Elusive LNG

LNG has evoked a considerable controversy again. Successive governments have been touting LNG projects for now more than a decade as a short-term solution. It has not materialised. But the enthusiasm continues unabated, despite negative court orders, controversies and successive failures. Had this kind of attention been paid to other solutions, Pakistan would have been better off. It is widely known that LNG is expensive, almost as expensive as oil and commercial conditions demanded by the suppliers being stringent.

Irrespective of my disdain for LNG, I would make some recommendations in these lines for faster and smooth implementation of the proposed LNG projects. I would in the end also make a case for approving the initial local shale gas projects on LNG rates as well.

It would be a folly to get bogged down in the controversies of long-term mega deals of LNG for 20 years involving 20-25 billion USD. The last international tendering process indicated that only one party Shell (based on Qatar supplies) could offer 20 years guaranteed supplies. But why insist on 20 years supply agreement. This in itself is a competition-scaring condition. Buyer should size up his specs and demands to the average and general conditions prevailing in the market in order to get a good price. 20-25 years is a long-time horizon in which market and technology can change dramatically. New players may come in as we are seeing the emergence of the US and East Africa. Terminal cost of 300 million USD is a negligible fraction of 20 billion USD of LNG cost. In any case, under merit order, energy sector is used to partial capacity utilisation. There was a time when Hubco had a capacity utilisation of fewer than 20 percent. A simple issue of installing an LNG terminal ala IPPs has been unnecessarily complicated by interlacing it with LNG supplies. One could go for spotting, partial short-term and mid-term contracts, users or private sector buying their own LNG, it was economic for them?

The LNG supply market scenario is fast changing. Although Qatar’s dominance would remain and even may increase, new parties and countries are coming into the market. Gas discoveries and LNG projects in Africa, an Australian ambitious LNG programme; and most importantly the North American LNG exports rather than being importers of yesteryear, all indicate a highly competitive LNG market with downward pressure on prices. Let me quote here from Bloomberg:

The US and Canada together may add as much as 77 million tons of capacity by 2020, an amount equal to the entire output of Qatar, the world’s biggest producer, according to Barclays and RBC. “Australia is set to eclipse Qatar as the world’s leading supplier of LNG,” RBC analysts led by Greg Pardy said in a May 22 report. The wave of new projects will probably drive down prices, enabling North American producers to supply Asia for as little as $11 per million British thermal units by 2015, compared with long-term contracts linked to crude that are now at about $17 per million Btu, Shiyang Wang, a New York-based energy analyst at Barclays. (http://www.bloomberg.com/news/2013-07-09/iran-s-lng-dreams-vanish-as-u-s-shale-gas-looms.html)

There is yet another negative side of LNG that has not been discussed in our public debate on the issue, which is ‘Take or Pay’ conditionality. This is to say that if for some reason, the buyer is not able to lift the quantities agreed to in the contract, he or she has still to pay and not only the capital cost of the assets and infrastructure, but of the commodity (gas) also. And one is bound for twenty years for such terms. In integrated projects, this condition can be implemented with harsh consequences for the buyer. So, if ‘Take or Pay’ conditions are applicable in the LNG projects offered to us, the margin of 10-15 percent price advantage withers away against the risks associated with ‘Take or pay’ clauses. Such clauses may be swallowed at classical commodity (gas) prices of 4-5 USD per MMBtu but not at the LNG prices that are under consideration.

A merchant terminal providing services to importers and end-users may be ideally suited to Pakistan market and circumstances. There is no need of tying it with gas supplies. In fact there may not be any need for a long-term contract. Importers and end-users may rely on fast expanding spot market. Platts maintains that spot market stands at 25 percent of total global LNG sales. Spot prices, on the average, are no higher than long-term contract prices. For Example Platt reports (http://www.lngworldnews.com/platts-asia-july-lng-spot-prices-drop) July, 2013, average spot for LNG Asia(Singapore) to be 14.485 USD per MMBtu, which comes out to give a slope(coefficient) of 13.5 percent, which is almost the lowest MPNR got in their tendering process. Interestingly, Hazira LNG terminal in India is based on this business model. Hazira is owned 75 percent by Shell and 25 percent by Total, a 100 percent FDI. We should apply our minds to learn as to why Shell invested in a terminal next door India without insisting in long-term supplies contract, and in Pakistan Shell did just the opposite.

If there is a clear headed policy environment and full openness and transparency, a similar project can be attracted to Pakistan as well. An IPP cost-plus model should be good enough. There is ample experience in this model in the power sector in Pakistan. A private-public partnership arrangement may also be considered, if FDI is not forthcoming. The proposed gas pipeline from Iran could also be implemented on the same lines. If well functioning markets are to be established in the region, supplies (commodity) have to be separated from network operating business.

Irrespective of our reservations on the efficacy or desirability of LNG, we would offer some sane advice to the new government, in implementing the LNG project(s):

— Follow an unbundled approach, meaning that keep the LNG terminal construction and the LNG supply issue separate. Results of the last international tendering indicate that bundling did not elicit the interest of majority of parties. Following Shell’s footprint in the earlier tender, Even Qatar government has declined to be a party in the construction of the terminal.

— Do not get government involved in the procurement of LNG except as facilitators and oversight functions.

— Do not go for long-term LNG deals, especially, if these come with ‘Take or Pay’ clauses and non-diversion stipulations. Recent Qatar offer has the stringency of both. Long-term deals involving 25 billion dollars become controversial, especially, if you want to avoid PPRA framework which has been found to be time consuming.

— Go for short-term and spot purchases under MSA (Master Supply Agreements) on the line of TCP purchases for fertilisers and other commodities.

— Make minor amendments to LNG policy. Bring LNG under PPIB framework which allows cost-plus processes guaranteeing the payment of capacity charge to the developer. This would facilitate financing of the LNG termini by banks. SSGC includes the capacity charge in its revenue requirements submission to Ogra.

Potential Shale gas resources of 58-65 TCF higher than the existing ones have been reported. These are widely spread and not only in Balochistan. If the government is hell-bent on bringing in expensive LNG, then I would propose that one or two shale gas projects be approved on LNG rates as well. In fact, slightly cheaper LNG rates have been received by the government from a respectable foreign company. One or two pioneer projects can be given special rates. When ice is broken and some quantities of Shale gas discovered and developed, competition would set in, rates would come down. Work on both conventional and Shale or tight gas discoveries has to start.

There is a strong case for revising the whole sale tariff of conventional gas as well, except for the fields that have already been discovered. The time for the classical rate of 4-5 USD per MMBtu is gone. Gas rates are 8-10 USD per MMBtu in Europe. Comparable rates were there in the US as well, when there were gas supply crunch. Current low rates are due to the new found Shale gas resources.