Review of Natural Gas Market in Asian Pacific Region and Future Natural Gas Industry Issues in Japan

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1 Review of Natural Gas Market in Asian Pacific Region and Future Natural Gas Industry Issues in Japan YOSHITAKE, Junji Tokyo Gas Co., Corporate Planning Dept. 1.PREFACE The 21 st century is the Asian Age has been heard for a long time. Now, developing countries in the Asian Pacific Region have been increasing their energy consumption in accordance with their growing economies. Natural gas use is no exception! Compared to the level of energy consumption that would be necessary to raise their Gross Domestic Product (GDP) to that of developed countries, developing countries need to consume a greater quantity of energy. Furthermore, Asian developing countries are suffering from too much dependency on oil imports from the Middle East. Untuned vehicles, plus heavy reliance on diesel and 2-cycle scooters, has caused smog in many large cities. Health hazards are also caused by the air pollution resulting from coal burning (residential/industrial/utility). Both coal burning and the use of oil for transportation produce a large amount of carbon emissions. In these developing countries, the use of clean natural gas is under active consideration. There is a lot of natural gas pipeline construction and many LNG projects have been planed to enhance energy security and promote clean energy utilization. Developing Asian countries recognize that natural gas/lng use is very important to their economies; however, currently only a few Asian countries are utilizing their own domestic natural gas reserves or are importing LNG from overseas/elsewhere in the region. Once these countries start to substantially increase their use of natural gas, the natural gas/lng supply and demand balance in Asia will be dramatically changed. In particular, it is quite certain that China and India, which currently, by virtue of their population size (not economic size), are consuming huge amount of energy (mostly coal), will change into major natural gas importing nations in the near future. This means that natural gas importation by these two highly populated countries will have a huge impact on supply and demand balance between the exporting countries (such as Indonesia, Malaysia, and Australia) and the current major importing countries (such as Japan, Korea, and Taiwan). This report will discuss long-term supply and demand forecasts of natural gas including future completion of LNG projects, which are now being planned or 1

2 studied in the same region. market and what subjects need to be overcome. It will make it clear what is going on in Japan s LNG 2. NATURAL GAS DEMAND FORECAST IN ASIAN PACIFIC REGION 2.1 Natural Gas Demand Forecast for China The natural gas demand forecast of China, shown at Table 1, was taken from the WORLD ENERGY OUTLOOK 2002 published by International Energy Agency. Consumption of natural gas will increase from 32 billion cubic meters (bcm) in 2000 to 61 bcm in 2010 and 162 bcm in On the other hand, production of natural gas will only increase from 30 bcm in 2000 to 55 bcm and 115 bcm in While production will increase, it will not keep up to the level of demand. Table 1. Natural Gas Demand Forecast for China (bcm) Year Consumption Production Shortage (Source: IEA WORLD ENERGY OUTLOOK 2002 ) So that China will be able to meet this projected increased demand, two projects, one pipeline and a LNG project will be introduced. The first is the 4,000-km West-East natural gas pipeline project, which will transport gas to Shanghai from the Tarim basin in the west. It is one of several major infrastructure projects to promote economic development in the poor central and western provinces currently underway. The line, which will have a capacity of 12 bcm per year, is expected to cost $6 billion. When complete in 2004, it is expected to have commitments from very large customers, including power plants and big industrial end users, to supply sufficient gas to make the project economically viable. The second is the LNG project contract which China and Australia concluded on 12 th August 2002, under which gas will be supplied from Australia s North-West Shelf Projects for 25 years. First gas is expected to be imported in Furthermore, on 26 th September 2002 CNOOC and BP reported that construction of a second project is also planed. A receiving terminal will be built in Fujian, to receive 250 million tons of LNG per year from Tangguh, Indonesia, starting in

