is expected to have a fleet of up to 90 vessels by 2010, and among them are the largest LNG carriers ever build, with capacity of 270.000 m3.
3.2.3 LNG Regasification
Regasification takes place in a receiving terminal in the country of destination. Essentially a simple process, the unit costs of unloading LNG carriers, storing and regasification of LNG are considerable lower than those of a liquefaction plant. Further cost reductions have been realised through shorter construction times, larger storage units and design improvements based on rationalisation of safety measures. In addition, there are synergies to be found in developing on-site power generation, as lower air inlet temperatures can increase electricity-generating efficiencies by up to 10%.
3.3 Financial Aspects
In order to provide a clear overview, I will now describe the whole value chain and its financial aspects. Every LNG project has its own specific circumstances and characteristics and costs can differ because of the location of the gas, the remoteness, the climate, the political environment as well as many other factors. Therefore, this example only can be used as a guideline, and gives a good approximation of magnitude of LNG projects.
The LNG industry is not very complex, the process of cooling down the liquid, putting it in a boat, travel the world and unload it at specific places where the gas is warmed up again, is a basic process, but it is extremely expensive. A typical average benchmark project I will describe is a 7 bcm “single train” project. This will have a total Capital Expenditure (CAPEX) of roughly 3.75 Billion US Dollar. This chain consists of 4 links in the chain, and therefore the success of the project is at risk to the possible failure of its weakest link.
The first link in the chain is field development or the upstream investment and on average the development of a tonne gas costs US$ 200 million, so this totals to US$ 1 Billion. The liquefaction costs are on average 250 million per tonne, so this totals to US$ 1.25 Billion. From this point on, the LNG did not move at all, so the portion of the CAPEX in this case that is spend in the producing country already takes up 60% of total CAPEX. In general, the cost percentage of the producing country lies between 51 and 70% and therefore the position of the host country in negotiations and in the development of a LNG project is very important. The third link in the chain is the transportation. This part can differ to a large extend since it ultimately depends upon the distance to the consuming market. Since transportation is a fundamental aspect of LNG pricing and LNG pricing is a key factor in my research, I will elaborate on the role of transport costs later on in my research, in chapter 7.
In the 5 Mtpa case, the transportation costs will amount to US$ 900 million, since 5 ships are needed and average CAPEX per ship is 180 million. Therefore, in this case transport in ships takes up 24% of the CAPEX. The terms of trade and the other relevant aspects of LNG transport such as contracts will be discussed in the next chapter. Finally, the re-gasification needs an average CAPEX of US$ 600 million and as can be seen in the pie chart, the portion of the CAPEX in the receiving country is relatively low at 16 %.
From this we can conclude that each element in the LNG product chain is highly capital– intensive and it is essential that you receive a free cash flow from LNG production as soon as possible. Therefore, delays and breakdowns in any part of the chain are very expensive and have large impact on the Internal Rate of Return (IRR). Basically, returns are destroyed by project delays. Financial institutions keep precise track of any delays in projects and delays in projects such as Sakhalin 2 in Russia or Bontang in Indonesia can result in lower stock valuations of the participating major listed companies by financial analysts on stock exchanges. At the moment, the costs of LNG projects are under pressure due to high prices of steel and other production material, the strong demand for LNG ships, the strong demand for LNG qualified personnel -mainly shippers- and the strongly competitive environment, resulting in mistakes due to time pressure.
