H. Kent Acord,
Mobil Oil Corp.,
Fairfax, Va
Just a half century ago, natural gas was often dismissed as a by-product of oil production.
Today, gas has achieved almost equal billing with crude oil. It's clean burning. It's cost effective. It's reliable. And it's fast becoming the fuel of choice for m any energy consumers worldwide.
Moreover, of the future hydrocarbons remaining to be discovered, the largest share is expected to be gas. Gas will remain a competitive energy alternative and, we think, the preferred fuel for many residential and industrial customers around the globe.
Where does liquefied natural gas fit? Since the LNG trade was born in the 1960s, the volume of LNG exports has risen substantially. Last year more than 45 million metric tons of LNG, or some 6 bcfd of gas, was marketed within the Pacific Rim. Another 2 bcfd of gas was imported by European countries, along with smaller volumes by the U.S.
Clearly, for many consumers, LNG is now becoming the most desirable energy alternative.
LNG provides a way to move natural gas to markets geographically restricted from pipeline connections. It, in effect, completed the global chain of the natural gas business, which came first with regional, then with international pipelines.
The availability of cheaper pipeline gas in certain markets, such as Europe and North America, may limit near term growth for LNG in those areas. Near term, LNG in the U.S. will remain primarily a peak-shaving resource, while European LNG growth will be affected by pipeline alternatives from Russia and potentially the Middle East.
ASIA-PACIFIC GROWTH
Focusing on the Asia-Pacific region, which will enjoy the largest growth rates and remain the largest LNG customer, we expect demand to more than double by 2010, approaching 120 million tons/year, or 15-16 bcfd (Fig. 1)(38562 bytes).
More than half the growth will be for electric power generation, which is essential to the projected economic gains in the region during the years ahead. As mentioned previously, gas is a preferred fuel, both for environmental reasons and because of the high thermal efficiencies achieved by new gas-fired combined-cycle turbine power plants. The availability of natural gas in many underdeveloped areas, along with emerging new private sector opportunities in power project investments, will drive this market.
We believe that LNG, with its proven dependability and guaranteed long-term supply capabilities, will capture a significant share of the power generating business in Asia-Pacific areas where domestic fuels are scarce and pipeline gas availability is limited (Fig. 2)(43180 bytes). We also believe LNG will find increasing use in the industrial and residential/commercial markets of the traditional importing nations: Japan, South Korea, and Taiwan.
A variety of supply sources appear to be available to meet Asia-Pacific demand growth. New projects have been proposed for Indonesia, Qatar, Oman, Malaysia, Yemen, Australia, and Russia (Sakhalin Island). These include both expansions to existing LNG projects and grassroots start-ups (Fig. 3)(55346 bytes).
COMPLEX INTERACTION
Mobil has been associated with this growth in LNG, and we are often asked to explain how we view this growing business.
It is important to remember that a successful LNG project involves a complex interaction of buyers and sellers, governments, financing institutions, and shipping companies. There is no established market for LNG, and there are no LNG projects or alternative sources of natural gas that can be readily brought on stream to meet market requirements. LNG projects are buyer/seller-specific, and facilities are commonly dedicated to a particular contract or sale. The partnerships formed to bring an LNG project together must be strong enough to travel the long, tedious road leading to project start-up. And the journey can be long, tricky, and torturous. However, we have found that these partnerships, if successful, can last many years and be very fruitful.
The elements of success obviously include low development costs and the shortest possible time to production start-up. A project has natural economic advantages if the resource base is large enough to support expansions beyond two trains, liquid yield is high, and shipping distances to prospective markets are as short as possible.
Many of the potential grassroots projects are in countries where, quite obviously, there is no experience with LNG. And these countries frequently have limited financial capabilities. To make an LNG project feasible, we rely on several basic principles.
First, our relationship with the host country requires a mutual understanding and commitment to every component of the LNG business chain. Our goal is to maximize the value of gas at
the wellhead. Concentrating on this key point yields the greatest economic benefits to the joint venture partners and host country. And it means the LNG plant and shipping are generally operated on a cost pass-through basis.
Second, to both justify and protect the partners' and the hosts' investment, a long term sales contract with a floor price is required in which the LNG buyers share some of the project risk and facilitate some of the financing.
Finally, getting LNG to the burner-tip requires a complex set of business arrangements, which extend from the gas reservoir to the power plant or industrial facility that burns the gas. The distance can cover thousands of miles. LNG is a business chain between seller and buyer that involves many activities and specialized single-purpose facilities: the gas field must be grilled and production equipment installed, onshore or offshore (Fig. 4)(46460 bytes). At the same time, an LNG plant and harbor facilities need to be constructed. Ships Must be ordered. The receiving country will need a port and regasification facilities and pipelines to the end-users. If the LNG is required for increased power generation, a new power plant will be needed.
THE COSTS
All this takes money - and lots of it (Fig. 5)(28019 bytes).
