PERSIAN LNG A GIANT AWAKES

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1 PERSIAN LNG A GIANT AWAKES Ate Visser, Shell Gas and Power Carlos Quintana, Repsol YPF 1. INTRODUCTION Any examination of the list of holders of the world s gas reserves immediately demonstrates why the Islamic Republic of Iran has to be regarded as a potential giant in the world s international gas business of the 21 st Century. Compared with the scale of its proven gas reserves, Iran s relatively minor export role is at first sight surprising. All the more so, since close to half of Iran s around 30 Trillion (10¹²) Cubic Metres of reserves is found in the supergiant South Pars field, a low cost resource rich in condensate. This same accumulation, as the North Field on the other side of the border with Qatar, already supports a flourishing gas export business. Iran has very strong credentials to take the lead in developing the next generation of LNG plants in the Persian Gulf region. Qatar, the other major reserve holder, is already a significant player and is heavily committed to expansions and new projects. Oman and Abu Dhabi which have made their mark on the world LNG scene are both resource limited, currently discussing pipeline imports from their neighbours via the Dolphin project and likely to be limited for the foreseeable future to the currently planned expansions. Saudi Arabia, Bahrain and Kuwait are all concentrating today on finding or importing gas for their rapidly growing power generation needs and their existing export industries. Iran not only has the reserves but also active production plans already under development at the South Pars and other gas fields which are likely to be more than sufficient to meet its growing local demand. Hence the stage is set for Iran to take the major step forward into the export markets. History shows several reasons for Iran s absence from those markets today. In the 1970s, Iran had already begun to develop, with its international partners, LNG projects aimed at both Asia and the Atlantic Basin and was a gas exporter by pipeline to the USSR. But before most of these concepts could come to fruition, Iran was overtaken by changing market conditions and politics, and subsequently shaken by internal and external conflicts. More recently however, gas export, and in particular LNG, has re-emerged as a viable business opportunity for Iran. The enormous scale and importance for the whole Iranian economy of the export opportunity being missed is now widely recognised among the country s leaders and the urgent need to commercialise Iran s huge gas reserves has been publicly stated on many occasions. The export drive is already apparent through the recent start up of pipeline gas exports to Turkey and the ongoing discussions with the European Commission and other interested parties about a longer term pipeline to Europe. As a result, and in order to bring in the international capital and expertise which is needed to play a role in these markets, Iran is in the process of creating an increasingly attractive climate for foreign investors, both for upstream and downstream export projects. Today several international companies are working with Iranian partners and vying to create the first Iranian LNG export project. This paper describes a significant LNG project designed to provide Iran for the first time with access to some of the world s major import markets. Persian LNG is a leading contender and offers exciting prospects not only for Iran but also for the LNG business in general. The LNG marketing support offered by both Repsol and Shell gives the project additional impetus. 2. WHAT IS PERSIAN LNG? 2.1 Background Persian LNG is being developed jointly by the National Iranian Oil Company (NIOC) with Repsol YPF of Spain and the Royal Dutch Shell Group, based in the Netherlands and the United Kingdom. A Memorandum of Understanding, finalised in January 2002, committed the three partners to undertake feasibility studies into an integrated LNG project to be located at Tombak on the Persian Gulf. The proposed partnership for the downstream project is 50% for NIOC and 25% each for the international partners. Repsol and Shell would jointly undertake the upstream part of the project on a 50/50 basis, although the precise nature and structure of how this would be done is still under discussion.

