Overview. Economics of the LNG Project Chain

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1 Economics of the LNG Project Chain Gordon Sandison Phillips Petroleum Company US/China Oil & Gas Forum Houston, Texas July 1999 Overview Economics of the LNG Project Chain US/China Oil & Gas Forum July 1999 Houston, Texas It is a distinct pleasure to be able to be here this afternoon. Phillips, as an LNG pioneer, establishing the first LNG trade with Japan some 30 years ago and we were also one of the early foreign oil and gas companies to establish exploration and production operations in China. It is in part because of this that China and LNG are two of my favorite subject and I am pleased to note that it is becoming easier and easier to use these two terms in the same sentence. Phillips, and many others, have been convinced for some time that the conditions are right for large LNG markets to emerge in coastal China particularly in the Zhujiang and Changjiang River Delta regions. Here the rapid pace of economic growth and industrial development has led to the availability of clean electricity becoming a quality of life issue as it has elsewhere in economically advanced parts of the world.

2 Criteria for LNG Import Project Market Perspective Market(s) are remote from potential pipeline supplies Desire to diversify imported fuel/energy supplies Air quality & emissions issues/concerns LNG represents competitively priced fuel Energy demand growth in coastal areas 2 But let us look more closely, what are the conditions which characterize a potential LNG market? First of all, and probably most importantly, alternative gas supplies primarily domestic gas reserves are either inadequate relative to energy needs or are remote from economic and industrial centers. LNG then, represents the opportunity to bring gas to the market place at volumes and prices which are more attractive than that which can be provided by domestic production. A second characteristic in a potential LNG market is a growing gas-specific energy demand. This could arise from a number of considerations: A desire to diversity fuel supplies. Concerns about air quality Concerns about global warming In China there is often the additional concern over the strain which the moving of coal places upon the transportation infrastructure. Thirdly, for LNG, gas demand must be located on or near coastal areas.

3 Criteria for LNG Export Project LNG Suppliers Perspective Relatively large gas reserves for which there is insufficient local market One or more buyers willing to purchase LNG for 15 or more years at sufficient price and volume to justify investment An appropriate fiscal regime which allows project sponsors to achieve economic viability Willingness among the various parties to cooperate through a long-term project involving significant front-end investments 3 The opposite situation exists in a potential LNG supply project. Here one must have a large volume of gas which greatly exceeds local demand. Selling gas to a local market is almost always a more profitable and lower risk opportunity than is LNG.

4 Project Structure/Financing Fundamental Requirements Long Term Gas Supply Agreement (LNG Plant) Long Term LNG Offtake Agreement Creditworthiness of LNG/Gas Buyers Long Term Gas Supply Agreement (LNG Plant) Stable Fiscal Terms EPC Agreements/Guarantees (LNG and Regas Plants) O&M Agreements Manageable Political Risk Insurable 4 And because of these risks and, therefore, the long-term nature of LNG projects, there are a number of commercial and financial requirements which must be satisfied to ensure that neither the buyer nor the seller nor the lender is taking undue risk in participating in an LNG project.

5 5 The cost to get regasified LNG into a pipeline in the market country is of course the sum of costs of several links in the gas and LNG value chain. Let s look at the costs of some of these links and what are the major factors which affect these costs. We can start with the value chain link closest to the host country market the LNG receiving and regasification terminal. On the chart you see how regasification terminal costs vary with terminal throughput capacity. A 3 million tonne per annum throughput would be between 400 and 450 million cubic feet per day. Notice that this is roughly the point in the curve where costs start to reach a reasonable value about 50 US cents or less and the curve is flattening out. It would be expensive to operate a terminal at much less than this volume. Also noted on the graph are the approximate combined cycle power plant fuel requirements which correspond to the volume figures on the x-axis.

6 Factors Affecting Regasification Costs Water Depth/Harbor Conditions Dredging Requirements Length of Jetty Breakwater Requirements Soil Conditions/Stability Storage Tank Foundations/Reinforcement Equipment Foundations Storage Requirements Size Construction Codes (e.g. tank containment type) 6 As well as plant capacity and throughput, the costs of regasification can be affected by a number of other factors, particularly site conditions. LNG storage tanks are a costly component of any terminal. Their size, number and the sophistication of the containment technology will significantly affect terminal construction costs.

