Value and Growth* - PwC · PricewaterhouseCoopers •Value and growth in the liquefied natural gas market 5 02 Liquefied natural gas, in effect, provides a ‘floating pipeline’

IndustriesEnergy, Utilities & Mining

Value and Growth*in the liquefied natural gas market

*connectedthinking

Liquefied natural gas (LNG) is one of thefastest growing sectors of the energymarket. It is expected to almost double insize between 2005 and 2010, deliveringaround 40% of global gas supply growthin just five years*.

*Source: International Energy Agency, Natural Gas Review 2006

Contents

01 Introduction page 2

02 LNG evolution page 4

03 LNG take-off page 8

04 LNG tomorrow page 16

05 Conclusion page 24

06 Contact us page 25

PricewaterhouseCoopers • Value and growth in the liquefied natural gas market 1

In this report we look at the challenges for the variousplayers. We map the nature of these challenges – fromhandling geopolitical and trading risk to determiningthe best commercial and tax structuring – and thedifferent strategies that need to be considered. Welook at how the LNG market is evolving and changingfrom a previously concentrated market to a futurewhere it will take on more of the characteristics of theglobal oil market. We look at where LNG is now andwhere it will be in the decade ahead.

We see a market that is characterised by bothcomplexity and globalisation, in which thedisaggregation of dedicated LNG chains opens up newpotential opportunities. We look at how technologicaladvances will hold the key to just how far this marketevolution will run and the judgments companies andother players will need to make in response.

Throughout the report, we feature a series of ‘LNG dialogues’, highlighting some of the criticalissues facing companies in the LNG sector and theconsiderations they need to take into account. These are based on our experience of working withcompanies around the globe.

The future development of LNG as one of the fastestgrowing areas of the energy market worldwide will alsorequire the development of new technologies and willdepend on the pace in which they are put into practice.These challenges for the engineering sector and theshipbuilding industry will have a considerable influenceon the investment programmes of governments,infrastructure and transportation companies as well asof private investors. Our report also covers thesepossible or, even, probable consequences.

Liquefied natural gas (LNG) is one of thefastest growing sectors of the energymarket. It is expected to almost doublein size between 2005 and 2010,delivering around 40% of global gassupply growth in just five years*. In the

US a significant increase in gas imports is expected tocome from LNG. In Europe, many countries are makingor considering investments in LNG import infrastructure.

The hype around LNG is intense. It is easy to overlookthe fact that LNG is a means of delivery not a new energysource. LNG technology and infrastructure provide ameans of monetising otherwise stranded gas reservesand bringing them to market. As figure 1 shows, there arevast proven gas reserves but 91.2% of these lie outsideof the main OECD market and much is beyond pipelineexport reach. For upstream owners of gas assets LNGopens up a worldwide market for gas. For utilitycompanies and energy departments in end markets it is ameans of diversifying and securing energy supply.

Whether you are an LNG bear or an LNG bull, it is certainthat LNG will play a growing part in the future gas market(see figure 2). However, the development of LNG projectsand businesses presents considerable new challenges forcompanies, whether they are upstream national orsmaller oil and gas companies looking to find newmarkets, super majors developing integrated LNG chainsor utility companies aiming to secure and diversifyprimary fuel supply sources.

Michael HurleyGlobal LNG Leader

Manfred WiegandGlobal Utilities Leader

Richard PatersonGlobal Energy, Utilities & Mining Leader

01 Introduction

2 PricewaterhouseCoopers • Value and growth in the liquefied natural gas market

Peter AlbrechtEurofirms Industrial Products Leader

Klaus-Dieter Ruske Global Transportation & Logistics Leader

*Source: International Energy Agency, Natural Gas Review 2006

Figure 2: Global gas volume growth (traded cross-border volumes)

Source: Cedigaz

2010200420001990198019700

2020

200

400

600

800

1000

1200

1400

5.9%

15.6%

23.5%

21.6%

22.2%

30-31%

37-38%bn cm

Pipelines

% share of global LNG in the total

We see a market that is characterised by bothcomplexity and globalisation, in which thedisaggregation of dedicated LNG chains opensup new potential opportunities.

Figure 1: Current gas reserves vs future demand

OPEC

Source: Cedigaz

CIS

Other countries

OECD

Proven reserves 180 tcm Gas demand 2020 3.8 tcm

31.8%

49.4%

10%

8.8%

20.5%

48.7%14.7%

16.1%

UPSTREAM

MIDSTREAM

DOWNSTREAM

Liquefaction plant

Field processing/separation

Production

Pipeline quality gas operationsand gas trading

Regasification

02 LNG evolution


Today’s rapid growth of the LNG sector might lead some people to believethat it is a relatively young market. On the contrary, LNG transportation begannearly fifty years ago. Indeed, the nature of LNG’s evolution has lessons forthe risks and opportunities of LNG in the future and influences many of thecharacteristics of LNG today.

Note: This diagram is not to scale

Figure 3: LNG – a floating pipeline

Distribution

Power/Industry


02

Liquefied natural gas, in effect,provides a ‘floating pipeline’ withgas cooled down to a liquid format -1600C and, in the process,shrinking by a factor of 600,making mass ship-bornetransportation possible.

LNG ups and downs

The LNG business has experienceddramatic ups and downs over theyears. After the opening of fourAtlantic import terminals in the USduring the 1970s, for example, LNGimports stalled due to falling naturalgas prices in the US and a pricingdispute with the supplier country,Algeria. Plant was mothballed and itwas not until the mid-1990s that USLNG importation significantly revivedwith a rise in natural gas prices andincreased energy demand.

Coming right up to date,development of LNG importinfrastructure in China has similarlystalled. Initial plans were for aroundfourteen LNG terminals to increaseenergy supplies and provide acleaner fuel alternative to coal. Theseambitions have been pared back tofour or five terminals by 2010.Soaring global gas prices havemeant that LNG cannot compete forthe most part against cheaper coal,leaving LNG developers caughtbetween high world energy pricesand the highly regulated domesticenergy market in China. Powerproducers in China have had to shutdown plant because they have nogas to burn.

Both China today and the US in the1980s and 1990s highlight the riskfor downstream LNG developers andpower utilities. Unlike pipeline gas, amajor attraction of LNG for upstreamplayers is its flexibility. It can beshipped to different markets and, ofcourse, there is no reason whyAustralian and Indonesian LNGsuppliers would ramp up theirexports to China when far higherprices can be obtained elsewhere.

The risks for developers in countrieslike China and India where locallyregulated energy markets are out ofstep with the global markets areobvious. But the emerging globalmarket and increasing flexibility inLNG trading also brings significantrisks in countries with moreliberalised markets. For example, theyears since 2003 have seen aconcerted drive to develop LNGimport infrastructure in the US.However, despite rising US energydemand and reduced supplies fromUS gas fields, US LNG imports fell in2005 and regasification facilitiesoperated at only half capacity.Instead, LNG went to countriesprepared to pay higher prices,including, in 2005, Spain where LNGdemand soared following a droughtthat hit hydroelectric power output.

“Both China today and the US in the 1980s and1990s highlight the risk for downstream LNGdevelopers and power utilities.”

02 LNG evolution


LNG pricing

The limit on LNG volumes, comparedto pipeline gas, means that LNG isoften going to be a price-taker ratherthan a price-setter, especially inEurope and the US. The price of LNGhas traditionally been based on thepricing norms of the delivery market.The traditional link is to oil but, inmarkets where natural gas is traded,such as the US and the UK, pricestend to be referenced against the gasprice.

Thus, we see a mix of pricingreference points – US directly indexedto gas (Henry Hub); UK directlyindexed to gas (National BalancingPoint (NBP)); continental Europetypically indexed to fuel oil and gasoil; and Japan indexed to theJapanese Crude Cocktail (JCC) index.

The Henry Hub price is a keydeterminant in the US, as is the NBPprice in the UK. Other trading hubs inEurope can act as contract referenceprices for LNG, for example theZeebrugge Hub (ZBT) in Belgium and,if proposed Dutch regasificationinfrastructure is built, the TitleTransfer Facility (TTF) in theNetherlands. Elsewhere in continentalEurope and Asia, where no liquidmarket for natural gas sales exists,the main reference is to crude oil andspecified petroleum products. In rarerinstance, there are also links to coaland electricity prices.