However, the LNG projects are still highly profitable. If we look at the profits from LNG investments, on average, a Return On Investments (ROI) of 12/13% is quoted by British Gas, one of the largest and leading International Gas Corporations in the LNG industry. The IRR of 12% is generally accepted by financial institutions and other major gas and oil companies. For the typical 5 Mtpa case, the ROI can be divided by the different links in the LNG project chain. The largest part of the profits is earned in the upstream part, the gas exploitation, as there is a typical return on investment between 15 and 20% and, as stated before, the upstream part is 27% of the total CAPEX. The liquefaction in this case takes up 36% and the average ROI is between 8-12%. The shipping and the regasification both have a ROI of 8-10%. The high profitability results in the interest of international banks, export-credit agencies and multilateral institutions, and they are willing to lend to LNG projects. Other factors that increase attractiveness to lend to LNG projects is the long term Take Or Pay contract commitment, resulting in security for lenders, the good track record of LNG projects and the creditworthy buyers. The recent trends have increased the risk profile, due to renewed business models and the decoupling of oil and gas prices in gas markets in the US and the EU, but I will elaborate on this later on. Another factor that should be taken into account is that the LNG industry is a highly international industry since the LNG is transported all over the world, and the required large capital investments also require large international companies, that can participate in these large projects. However, due to this international character, parts of the chain are subject to different laws and regulations. Production and liquefaction are subject to the fiscal and legal system of the producing country, while re-gasification is subject to consuming countries regulations, and tankers operate in a sort of international no-mans land. These different regulatory systems have an important impact on the success of the projects, so this introduces a political part into the LNG projects. However in general, the international banks, the export-credit agencies and the multilateral institutions still are highly interested in financing LNG projects.
3.4 LNG VS Pipeline Gas
in this part. Nowadays, in Spain and Portugal 60% of total gas use is supplied through LNG. North-Western Europe used to find LNG an economic unattractive option, except for Belgium but due to the diversification of supply sources, in light of security of supply, LNG nowadays is being a feasible option in this area as the UK and the Netherlands are developing LNG regasification terminals
The competitiveness of both LNG and pipeline gas have improved in the recent years due to cost reductions, technical progress in off-shore pipe laying and high gas prices compared to oil prices. Therefore, the choice of supply projects increased and this extended the reach of LNG and pipeline gas projects. As a result of this, the supply options from LNG and gas pipeline are overlapping more than in the past so that more markets are in a position to investigate the feasibility of both options.
LNG favours pipeline gas in that long distance pipeline gas needs to cross many countries, while LNG in general only involves the supplying and receiving country. Transit negotiations, treaties and possible high transit costs are factors that increase the cost and time of pipeline projects compared to LNG projects. On the other hand, for building LNG receiving terminals, permits are required, and many propositions for LNG terminals, in mostly the US face a lot of resistance from local interest groups that lobby against LNG terminals. The main arguments against the development of LNG receiving terminals are safety issues but history shows us that LNG has a very good track record for safety. The investment climate therefore is an important determining factor. Directly related to this is the security aspect of both LNG and pipeline projects. An extended pipeline system, transiting many countries, poses supply security issues, and for LNG these security issues are limited. However, LNG is transported in large vessels that are subject to bottle necks in energy infrastructure on sea, such as the Bosporus, or other strategic and politic consideration that limit the trade routes. Also, competition between LNG buyers could decrease the attractiveness of LNG compared to pipeline gas. If we take a look at safety, LNG has a better track record of safety and reliability than pipeline gas. Nevertheless, LNG is also subject to operating risk, as the Sonatrach explosion in Algeria in 2004 killed 27 employees and resulted in a decline of LNG production of 76% for the year, as well as a destruction of three trains.
Another factor that determines the trade of between LNG and pipeline gas is the diversity of supply. For a number of markets, LNG offers a realistic alternative to a single dominant supply. As the LNG market grows, so does its ability to offer flexibility of supply between markets. Hypothetically, we could expect a ship to be redirected to another terminal if a market cannot take its delivery, but I will discuss the likeliness of the increase in flexibility in more detail in the pricing part. LNG also could be a last resort supplier when demand is unexpectedly high, and it offers the possibility for new market participants to enter the market so therefore LNG supplies could increase flexibility. Consequently, LNG could fit well into more competitive markets.
gas pipelines. This can result in a reduction in price fluctuations.22 On the other hand, technological improvements have made possible short-distance offshore pipelines where previously LNG had been the only viable option. For large deliveries, around 30 bcm/a, the transport of gas by high pressure gas pipes are very competitive. This can be observed in figure 3.6.