For starters, the cost of field development, LNG plant, and harbor facilities in the exporting country alone may run as high as $1 billion for every million tons of annual capacity. These costs are the LNG supplier's responsibility and depend largely on location and the operating environment. For example, capital requirements for Qatargas trains 1 and 2 are estimated at $3.5 billion for 4 million tons/year.
On the receiving side of the LNG business chain, arrangements must be made for acquiring new LNG tankers and, assuming an electric Utility, for construction of a receiving terminal, regasification facilities, and a power plant. This could add $7-10 billion to overall costs.
The total cost thus could range from $10 billion to $15 billion for a grassroots LNG venture.
From the standpoint of the supplier, the large capital requirements and long lead times of such projects require:
- Long term contracts (20-30 years).
- Stringent take-or-pay obligations.
- Some protection against fluctuating economic conditions by, for example, a floor price.
At the same time, the supplier takes on the obligation to ensure sufficient gas/LNG supplies are available over the life of the contract to meet annual LNG demand requirements.
Maximum nonrecourse financing is normally used for construction of LNG facilities and ships. Because of the sheer magnitude of these projects, there is heavy involvement of governments on both sides. The buyers are, for the most part, public utilities, and the sellers usually include state oil companies. Equity partner,, such as Mobil play an important role as facilitator, technical advisor, and project coordinator.
KEY PLAYERS
Because of the high cost of initiating even a small LNG venture, the LNG business is clearly not for everyone. Who, then, are the key players in this game?
First and foremost, the supplier must have access to a significant gas resource base. Thus, suppliers often are partnerships between a state oil company and a major international company. The partners must possess strengths which will contribute to the success of the project, whether it be technical, financial, or commercial. In addition to the state oil company partners, the venture may include other oil companies, trading companies, power companies, and gas utilities.
Project managers are identified from the supplier partnership. Sometimes, the partner managing the upstream field development is different from the downstream plant and marketing manager, adding to the complexity. The managers take the lead in assisting the host country with
LNG marketing, financing, and technical services.
At the other end of the business chain are the buyers. The buyers' LNG needs must be defined with enough confidence to stand the risk of signing up for long term, take-or-pay contracts. Buyers normally are part of a gas users' consortium representing large individual companies or electrical utilities.
Shipping is a critical element in the LNG business. With Mobil's LNG projects, the responsibility for shipping is usually assumed by the buyers, and the LNG is generally priced on a free-onboard (fob) basis.
Projects of multi-billion dollar magnitude require financing. Banks and other lending institutions thus become indispensable players if the project is to succeed.
Finally, for such important national ventures, there are inevitable government involvement and oversight by both the LNG importing nations and supplying nations. By their nature, LNG projects need to be consistent with and, in fact, represent an extension of national energy policy. In LNG ventures, the governments' role tends to provide a degree of stability not common in most other businesses.
Thus, partnerships among governments, buyers, state oil companies, and equity partners are critical to the success of any LNG venture.
VENTURE ELEMENTS
Now that we have identified the players, let's look at the elements of the LNG venture that these players control.
Extraction of the resource and subsequent liquefaction of the gas become the sellers' responsibilities. These responsibilities involve not only efficient reservoir and plant management but also continuous refinement of technology in order to improve production efficiency and enhance profit margins.
A good example of this is Mobil's experience in Indonesia, where technical improvements at the P. T. Arun LNG plant in recent years have resulted in sustained production of 137,'/c of original design capacity. To date, the Arun field and Arun liquefaction plant have demonstrated an outstanding record of reliability, which has been a major factor in the successful expansion of Indonesia's LNG business.
The project manager provides a full range of services and coordinates a variety of technical and nontechnical teams. Experience is a big plus in this area.
Besides demonstrating the technical and management skills necessary to start and keep an LNG project running, the project management organization must gain and maintain the confidence of the buyers and lenders and provide reliable service over the LNG term. LNG cargoes must be loaded on schedule.
The ability to finance an LNG project depends on the strength of the project economics supported by solid, long term marketing agreements. LNG sales must be contractually committed to with terms that are consistent with the debt, equity, and cost overrun commitments of suppliers.
Usually, government guarantees of performance of both state-owned energy companies and private suppliers with inadequate financial standing are also required. Additionally, the project must have manageable political and economic risk.
The framework of a marketing agreement should be in place before the first shovel of earth is turned for construction. This is an extremely complex process that involves all the players in the LNG chain. It includes agreements to take-or-pay volumes, production build-ups, and price.
We view pricing as a two-part agreement-market price, which recently has been tied to parity with Crude oil, and a floor price, which protects the economic return of the project from both a supplier's and lender's perspective.
THE CHALLENGE
To sum up, the LNG business is complex. Ensuring that the economics, technology, and partnerships will be successful for long-term profitability is the challenge of LNG ventures.
Our experience has shown that despite their complexity, high cost, and high risk, LNG projects are competitive in today's global business environment.
Most important, they can bring a high reward. The cash flows and earnings from LNG can provide a long-term, stable financial base for the participating companies and host nations.