Greater market dynamism

An evolution away from regionalmarkets towards a more global markethas been accompanied by a moredynamic trading environment andgreater contract complexity. The part-regional, part-global market mixpresents opportunities for arbitrage.Diversion rights, accompanied bycompensatory conditions, create awin-win situation for both exportersand importers. The opportunities thathave created an active arbitragemarket in the Atlantic basin areillustrated in figure 4 which shows theprice differential and netback betweenthree major Atlantic destinations forNigerian LNG. Different markets areindirectly connected in that, as LNGflows, market prices adjust to newsupply-demand balances.

A short-term ‘spot’ LNG tradingmarket has developed, accounting foraround 11.4% of LNG sales in 2004 ifswaps and diversions are included aswell as true spot deals. This isexpected to grow to around 20% inthe coming years (International EnergyAgency, Natural Gas Market Review2006). However, true spot trading(LNG produced in excess ofcontractual arrangements) remainsrare.

Infrastructure costs mean thatproducers largely need the security of long-term contractual delivery tounderpin projects. Although someLNG projects are now beingdeveloped without traditional long-term contracts, this isuncommon. Nonetheless, the rise ofshort-term trading in LNG has beendramatic. As recently as 1997, short-term trades accounted for just1.5% of the LNG market (James TJenson, The Development of a GlobalLNG Market, Oxford Institute forEnergy Studies, 2004).

PwC LNG DialogueManaging price uncertainty

“There is no uniform global price forLNG, unlike other energycommodities such as oil. However,Henry Hub is increasingly becomingthe global benchmark price-setterfor LNG. Provided the US cancontinue to attract LNG volumes,LNG purchasers elsewhereincreasingly need to demonstratethat their market is an attractivemarket compared with the US.”

Index pricing differences create pricevolatility between the major demandmarkets which represents a dilemmaand an opportunity for sellers andbuyers. They need to be sure whatpricing conditions will make a particularregion, such as Europe, represent bestvalue for the LNG over the lifetime ofthe contract. Given the long-termnature of contracts and the short-termview provided by the tradedcommodity markets this is not an easyproblem to resolve and may requireinnovative solutions in either pricing ortechnology to attract the LNG.

The construction of suitable pricingmechanisms and indices thatappropriately share risks and rewardsacross the chain over a range ofexpected energy prices, and enableprofits to be generated and shared, canhelp mitigate some of these concerns.The selection of suitable pricing indicesis vital to ensure the gas price isrelevant to the destination market andenables trading in the underlyingcommodity so that companies caneffectively manage price risk.


02

Regional LNG marketsLNG trading evolved in the three decadesfrom the 1970s onwards in an essentiallyregional pattern in the Atlantic and Pacificbasins with hardly any interactionbetween the two.

Algeria became an exporter to Europeancountries and the US. Indonesia becamea major supplier to Japan and SouthKorea, both of whom lack any indigenousgas supplies. By the mid-1980s, LNGimports by Japan dominated LNG activity,accounting for three-quarters of worldLNG trade.

Destinations and trading werecharacterised by long-term contractualrelations, high transportation costs andgeographic market distinctions.

Figure 4: Netback prices to Nigeria

PwC LNG DialogueGreater contract complexity

“More dynamic trading markets areintroducing considerable complexityinto supply and purchase agreementsand company accounting. Thesecomplexities are being given a furthertwist by the continuing evolution ofInternational Accounting Standards.”

Contract pricing will generally reflect thebest estimation of the LNG price in thedestination markets. Different parties,however, may differ in their view ofwhich market the commodity ultimatelycompetes in.

Another accounting complication stemsfrom the fact that trading contracts maybe based on traditional oil index pricingformulas when the destination markethas developed in an actively traded spotand future market. Those types ofcontracts represent a value compared tothe market that should be considered forfair value accounting under InternationalAccounting Standards. Thedetermination of an active market,however, often leads to much debate.

Also, how should optimisation of salesand purchases within the conditions setin the contract be treated? Is itconsidered trading activity, precludingthe contract from applying for the ‘ownuse’ exemption for fair value accounting,or should it be viewed as part of normalpractice in the industry, designed foroperational reasons? The answer lies inthe intention and actual behaviour of thecompany.

A more global marketIn recent years, a host of new supply anddestination countries have emerged,bringing greater volume and dynamism tothe LNG market. Higher energy prices,improved and more cost-effectivetechnologies and depleting indigenousreserves in major markets have spurredgrowth.

Australia has developed LNG projects tojoin Indonesia and Malaysia in supplying Far East and Asian markets. In theAtlantic, Trinidad & Tobago and Nigeriahave both invested in LNG projects.

Perhaps most significant is the upsurge inMiddle Eastern production, as a result ofmajor expansion of LNG in Qatar as wellas in Egypt and Oman. This has createdone supply-side link between thepreviously separate Atlantic and Pacificmarkets.

Qatar will shortly become the globalleader in LNG production. It produceslarge volumes that can ‘swing’ either way.This, coupled with a reduction intransportation costs, has strengthenedprice relationships in what is now anincreasingly global LNG market. Thestrongly regional nature of LNG trade isbreaking down. Price signals are nowtransmitted freely between previouslyisolated regional markets.

LNG originsLNG has its origins in the nineteenthcentury when the first experiments tookplace to liquefy gas. However, it wasmany years later when the firstcommercial liquefaction plant opened, inOhio in 1941. The world’s first LNG seatransportation was in 1959 with a journeyfrom the US to the UK followed by sevenfurther cargoes which were delivered withonly minor problems over the next 14 months.

From those beginnings, the LNG sectorbegan to develop. Initial plans to importLNG from Venezuela to the UK wereovertaken by the discovery of enormousgas reserves in Algeria. The shorterjourney to the UK, compared totransatlantic imports, meant that Algeriabecame the world’s first regular LNGexporter and the UK the first regularimporter in the mid-1960s.

Netback from Lake Charles: US$4.59/mmBtuHenry Hub, 1st month, Dec 2006: US$5.63/mmBtuShipping: US$0.59/mmBtuRegas: US$0.45/mmBtu

Netback from Isle of Grain: US$6.99/mmBtuUK NBP, 1st month, Dec 2006: US$7.87/mmBtuShipping: US$0.43/mmBtuRegas: US$0.45/mmBtu

Netback from Zeebrugge: US$6.75/mmBtuZeebrugge, 1st month, Dec 2006: US$7.64/mmBtuShipping: US$0.44/mmBtuRegas: US$0.45/mmBtu

Source: Argus Global LNG, January 2007

“The part-regional, part-global market mix presentsopportunities for arbitrage. Diversion rights,accompanied by compensatory conditions, create awin-win situation for both exporters and importers.”

03 LNG take-off

LNG today

The current pattern of LNG trade isshown in figure 5. Figure 6 gives abreakdown of volumes betweendifferent import and export countries.Japan and South Korea dominateimports, accounting for over 56.5%of global LNG trade. On the exportside, four countries – Indonesia,Qatar, Algeria and Malaysia –account for 59.3% of production.However, the situation is changingrapidly. Much of the growth in LNG isbeing driven by expansion ofliquefaction in countries such asQatar and Nigeria that can serveEuropean and North Americanmarkets.

The LNG market is taking off around the globe. Fordecades, LNG had been restricted largely to marketswith limited fuel choices. Indeed, by 2005, Asia Pacifictrade, dominated by Japan and South Korea, stillaccounted for the majority of global LNG imports. Thisdominance is fast being eroded by import growth inEurope and the US.


