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[December 2005]  An LNG Primer, Cheryl Morgan

There can be little doubt that natural gas is the fuel of the moment. Generation markets the world over are becoming dependent on it and the advent of carbon markets will only increase that trend. Scarcely a day goes by without some news story about LNG: Liquid Natural Gas. While natural gas itself is still in reasonably good supply around the world, it is no longer so readily available in the places where it is most needed: the USA and Western Europe. But what exactly is LNG? What investment opportunities exist in this burgeoning industry? Who will become the OPEC-like countries of the LNG market? And will LNG really become a global commodity market just like oil?

The Transport Problem

Traditionally natural gas has been transported by pipeline. Both North America and Europe are crisscrossed with such systems. However, there is now considerable nervousness about further expanding gas pipeline networks. To start with they can go wrong all by themselves. It was an accidental explosion on a gas pipeline in the Southwestern USA, causing twelve fatalities, that was the inadvertent trigger for the California Energy Crisis. Furthermore, a gas pipeline is a very tempting target for terrorists. Not only will attacking one create what they will see as a very satisfying bang, it will also cripple the energy industry in the area it was supplying.

Perhaps more importantly, however, there is a limit to the usefulness of pipelines in shipping gas from more remote places to where it is needed. Peru, for example, has natural gas reserves deep in the Amazon jungle near Cuzco. Building a pipeline to, say, Chile or Argentina would be prohibitively expensive - but building one as far as Lima on the coast, and then shipping the gas by sea to the USA, is a much more attractive prospect. Indonesia has substantial gas reserves, but is too remote (and rather too close to several active volcanoes) for an undersea pipeline to seem attractive. Trinidad and Tobago has chosen to export its gas by tanker to the United States rather than by a short pipeline to Venezuela.

Some developing countries are even seeing LNG as a solution to inland transport needs. The Indian Oil Corporation has announced that it is buying a fleet of cryogenic tankers to deliver gas to rural townships because it cannot wait for a pipeline network to be built, and a pipeline to every township would be an uneconomic solution for their energy needs.

What is LNG?

If gas can be shipped, then it can be transported easily around the world. LNG is simply a compressed form of natural gas that can be put into a tanker and sent where there is a market for it. To get it into this state it has to be cooled to a temperature of around –160 C, but it is compressed to 1/600th of its volume as a gas.

Considerable investment is going into countries where extensive natural gas reserves exist, but which are not suitable for transport by pipeline. This investment is in the form of exploration and exploitation of gas fields, building of pipelines to the nearest convenient port, and construction of terminals where the gas can be compressed and loaded into tankers. The Peruvian project is estimated to be worth about $1.6 billion. Bolivia is undertaking a similar venture. In Africa Exxon-Mobil is leading a $3.5 billion project to build pipelines to carry oil and natural gas from Chad to Cameroon where it can be shipped around the world. GEA Advisor, Dr. Fereidoon P. Sioshansi estimates that, when reception facilities are included, the worldwide need for LNG investment will top $100 billion.

Not In My Backyard
 
Getting less developed countries to invest in shipping their gas out is not hard. The Peruvian government is delighted with its new project and the Bolivian people voted in favour of theirs. But persuading people in Europe and North America to allow LNG to be landed is not so easy. Their citizens are familiar with natural gas as a fuel and know to be careful with it - they are aware of neighbourhoods being evacuated due to gas leaks and other incidents. The accepted wisdom is that natural gas is highly explosive, so why would anyone want an LNG terminal near their home?



The truth, of course, is a lot more complex. Natural gas is explosive, but only within a certain range of densities (between 5 and 15 percent concentration in air). Blowing up your house is possible, but not easy. You would have to leave the gas leaking for a fair time in a confined space before it became dangerous. Equally, when highly compressed in the form of LNG, natural gas will not explode. Under normal circumstances LNG tankers and terminals are perfectly safe. But if one were to develop a leak… Not to mention the fact that there is always a small amount of leakage. LNG terminals do emit measurable amounts of pollutants such as NO2 and SO2. It is easy to see how local communities can be persuaded that they don’t want LNG in their back yard, even if the dangers are not really that great.

The Offshore Solution

One of the alternatives is to place the terminal offshore. The traditional LNG terminal, like an equivalent oil terminal, is a large installation near a big port. But suppose instead we were to build the terminal out at sea like an oil rig and connect it to land with a pipeline. Indeed, it is out-of-work oil and gas drilling platforms that engineers propose to use for this type of installation. That would make it no more dangerous than the many existing gas rigs in the North Sea and the Gulf of Mexico. And as fish don’t vote, there is a lot less trouble with the locals.