Figure 3-7: Competition between Pipeline gas and LNG (based on 30 bcm/year capacity) Source: Standard & Poors 2006
For smaller quantities, LNG soon becomes the cheapest alternative. This was concluded by a study done for the European Commission. The European Commission has asked a consortium of economic consultants to carry out a simulation which allows a comparison of the costs of LNG with gas from long-distance pipelines.23 The results are based on different scenarios instead of using a standard 30 bcm/y. This consortium made a comparison between the costs of pipelines of different throughputs (10, 25, 40 bcm/y) and LNG costs necessary for covering the same throughput.24 This comparison is based on a number of critical assumptions, and it is therefore of purely indicative value, however, it does enables us to compare pipelines and LNG for different volume outputs. For LNG, the project chosen includes a tanker of 135,000 m3 LNG, a standard size and a re-gasification terminal with a capacity of 8 bcm per year. All facilities, including the liquefaction plant are assumed to be according to current best technological practice.
The results of these comparisons suggest that, for a typical 25 bcm/year pipeline project if the pipeline is built on a completely plain territory, it remains cheaper than the LNG project up to a 6,500 km distance from the production site. If the pipeline is built on a topographically more mixed territory, LNG becomes cheaper from 5,500 km. For smaller projects; (10 bcm/year) LNG becomes cheaper from 3,000 km if the pipeline is built on a completely plain territory and for shorter distance in case of mountainous territory. For bigger projects (40 bcm/year) the pipeline remains more competitive for all distances. These results would change in case of submarine pipelines whose costs are assumed to be twice the cost for inland pipelines in plain territory. The results are shown in the figure 3-7, down below.
22 Deutsche Bank Securities, Global LNG, blowing the myths, 2005 23 A consortium of Bocconi University, IEFE, Ernst & Young.
Figure 3-8; Cost comparison between inland pipe and LNG at flat territory
This comparison illustrates that the economics of transportation (distance between production and consumption centres, topography of territory, economies of scale, etc.) strongly influences the ability of LNG to compete with gas delivered via pipeline and thus to constrain the price of the latter. However, as pointed out above, transport cost will only be one factor for the producer in deciding between LNG and pipeline gas.25 Therefore, we can conclude the LNG is highly competitive for small quantities, based on its characteristics and based on its economics.
A case example is a Middle East supply to Europe, roughly covering a distance between 2800 km and 3700 km. Over such a distance LNG allows a cost saving of roughly 30%, compared to transport high pressure pipes, as it crosses mountainous territory.26 Also, from an environmental perspective, LNG losses are around 8 to 11% for the whole chain, over a distance of 3000 kilometres, compared with 10 to 11% for pipeline gas over the same distance, so LNG is relatively efficient.27
3.5 Competition from Pipeline gas
In this part I will discuss the competition from piped gas fro LNG. As pointed out above, the decision for LNG or pipeline gas is determined by several factors. This part will discuss the actual alternatives of pipeline gas to places that are expected to see strong LNG import growth. Competition for LNG in the US from pipeline gas could come from the large gas reserves from Alaska’s North slope and Canada’s Mackenzie Delta These reserves are currently too far to be transported by pipeline but if gas prices will increase then it quickly could become feasible. In Europe, there are large gas reserves that can be transported by pipeline to the largest consuming markets in North West Europe and the UK. Norway and Russia are currently expanding the pipelines to Europe and the UK is connected by pipeline gas from Norway in Belgium (through expansion of the Interconnector) and the Netherlands. The development of several LNG regasification terminals will add up to the supply of gas to
25 European Commission, Energy Sector Enquiry; Final Report, 10th of January 2007, p 273 26 Security of gas supply in open markets, IEA, 2005
the UK. This could lead to several years of overcapacity but the demand is expected to grow strongly and domestic supply is expected to decrease significantly so the outlook that gas imports to the UK will grow strongly. Libya could become an important supplier to the Mediterranean by exporting pipeline gas together with its North African neighbour, Algeria. Both countries are planning to expand the gas flows by pipeline to the Mediterranean and this will free up LNG for export to other places.