3 2.2 Natural Gas Demand Forecast for India According to data from the WORLD ENERGY OUTLOOK 2002, the India s natural gas demand is projected to jump by 440%, from 22bcm in 2000 to 97bcm in Just over 62% of all gas consumed in India will be used for power generation. Imports, which will play a major role in meeting the projected increase in gas demand, are projected reach 9 bcm in 2010 and 38 bcm in Much of this gas will be imported as LNG. The country s first LNG terminal at Dabhol was due to be commissioned in It will have a capacity of 5 million tons per year, almost all of which is earmarked to supply a power plant already in operation. However, a dispute over power tariff and sales between the owners of the plant, in which the bankrupt Enron Company holds a 65% stake, has delayed completion of the project. First gas is expected in 2004 at a second 5 Mt per year terminal to be built by Petronet LNG, Ltd. at Dahej. 2.3 Natural Gas Demand Forecast for Japan, Korea and Taiwan According to the long-term energy forecast published by the Japanese government in July 2001, natural gas demand will increase largely due to the promotion of natural gas for its environment friendliness. Imports, entirely in the form of LNG, come from Indonesia, Malaysia, Australia, Brunei, the United Arab Emirates, Qatar, Oman and the US state of Alaska. Imports reached 72.3 bcm in 2000, making Japan the world s largest LNG market. Japan is already committed to importing more LNG from Malaysia starting in 2003 and from Australia (NWS) in Like Japan, Korea has very limited gas reserves and, also like Japan, its imports are entirely in the form of LNG. In 2000, 42% of the country s gas imports came from Indonesia, 22% from Qatar and 17% from Malaysia. Korea also imports LNG from Brunei, the United Arab Emirates, Australia and Oman. All the LNG import contracts have been negotiated by KOGAS, the Korean national supplier. KOGAS operates the LNG receiving terminals, storage facilities and transmission pipelines in the country. It also has a monopoly of gas sales to large industrial customers, power generators and distribution companies. Primary energy demand of Taiwan increased at the rate of 5.6% for the 20 years from 1980 to 1999 and is projected to increase at the rate of 2.9%, up through the year The growth rate of natural gas is expected to increase at 3

4 the rate of 7.3% in the coming 20 coming years. The percentage of natural gas in Korea s primary energy mix, currently 6.4%, and is projected to increase to 15.3% in LNG PROJECTS FOR JAPAN IN THE ASIAN PACIFIC REGION 3.1 LNG Projects in the Near Future Table 2 shows the list of new/expanded LNG projects (through 2006) that will start to supply LNG to Japan. The planned amount totals 7.05 million tons per year, of which 3 Mt/year is for electricity and 4.05 Mt/year for city gas. Table 2. Japanese Near-term LNG projects (thousand tons /year) Project Importation to Start LNG for Electricity Generation Gas for Other Uses Total MalaysiaⅢ 2003~ ,180 Expansion of NWS 2004~ ,370 2,870 Darwin ,000 1,000 3,000 Total 3,000 4,050 7,050 North West Shelf (Source: Various trade papers, magazines, and journals) 3.2 LNG Project for the Middle and Long Term Table 3 shows the list of LNG projects that are going to start to supply LNG/natural gas to Japan in the middle and long-term. Several other proposed LNG projects also exist, but are not listed on Table 3 due to too much uncertainty. Those are Alaska s North Slope, Papua New Guinea, Indonesia s Natuna, and so on. This table shows that there are plenty of LNG projects, which means that those projects will be realized within a short lead time, if it can attract a certain amount of demand and secure the productivity and economic stabilization. Currently natural gas reserves in the Asian Pacific region are widely distributed and abundant. There simultaneously exists producing counties, such as Indonesia, Malaysia, and Australia, importing counties, such as Japan, Korea, Taiwan, as well as potential consuming countries, such as China and India. This geographic fact means that the natural gas market exists, almost entirely, within the same region and that this region has a high potential to expand natural gas trade in the future. 4

5 Table 3. LNG Project for Japan, for Middle and Long-term (thousand tons) Project Nation Liquefaction Terminal Production Tangguh Indonesia 7,000 Sakhalin Ⅰ Russia (pipeline) 6,000 Sakhalin Ⅱ Russia 7,000 Expansion of Ras 8,800 Qatar Ras Laffan Laffan Oman Ⅲ Oman 3,300 Gorgon Australia Karatha 6,600 Greater Sunrise Australia & Timor To be determined 5,000 (Source: Various world business newspapers, magazines, journals, etc.) 4. SUPPLY AND DEMAND BALANCE FOR NATURAL GAS IN THE ASIAN PACIFIC REGION Table 4 shows the forecast of supply and demand of five LNG importing countries. From the present time to the year 2005, supply and demand balance of natural gas will maintained. However, as China and India increase their demand, potential supply shortfall of about 14 million tons in 2010 and 33 million tons in 2015 is forecast.. Table 4. LNG Demand Forecast in Asia (million tons/year) Japan Korea Demand Taiwan China India Sub total Existing contract Supply Expansion of contract Sub total Shortage (Source: Various world business newspapers, magazines, journals, etc.) In addition to the supply/demand listed on Table 4, the construction of receiving terminals on the west coast in the US and Mexico is currently under consideration. New demand of LNG in each of these countries will increase 5 5

