Upstream perspective LNGINDUSTRY

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1 Girish Shirodkar and Hitanshu Gandhi, Strategic Decisions Group AsiaPacific, take a look at the bumpy road ahead for LNG in Africa. A frica is no stranger to LNG Algeria was the first country to export LNG in Over the last few decades, LNG plants have emerged in Libya, Nigeria, Egypt, Angola and Equatorial Guinea. While North and West Africa will remain important contributors to the LNG trade, East Africa is now set to occupy a prime place in the global LNG market. Upstream perspective Giant play opening discoveries made offshore East Africa Over the last five years, East Africa has emerged as a global exploration hotspot, led by Mozambique and Tanzania with over 100 trillion ft3 of proven gas reserves.1 Even though Africa only holds 8% of the proven oil and gas reserves, it has contributed 40% of the giant discoveries (>500 million boe) in the last decade. LNGINDUSTRY

2 Table 1. Proposed African LNG projects Project Country Companies Expected capacity (million tpy) Proposed start-up date Golar FLNG Cameroon Golar, SNH, Perenco Mozambique LNG Mozambique Anadarko, Eni 10 (first phase) 2018 Cameroon LNG Cameroon GDF SUEZ, Mitsubishi, Mitsui, Sempra Fortune LNG Equatorial Guinea Excelerate Energy, GEPetrol, Ophir Energy Tanzania LNG Tanzania BG (acquired by Shell), Ophir Energy, Pavilion Energy, Statoil, Tanzania Petroleum Development Corp NLNG Train 7 Nigeria NNPC, Shell, Total, Eni 8.4 N/A bringing in partners or selling out entirely, with a marked trend of divestments in West Africa, as highlighted by Anadarko and Statoil s recent farmouts from its Cote d Ivoire and Angola blocks, respectively. Downstream perspective Regional demand Although aggregate East African gas demand in city gas, fertiliser plants, power generation and transportation is projected to be substantial in the long-term, the only sizeable current demand centre in the short-term is exports to South Africa. 4 However, as of 2013, South Africa only consumed 138 billion ft 3 /yr, making LNG the only practical short-term demand to monetise the 100+ trillion ft 3 of gas discovered in Mozambique and Tanzania. 5 Figure 1. Creaming curve conventional exploration. Source: Eni presentation. 2 These massive deepwater discoveries have drawn attention from a complex mix of majors (Total, Eni, Statoil, BG [acquired by Shell]), mid-caps (Anadarko), juniors and Asian national oil companies (Indian Oil Corp., CNPV, China National Offshore Oil Corp., PTT Public Co. Ltd), as well as traditional LNG buyers (Kogas, Galp Energia). Other exciting emerging plays in Africa include pre-salt (Gabon, Angola, Congo), Senegal (Cairn Energy s Sangomar Deep), Kenya s onshore rifts, deepwater Morocco and offshore Madagascar, where exploration is still in the preliminary stages. 2,3 Low oil price hastens shift towards value over volume In today s low crude oil price scenario, shareholder demand for value over volume has enhanced capital discipline among exploration and production (E&P) companies, who are now prioritising cashflows and monetising existing discoveries, while cutting back on near-term exploration and divesting non-core assets. Tullow has slashed its 2015 exploration budget to US$300 million, down 70% from Sinopec reversed the US$2.5 billion purchase of a 20% share in the Usan field in Nigeria from Total. At the industry level, this will lead to consolidation among the various independents. We can expect to see the super-majors acquiring resources from distressed independents at attractive valuations. Independents are de-risking projects by Proposed projects There are two distinct trends when it comes to LNG projects. Even as non-lng exporting nations led by Mozambique and Tanzania seek to develop and monetise their recent discoveries, key Nigerian projects have not advanced in the last couple of years due to reservations over the country s long awaited Petroleum Industry Bill. The Olokola LNG (OK LNG) project stalled as all international oil companies (BG, Shell, Chevron) withdrew from the project. Conoco Phillips withdrew from Brass LNG in Even after placing Train 7 volumes in 2014, Nigeria LNG has not yet finalised the date for final investment decision (FID). 6 Challenges in the construction of LNG terminals Building an LNG terminal in a new territory such as Tanzania, with no infrastructure and quality service providers is difficult. The Angola LNG project is a case in point it took 11 years and US$10 billion. Acute skills shortages, as witnessed in Mozambique, can restrict local citizens to menial work, while import of skilled personnel can raise local tensions. The government can also go too far in restricting work permits, with Mozambique pursuing high profile targets such as Vale and Kenmare for scrutiny. 7 Monetising gas resources in land-locked countries (Rwanda, Uganda) requires complex negotiations for costly inter-country pipelines. Currency risk can be critical in economies like Mozambique where the planned LNG projects (~US$40 billion) would easily LNGINDUSTRY