03

Figure 5: LNG trade movements, 2005*

Source: Cedigaz/Petroleum Economist LNG Data Centre, 2006

Figure 6: Import and export volumes by country

United States

Dominican Rep.Puerto Rico

Trinidad & Tobago

United Kingdom

BelgiumFrance

SpainPortugal

Italy

Greece

India

South Korea

Japan

Taiwan

Malaysia

Indonesia

Brunei

Australia

OmanUAE

QatarEgyptLibya

Nigeria

Algeria

United States

Turkey

Existing export country/state

Existing import country

Trade route

bn cm

To

North America

United States - 12.44 0.07 0.08 - 2.75 2.05 - 0.23 - - - 0.25 17.87

S and C America

Dominican Republic - 0.25 - - - - - - - - - - - 0.25

Puerto Rico - 0.67 - - - - - - - - - - - 0.67

Europe

Belgium - 0.08 - - - 2.90 - - - - - - - 2.98

France - - 0.08 - - 7.50 1.05 - 4.20 - - - - 12.83

Greece - - - - - 0.46 - - - - - - - 0.46

Italy - - - - - 2.50 - - - - - - - 2.50

Portugal - - - - - - - - 1.58 - - - - 1.58

Spain - 0.50 1.65 4.56 0.31 5.19 3.53 0.87 5.00 0.08 - - 0.16 21.85

Turkey - - - - - 3.85 - - 1.03 - - - - 4.88

United Kingdom - 0.07 - - - 0.45 - - - - - - - 0.52

Asia Pacific

India - - 0.08 5.80 - - - - - 0.16 - - - 6.04

Japan 1.84 - 1.25 8.35 6.75 0.08 - - - 13.05 8.35 19.00 17.65 76.32

South Korea - - 5.93 8.31 0.08 - 0.30 - - 1.16 0.80 7.51 6.36 30.45

Taiwan - - 0.16 - - - - - - 0.40 - 4.95 4.10 9.61

Total exports 1.84 14.01 9.22 27.10 7.14 25.68 6.93 0.87 12.04 14.85 9.15 31.46 25.52 188.81

Uni

ted

Sta

tes

Trin

idad

& T

obag

o

Om

an

Qat

ar

UA

E

Alg

eria

Egy

pt

Liby

a

Nig

eria

Aus

tral

ia

Bru

nei

Indo

nesi

a

Mal

aysi

a

Tota

l im

po

rts

From

* Became importers during 2006

Abu DhabiAlgeria

AustraliaBruneiEgyptIndonesiaLibyaMalaysiaNigeriaOmanQatarTrinidadUnited States

ADGAS (Das Island I & II)Arzew GL1Z; GL2Z; GL4Z (Camel);Skikda GL1K Phase I & IIDarwin LNG; NWS Australia LNG T1-4LumutDamietta LNG; ELNG T1-2Arun Phase I-VI; Bontang A-HMarsa el-BregaBintulu MLNG I-IIINLNG T1-5OLNG; Qalhat LNGQatargas 1; RasGas 1 & 2Atlantic LNG T1-4Kenai

BelgiumChina*Dominican Rep.FranceGreeceIndiaItalyJapan

Mexico*PortugalPuerto RicoSouth Korea

Spain

TaiwanTurkeyUnited KingdomUnited States

ZeebruggeGuangdongAndresFos-sur-Mer; Montoir-de-BretagneRevythoussaDahej; HaziraLa SpeziaChita; Chita (Kyodo); Chita-Midorihama;Fukuoka; Futtsu; Hatsukaichi; Higashi-Niigata; Higashi-Ohgishima; Himeji;Himeji II; Kagoshima; Kawagoe;Mizushima; Negishi; Ohgishima;Senboku I; Senboku II; Shin-Minato;Shin-Oita; Sodegaura; Sodeshi/Shimizu;Tobata; Yanai; Yokkaichi (LNG centre);Yokkaichi (Works)Terminal de LNG de AltamiraSinesPenuelasGwangyang; Inchon; Pyeong Taek;Tong YeongBarcelona; Bilbao; Cartagena; Huelva;SaguntoYung-AnIzmir; Marmara EreglisiGrain LNGCove Point; Elba Island; Everett; GulfGateway; Lake Charles

Export Plants:

Import Terminals:

*Based on trade movements of LNG in 2005

“We are shifting towards a global market that is setto be fairly evenly balanced between Asia, Europeand North America.”

03 LNG take-off


Demand growth

In Europe and North America,domestic natural gas productioncannot keep up with demand. There isincreasing concern about security ofsupply and a desire to diversify awayfrom over-reliance on single sources.The result is a major surge in LNGvolumes and a shift towards a globalmarket that is set to be fairly evenlybalanced between Asia, Europe andNorth America by 2020 (see figure 7).

Looking ahead, in the near term theInternational Energy Agency observesthat “a conservative estimation of LNGtrade is 300-350 bn cm per year by2010 up from 192 bn cm in 2005. The figure will be higher if allproduction projects are realised asplanned” (Natural Gas Market Review,2006). In the longer term, manyobservers forecast a trebling of theLNG market in the fifteen-year periodrunning up to 2020 (see figure 7).

These projections, however, assumethat key major LNG projects will cometo fruition. The challenges thatcompanies face in delivering these largemega-projects are considerable. Manyprojects are in environmentally sensitiveareas or face other planning hurdles.Financing is often complex. Thetechnological and constructionchallenges are substantial and arecompounded, in some locations, byshortages of qualified engineers andcontractors. These factors areexacerbated by currency risk,particularly the recent weakness of theUS dollar.

Companies developing LNG projectsalso face considerable political risk,both in their dealings with nationalgovernments and at a regional orcommunity level within countries. In Russia, for example, the companiesdeveloping the Sakalin-2 project finallyceded majority control followingsustained pressure from the Russianauthorities.

This included threats to revoke licences,including the withdrawal of a permit forthe LNG part of the project, and opencriminal investigations for allegedviolations of environmental rules. InNigeria, LNG developers have facedmore local political risk in the form ofcivil unrest.

Growth projections also assume thatcompanies will remain committed toLNG. The impact of the withdrawal ofprojects on future supply washighlighted by Gazprom’s decision in2006 to switch the giant Shtokman gasfield development from a US-boundliquefied gas hub to a pipeline venturesupplying European markets. ShtokmanLNG could have been expected tobecome available around 2015. Theeffect will be to leave a gap of 30 milliontonnes in the projected worldwide LNGmarket (Go-it-alone tactics fromGazprom leave experts divided,Financial Times, 10 October 2006).

The high oil and, consequently, high gasprice environment, combined with moreefficient infrastructure and lowertransportation costs, has boostedexpectations on returns on LNGinvestment.

However, it has also reduced LNG’scost competitiveness with other fuelchoices such as coal, nuclear and,where available, pipeline gas. The priceplaced on pollution emissions fromcarbon trading and other regulatoryschemes, thus, becomes a highlyrelevant consideration in projectingdemand for LNG.

The changing LNG marketplace

The LNG marketplace is changing. On average, US$20-30bn capitalexpenditure in LNG infrastructure isexpected to be required per annum forthe completion of all planned LNGprojects. However, the contracts indeveloped downstream markets aremoving to shorter contract periods orindexation to gas prices. This createsrisks with regard to cost recoveryshould a low price energy environmentrecur.

PwC LNG DialogueTaking account of regulatory risk

“LNG operations are spreading to manynew locations. The maturity and formatof regulatory frameworks varyconsiderably. The economic viability ofan LNG chain can be influencedsignificantly by national or regionalregulation, particularly on regasificationfacilities.”

In developed markets, companies need tonegotiate and manage arrangementsconcerning third party access exemption,network access capacity and access tomarkets and storage. Even within thesame regulatory area, companies inmature markets will encounter regulatoryvariation. In the European Union, forexample, country regulators can maketheir own decisions on certainderogations, such as on how third partyaccess rights are applied.

Such policies can have a major impact.For example, regulators may not onlydeem that a certain proportion ofregasification capacity is offered to themarket but also insist that the owner ‘usesor loses’ the capacity reserved forthemselves. Without effective utilisationmanagement, infrastructure owners mayquickly find that they lose their exemptionrights.

In developing markets, pricing and accessregulation can potentially strike at theheart of the overall viability of the project.Tariff-setting is critical for cost recoveryand returns on investment. In manyinstances, where LNG infrastructure isnew and end-markets are relativelyimmature, companies need to be theactive policy-shapers. Market access,with concurrent development of pipelinedistribution capacity, is also fundamental.

The structure of network and end-tariffregulation varies greatly andunderstanding the roles of regulators ineach downstream market will provideuseful data regarding market risks andlikely returns. Even if an LNG developer is not directly selling to end-market, off-takers (and therefore contractcounterparties) will be exposed to thoserisks and the developer shouldunderstand his counterparty risk in thisregard.


03

Figure 7: The changing global LNG market

1990 2004 2020

Source: Shell, The role of LNG in a global gas market, Oil & Money Conference, London 2005

Europe

Americas

Asia

77 bn cm (4% global gas) 180 bn cm (7% global gas) 635 bn cm (15% global gas)

PwC LNG DialogueOptimising asset portfolios

“Many companies are struggling tooptimise their LNG portfolio of assetsand contracts in a way thatmaximises value. Opportunities for‘arbitrage’ profits require ever moreclever valuation and modelling. Thecompanies that identify, assess andmanage the increasingly complexinterdependencies and uncertaintiesin the evolving LNG market will bethe ones who take the profits.”