6 million tons per year. Suppliers are expected to be Australia and/or Indonesia. Careful observation of these activities is advised. Viewing from the supply side, there currently are a lot of natural gas resources in the area, as seen previously in Table 3, however we may produce an overly optimistic perspective regarding the supply and demand balance of natural gas in the Asian Pacific region, if potential extra-regional demand is ignored. 5. CHANGING LNG MARKET IN JAPAN It describes in the previous chapter that there are a lot of natural gas reserves in Asian Pacific region and there are also importing countries such as Japan, Korea and Taiwan which makeup the natural gas market. In what direction is Japan s LNG market going, even though it s been only 33 years have passed since the first LNG ship arrived at Negishi Terminal, Yokohama, Japan? This paper will discuss the Japanese LNG market in 5 aspects that are 1 character of LNG market, 2 formation of buyers, 3 contract form, 4 period of contract, 5 pricing formula. 5.1 Character of the LNG Market Concerning the character of Japan s LNG market, it should be pointed out that the market is changing from a regulated market to a liberalized market due to the enforcement of electricity and gas business deregulation. In Japan, the Electricity Business Law and the Gas Business Law were amended in Bidding system Independent Power Producer(s) (IPPs), the creation of a Power Producers and Suppliers (PPS) system, and so on have been emerged in the electricity business. Liberalization for large scaled customers has been carried out in gas market and market competitive principle has been promoted. In 1999, the two laws have been re-amended, the electricity business was liberalized more widely in the retail area, while the gas business was liberalized by increasing the range of customers covered by deregulation. Once again, the Japanese government is now considering the possibility of widening range of deregulation. In this context, the market is changing from the regulated market to liberalized market. 5.2 Formation of Buyers While there are still electric power companies and gas companies contracting for LNG, as there used to be, nowadays, new comers such as oil 6

7 companies and general trading companies have entered the electricity and city gas markets. Simultaneously, electric power companies are trying enter the markets of existing gas businesses and gas companies are trying to do the same by supplying electricity made from their LNG directly to large customers. New entries and mutual entries are the new recent trend. 5.3 Contract Form In the early days of LNG importing, the form of the sales and purchase contract was quite commonly a buyers consortium when a LNG project was first planned. Nowadays, in the case where expansion of the contract period or an increase in the contract quantity is desired, individual negotiation are conducted between the buyer and the seller(s). This means that in early stage, it was necessary for Japanese buyers to cooperate with each other, as they sought economies of scale. At that time, it was also necessary for buyers to invest in various facilities, such as receiving terminal, storage tanks, and so on. Today, now that this stage of huge capital investment has passed, all buyers can act on their own to negotiate with the seller(s). 5.4 Period of Contract In the 1970s, the contract period used to be about 20 years, but now shorter periods and/or spot deals have started to appear. More than 20 receiving terminal in Japan and about 130 LNG ships running in the oceans worldwide enable short term contracts and spot deals, in addition to the standard long-term contracts. 5.5 Pricing Formula Great effort has been devoting recently in moving the pricing formula from oil-linked pricing to competitive fuel linked pricing, because aggressive competition is emerging among energy industries due to deregulation. Competitive fuels could be, for example, heavy oil, coal, nuclear power. and so on. Table 5. Changing LNG Market in Japan Old form New form memorandum 1 Regulated market Deregulated market Aggravation of competition among energy industries 2 Electric power company and gas company as Oil companies and general trading companies New entries buyers entering market 3 Buyers in a group Individual negotiation From consortium to aggregation 7