3 dwarf the local GDP. Appreciation of the Papua New Guinea (PNG) kina vis-à-vis the US dollar resulted in a US$1.4 billion escalation in the US$19 billion PNG LNG project. Will FLNG rescue African stranded gas discoveries? Floating LNG (FLNG) is likely to have niche applications, helping to unlock modest gas discoveries in remote locations. Even though the first FLNG facility Caribbean FLNG (0.5 million tpy) has been completed, its owner Pacific Rubiales has postponed the delivery to late Today, there are three other FLNG projects in advanced stages of construction: Shell s Prelude (3.6 million tpy) and Petronas PFLNG1 and PFLNG2 (1.2 million tpy and 1.5 million tpy, respectively). None are yet in production, with PFLNG 1 and Caribbean FLNG coming onstream in The Western Africa Transform Margin s (WATM) Atlantic Coast is ideal for FLNG, with multiple pockets of stranded gas, a complete absence of infrastructure and a skilled workforce, benign sea conditions, highly prospective geology and limited domestic markets. FLNG opportunities also exist in other parts of Africa, including Tanzania, Equatorial Guinea, Cameroon and Mozambique (Coral FLNG). 8 FLNG is not without its challenges its economics still require a demonstrable success. FLNG often conflicts with host countries national interests on local job generation and local content obligations. There also remain significant uncertainties regarding technology, vessel costs, OPEX and longevity, which are yet to be worked out. Country risks There are a few central themes that will play out in the development of major LNG projects in Africa: Corruption and inefficiencies remain high. Most major African countries are ranked below 40 in Transparency International s Corruption Perception Index (CPI). 9 Compliance risks exist, given potential interference from country elites and endemic corruption issues (e.g. securing work permits for work with local suppliers and employees). Local content obligations are rising. Uganda requires investors to give preference to Ugandan goods and services. Ghana s Local Content Policy could ask for up to 90% of particular petroleum operations to be provided by local firms. Mergers and acquisitions (M&A) are becoming harder. Increasingly, transfer taxes and capital gains taxes are being applied. Mozambique has fixed a tax rate of 32% on the sale of assets by foreign companies, triple the current rate. Geopolitical risk remains high. West Africa, with its tribal conflict and political corruption, has long been perceived negatively. The growing number of attacks by Boko Haram in Nigeria, Cameroon, Chad and Niger, will further destabilise West Africa. East Africa, meanwhile, is home to the most countries with an increase in political violence risk in 2014, with Mozambique and Tanzania ranked high. Fiscal terms will get stricter. Average government take in most African countries has risen steeply to over 70%, with Mozambique and Tanzania reaching 60%. In mature basins in Angola and Nigeria, average higher government take is approximately 85%, with royalties comprising 20%. Exchange controls apply in many African countries (e.g. Uganda has a 15% additional tax on profits repatriated outside the country). 9 Financing risk remains high. Low sovereign credit ratings (substantially below investment grade) combined with fears of LNG oversupply, make financing difficult. The huge scale of long-term investments will require external financing from multilateral partners such as the World Bank and the private sector, which may be complex. For example, in Mozambique, land is a property of the state and cannot be sold, transferred, mortgaged or charged. A foreign developer can only gain a right to use the land, preventing a traditional mortgage. One positive development has been Mozambique s December 2014 decree for Area 1 and 4 LNG developments, Figure 2. Proposed LNG supply by region. Source: BG Group LNGINDUSTRY