An LNG player who wishes to movebeyond the traditional model of long-term point-to-point contracts in searchof higher margins must first establish anLNG portfolio and then actively managethis portfolio in response to marketsignals.

Establishing the initial portfolio requiresdecisions such as what sources ofsupply and market access points totake positions in, the balance of short-term versus long-term contractualarrangements between them, and thelevel of committed versus uncommittedvolumes. Active management of theportfolio is then needed with companiesrecognising and acting on signals forportfolio optimisation. A major cause ofcomplexity stems from the fact that theinitial portfolio will actually depend onexpectations of what additional value(option value) that portfolio cangenerate in the future. Thus,optimisation modelling is needed tohelp build the portfolio in the first place.

A dynamic optimisation model canproject potential opportunities foradditional profits by using stochasticmodelling to project potential futureprice differentials between markets and,thereby, provide the signals for cargodiversions and spot trades. Once theportfolio is in place, a static model canalso help minimise shipping costsbetween predetermined points by usinglinear programming to calculate theoptimal allocation of shipping journeysbetween sources and destinations(supplemented by any opportunities forcargo swaps).

The oil sector went through a similardevelopment in the early 1970s.However, the LNG market may notultimately conform to a market modelthat has straightforward parallels. Keydifferences constrain, for example, theextent to which it can achieve theliquidity of the oil market. The numberof market participants and the numberof loading and unloading ports isalways going to be far less than oil dueto the high investment cost and thespecialised technology required.

The emerging and dual character of theLNG market presents challenges formarket participants. As one study ofLNG observes: “The clash between thetwo structural models of theinternational LNG industry – thetraditional, risk-averse, contract-dependent model and the free markettrading model – has substantially shiftedthe balance of risks and rewards amongthe parties in ways that are not yet fullyunderstood” (James T Jenson, TheDevelopment of a Global LNG Market,Oxford Institute for Energy Studies,2004). The implications of wideracceptance of the new model are thatthe scope for greater liquidity and spottrading of LNG is expected to increasefurther in the coming decade.

Steering a course in changing seas

There are considerable challengesfacing companies in all parts of theLNG market. On the supply front, LNGpresents a paradoxical picture. On theone hand, supplies are potentiallyabundant. Nigeria alone has anestimated 180 tcf of gas reserves andis reported to be flaring about half ofits daily gas output of five bn cf whichcould go to the LNG market if theinfrastructure was in place. On theother hand, LNG has shifted frombeing a buyer’s market to a seller’smarket. LNG supply has become theconstraint point in the global LNGchain. Financing, infrastructureconstruction and project managementchallenges, partnering arrangements,national government and internationalgovernment relations, environmentaland geopolitical concerns cometogether in various combinations tocreate uncertainty for many upstreamLNG projects.

However, the switch to a seller’smarket presents new opportunities forupstream players to movedownstream. In particular, it opens upa chance for new players, national oilcompanies and smaller oil and gascompanies to move down the valuechain by putting together contractual,technological and partnershiparrangements with buyers.

“The switch to a seller’s market presents newopportunities for upstream players to movedownstream.”

03 LNG take-off: LNG asset strategies


Companies are responding to the challenges of a changing LNG market in a variety of ways. It ispossible to identify four strategic plays that arisefrom the asset position of companies in differentparts of the market.

1 2‘Upstream push’

Who?National oil companies or small independent oil and gascompanies.

What?These entities have upstream supplies and have developedan upstream field and associated liquefaction plant either ontheir own or with a partner. Their involvement in the LNGchain had traditionally ended at that point with LNG beingsold ‘free on board’ at the liquefaction outlet. Many suchcompanies, though, are now building presence furtherdownstream.

Key issues? The key challenge for such players is to ‘push’ LNG from theupstream and attract the best transfer price. In the past,transfer prices were modest, reflecting the low alternativeeconomic value of the gas. Now, companies are seeking togain a greater share of the market netback price and anyextra value that can be gained from switching betweenoutlets. In the short term with tight market conditions, thesecompanies have no real need to ‘push’ LNG at the marketsince the market is coming to them. However, they aremoving further down the LNG chain for a variety of otherreasons – to capture more of the economic rent of thegas/LNG produced, to negate adverse implications ofregulatory constraints (e.g. the EU second gas directive,which covers topics such as non-discriminatory pricing,removal of destination clauses, and market access) and tomatch their aspirations to develop into portfolio/globalplayers. Companies such as the Nigerian National PetroleumCompany (NNPC) and Sonatrach have establishedthemselves in the shipping part of the chain. The lattercompany is also progressively seeking to secure directaccess in downstream markets by holding regasificationcapacity in, for example, the UK’s Isle of Grain.

Challenges?High oil prices could encourage more gas reserves to comeonstream, in turn bringing more liquidity and allowing theLNG market to become less tight. In this scenario, thebalance of power will swing away from the upstream. Otherhigh oil price scenarios could include LNG becominguncompetitive in the power utility market compared tonuclear and coal which, again, would see market advantageswing away from the upstream. Alternatively, supplies couldremain constrained, even with high oil prices. In thissituation, upstream players would remain in a strongposition.

‘Market pull’

Who?Downstream utility supply companies or governments seekingto diversify supply sources.

What?Downstream utilities with significant gas demand from theircustomer base can either build or buy access to regasificationfacilities. The challenge then is to make their proposition easyand attractive to ‘pull’ LNG supplies to them. To mitigate risk,these companies will move up the LNG value chain, e.g. Gaz de France acquiring an equity interest in Egypt andNorway’s liquefaction facilities or CNOOC taking an interest inAustralia’s Northwest Shelf (NWS) LNG venture.

Key issues?In response to tight market conditions, some downstreamplayers are moving up the value chain by taking equitypositions upstream to secure supply. Utility companies suchas GdF and Mitsui, for example, have procured directly withproducers. Typically these companies have invested in the midstream part of the LNG chain such as shipping andliquefaction as well as being present in the downstream.Increased demand from existing markets and new marketssuch as China, as well as European liberalisation, hasincreased downstream pull demand. Some of these newentrants are also willing to invest in upstream producing assetsin addition to midstream assets to help them secure LNG fortheir markets. European liberalisation and dramatic economicgrowth in Asia Pacific have also increased the number ofdownstream companies willing to enter the LNG market ascompanies seek to diversify their procurement portfolios andstrengthen their ability to compete in new markets. This isreflected in the average utilisation of regasifiation terminals(see figure 8).

Challenges?Understanding the position of LNG contract prices relative toother energy contracts serving the market is a criticalconsideration for these companies. The situation of ‘marketpull’ companies will vary considerably between territories. Theregulatory framework for power utilities will have a crucialimpact, in particular vis-à-vis price-setting and the extent towhich LNG is competitive in the energy mix. For the samereason, the future direction of carbon emission regulation willalso be an important influence.

03

3 4‘Full integration’

Who?Large international oil companies seeking to gain value bymanaging an integrated value chain.

What?A dedicated chain with the same company, or partnership ofcompanies, being present in all parts of the chain in thesame proportions, with LNG flowing from one source to onemarket, like a ‘floating pipeline’.

Key issues?The strategy offers the advantages of simplicity, stability anda sound basis for financing. The disadvantage is that it canlimit opportunities to capture value from other markets,thereby limiting upside. It also concentrates risk betweenone export and one import country.

Challenges?This traditional model may become more prevalent for NOCsas they increasingly integrate downstream. If theseintegrated chains are repeated at different destinationlocations, it gains a portfolio dimension, albeit only in thedownstream.

‘Portfolio players’

Who?Companies who manage their assets as a portfolio withpresence in many parts of the LNG chain with liquefactionand regasification capacity in a number of locations. Theexact proportion of their involvement may be different indifferent parts of the chain. They have a variety of upstreamand downstream positions in terms of equity stakes, supplyagreements, offtake agreements, access rights and options.

What?This positioning enables them to buy and sell, takingadvantage of location, market pricing and changes indemand, and to manage these different types of conditionsas a portfolio. Portfolio optimisations can reduce costs,alleviate operational difficulties and allow them to takeadvantage of arbitrage opportunities.

Key issues?The scale and presence of international oil companies putsthem in a strong position to gain value from managingtheir LNG assets as a portfolio player. However, the successof such a strategy requires a more liquid market with morecommodity to play with. In such conditions, LNG movescloser to oil market-like trading, albeit overlaid withcontinuing structural challenges that create economic andcommercial barriers to entry. This, of course, is a strong fitwith international oil and gas company expertise andexperience.