A third alternative for LNG reception is the floating terminal. Instead of being a converted oil rig, this is a converted tanker moored to the seabed. There is a dispute as to which type of terminal is the most cost-effective, and rival bids of different types may be seen in tenders for terminal construction. The best option may depend on local circumstances.

Regardless of the political issues, however, energy companies are desperate to get more LNG terminals built. According to a May 2004 report to the US Congress, there are currently four LNG terminals operating in the continental USA (and one in Puerto Rico), another three under construction. A further 13 have applied for permits, and nine more are undergoing feasibility studies. In addition three of the existing four installations have ambitious plans to increase their throughput and storage capacities.

LNG Storage

One of the major problems with natural gas markets is the seasonal structure of the forward curve. Gas consumption is heavily influenced by the need for seasonal heating and cooling, and prices vary in response throughout the year. Gas is a profitable commodity as you can buy it when it is cheap, store it, and sell it again when the price rises.

LNG, because it is highly compressed, requires far less storage space than natural gas at normal pressure, increasing profit margins. Nor does it require a specific geological feature such as an aquifer or depleted oil field. It does require a more high-tech container, but that can bring other advantages in that an LNG storage unit can typically cycle gas in and out much faster than an underground reservoir. This makes it particularly useful for responding to spikes in the spot market and managing the use of transmission capacity.

Currently around 2% of the USA’s gas storage capacity is in the form of LNG installations, most of it in the North East.

Dwindling Supplies, Increasing Demand

Some countries have relied on LNG for a long time. Japan, for example, imports 97% of its gas consumption, all of it as LNG. South Korea, France, Spain and Taiwan are also significant importers of LNG. The current market buzz, however, has been caused by two things. Firstly the North Sea gas fields are beginning to run out. If Western Europe wants to continue to burn gas at its current rate (or rather to increase its use because of burgeoning demand and a desire to phase out coal and nuclear power stations) then it has to source gas from elsewhere.

The USA, while it still has plenty of gas, has very little in the way of untapped resources. Existing gas fields are slowly beginning to dry up, and there is little in the way of prospects for new discoveries. The now notorious Energy Plan drawn up by Dick Cheney at the start of President Bush’s first term predicted only a 14% growth in the USA’s natural gas production capacity by 2020, while consumption was predicted to rise by 50%. Consequently US imports of LNG are increasing rapidly and now amount to more than 10% of all gas imported.

Who Has Natural Gas, and Who Wants It?

As noted earlier, some Asian countries have always been big importers of LNG (others are big exporters). The current level of imports for the big consumers (Japan, South Korea, India, Taiwan and China) is around 81 million tons/yr. World Gas Intelligence predicts that by 2010 that figure will have grown to around 118 million tons/yr, the growth being driven primarily by China’s desperate need for energy. India is also expected to become a major customer for LNG, but its energy industry is growing more slowly than China’s.



France is the largest importer of LNG in Western Europe, but as North Sea reserves run out and gas-fired generation continues to be built the demand for LNG in other countries will grow. Spain has three terminals and is building three more. The UK is planning terminals at London and Milford Haven. Centrica has already signed a £4 billion deal to bring LNG into the Milford Haven terminal starting in 2007 or 2008.

The primary suppliers of LNG into the Pacific market are Indonesia and Malaysia, with Australia and Brunei also significant players. The Middle East and Africa sell into the Atlantic market, as does Trinidad & Tobago, the main supplier of LNG to the USA.

The pattern of LNG supply, however, is set to change. As noted above, many countries, including some in South America, are looking to cash in on the growing LNG trade. The biggest growth, however, will probably come from the countries with the biggest gas reserves. Qatar will doubtless ramp up its exports, but the main areas of interest are Iran and Russia. Both of these countries are looking to get into the LNG game, and are also exporters by pipeline (although the Iranian pipeline into Turkey does not yet connect to the European system). Interestingly Iran has just agreed a major gas supply deal with China, which will be via LNG.



How Do LNG Prices Compare To Normal Natural Gas?

The obvious issue with LNG is that energy has to be expended to liquefy the gas in the first place. Estimates for this come in at between 30% and 45% of total cost. Liquefaction makes up the bulk of this cost, and has become much more efficient over the past few years as the LNG trade has increased and equipment improved. These costs can be expected to fall further with time, but not indefinitely. Some costs are also incurred at the receiving terminal. These can be between 15% and 25% of the total cost.

In addition, LNG has to be transported. Shipping costs can vary between 10% and 30% of total cost, depending on transport distance. Once again these costs have fallen with time as more and more tankers are built, but with the current squeeze on shipping capacity generally it seems unlikely that further falls will occur any time soon. Indeed, transport costs may rise due to a shortage of available vessels.