7 New LNG Tanker Cost Trends (by approximate date of ship order) $ MM ~1991 ~1993 ~ Prices reflect Standard 135,000 cu. m. vessel and exchange rates of the day Source: Poten & Partners 7 The costs of new-build LNG tankers have fallen significantly in the last few years. The figures shown here are in the money-of-the-day terms and are not adjusted for inflation. The falling tanker costs can be attributed to: Increases in shipbuilding capacity particularly in Korea. Efforts of established LNG shipbuilders to maintain market share versus new entrants, and Competition between shipboard containment technologies as membrane systems and self-supporting systems challenge spherical tank designs.

8 Shipping Cost vs. Distance (2 MTPA to 6 MTPA) $1.40 Shipping Cost ($/mmbtu) $1.20 $1.00 $0.80 $0.60 $0.40 $ Miles to Market (one way) 2 MTPA 3 MTPA 4 MTPA 5 MTPA 6 MTPA 8 Like LNG regasification, LNG shipping costs are normally lower as volumes increase. However, low shipping costs require short distances plus a good match of plant offtake volume, ship capacity and the number of ships. Often a relatively small project can also achieve these balances.

9 9 The band of shipping costs per mile shown here is taken from the previous chart and shows typical shipping distances from well known LNG project sites to Shenzhen. Of course relatively high shipping costs can often be compensated by savings in other areas and vice versa.

10 Cost of Service Economic Analyses LNG Supply to Guangdong Competitive Nominal 3 mtpa Greenfield Projects Percentage of Total Cost of Service 100% 80% 60% 40% 20% 0% Middle East Origin of Supply Far East Gas Liquefaction Transportation 10 We can illustrate this by comparing 2 typical greenfield projects, one in Asia/Pacific and one in the Middle East both serving a Far East market. The shipping distance is much farther from the Middle East but that project may be able to compensate for all or part of the higher shipping cost by the typically cheaper cost of gas in the Middle East.

11 Estimated LNG Plant Cost Trend 1996 $ 700 $ / TPA Recent Phillips/ Bechtel Estimates Costs reflect all costs inside plant fence with the exception of some Owner costs such as land and Owner project management Source: BP, Phillips/Bechtel 11 The costs of new LNG plants have been falling significantly since about The range of values represented by the yellow section is the Phillips and Bechtel estimate of the engineering, procurement and construction costs which can be achieved today with current technology and construction technologies.

12 Key Factors Lowering LNG Plant Costs Competition Among Liquefaction Technology Providers APCI Propane Precooled MCR Process Phillips Optimized Cascade Process Competition Among Major EPC Companies Change in LNG Plant Design Philosophy 12 Much of the precipitous drop in LNG plant engineering, procurement and construction cost has been brought about by competition. In recent years we have seen the emergence of two competing LNG processes, instead of only the Air Products process as has been the case for many years and an increase in the number of EPC contractors on LNG projects. The Atlantic LNG project made effective use of both of these developments to keep costs for their plant far below historical industry levels. Moreover, as technology providers and EPC companies have competed to bring costs down, there has been a move to smaller and simpler LNG plants. A new design philosophy has emerged.

13 Insert Aerial Shot of ALNG (Trinidad) LNG Plant The Atlantic LNG project shown under construction in this photograph is the best example of this new design philosophy and, as such, is a harbinger of future LNG plant designs. The Atlantic team believed, and we heartily agree, that over the years a certain LNG mystique had arisen which had severely narrowed the process and designs which were considered acceptable for an LNG plant. The fact is however, that laws of thermodynamics are no different for an LNG plant than for a gas separation plant, although historically the costs were radically different even after allowing for differences in scale and scope of operation. The Atlantic team sought to break through this mystique by allowing the two rival LNG processes and three EPC contractors to compete. This not only resulted in lower costs but also a re-think of traditional LNG practices. The design philosophy was to keep the plant as simple as possible while providing the necessary safety and reliability features Atlantic LNG was the first single-train plant to be built in over 25 years, yet was able to do this with no loss of reliability. This reduced the amount of LNG which had to be committed to in the market place and significantly reduced project development time, making Atlantic LNG one of the fastest LNG projects from concept to initial production.