Challenges?The success of this strategy will be closely linked to how thecharacteristics of the LNG market evolve with liquidity beinga key factor.


03 LNG take-off


Belgium

Greece

India

Italy

Japan

Spain

UK

US

bn cm240100806040200

Figure 8: Utilisation of regasification terminals (2005)


37.87%

18.12%

75.47%

20.81%

58.36%

51.76%

31.54%

28.62%

97.10%

48.28%

53.55%

88.49%

84.14%

11.43%

53.96%

Total capacity

Utilisation of capacity

Total World: 418.82 bn cm (45.08%)

Dom Republic

France

Portugal

Puerto Rico

South Korea

Taiwan

Turkey

PwC LNG DialogueStructuring infrastructure contractsand ownership

“LNG relies on two vital ingredients –infrastructure and gas. Sometimesthe owner of the infrastructure andthe owner of gas who uses theinfrastructure capacity is the samecompany. In other cases, they areseparate entities. In either case,companies face choices in how theyallocate risk between capacity andequity optimisation.”

Tolling arrangements for the use of LNGinfrastructure, such as regasificationand liquefaction plant, are wellestablished. The user of the capacitytakes on the volume and price risk. Thelow volatility of cash flows for aninfrastructure owner associated with thismodel gives the infrastructure owner astrong basis for a more highly leveragedfinancing structure with long debt tenorand the ability to release near term cashdistribution to equity investors.

Most European regasification terminalsare structured on a tolling basis, evenwhen the regasification plantcommercially is part of a singleintegrated value chain. Theregasification terminal is structured as aseparate legal entity to maximise theamount of non-recourse funding (projectfinancing). Such a mechanism providesstable but only limited returns toinfrastructure equity investors.

However, companies need to makecareful judgements. There is highreliance on a single entity (the toller),who must represent an adequate creditrating and/or demonstrate a long-termneed for the tolling services. Companiesalso need to judge the allocation ofcapacity and how much marketexposure to take on. This will, in turn,determine how much ‘anchor load’should be tolled and how muchcapacity should be left free for theinfrastructure owner to use, auction orotherwise expose to the market.

Companies undertaking LNGoperations need to manage amultiplicity of risks. At a strategiclevel, there is the threat of high gasprices leading to demand reductionas LNG competes against otherfuels, initially through fuel switchingand more permanently throughcapital investment decision making.Currently, companies also faceconsiderable resource shortages andcosts, in terms of both hardware andpeople. At both the export and theimport end, infrastructure projectscan also raise social andenvironmental concerns which haveto be managed carefully.

Starting at the top of the value chain,the upstream E&P arena presentsnormally the highest risks related toproject completion, developmentcosts, reserves uncertainty andfacilities performance.

Managing risk along the value chain Companies who decide to monetisegas through LNG must then establishminimum offtake volumes in order toprovide an assured revenue flow andbe sure that the gas price will behigh enough to deliver acceptableeconomics.

Liquefaction is a lower risk activitythan those associated with LNG’supstream operations. Project financerequirements often make a tollingarrangement appropriate to providelong-term stable revenues and lowrisk. In turn, however, this part of thevalue chain tends to attract a lowerrate of return because of the lowerrisks involved.

Moving further along the value chain,the ‘marketing company’ is the entitythat takes the responsibility forexporting and shipping the gas. Itmay be a wholly owned subsidiary ora joint venture company. The‘marketing company’ carriessignificant volume and price riskarising from trading activity.


This risk will be subject to thecontract terms of the LNG GasPurchase Agreement (GPA) underwhich it purchases LNG from theupstream supplier, and the terms ofthe Gas Sales Agreement (GSA)under which it sells gas to thedownstream offtaker(s). The partnerswill need to agree a risk sharingcontract (as part of the shareholderagreement) that clearly allocates theexposure as well as the rewards tothe relevant parties. The ‘marketingcompany’ may need to have parentcompany guarantees, which meansthat the parent companies are fullyexposed to the risks of the‘marketing company’ and will need toput this exposure on their balancesheet.

The ‘marketing company’ guarantorneeds a sufficiently high credit ratingto back long-term contracts andcredit lines so that they can surviveperiods of adverse market conditions.

On the operational side, the‘marketing company’ needs to secureaccess to liquefaction, shipping andregasification capacity. To someextent, its risks can be mitigated ifthe company has a large number ofregasification terminals servingdifferent markets.

Regasification is a lower risk activitythan the upstream andmarketing/shipping activities. LNGshipping is also a lower risk activitythan the upstream and marketingactivities. It is even considered to belower risk than regasification andliquefaction, because ships can beused elsewhere and are therefore notnecessarily linked to the markets of aparticular project.

PwC LNG DialogueMaximising tax efficiency

“Tax treatment of LNG operationsposes a significant challenge forcompanies. LNG taxation is highlydynamic, with complex and evolvingrules spread across many taxjurisdictions. Specialised taxstructuring is needed to realise all theadvantages afforded through theinteraction of the various systems.”

LNG supply sources are, by their nature,typically located in areas far removedfrom end-markets. Stretched supply linesrequire international organisation ofpeople and resources. In turn, thisnecessitates complicated corporatestructures, often spread across many taxjurisdictions. Different tax jurisdictionshave developed their own specificapproaches for taxing the business ofLNG production, transportation andmarketing.

International business operations haveunique taxation considerations that canlead to the need for complex structuring.Global inter-group cash flows, oftennecessitated by the need for new capitalas projects expand or relocate, createchallenges to tax optimisation when those flows move across tax jurisdictionboundaries. Consideration must be givento debt or equity financing alternativesand to future prospects for repatriationdividend flows from subsidiaries. Globalor regional finance centres are oftenappropriate to deal with these issues. In each of these cases, tax ramificationsshould be understood and considered inthe overall decisions.

In addition, the physical movement ofLNG products through the phases of acompany's business model, be itproduction, transportation, marketing, or all three, often occurs across jurisdictional borders and between legalentities, adding more complication to theoverall tax position. Transfer pricingconcerns and questions about the exacttiming or location of a legal title transferrequire specific consideration ifcompanies are to optimise their taxposition.

CEO checklist: the key issues

1 LNG versus the alternative options• Producers – LNG vs. pipeline gas, Gas to liquids (GTL), domestic supply,

compressed natural gas, power• Buyers – LNG vs. pipeline gas, coal, renewables, oil, nuclear

2 Risk exposure• Producers – optimum level of market exposure, natural hedging by

integrating down the value chain (shipping, regasification, marketing)• Buyers – maximum security of supply, natural hedging by integrating

up the value chain

3 Flexibility requirements• Producers – volumes, timings, destination, storage• Buyers – seasonality, volumes, diversity of supply, storage

4 Pricing• Producers – minimum price willing to accept (price of next best option),

caps + collars• Buyers – maximum price willing to pay (cost of next best option), link to

oil, oil product or power prices

5 Contractual arrangements• Producers – volumes required to underpin finance, volumes under

long-term contracts, capacity set aside for spot trading opportunities (if any)• Buyers – investment capital requirements, supply and offtake guarantees

Underpinning success factors• Managing geopolitical and regulatory risk• Managing planning and environmental issues• Credible lender selection and clearly agreed finance structure• Expert project development, experienced contractors and smart asset management• Managing gas specification requirements

03

The future map of the LNG sector around the worldwill be very different from today. Major newdevelopments are set to come onstream over the nextdecade. The commercial risk posed by the shortage ofLNG over the next five years or so highlights theimportance of such developments.

04 LNG tomorrow

As we saw in the previous chapter,though, many of these developmentsare far from certain. In this chapter,we look at the future landscape ofLNG and consider how smaller-scaleand more flexible technology is likelyto further change the nature of LNGtrading.

The future LNG world

The future LNG world map (figure 9)looks very different from the currentone shown on page 9. By 2015,Qatar is expected to be theundisputed lead producer. There willbe significant expansion of LNG fromsources like Nigeria. In addition, newsources may enter the market fromthe Russian Federation and Iran.Increased imports by China andIndia in the Asia Pacific region, theUK and Italy in Europe and the US inNorth America will fuel LNG growth(see figure 11). The growth in importsby the US alone is expected toaccount for between a third and ahalf of the increase in global LNGvolumes between 2005 and 2015.