This can be weighed against the fact that much LNG comes from countries where production costs are low and which may be happy to accept a lower price for their gas because they have no means of selling it other than as LNG. It is better to get paid something than not be able to sell at all. In 2003 Trinidad & Tobago sold LNG to the USA at a price well below that offered by Canada for pipeline supply.

It is worth noting at this point that if the all of the upper estimates for cost proportions are used we end up with more than 100% of the total cost of the gas. This suggests that some shipping routes are uneconomic.

Geographical Implications

The LNG trade has developed separately in the two main ocean basins: the Atlantic and the Pacific. Thus far the distance and difficulty of sending tankers round one of the southern capes or through Suez has kept prices bifurcated (although as we can see from the chart of suppliers to the USA such trade is not unknown). Pacific prices have historically run around the $5/mmBtu mark, which until recently would have been uncompetitive in both Europe and the USA, but which the energy-poor Japanese and Koreans have been happy to pay. The Atlantic market, which includes the USA as all of America’s existing LNG terminals are on the Atlantic coast, has been squeezed by cheap gas from the Gulf of Mexico and the North Sea. However, demand has now risen to the point where January 2005 contracts have been trading at over $8/mmBtu in America and a whopping $11/mmBtu in the UK. This should be more than enough to cover any excess costs faced by Atlantic LNG suppliers.

(It is worth noting in passing that LNG prices are quoted in two different ways. An “f.o.b.” price (free on board) refers to gas purchased on the ship whereas a d.e.s. price (delivered ex-ship) is landed. Most LNG traders prefer to buy f.o.b. because this gives them more control over the cargo.)

Is All Gas Created Equal?

Some of you reading this article may have wondered why we are sometimes quoting amounts of gas by volume and sometimes by energy content, and have not converted all data to a single unit. Gas industry professionals will be smiling quietly to themselves, because they know that not all gas is created equal. The calorific value of gas from different parts of the world can vary quite widely, dependent on the purity of the fuel (see figure below).

In order to charge fairly for gas in a national or international network, network operators specify a range of acceptable calorific values for gas that is injected into their system. Shippers will tend not to buy gas if the calorific value is too low, but if it is too high this can also cause problems as the gas has to be diluted before it can be sold.



A Worldwide Market?

Given the huge demand for natural gas in North America, Western Europe and China, the market for LNG can only grow. If gas prices in the USA and Western Europe continue at their present high levels then it is likely that prices in the Atlantic and Pacific markets will converge as Pacific market suppliers seek to take advantage of the higher prices available in the Atlantic. And when the vast reserves in Russia and Iran become available to the market LNG could become a major global market similar to oil.

However, there are potential pitfalls along the way. Firstly some of the major players in the market have a traditional preference for long-term contracts rather than spot markets. Japan’s LNG trade has traditionally been conducted in this way, and the Chinese are not known to be great fans of free markets. Perhaps more importantly, there is a problem with shipping capacity. America’s International Energy Agency predicts that the volume of LNG will rise substantially in the coming years. It also predicts that the volume of international coal trade is set to rise significantly. Much of this is driven by the rapid industrialisation of countries like China and India. But there is already a severe shortage of shipping capacity in the world. The current LNG fleet comprises just over 150 tankers and, to meet growing demand, 100 or so more may be needed by the end of the decade.

All of this leads to competing pressures on market formation. Consumers of LNG will try hard to lock up supplies in long-term contracts to ensure that they have the gas (and transport capacity) that they need. Shipping owners, on the other hand, will be anticipating a volatile market for their services and will want to see spot trading of LNG. As yet it is unclear how things will turn out.

References

The following publications were consulted in the preparation of this article:

LNG the Growing Alternative Emergence of a US Market & the Role of Qatar as an International LNG Hub, Frank A. Verrastro, Center for Strategic and International Studies, March 2004

Evaluation of Liquefied Natural Gas Receiving Terminals for Southern California, April Chan, Donna Hartline, Rob Hurley and Leanna Struzziery, Donald Bren School of Environmental Science Management, Spring 2004

LNG Receiving Terminals, Shell Gas & Power, undated

US LNG Markets and Uses, Damien Gaul, Energy Information Administration, June 2004

U.S. Natural Gas Imports and Exports: Issues and Trends 2003, Damien Gaul, Energy Information Administration, August 2004

Liquefied Natural Gas (LNG) Import Terminals: Siting, Safety and Regulation, Paul W. Parfomak & Aaron M. Flynn, Congressional Research Service, May 2004

“Natural Gas To Replace Oil As Dominant Fuel By 2025”, Dr. Fereidoon P. Sioshansi, EEnergy Informer, October 2004

World Gas Intelligence newsletter, Energy Intelligence

World Energy Outlook 2004, International Energy Agency, October 2004

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