8 4 Long term contract 5 Rigid price formula Addition of short term or spot contracts Flexed price formula From rigidity to flexibility From oil linked pricing to competitive fuel linked pricing 6. SUBJECTS FOR JAPANESE GAS PIPELINE TO OVERCOME 6.1 Present Condition of Transportation Pipeline The role of natural gas in Japan is increasing by overcoming political subjects such as CO 2 emissions reduction, prolonged construction of nuclear power plants, reduction of oil dependency on Middle East and so on. Construction of a pipeline network is definitely necessary to expand natural gas utilization in Japan. Electric power companies are the only energy entities that own their own energy supply networks all over Japan (of course, the ownership issue may change slightly as deregulation plays out). Concerning the natural gas sector, city gas companies merely use their own pipeline networks only to supply their customers within their own territories. Transportation pipeline companies normally transport only domestic natural gas to point of use. There are quite few transportation pipelines that connect one city with another city, like Tokyo and Osaka. Figure 1 shows the length of natural gas transportation pipeline in selected countries. While the United States has about 409 thousand kilometers of pipelines, Japan has only 3 thousand kilometers. To enable the future penetration of natural gas, additional pipeline construction is expected nationwide. Fig.1. The length of transpotation pipelines thousand km USA Canada England France Germany Italy Korea Japan (source:japan Gas Association) 8

9 6.2 The Points at Issue on the Sakhalin Gas Pipeline Project The SakhalinⅠ project shown on Table 3, has been gathering much attention, because it might have the possibility of stimulating the construction of a nationwide NG transportation pipeline in Japan. It is reported that Exxon/Mobile and SODECO, which are promoting this project, are currently making efforts to get commitments this project from potential users however. The meaning of this project can be described for Japan as follows: 1 SakhalinⅠ is a concrete project which has the possibility of generating nationwide natural gas penetration. The percentage of natural gas in the Japanese primary energy mix is about 13%. By the promotion of SakhalinⅠ, Japan will have the opportunity to increase this level approximately 20%, like West Europe and the USA. It will promote the accelerated shift to natural gas as one of Japan s national energy policies. 2 As local distributing gas companies have the chance to connect their pipelines to that of SakhalinⅠproject, the promotion of deregulation can be more easily obtained. 3 Preparation of transportation pipeline for SakhalinⅠ, means an energy shift to natural gas. This project will contribute to reductions not only of CO 2 emissions, but also SO X and NO X emissions as well. 4 Once SakhalinⅠ is completed, natural gas penetration in northern Japan, Hokkaido and Tohoku, can be expected. 5 If SakhalinⅠ is completed, it will contribute energy security in Japan due to the increase in the variety of supply sources available. Not only do the Sakhalin gas fields exist, but also there are the Yakutsk, Irkutsk, and Kovykta gas fields in Siberia. Natural gas from those gas fields will be exported to Japan, China, and Korea. If this natural gas trade comes to fruition, a new economic linkage between Russia as an exporter and Japan, China and Korea as importer will be formed in the future. Therefore, it has the potentiality to build international security ties which have never been experienced (or maybe not even thought about) before. That is, an energy alliance between the four countries. 9

10 Figure 2 Possible Routes for the Undersea Pipeline(s) Figure 2, above, shows the geography northern Japan plus possible Pacific and Japan Sea routes proposed by private developers. The Pacific route is designed for getting to the high demand areas (Tokyo and surrounding environs) while the Japan Sea route is designed for connect to existing pipelines which exist in the Niigata area. While we discuss the necessity and meaning of the Sakhalin pipeline gas project, we might think that we should promote to construct of this project as soon as possible. However, there are still a few people who have negative opinions about this project. Japanese electric power companies and major gas companies have taken a very careful attitude toward this project, because it hasn t been decided yet which form this project might be designed for a pipeline or by using LNG. The following reasons describe why those companies have shown such attitudes. 1 The energy demand of each electric power and city gas company has matured and, it is difficult to commit to a huge amount of Sakhalin gas under the current uncertainties, due to the upcoming continuation of deregulation. 2 There are a lot of subjects that are yet to be resolved: politically, economically, and technologically. 3 As Japan has more than 20 receiving terminals, new natural gas supplies can be handled by the existing terminals (maybe there s no need for a pipeline). These are both positive and negative opinions. It is quite clear that Japan needs fundamental NG transportation pipelines throughout Japan and this infrastructure would have a large, positive influence on the Japanese economy. 7.SUBJECTS ON LNG TRADE IN JAPAN 10