2 The feasibility studies have now been completed and confirm the potential for a viable project, based on a liquefaction plant with a total annual production capacity well in excess of 10 million (10 6 ) tonnes. Some of the key conclusions are set out below. 2.2 Liquefaction Plant Persian LNG envisages the use of the double mixed refrigerant (DMR) liquefaction technology developed by Shell. This technology would allow the cost-effective construction of some of the largest LNG trains currently proposed, which would be cooled. Each will have a capacity of well over 5 million tonnes per annum, and a unit capital cost lower than any of today s projects two of these liquefaction trains could be constructed at Tombak for less than US$ 2 billion (10 9 ). An artist s impression of the layout is shown as Figure 1. Figure 1: Artist s Impression of Proposed Layout at Tombak The project can be implemented without infringing United States export controls, an important consideration given the dominant role of US companies in LNG technology. Agreements for the provision of the technology and support services are currently being negotiated by Persian LNG with Shell Global Solutions International B.V., based in the Netherlands. 2.3 Marketing The feasibility studies have assumed that LNG will be marketed to a wide range of LNG markets, bearing in mind the particular marketing strengths of the project promoters. Target markets for the project include the Mediterranean and, in particular, Spain, a market in which strong demand growth for pipeline gas and LNG is forecast well into the next decade. The potential of this market is backed by Spain s strong political links with Iran, recently demonstrated by the Iranian President Khatami s recent successful visit. Moreover Repsol, together with Gas Natural, in which it has a significant shareholding, holds an extremely strong market position in this market as well as a developing role in the international LNG business. Shell too has a market position in Europe and the larger Atlantic Basin which it is seeking to grow by building on its expanding world network of LNG transportation and reception facilities. A significant proportion of the volume that Shell would be marketing would be aimed at the Indian market through the regasification terminal at Hazira in North West India which is currently under construction. In the longer term, the partners in Persian LNG recognise the potential of the Asia-Pacific markets to provide attractive project returns. This potential is enhanced by the growing links between Iran and both Korea and Japan. These are exemplified by the US $3 billion loans recently made available by Japan to the Iranian energy industry and the significant roles likely to be played by the Korean company LG and Japanese contractors and financiers in the development of Phases 9 and 10 of South Pars.

3 2.4 Offtake The studies are based on the assumption that, in the first instance, 8 million tonnes of LNG will be purchased at the outlet of the liquefaction plant by Repsol and Shell, with shipping being provided by those companies. LNG Sales and Purchase Agreements are currently being negotiated by Persian LNG with subsidiaries of each of the international partners. It is expected that these will be completed in the first half of 2003, thereby giving the project a sound basis to justify proceeding to the next stage of technical development. 2.5 Upstream Following the model which has proved successful in many other LNG projects around the world, the feasibility studies concluded that benefits would be gained by Persian LNG and all its partners if the project were developed on an integrated upstream/downstream basis. In particular, this was likely to provide the best foundation for raising external finance on behalf of the project as a whole. To provide a basis for the upstream section of the studies, NIOC has provisionally set aside a block (Phase 13) of South Pars as the intended supply source (See Figure 2). Figure 2: South Pars Development Phase 13 To meet the requirements of the plant mentioned above, a delivery capacity of some 60 million cubic metres (1800 million cubic feet) per day would be needed. Commercial arrangements on the nature of the upstream structure and the terms of gas supply are under negotiation. These discussions are being led by Repsol on behalf of the partners and are now well advanced. It is once again anticipated that agreements can be reached in the next few months, which will allow the project to move forward. 2.6 Financing The feasibility studies proposed that Persian LNG should be project financed, with the expectation that significant cover from Export Credit Agencies would be used. Now that the commercial framework has been more sharply defined, Persian LNG has undertaken a selection procedure for a financial adviser. Interest was shown by a significant group of major international banks, and, after a thorough review, the partners selected Société Générale. This bank is now working with the project to optimise the financing plan.