4 which clarified the legal and fiscal framework concessions and set out clear parameters for future revisions. Commercial perspective LNG projects only the fittest will survive Led by the shale gas boom in the US and substantial discoveries in Australia and East Africa, we are now entering a period where the market may see many projects compete among each other to secure buyers and reach FID. As of September 2014, the set of pre-fid projects (excluding those under construction) was well over twice the global trade in LNG in Many pre-fid LNG supply projects are likely to be delayed, given a widening gap between buyer price expectations and required supplier returns. Many Australian LNG projects, such as Browse, Arrow, and Cash Maple FLNG, have already been postponed. It is expected that East African projects would supply significant volumes (~50 million tpy) by Although East African LNG projects have competitive costs, they are likely to see FID delays in 2015, given the current uncertain market environment. Even though Mozambique LNG has secured non-binding commitments for up to 80% of the initial 10 million tpy capacity with Asian buyers, Anadarko plans to finalise an engineering, procurement and construction (EPC) vendor by 4Q15, delaying the project by at least six months. Downward revisions in supplier quotes, given a decline in orders, could improve its economics. Asia will continue to drive global LNG demand Global LNG demand continues to grow steadily, with strong demand from China, India and ASEAN. China Even though the recent Russia deal boosted China s pipeline options, China reduced its 2020 forecasts for domestic shale gas production to 30 billion m 3 /yr, down from a previous target of billion m 3, given complex geology, a lack of water resources and local opposition. 13 Replicating the US shale gas revolution looks unlikely as CNOOC and PetroChina have significantly cut back on their key shale gas projects in Anhui and Sichuan province, respectively. 14 India Based on contracts so far, India will receive new supplies from Australia (Gorgon) and the US (Sabine Pass, Cove Point) in India does not allow market pricing of domestically produced gas. The government has specified a globally benchmarked gas price (currently US$4.66/million Btu). With low domestic gas prices, the outlook for LNG remains unclear given the strong price sensitivity amongst end gas consumers. ASEAN Strong growth combined with declining gas production in ASEAN has helped the region develop into a large demand centre, with LNG displacing oil consumption and pipeline gas locally. However, a key uncertainty would be pricing reforms and the timing of proposed/under construction regasification terminals. A total of 15 million tpy of regasification capacity is expected to come online after Figure 3. Global LNG supply projection, by region/country. Source: Poten & Partners, via Arcticgas.gov. 11 Figure 4. Global LNG demand projection, by region. Source: Shell. 12 Japan Japanese LNG demand growth is forecasted to remain weak (0.9% growth) over the next decade, with the recovery of nuclear power generation a key uncertainty. With high losses (US$3.3 billion) in FY14, the government is pushing Japan s gas and electric utilities to focus on reducing LNG contract prices. 15 Japanese buyers are increasingly seeking Henry Hub linked US LNG shipments, in the hope that the price may be potentially lower. The energy shortfall post-fukushima resulted in almost equal share increases by oil and LNG. 16 Hence, a successful nuclear restart may be a negative signal for long-term LNG demand. Demand for LNG within Africa Some African countries, such as Morocco, Egypt and South Africa, are facing challenges in meeting increasing gas demand, despite huge reserves. 17 African gas producers with large discoveries may be uniquely positioned to serve these markets. Egypt is now considering purchasing 31 cargoes of LNG from Russia at a premium to European LNGINDUSTRY

5 prices. 18 Morocco has launched a national plan to boost LNG imports (7 billion m 3 by 2025), including the construction of a US$4.6 billion LNG terminal. Sasol is in discussions with the South African government regarding the construction of onshore LNG import facilities. 19 Pricing The oil price decline is likely to stall the LNG market, with spot LNG prices reducing in line with crude oil prices, and buyers not wanting to sign contracts quickly. The large size of East African discoveries enables them to be profitable at much lower prices than West African projects. However, the distance of proposed African LNG terminals from key markets has eroded their competitiveness, especially for the premium Japan-Korea-Taiwan market. Downstream project costs are unlikely to change substantially in the short-term, as EPC contractors still have healthy order pipelines, owing to the ongoing LNG boom in the US and Australia. Should oil prices remain low, the traditional 12 15% Japan Customs-cleared Crude (JCC) slope range will be tested because lower condensate realisation will force gas prices higher to meet project internal rates of return (IRR), reducing deal flow. However, if any deals are concluded at higher JCC slopes, they will be closely bounded to protect buyers. Conclusion East Africa has substantial gas reserves that should be monetised in the next few years, given their size and favourable economics. However, there are severe headwinds. The low oil price reduces deal flow since it would require a higher JCC slope for breakeven. African projects may be further held back due to endemic corruption, lack of local infrastructure and the inexperience of LNG developers. References 1. EIA Proved Reserves of Natural Gas (TCF) Information Sheet TOSI, A., A new exploration age in Africa, Eni, (21 March 2014). 3. OCP Policy Center Conference series: IHS presentation, The Booming Africa Oil and Gas Industry, (September 2014). 4. DEMIERRE, J., BAZILIAN, M., CARBAJAL, J., SHERPA, S. and MODI, V., Potential for Regional Use of East African Gas, Sustainable Energy Lab, The Earth Institute, Columbia University, (May 2014). 5. BP Statistical Review of World Energy (2014). 6. Nigeria LNG, Facts and Figures on NLNG 2014, FACTS%20AND%20FIGURES%20PART%201.pdf 7. FRÜHAUF, A., Mozambique s LNG Revolution, OIES Paper: NG 86 (April 2014), The Oxford Institue for Energy Studies, University of Oxford Energy-FLNG-projects-progressing-455/ BG Group, The influence of North American LNG exports on the Asian gas market, (17 December 2014), pdf Publications_Energy/2014%20October%20Berlin/141010_ Trends%20in%20Global%20Gas%20Markets%20and%20 their%20implications%20for%20lng%20project%20 Development%20by%20Stuart%20Bradford%20 %28Shell%29.pdf IEA, Electricity and Heat Statistics for Japan, report/?country= JAPAN=&product=electricityandheat& year=select html##ixzz3u2kaayvu LNGINDUSTRY