04

Canada

Bahamas

Honduras

Brazil

Jamaica

Peru

Venezuela

Chile

Russian Federation

Yemen

Equatorial Guinea

Angola

Iran

Norway

Netherlands

Cyprus

Croatia

United States

Dominican Rep.Puerto Rico

Trinidad & Tobago

United Kingdom

BelgiumFrance

Spain

Portugal

Italy

Greece

Turkey

India

South Korea

JapanTaiwan

Malaysia

Indonesia

Brunei

Australia

OmanUAEQatarEgyptLibya

Nigeria

Algeria

United States

Philippines

China

Mexico

Poland

Thailand

Export country/state

Import country

Trade route(contracted)

Trade route(non contracted)

Other prospective countries with studies in progress include:Exporters - Brazil, Mauritania, Papua New GuineaImporters - Hong Kong, New Zealand, Sweden, Ukraine

Pakistan

Germany

Singapore

Figure 9: LNG trade movements, 2015*

*Note: All trade movement figures associated with this table are directly derived from contracts currently in place (either as SPA, HOA or MOU) as at December 2006, according to Cedigaz data. No concession has been made for current contracts expiring before 2015 or for current HOAs or MOUs to be terminated.



Figure 10: LNG exporters – main growth countries

2005 2015 % increasebn cm bn cm

Qatar 27.1 115.0 324%

Nigeria 12.0 33.7 180%

Australia 14.8 26.4 78%

Egypt 6.9 17.1 146%

Iran 10.8 n/a

Russian Federation 10.6 n/a

Yemen 8.8 n/a

Figure 11: LNG importers – main growth countries

2005 2015 % increasebn cm bn cm

US 17.9 75.0 319%

Spain 21.9 29.8 36%

UK 0.5 21.0 3925%

Italy 2.5 19.7 685%

India 6.0 16.9 179%

China 12.0 n/a

Portugal 1.6 3.5 119%

04 LNG tomorrow


1995 2006 2015*

Total capacity

Utilisation of capacity

Note: *Derived from data based on all known future projectsSource: Petroleum Economist LNG Data Centre, 2006

Top Ten 84.58% Top Ten 66.87% Top Ten 60.21%

Figure 12: Top Ten LNG exporters (by capacity)

Million t/y 1995

Sonatrach 21.95

Pertamina 13.70

Petronas 11.97

Shell 4.65

Mitsubishi 4.01

ADNOC 3.92

JILCO (Indonesia) 3.74

VICO (Indonesia) 3.62

Brunei Government 3.60

NOC (Libya) 2.30

Total World 86.85

Million t/y 2006

Sonatrach 21.95

Petronas 18.70

Qatar Petroleum 16.92

Pertamina 16.16

Shell 12.72

BP 8.52

NNPC 8.36

ExxonMobil 7.46

BG 7.24

Total 6.50

Total World 186.23

Million t/y 2015*

Qatar Petroleum 52.46

Shell 39.00

NNPC 36.40

Pertamina 23.16

ExxonMobil 22.90

Sonatrach 22.75

NIOC (Iran) 21.57

Petronas 20.28

BP 19.09

Total 19.02

Total World 459.48

The expected increased capacity inQatar is spectacular, accounting fortwo thirds of the increase in LNGexports between 2005 and 2015.Seventy per cent of the plannedexpansion in infrastructure capacityin Qatar is already underconstruction so this element ofoverall LNG growth is relativelycertain. In contrast, the growth inIran is speculative and is yet to moveto the planning stage. Elsewhere,new LNG export infrastructure is amix of current construction, plannedand speculative projects.

In Africa, current construction ofplant is expected to bring EquatorialGuinea on to the LNG map by 2007or soon after. The main export andimport growth countries are listed infigures 10 and 11. On the importside, the table highlights the extentto which demand expansion incountries such as the UK, US andItaly represents a significant materialshift from the current situation.

04


Behind the overall growth in LNG isthe growth of individual players inthe marketplace. Not surprisingly, thenational oil and gas companies inQatar and Nigeria figure prominently(see figure 10). These companies,together with the internationalmajors, are set to dominate the LNGexport top ten which is now takingon a different look compared to pastdecades when LNG trade in the FarEast took the dominant share ofworld LNG trade. Figure 12 alsoshows a trend towards anincreasingly competitive marketplacewith more players. By 2015 the tenlargest exporting companies’ shareof total world LNG export capacitywill have fallen to 60% compared to84.5% back in 1995.

Technology advances

The increased competitiveness of the market is likely to be boosted still further by technologicaladvances. Economies of scale andlearning have reduced unit costs ofgas transport by LNG at a greaterrate than by pipeline alternatives.Investment in LNG infrastructureoccurs in smaller increments thanpipelines. LNG costs have beenreduced. Nonetheless, infrastructureinvestment remains large-scale andplaces constraints on the number ofcompanies that can enter themarket.

“We are seeing an increasingly competitivemarketplace that is less concentrated on thebiggest players and has more companiesoverall.”

Small-scale liquefaction

Ultimately, any natural gas that isaccessible to shipping, eitheroffshore or piped to coastallocations, could be directly used forthe LNG market. Typically, gas fieldsthat were developed for LNG exportshad minimum proven reserves of 500bcm or above. However, small-scaleliquefaction plants (i.e. 250 to 1,000tonnes per day) are now beingdeveloped and tested. Small-scale,and to some extent mobile, LNGproduction units and flexible LNGtransportation in ten ton containerscould monetise smaller reserves.This could increase the number ofreserves and markets, opening upthe prospect of many more playerswith a greater number of loading andoffloading options.

04 LNG tomorrow


LNG gallons per day

1,000,000100,00010,0001,0001000

Figure 13: Capital cost (US$/LNG gallons per day)

Source: MEI LLC, a member of the ILF Group

200

400

600

800

1,000

10,000,000

Cap

ital c

ost

per

day

(US

$)

Conventional negativescaling effect

Target small-scaleliquefaction plants Conventional

liquefaction plants

Alternative source and uses of LNG

Opportunity fuels (any fuel that hasthe potential to be used foreconomically viable power generationbut is not traditionally used for thispurpose) such as associated gas,landfill gas, and coal-methane couldalso be suitable for small-to medium-scale LNG applications. This would enable methane gasrecovery from coal mining or landfillsites to be converted to LNG andtransported by LNG road tanker toregasification facilities. Alternatively,LNG applications as a transport fuelmay evolve in regions where it iseconomical to do so. For example,LNG-powered buses and heavymachinery in Western Australia.

Liquefaction hubs

Liquefaction hubs are likely to beboth regionally and globallysignificant as the LNG industrymatures and new gas supply sourcesare pulled into existing liquefactioninfrastructure positions. Currently,liquefaction plants can be veryeffective barriers to entry thatprevent new upstream suppliersentering the market. However, sometraditional gas supplies arebecoming depleted and existinginfrastructure owners/stakeholderswill be very keen to see new gassupplies pulled in to utilise theexisting liquefaction infrastructure. InIndonesia, Malaysia and Australia, forexample, it is likely that LNGliquefaction asset lives will beextended by becoming hubs fordisparate gas supplies. This willopen up the potential for non-traditional suppliers to break into thetraditional supply models/consortia.Such developments will becomeeven more likely in the light of theplanning difficulties of developingnew greenfield LNG infrastructure. In contrast, existing liquefaction sitesoffer brownfield opportunities fordevelopment.

04


OFFSHORE PRODUCTION

Intermediate LPG StorageLPG Extraction

Gas TreatmentCold Box

Intermediate LNG Storage

Wet Gas

FLOATING LNG PRODUCTION

Source: MEI LLC, a member of the ILF Group

Figure 14: Floating LNG productionFigure 14, for example, illustrates anexample of the use of floating LNGproduction vessels to captureoffshore gas and eliminate flaring.Medium-sized vessels could equallybe well used. So far only conceptsexist of this type of application. A number of hurdles need to beovercome. Separation treatment ofthe raw gas has to take place beforeliquefaction. Also, the technology toreliquefy boil-off gas on vesselsexists but not yet on a scale suitablefor LNG production.

Gas storage for peak shaving

Typically large-scale (150 to 500 m cm)underground gas storage usingdepleted oil and gas fields or saltcaverns have been used for seasonalgas storage for peak shavingpurposes. Smaller and more flexiblecryogenic storage could be utilised forsmaller communities/islands or regionswhere no underground gas storage ispossible. Current technology enablessmall-scale LNG peak shaving plantand satellite plants to provide flexibleoptions for power utilities. Already, thelatter are fairly common in the USalthough they are rare in Europe andthe rest of the world.