4 2.7 Project Structure Once the conclusions of the feasibility studies had been presented and accepted, the partners agreed to undertake immediate negotiations to conclude the remainder of the major Commercial and Technical contractual agreements which would be required to underpin the project. As well as the Sales and Purchase Agreements and Upstream/Gas Supply Agreements mentioned above, these include the internal agreements such as the Project Agreement, Shareholders Agreement and Service Agreements which would allow a joint venture company to be established to carry the project forward. Discussions are proceeding well and only a few outstanding issues remain. If these agreements can be completed, as planned, in the first half of 2003, the project could move rapidly forward, with plant start up targeted for end WHAT IS NOTABLE ABOUT PERSIAN LNG? The main purpose of this section of the paper is to highlight a number of factors that, in the view of the participants, make Persian LNG stand out as a world-class project. It considers both technical and commercial issues for upstream and downstream phases of the project. But it also reviews the approach to other issues such as Sustainable Development which, as recent experience with other major energy projects has shown, now need to be incorporated in project planning from an early stage. 3.1 The Liquefaction Plant As with any LNG project, the liquefaction plant is the heart of the Persian LNG venture. The facility will handle the whole process of removing contaminants from the natural gas supplied from offshore, separation of condensate and liquefaction. The partners are considering the use of Shell s proprietary Dual Mixed Refrigerant (DMR) process and the proposed facility would have a total nameplate production capacity of some 10.6 million tonnes a year from two trains. This design proposed by Shell answers several technical challenges. In the first place, the plant will be built in a location where very little infrastructure is present. It will be a challenge in itself to bring the necessary material and manpower to build liquefaction trains larger than currently built anywhere else. In the second place, the technology and equipment used must not be subject to US export controls, a factor which severely limits the possible options in an LNG technology market where US companies play an important role. Further, the wide variation in temperature of the ambient calls for careful consideration of the robustness and operability of the design. Last but not least, the need to preserve the Persian Gulf environment has led to the selection of cooling, in preference to water cooling The DMR process uses a mixture of nitrogen, methane, ethane and propane in two cycles to achieve the liquefaction of the gas (See Figure 3). The first (or precooling) cycle cools the natural gas to around minus 50 degrees Celsius and the second (or liquefaction) cycle cools it to around minus 150 degrees, with the actual liquefaction occurring at around minus 100 degrees. The LNG is produced in an endflash vessel that effectively functions as an open nitrogen cycle. Through balancing of the composition of the refrigerants and careful integration of the two cycles, the process makes optimum use of the power that is provided by several electric motors. PMR cycle FC PM R A PM R B Scrub column A LPPMR MCHE PC MR MCHE A to Nitrogen Rejection Unit treated natural gas PC HP PMR TC MCHE Scrub column B TC FC FC MR MCHE B Endflash stripper MR cycle MR B MR A Figure 3: Air Cooled DMR LNG Plant Simplified Flow Scheme LNG rundown to Fractionation Unit

5 The process design provides for a parallel arrangement of the key equipment in the liquefaction train: drivers, compressors and heat exchangers. This GameChanger concept allows use of standard size equipment which is cheaper and can be purchased under more conventional and competitive conditions. It also has a shorter delivery time than the largest equipment on the market, and may give some increased scope to meet the partners wish to use local content in construction, which would be greatly welcomed by Iran. In this particular project, the proposed design means not only a cost and schedule reduction, but also a solution for the US export control restrictions. Also, by tapping into Shell s experience with another cooled plant built in a very similar environment, the North West Shelf of Australia, the design allows for reliable operation under conditions of wide daily fluctuation in temperature (See Figure 4). Cooling medium temperature [ C] Daily average Daily maximum Seawater intake Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Month Figure 4: Yearly Temperature Ranges at Tombak In recognition of the increasing pressures to be cost competitive, a new LNG plant was designed by Shell in the second half of the last decade for Oman LNG to meet the specific cost benchmark for greenfield LNG projects worldwide of US$ 200 per tonne of annual capacity. But by stringent cost control in the development phase, the actual construction cost of the plant ended up well below this figure, as demonstrated in recent benchmarking studies carried out by an independent party. The combination of the GameChanger concept, the DMR process and Shell s experience of more than 25 years with LNG plant design, construction and operation in Brunei, Malaysia, Australia, Nigeria and Oman has resulted in a liquefaction plant design for Persian LNG which is reliable, safe and efficient. If the project is implemented, its unit LNG cost will set yet another new benchmark for greenfield LNG plants. The benchmarking study also demonstrated that the high level of thermal efficiency achieved through the design process outlined above would mean that considerably less CO 2 would be emitted per tonne of LNG produced relative to other liquefaction plants currently in operation. 