In the long term, Europe also could get gas supply by pipeline from Central Asia and Iranian gas could flow through pipelines to central Europe. The Nabucco pipeline is an important development, connecting several markets. It would bring gas from the Caspian and the Middle East to Europe through Turkey and the infrastructure linking to Iran and Central Asia is already in place. It is planned to have a minimal capacity of 8 bcm/y in 2010, with possible expansion to 31 bcm in 2020. Half the capacity is planned to be tapped by the countries along the route but the other half is expected to reach the end of the pipeline in Austria, and then it can be exported to large consuming markets in Germany or Italy. This development would end Gazprom’s supply monopoly in Hungary, Romania and Bulgaria and it would challenge its dominance in Austria where it is responsible for 65% of the supply, 28 Therefore, Gazprom is keen to prevent the development of this pipeline. The European Union is supporting the Nabucco pipeline development to the fullest in its effort to diversify its supply sources. Russia’s alternative plan is to supply the Nabucco route by expanding the existing Blue Stream pipeline into East Turkey but this does not contribute to the diversification of supply to Europe since capacity will be used by Russia.
Pipeline gas is also expected to compete with LNG in China and India. In China, the pipeline from the west of China, from the gas reserves in the Taksim basin and there are plans to receive supplies from Pakistan and Kazachstan. The West East pipeline recently began deliveries and it will be competitive to a proposed LNG regasification plant in Shanghai as the pipeline ends in Shanghai. Pipeline gas supplies also might come from Russia as there are large reserves in the West of Siberia, relatively close to China; however, these developments are still uncertain. In India LNG is also facing competition fro pipeline gas as India has discovered substantial new gas reserves out of the Eastern coast, however, there have been serious delays in bringing these gas reserves to the market. There are also serious plans for the development of a pipeline from Iran through Pakistan to India. From this, we can conclude that there are several serious alternatives to LNG imports and that the decision for LNG imports compared to pipeline gas is dependent on the developments pointed out in this part.
4 LNG Supply
4.1 Introduction
In this part, I will discuss the main LNG suppliers and its producing capacities. I will describe the present capacity but I also am going to discuss the outlook for capacity by looking at the current developments in building new -and expanding current- liquefaction capacity.
I will start with a description of the countries with the largest gas reserves so that the LNG production can be placed into perspective. After describing this, I will describe the main LNG producing countries, with its reserves and risk profiles, since LNG is a capital intensive
industry, and a stable investment environment is essential in this industry. In the second part, I will describe the main consumers of gas and LNG, and I will describe the reasons for this and the possible demand for LNG in the future. In this part I will also describe the major corporate players in re-gasification as well as in trade. I finally will describe the current trade flows on a global scale, and I will make an outlook for the possible future trade flows, based upon projected supply and demand outlooks.
To put LNG into perspective I will start with a concise overview of the major gas countries. The total proved world natural gas reserves are at the end of 2005 179.83 trillion cubic metres (tcm) following the BP Statistical Review of World Energy 2006. The single country Russia is by far having the largest gas reserves with 47.82 tcm, 26.6% of the total world gas reserves. The Middle East is the continent with the largest gas reserves, 72.13 tcm, (40.1% of total). Iran with 26.74 (14.9% of total) and Qatar with 25.78 (14.3% of total) are the countries with the largest reserves in the Middle East since they are located on the largest gas field in the world, the so called South Pars/North Field. The gas field lies on the border of both countries and the South part belongs to Iran while the North part belongs to Qatar. The size of these parts is roughly equal and totals 52.53 tcm. The global distribution of gas reserved by continent can be observed in figure 4.1.
Figure 4-1: Proven reserves of gas at the end of 2005 Source: Statistical review of energy 2006
If we take a look at the gas production, the total production over 2005 was 2763.0 Billion Cubic Metres (bcm) and we observe that Russia again is the largest single player with a total production of 598.0 Billion Cubic Metres (21.6 % of total production). Even though the US Canada and Mexico only have 4.1% of total gas reserves, they together produce 27.2% (of total gas production, with the US as major producer, accounting for 19%. The production outlook is that the US production will decrease significantly, while demand will grow, so this gap needs to be filled with new gas supplies and LNG can partly fill up this gap.