Type Cushion to Utilisations working gas ratio (cycle times per year)

Aquifer and depleted Cushion: 50% to 80% 1 oil and gas reservoirs

Salt cavern Cushion: 20% to 30% 6-10

Cryogenic surface storage Heel: 3% to 6% 24

“Technological innovation could open up theprospect of many more players with a greaternumber of loading and offloading options.”

04 LNG tomorrow


Shipboard regasification

The development of shipboardregasification and shipboardliquefaction would enable LNG to besourced and supplied to amultiplicity of sources without theneed for significant investment inliquefaction and regasificationinfrastructure. Excelerate Energy’sEnergy BridgeTM shipboardregasification technology has beenoperational in the Gulf of Mexicoserving LNG terminals in Louisianasince 2005 and in Teesside (UK)which is due to be on-stream in2007. The reduced need forinvestment at the receiving port canmake LNG an economic option formore destinations. An example issituations where only seasonalsupplies rather than baseloadsupplies are needed and where,otherwise, the utilisation rate of anyregasification plant would beuneconomically low. Shipboardliquefaction and regasification alsohelps to allay safety fears sometimesexpressed by people living orworking near port LNG infrastructure.This was, for example, a factorbehind the initiatives in the Gulf ofMexico.

A truly global market?

The LNG market will undoubtedlybecome more global in the sensethat the historical concentration ofvolumes in the North East Asian andPacific markets will becomebalanced by the rapid growth ofdemand from Europe, NorthAmerica, India and China. Newsources of LNG supply may emergefrom countries such as Libya, Angolaand Equatorial Guinea. This willfurther accelerate the shift in LNGfrom the Pacific to the Atlantic.Middle Eastern sources will play apivotal supply role in the market withthe flexibility to serve both eastwardand westward destinations.

The traditional value chain representsa linear set of investments. However,the different and evolving LNGenvironment of today and tomorrowdemands a mind-shift by manyplayers away from the predominantlinear fixed supplier and buyer chainof supply to a more flexible,disaggregated model of the market.Instead of fixed routes and wholly-owned value chains, we are enteringan era where, increasingly, morecargoes move to where they cangain the highest netback and manycompanies use trading, partnershipsand other mechanisms to assembletheir own value chains.“The different and evolving LNG environment of

today and tomorrow demands a mind-shift bymany players away from the predominant linearfixed supplier and buyer chain of supply to a moreflexible, disaggregated model of the market.”

04


The prospects for the emergence of atruly global market that comes closer to the characteristics of the oil marketwith a fairly homogenous price are more questionable. How far the LNGsector can move in that direction will,in part, be dependent on the extent towhich technological developments,with the development of super-scaletankers combining shipboardliquefaction and regasification, canincrease the volume of short-termtrading. Another key factor will begrowth in the number of supply andreceiving points.

A key macro-level determinant of LNG growth will, of course, be LNG’scompetitiveness against other fuelsources. Its inability to competeagainst cheap coal continues, forexample, to restrict LNG supplygrowth in the major markets of Indiaand China. Changes in energy marketregulation, environmental taxes andcarbon trading will all have aninfluence on LNG’s future place in the fuel mix.

PwC LNG DialogueFactoring in the cost of carbon

“Downstream power utilities are already considering the costof carbon in their operational and investment decisionmaking. Notwithstanding the medium-and longer-termuncertainty surrounding the regulatory framework aroundcarbon, it is imperative that energy players evaluate the risksand opportunities around this new value driver in the energymarkets.”

What is striking about the EU Emissions Trading Scheme (EU-ETS) is its rapid success in providing a new price signal. The electricity markets now distinguish between the dark spread(the differential between power prices and the coal pricecomponent of generation costs) and the green spread (thedifferential after taking into account the cost of the carbonallowance associated with generating the power). When themarket price of carbon allowances fell, this had repercussions forgenerators’ share prices. Operating companies are taking carbonimpacts into account in their investment decisions, and investorsare looking to benefit from the potential upside.

It is often claimed that the short-term nature of carbonregulation, both within the EU-ETS and under the KyotoProtocol, combined with significant volatility in carbon markets,are a major disincentive to long-term investment. The powersector, in particular, has argued strongly that it requires a muchlonger regulatory horizon (ten-year carbon trading windows ormore) if major investment shifts to cleaner generation are tooccur. This will naturally have implications further upstream andshould favour cleaner fuel sources such as LNG.

Many energy players have already taken the strategic view that a price for carbon will exist after 2012 and are planningaccordingly. The year 2006 saw announcements on powerprojects incorporating carbon capture and storage (CCS)projects despite there being no mechanism currently in placethrough which a dollar value can be attributed to the CO2 saved.CCS technology may offer an interesting bridge betweenupstream and downstream activities. It is likely that similar playscould emerge around LNG value chains, particularly withrespect to the separation of CO2 in gas treatment phases (fromhigh CO2 content fields) prior to liquefaction.

05 Conclusion


As we look ahead, it is clear LNG will have a growing part to playin world energy. It is likely that this will be in the context of amarket that will become increasingly flexible and liquid, althoughstill characterised by structural and regional differences.Opportunities for arbitrage will continue to be a feature of themarketplace.

The extent to which companies will be able to optimise their LNGstrategies through portfolio trading will, in a large part, bedetermined by whether the market remains constrained. In a tightmarket, supplies will be dominated by the national oil companiesand sufficient liquidity is unlikely to be present for such trading toplay a central role. However, both current infrastructuredevelopments and future technological developments point togreater volumes, more market participants and, hence, greaterliquidity. This will allow all players to benefit from more flexiblevalue chains.

This trend may be reinforced by technological developments.Increasingly, niche technology will mean LNG can be taken fromlocations where gas is currently not recovered. This will enablethe LNG sector to offer flexible small-scale transportation anddelivery options as well as larger-scale LNG shipping routes, akinto the strategy currently being played out in the aviation industrybetween Boeing’s investment in a smaller-scale shorter haul fleetversus Airbus’s investment in the large-scale longer distancesuper-jumbo.

The ultimate course of LNG development will depend on itscompetitiveness on both the supply and demand side. On thesupply side, GTL may provide an increasingly significantalternative route to monetise stranded gas. On the demand side,technology, price regulation and government policies will be keyinfluences on the big macro-level question of LNG’scompetitiveness in the power utility fuel mix. Clean coal andnuclear power will be potential demand dampeners. However, allare likely to be part of the energy mix, especially in a future whereLNG can be accessed by utility companies in more locations, ingreater volumes and in more flexible delivery modes.


Contact us 06

Global contacts

Richard PatersonGlobal Energy, Utilities & Mining LeaderTelephone: +1 214 756 1579Email: [email protected]

Manfred WiegandGlobal Utilities LeaderTelephone: +49 201 438 1517Email: [email protected]

Michael HurleyGlobal LNG LeaderTelephone: +44 207 804 4465Email: [email protected]

Fred CohenGlobal Energy, Utilities & Mining Advisory LeaderTelephone: +1 646 471 8252Email: [email protected]

James KochGlobal Energy, Utilities & Mining Tax LeaderTelephone: +1 713 356 4626Email: [email protected]

Peter AlbrechtEurofirms Industrial Products LeaderTelephone: +49 201 438 1518Email: [email protected]

Klaus-Dieter RuskeGlobal Transportation & Logistics LeaderTelephone: +49 211 981 2877Email: [email protected]

Territory contacts

Europe

AustriaGerhard Prachner Telephone: +43 1 501 88 1800Email: [email protected]

Bernhard HaiderTelephone: + 43 1 501 88 2900Email: [email protected]

BelgiumJoost De GrooteTelephone: +32 2 710 7419Email: [email protected]

Central and Eastern EuropeTibor AlmassyTelephone: +36 1 461 9644 Email: [email protected]

Czech RepublicHelena CadanovaTelephone: +420 251 152 011Email: [email protected]

DenmarkPer Timmermann Telephone: +45 39 459 145Email: [email protected]

FinlandJuha TuomalaTelephone: +358 9 228 01 451Email: [email protected]

FranceJean Gaignon Telephone: +33 1 565 74 028Email: [email protected]

Philippe GiraultTelephone: +33 1 565 78 897Email: [email protected]

GermanyManfred WiegandTelephone: +49 201 438 1517Email: [email protected]