3.2 Marketing The readiness of Repsol and Shell each to underwrite 4 million tonnes per annum of the LNG offtake, once suitable commercial conditions are concluded, is a significant plus for the project. The two companies are presently involved in parallel negotiations with Persian LNG, with the aim of concluding LNG Sales and Purchase Agreements. Each will be on an FOB basis, and will feature many of the typical features of such agreements, including a take or pay element. The opportunities for LNG in each market are likely to be constrained by a different and changing pattern of energy alternatives and LNG prices are likely to differ by market. This will apply not only to price levels but the applicable indexation formulae and the need or desirability for price floors and ceilings. As an example, the Atlantic market may be influenced by Henry Hub gas prices in the United States, European markets may continue to reflect competing oil prices but a developing market like India may need new pricing patterns which reflect the ability of the end consumer, often the user of electricity, to pay his bills and remain competitive. An important issue will be how the volume risk is shared between the players. In an established market such as Europe, the buyer may have sufficient confidence to accept

6 a take or pay level linked to identifiable formulae. But in a different market environment, the offtake and price risks may need to be shared to some extent down the production and marketing chain, in order to ensure that no single part of that chain is left too vulnerable to the inevitable uncertainties. Repsol, through its interest in Gas Natural, is the leading gas marketer in Spain. While the Spanish market is in the process of liberalisation, with measures to reduce the position of Gas Natural and encourage the participation of new entrants, Repsol is expected to retain access to a significant market share, which will provide an anchor for its offtake commitment. This will be enhanced by the continued strong growth in gas market demand which is forecast without exception by market analysts. At the same time, Gas Natural is aiming to enhance its role in other market sectors such as power generation. This, together with Repsol s role in Atlantic LNG and potential for swaps of volumes from that project into other Atlantic Basin markets gives confidence that they can effectively place their share of the Persian LNG production. In addition to its established networks in both the Asia-Pacific and Atlantic LNG businesses, Shell is looking to strengthen its position, in particular in India and to the West of the Suez Canal. As part of this programme, it is currently constructing an LNG regasification terminal at Hazira, in the North West Indian state of Gujarat. To date, Shell has maintained 100% ownership in the terminal but is engaging in discussions with potential partners who could bring value to the project. During 2002, the main EPC contracts for the terminal were signed and, by the end of the year, construction was one third complete (See Figure 5). Figure 5: Hazira Regasification Terminal Under Construction Hazira is expected to be receiving LNG before the end of With its short shipping distance from Iran, this terminal holds excellent prospects for Persian LNG. Shell has separately established a marketing company, and a local sales team is maintaining active contact with all potential customers in North West India. Affiliates of the company are also preparing a bid to become the selected partners to supply the tender for 3 million tonnes of LNG a year recently announced by the National Thermal Power Corporation of India (NTPC), a public utility which generated over 30% of the power sold in India in The NTPC bid is one of a series of firm orders that the various gas consumers producing fertiliser and power in Northern India expect to place with gas suppliers during the coming year. Meanwhile, the value on offer to LNG suppliers from the Indian market is expected to grow robustly from 2004 onwards as power reforms, regional gas grids and a deregulated market begin to unlock more demand. To enhance their marketing efforts, both Repsol and Shell have in the last few years increased their emphasis on acquiring LNG shipping capacity to service their marketing positions around the

7 world. This shipping capacity will allow further opportunities to market Persian LNG, while reducing the level of initial capital commitment required from the project itself. The other market that naturally interests any new LNG project in the Middle East is the Asia- Pacific, the world s largest destination for LNG. Despite a potential oversupply in the short term, there are positive signs that, by 2010, markets in Japan, Korea, China and Taiwan may well be ready to take significant extra volumes. In particular, the forecasts of higher economic growth and the loss of confidence in nuclear supply bode well for gas in a world where demand for clean burning fuels is expected to increase. 3.3 Upstream - Proven Upstream Experience The combination of the international expertise of both Repsol and Shell together with NIOC s local knowledge of developing South Pars will ensure the lowest possible upstream costs. While the upstream will be developed under the prevailing laws in Iran that prevent foreign ownership of hydrocarbon resources, the parties are considering proposals that may provide a more suitable model for a long-term gas project like Persian LNG. These proposals are intended to provide a satisfactory basis for the financing of a capital-intensive, world-scale project. The opportunity for long term operational involvement by Repsol/Shell and the need to ensure proper alignment between the upstream contractor and the national oil company are considered vital for the long-term competitiveness of the project. 