11 7.1 Aiming at Lowered LNG Pricing It is often indicated that the price at LNG arriving in Japan is expensive. Figure 2 shows, the prices of world crude oil, natural gas and LNG from various sources. The Japanese LNG price level consistently lies at the top and has sometimes been substantially higher than the rest. The driving force of economic growth totally depends on how inexpensively and stably the supply of energy can be obtained. It is closely related to industrial development and people s standard of living. Japan, with its poor energy resources, is no exception. It is extremely important for Japan to obtain a relatively low priced and stable natural gas supply in order to keep or promote economic growth and enhance people s living standards. LNG price is currently linked with the crude oil price arriving in Japan. That price itself is higher than the world level for oil so it s no wonder that Japan s LNG pricing is so high. There is no hope to expect cheaper LNG pricing, unless the link can be changed from a crude oil link to one based on any other competitive fuel price. It is quite remarkable that the LNG price level for China is supposed to be the cheapest in the world. It is said that LNG price from Tangguh is 1.80$/Mmbtu and from NWS Australia it s 2.05$/Mmbtu. We can not simply regarded this as cheap LNG pricing, because we are not privy to the whole context of contract. However, these price reports are stimulating Japanese buyers to do whatever is necessary in their price negotiations to take advantage of Japan s bargaining power Fig.2. Natural gas price LNG Japan cif Natural Gas Eurpean Union cif Natural Gas UK Natural Gas USA Henry Hub (source: BP statistic data) Natural Gas Canada Alberta Crude oil OECD counties cif 11

12 7.2 Establishment of Flexible Receivable- Close Seasonal variation and climate change affect LNG demand, which is used for as fuel for electric power generation and as the raw material for city gas production, with industrial use being the largest category. Electric power companies are making efforts to generate electricity with the best economic mix with other fuels such as nuclear, coal, heavy oil, and others. On the other hand, the demand for city gas greatly fluctuates at the mercy of cyclical seasonal variations and climate change. This is the reason why LNG buyers from electric power companies and city gas companies have always insisted on more flexibility in the current rigid Take and Receive contracts. It has been quite common for the contract term for LNG purchase and sales agreements to be about 20 years. However, since many new LNG projects have been created, the combination of long-term contracts and short-term contracts have become possible. The short spot market has also appeared. It is necessary for LNG buyers to try to create more flexible contracts by taking advantage of the current variety of LNG projects. 7.3 From Ex-ship Contract to FOB Contract Marine transport of LNG has been performed, up to now, using Ex-ship contracts. That is, when LNG is unloaded after a LNG ship arrives at buyer s birth (pier), property rights to the LNG transfers from the seller(s) to a buyer(s). The seller has been accordingly charged with all risks, all the way from the seller s loading terminal up to the buyer s receiving terminal (until LNG ship arrives at buyer s pier). On the contrary, in a Free On Board (FOB) contract, after a seller loads the LNG on the ship, the seller s obligation will end. Since liberalization in the current energy market has been bringing about severe competition, the quantity of inexpensive energy that can be obtained proves to be the key to overcoming this competition. Therefore, it is definitely necessary to reduce transportation costs, even if it seems insignificant, by shifting from Ex-ship to FOB. The Japanese energy industries can not survive against energy competition without making all efforts to reduce cost. 8. CLOSING There are abundant natural gas deposits in the Asian Pacific region. In the same region, both natural gas exporting countries and importing countries exist. Natural gas is the most environmentally friendly fossil fuel and it is most important to use this variable energy in well ordered manner.. More than 30 years have 12

13 passed, since Japan first started to import LNG into Asia. Japan should continue to present a good example for the economical, stable, and efficient use of natural gas in the future. Reference: [1]IEA: WORLD ENERGY OUTLOOK 2002 [2]APERC: APEC Energy Demand and Supply Outlook 2002 [3]LNG JAPAN: LNG news NO.012 [4]Japan Industrial Newspaper: Energy and Environment for tomorrow [5]The Energy Date and Modeling Center: Handbook of Energy Economic Statistics in Japan [6]METI Energy Resources Agency Energy 2002 [7]Mitsubishi Sogo Institute: Transportation Gas Pipeline throughout Nation land 13