GreeceDinos MichalatosTelephone: +30 1 687 4730Email: [email protected]

IrelandCarmel O’ConnorTelephone: +353 1 662 6417Email: [email protected]

ItalyJohn McQuistonTelephone: +390 6 570 25 2439Email: [email protected]

MaltaFrederick Mifsud BonniciTelephone: +356 256 47 604Email: [email protected]

NetherlandsAad GroenenboomTelephone: +31 26 371 2509Email: [email protected]

Fred KoningsTelephone: +31 70 342 6150Email: [email protected]

Arthur KramerTelephone: +31 70 342 6033Email: [email protected]

NorwayOle Schei MartinsenTelephone: +47 95 261 162Email: [email protected]

PolandWilhelm SimonsTelephone: +48 22 523 4150Email: [email protected]

PortugalLuis FerreiraTelephone: +351 213 599 296Email: [email protected]

06 Contact us


Europe (continued)

Russia and the Former Soviet UnionJohn GrossTelephone: +7 495 967 6260Email: [email protected]

Gerald RohanTelephone: +7 495 967 6267Email: [email protected]

SpainFrancisco MartinezTelephone: +34 91 568 47 04Email: [email protected]

SwedenMats EdvinssonTelephone: +46 8 555 33 706Email: [email protected]

SwitzerlandRalf SchlaepferTelephone: +41 58 792 1620Email: [email protected]

TurkeyFaruk SabuncuTelephone: +90 212 326 6082Email: [email protected]

United KingdomRoss HunterTelephone: +44 207 804 4326Email: [email protected]

Albrecht Muller von BlumencronTelephone: +44 207 213 3956Email: [email protected]

Adrian LeakerTelephone: +44 207 213 2203Email: [email protected]

Pooya AlaiTelephone: +44 207 804 9808Email: [email protected]

John HutchinsTelephone: +44 207 212 2760Email: [email protected]

The Americas

United StatesMartha CarnesTelephone: +1 713 356 6504Email: [email protected]

Paul KeglevicTelephone: +1 312 298 2029Email: [email protected]

Stephen ParkerTelephone: +1 713 356 6505Email: [email protected]

Christopher BryantTelephone: +1 713 356 4572Email: [email protected]

Manish KumarTelephone: +1 713 356 4014Email: [email protected]

Dario QuirogaTelephone: +1 703 918 1151Email: [email protected]

CanadaAngelo ToselliTelephone: +1 403 509 7581Email: [email protected]

Tom CollinsTelephone: +1 403 509 7359Email: [email protected]

Latin AmericaJorge BacherTelephone: +54 11 485 06 801Email: [email protected]

MexicoJavier HernandezTelephone: +52 555 263 5819Email: [email protected]

Jorge SilvaTelephone: +52 555 263 8632Email: [email protected]


Asia-Pacific

AustraliaDerek KidleyTelephone: +61 2 826 69 267Email:[email protected]

Robert GrayTelephone: +61 3 860 33 499Email: [email protected]

ChinaGavin ChuiTelephone: +86 10 653 32 188Email: [email protected]

Allan ZhangTelephone: +86 10 653 37 280Email: [email protected]

IndiaKameswara RaoTelephone: +91 40 233 00 750Email: [email protected]

SingaporeRobert MontgomeryTelephone: +65 623 64 178Email: [email protected]

Middle East

Paul SuddabyTelephone: +971 4 304 3451Email: [email protected]

OmanKenneth MacfarlaneTelephone: +968 24 563 7113Email: [email protected]

QatarIan ClayTelephone: +974 44 15 722Email: [email protected]

Timothy WellsTelephone: +974 44 15 700Email: [email protected]

Africa

Elias PungongTelephone: +241 77 2335Email: [email protected]

AngolaJulian InceTelephone: +244 2 395 004Email: [email protected]

Allan DulanyTelephone: +244 2 395 004Email: [email protected]

NigeriaUyiosa AkpataTelephone: +234 1 320 2101Email: [email protected]

Southern AfricaStanley SubramoneyTelephone: +27 11 797 4380Email: [email protected]

Additional information

Olesya HatopGlobal Energy, Utilities & Mining Marketing Telephone: +49 201 438 1431Email: [email protected]

Contact us 06

For further information, please visit www.pwc.com/lng


Higher natural gas prices and growingefficiencies in the LNG value chain aremaking it economically feasible to shipLNG over long distances, transformingnatural gas from a regional to a globalmarketplace. LNG is one of the fastestgrowing energy markets worldwide.Given the number of new LNG projectsproposed or under construction, globalproduction capacity could more thandouble by the end of the decade.According to the International EnergyAgency, such fast growth will require$250 billion to be invested inliquefaction plants, coastalregasification import terminals, andspecial LNG tankers over the next 30 years.

The players in the LNG market includeintegrated oil and gas companies,national oil companies andgovernments, independent upstreamplayers, utilities, infrastructure andtransportation companies, and privateinvestors. The upstream anddownstream players hail from allcorners of the globe – Americas, Africa,Europe, Middle East and Asia Pacific.Although the economics of widespreaduse of LNG are becoming moreattractive, there still remain a number ofissues that need to be addressed tobring on many of the planned projects.

PricewaterhouseCoopers has been working with clients who are deeplyinvolved in the LNG market across the globe and are at the leading edge of developments. We have worked withthese clients across all stages of LNG projects:

Fast-paced growth in LNG:How PwC can help you

Market analysis and strategic options

• LNG capacity and phasing decisions • Which markets should be served? • Assessment of market trends and drivers • Pipeline versus LNG supply analysis • LNG Workshops

Economic and commercial assessments of LNG projects

• Commercial feasibility analysis • Netback calculations for the entire value chain • Which project will increase shareholder value the most? • Return and risk assessment • Risk mitigation • Tariff calculation/setting along the value chain• International tax and tax structuring

Project development and structuring

• Partnering along the value chain • Commercial principles and Heads of Terms • Development of suitable project structures • Financial structuring • Finance raising • Refinancing procurement tenders • Selection of EPC contractors

List of abbreviations used throughout this report

bn cf billion cubic feet

bn cm billion cubic metres

CIS Commonwealth of Independent States

GTL Gas to liquids

JCC Japanese Crude Cocktail

LPG Liquefied Petroleum Gas

mmBtu million British thermal units

m cm million cubic metres

NBP National Balancing Point

NNPC Nigerian National Petroleum Company

OECD Organisation for Economic Co-operation and Development

OPEC Organization of the Petroleum Exporting Countries

tcf trillion cubic feet

tcm trillion cubic metres

TTF Title Transfer Facility

ZBT Zeebrugge Hub

More LNG terminology can be found in LNG – A glossary of terms,which PricewaterhouseCoopers has published in conjunction with The Petroleum Economist Ltd. as a practical contribution to promotingtransparency, understanding and knowledge in the global LNG industry. Furthermore, together with The Petroleum Economist Ltd.,PricewaterhouseCoopers produced the The Future of LNG Map.This map represents the global LNG market with a focus on futureprojects: construction of liquefaction and regasification terminals aroundthe world and an indication of future LNG trading routes.

To order the LNG – A glossary of terms or The Future of LNG Map,please visit: www.petroleum-economist.com

Acknowledgments

We would like to acknowledge the assistance of BP p.l.c. for providingimages used throughout this report.Front cover, inside front/back cover, pages 2, 8, 16, 19, 22, 23 and 24 © BP p.l.c.

*connectedthinking

*connectedthinking

PricewaterhouseCoopers (www.pwc.com) provides industry-focusedassurance, tax and advisory services to build public trust and enhancevalue for its clients and their stakeholders. More than 140,000 people in 149 countries across our network share their thinking, experience andsolutions to develop fresh perspectives and practical advice.

PricewaterhouseCoopers refers to the network of member firms ofPricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.

The Global Energy, Utilities and Mining group (www.pwc.com/energy) is the professional services leader in the international energy, utilities andmining community, advising clients through a global network of fullydedicated specialists.

For copies of the report, order online at:www.pwc.com/lng

© 2007 PricewaterhouseCoopers. All rights reserved. PricewaterhouseCoopers refers to the network of member firms ofPricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. *connectedthinking is atrademark of PricewaterhouseCoopers LLP.

Documents

Value and Growth* - PwC · PricewaterhouseCoopers •Value and growth in the liquefied natural gas market 5 02 Liquefied natural gas, in effect, provides a ‘floating pipeline’