3.4 Finance - Financial Strength The financial position of the international partners and their wide experience in structuring major projects will give Persian LNG a good understanding of and access to financial markets. The resulting ability to develop the project from the outset in a manner consistent with financing needs will greatly assist its chances of obtaining the most attractive financial package. While the Repsol Group has been active recently in the development and financing of LNG projects in the Atlantic Basin, the Royal Dutch/Shell Group has been involved in many of the largest energy project financing deals of the last decade, both in their sponsorship and in the structuring and negotiation of the complex financing packages. Shell s recent experiences as adviser and negotiator for the recent refinancing of Oman LNG has given its project finance specialists an excellent understanding of current trends in Middle East project financing. 3.5 Sustainable Development Apart from the need to provide significant economic advantages for Iran, all three partners are publicly committed to the position that major projects such as Persian LNG must be socially and environmentally acceptable to project stakeholders in Iran and elsewhere. This commitment to engage in discussion at an early stage with all the project stakeholders is enshrined in the project agreements and is being followed in action. This is simply an issue of sound project development. The project will undertake an Environmental, Social and Health assessment (ESHA) of the development which will identify and assess the impacts (both positive and negative) in each of these areas. It will also seek to mitigate the negatives and enhance the positives. Today, the world expects major energy projects to meet the highest standards and provide benefits to society. Persian LNG can meet this challenge on all three fronts. i) Economic benefit. The potential benefits to Iran arising from Persian LNG can be clearly demonstrated even at this early stage of project development. In the first instance, substantial income will accrue to the Iranian treasury through dividends and taxes from Persian LNG. In addition, NIOC will, as the owner of the upstream resources, receive the gas price paid by Persian LNG for its gas supply as well as the revenue from upstream condensate production, once the contractor has been remunerated. Persian LNG will also contribute to other national development objectives. The establishment of a major LNG export project would be an important step for Iran towards its declared ambition of commercialising its hydrocarbon reserves and reducing its dependence on international oil markets. Moreover, it would provide significant opportunities for Iranian manufacturers to supply local content for both upstream facilities and the liquefaction plant. The issue of the scope for Iranian content will be developed in the next phase of the project, but the partners are confident that with the experience gained by Iranian industry in other upstream projects and the development of similar large scale plants, for example in petrochemicals, many suitable opportunities will be found. ii) Social benefit. In this field too, Persian LNG can offer a number of benefits to the region. First, the potential for high quality local employment. During construction there will be employment for

8 up to 10,000 people and thereafter, on a sustained basis, several hundred permanent positions. Persian LNG is committed to train local staff to occupy as many as possible of these. The social assessment undertaken as part of the project development will look for ways to maximise job opportunities for Iranians. But this would only be part of the overall benefit. The involvement of local people in many aspects of the project development would inevitably create a multiplier effect for the local economy as the resulting incomes are spent and in turn create further economic activity. Provided these effects are carefully controlled and managed, this is likely to have a major and positive effect on the quality of life in the Tombak area. It is possible that the development of an LNG project in the Tombak area might involve a relocation of some local villages for safety and other reasons. This issue would be planned for and handled in a sensitive manner from an early stage. Any relocation would seek to restore or replace the livelihoods of communities on a sustainable basis rather than simply to provide monetary compensation. iii) Environmental benefit. The conscious selection of highly efficient technology in both the upstream and the liquefaction plant will minimise the quantity of gas used, with the added benefit of reducing total emissions to world-class minimum levels. As an example of this approach, the efficiency of the power plants has been enhanced by the use of condensing turbines and waste heat recovery. In addition, cooled technology has been selected in preference to water cooling. One of the main drivers in this decision was the need to cause the minimum impact on the sensitive environment of the Persian Gulf, in line with the conclusions of the recent Kuwait convention, subscribed to by most of the regional states. Careful attention is also being paid to the disposal of by-products and wastes. One such issue is the large quantity of sulphur resulting from the pre treatment of the gas feedstock stream. Although it may not be easy to market the sulphur, early planning would be implemented to ensure that if this is not possible, the surplus is carefully handled in order to minimise any adverse local impact. The ESHA will, among other things, consider and assess the options for handling and disposal of all by-products and wastes. These are considerations for the local environment. But in looking at a project such as Persian LNG, it is also relevant to consider the wider international benefits. In this respect, the project will begin the development of an enormous source of clean energy sufficient for use in the major world markets for many years to come, through a period where the demand for such fuels can only continue to increase. This impressive list gives confidence that Persian LNG can demonstrate not just to the Iranian government but to all its stakeholders that it is not only an economically justified project but also provides benefits to Iran in many different ways. 3.6 Credible Project Promoters A further clear advantage is the combined strength of the three project promoters. NIOC was recently rated as number 4 in a survey of the top half-dozen upstream producers in the world. In addition to its huge reserve base, it has decades of upstream experience, often maintaining production under the most difficult of conditions. NIOC has recently shown its increasing readiness to become a significant player in the international gas business to match the important role it has long adopted in the marketing and trading of crude oil In recent years, Repsol has diversified from its oil base by including within its portfolio a range of international upstream and gas interests through its positions in Gas Natural and Enagas in Spain and purchase of YPF in Argentina. Gas NaturaI is the dominant player in the Spanish gas market and, on a broader scale, Repsol has a clear strategy to increase its international role in LNG. Further, Repsol has successfully completed a number of portfolio measures to mitigate the effects of the Argentinian crisis and to strengthen its balance sheet, thereby providing a firmer basis to expand its LNG portfolio by purchasing LNG from new projects such as Persian LNG. In LNG, Shell is a clear industry leader, technically and commercially, based on its involvement in the first major commercial LNG trade from Algeria and the first large-scale development in Brunei. Since that time it has successfully developed LNG projects in Malaysia, Australia, Nigeria and Oman with the Sakhalin project in Russia about to commence. It remains the largest private sector marketer of LNG and because of the leadership role it has played in all these projects, it has immense experience in the development of such projects The combination of three such significant players with combined experience in all aspects of the LNG business upstream, liquefaction, shipping, finance and marketing - gives confidence that

9 Persian LNG is soundly based and can be a major contributor to the LNG business for many years to come. 4. WHY WILL PERSIAN LNG BE COMPETITIVE? In today s highly challenging LNG market, a combination of many factors will be needed to succeed. This much is obvious from the number of major projects that have remained stalled at the starting gate for many years. Persian LNG believes that it passes the test of credibility. To summarise some of the key factors: Persian LNG has received from NIOC their confirmation of access to a huge, low cost gas reservoir and agreements to establish the basis for this are close to completion. Gas availability of this kind will allow the project to face the uncertainties of the changing LNG market with confidence. To reinforce this advantage, Persian LNG benefits from Shell s proven technology base and tried and tested abilities to develop new projects effectively. This is exemplified by the GameChanger technology, which offers the fastest construction time with least vulnerability to the vagaries of the LNG equipment market. Another advantage for Persian LNG is the opportunity to benefit from local Iranian expertise. Iran is a populous country with a long history of technical education and, in recent years, Iranian industry has demonstrated its ability to provide significant input to the development of the country s refining and petrochemicals industries. There is no fundamental reason why LNG should be different. However, in the current situation of potential oversupply, particularly in Eastern markets, even a low cost project will be unable to get off the ground unless it can gain access to markets. And not just any market - access to credible and bankable customers will decide between success and failure, or at best significant delay. Here too, Persian LNG offers an attractive package, involving the following aspects: 4.1 Price While no project can promise a particular customer the most attractive price on every occasion, Persian LNG has a cost base to match any other greenfield project and many brownfield expansions. Marketing will also gain from the extensive reach of the partners, which will continue to provide the project with an excellent overview of the changing opportunities in LNG markets worldwide. 4.2 Security of long-term supply The size of South Pars offers the potential for a long project life and the ability to expand to meet growing markets. Moreover, for customers concerned about relying on a single plant, the worldwide positions of Repsol and Shell and their ability to access LNG from alternative sources provides reassurance. 4.3 Confidence in project delivery In recent years, both for LNG and pipelines, the list of failed projects and frustrated customers is significant. Repsol and Shell both have a strong track record of project delivery and NIOC, having implemented the first phases of South Pars and the export of gas by pipeline to Turkey, has also shown that it can deliver major gas projects in an effective manner. In short, the story of Persian LNG is of a project based on a strong competitive position, using world-class technology and promoted by three credible, financially sound partners, each of whom has a wide range of experience in many aspects of the energy business. In 2003, it is expected that the commitment of these partners will be reinforced by the completion of a set of project agreements that would allow a Persian LNG joint venture company to be formed and to undertake further development on its own account. All this demonstrates why LNG customers in the Atlantic/Mediterranean, Indian and Asia-Pacific markets will be following with interest the progress of Persian LNG.