THE STATUS AND DEREGULATION OF THE NATURAL GAS MARKET IN KOREA LA SITUATION ET LA DEREGLEMENTATION DU MARCHE DE GAZ NATUREL EN COREE

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1 THE STATUS AND DEREGULATION OF THE NATURAL GAS MARKET IN KOREA LA SITUATION ET LA DEREGLEMENTATION DU MARCHE DE GAZ NATUREL EN COREE Dongin Lee Head of Managerial Research Team Korea Gas Corporation (KOGAS) 215 Jeongja, Pundang, Seongnam, Kyunggi, , Korea ABSTRACT Natural gas has been introduced in Korea in 1986 as an alternative fuel for power generation and residential heating to reduce the dependency on oil and to improve the air quality in the populated metropolitan areas. Since then, the growth of natural gas industry was unprecedented. The natural gas industry is now facing the new era of development. With the deregulation and restructuring of the economy, competition and market efficiency would be introduced in the natural gas market. A cooperative effort to support the restructuring of the industry is needed for the prosperity and the economic growth of the countries involved. RESUME Le gaz naturel a été introduit en Corée en 1986 comme combustible substitutable pour la production de l énergie électrique et le chauffage résidentiel afin de réduire la dépendance du pétrole et d améliorer la qualité de l air dans les zones métropolitaines peuplées. Depuis lors, l industrie de gaz naturel a crû sans précédent. L industrie de gaz naturel se trouve aujourd hui devant une nouvelle époque pour son développement. Avec la déréglementation et la restructuration de l économie, la concurrence et l éfficacité de marché seraient introduites sur le marché de gaz naturel. Les efforts coopératifs de supporter la restructuration de l industrie sont nécessaire pour la prospriété et la croissance économique des pays impliqués. PS1-8.1

2 THE STATUS AND DEREGULATION OF THE NATURAL GAS MARKET IN KOREA 1. ENERGY BALANCE AND ROLE OF NATURAL GAS Korea relies heavily on fossil fuels such as coal, crude oil, and natural gas for imports, since only a small amount of anthracite is domestically produced. Most of the primary energy are imported in Korea, while the domestic anthracite provides only 3% of primary needs. Primary energy consumption has increased over the last two decades due to the high economic growth and the improvement of living standard. Experiencing the two oil shocks in the 1970s, Korean government set the energy policy in a way that reduces heavy reliance on oil mostly from Middle East. The policy brought natural gas into Korea in 1986 for the first time as an alternative source of energy. The natural gas, which has been imported in the form of LNG, introduced in Korea to supply the fuel for power generation and substitute for the heating oil in residential houses. Since then, natural gas consumption has increased rapidly. With the high economic growth, domestic primary energy consumption in 1999 totaled around Mtoe, a 75.8% increase from the level of It is expected to increase to about 309 Mtoe in In 1999, in the total primary energy demand, petroleum consisted of 54%, coal consisted of 21%, and natural gas took 9.3%. Observing the consumption trends by the type of energy, petroleum consumption increased more than three times from 26.8 Mtoe in 1980 to 97.5 Mtoe in Nevertheless, its share in the total energy consumption decreased from 61.1% to 53.7% over the same period. Its share is predicted to decrease further to 48.5% in During the same period, the share of coal consumption decreased from 30.1% to 21%, although its consumption increased around three times from 13.2 Mtoe to 38.1 Mtoe. Coal s share is expected to decrease to 18.2% in This downward movement in the share of coal consumption has been a worldwide trend, as the environmental regulations have become stricter. The role of natural gas in the primary demand is forecasted to increase. Natural gas consumption in 1999 was 16.9 Mtoe and is expected to increase to 42.2 Mtoe in Thus the share to the total will be 13.7% in 2020 from 9.3% in Unlike petroleum and coal, nuclear energy enjoyed a high demand growth. In 1980, its share was only 2%, but increased to 14.2% in It is expected to increase further to 17.7% in 2020 with a support by the government. The government s support for the nuclear industry is aimed at reducing the dependency of energy resources on imports and reducing green house gas emissions. PS1-8.2

3 Table 1.1 Primary Energy Consumption, Coal Petroleum Natural gas 13,199 (30.1) 26,830 (61.1) - Unit: 1,000 TOE Hydro Nuclear Others Total 496 (1.1) 869 (2.0) 2,517 (5.7) 43, ,022 (39.1) 27,142 (48.2) (1.6) 4,186 (7.4) 2,031 (3.6) 56, ,385 (26.2) 50,175 (53.8) 3,023 (3.2) 1,590 (1.7) 13,222 (14.2) 797 (0.9) 93, ,091 (18.7) 93,955 (62.5) 9,213 (6.1) 1,369 (0.9) 16,757 (11.1) 1,051 (0.7) 150, ,139 (21.0) 97,481 (53.7) 16,851 (9.3) 1,517 (0.8) 25,766 (14.2) 1,806 (1.0) 181, ,542 (21.1) 104,792 (54.7) 17,609 (9.2) 1,156 (0.6) 25,740 (13.4) 1,889 (1.0) 191, ,000 (20.4) 133,600 (51.3) 25,800 (9.9) 1,100 (0.4) 43,700 (16.8) 3,000 (1.2) 260, ,300 (18.2) 150,000 (48.5) 42,200 (13.7) 1,300 (0.4) 54,800 (17.7) 4,400 (1.4) 309,100 Note: The share of each fuel is in parentheses. Source: Korea Energy Economics Institute, Korea Energy Review, NATURAL GAS DEMAND IN KOREA 2.1. Use of Natural Gas in Korea Since natural gas was introduced into Korea in 1986, its consumption has sharply increased. Initially it was consumed in the capital area including Seoul metropolitan city as a fuel for power generation and residential heating. As shown in Table 2.1, natural gas consumption increased from 2.3 million tons in 1990 to 12.7 million tons in According to Ministry of Commerce, Industry, and Energy (MOCIE) of the Korean government, the natural gas demand will increase at an average annual growth rate of 4.9% and reach around 21 million tons in In the early period of the Korean gas market, most of the natural gas was consumed for power generation. As expansion of pipelines for transportation of natural gas, service areas of natural gas have been increased, and the role of city gas for the use of natural gas has been intensified. With the total of 2.3 million tons of natural gas in 1990, 75% of natural gas was consumed as a fuel for power generation, while 25% consumed for the city gas services. In 1999, total volume of natural gas consumption increased to 12.7 million tons, and the share for the power generation was reduced to 38%, and the share for the city gas services was increased to 62%, however. In 2010, according to the government s forecast, the share of city gas services would be increased further to 71%, so that the share for the power generation fuel would be less than 30%. PS1-8.3

4 Table 2.1 Natural Gas Consumption Unit: 1,000 Tons City Gas 576 3,417 7,886 8,986 12,098 14,917 Power Generation 1,741 3,562 4,769 4,820 6,202 6,054 Total 2,317 6,979 12,655 13,806 18,300 20,971 City Gas Share (%) Power Generation Source: Ministry of Commerce, Industry, and Energy, Korea, The 5th Long-term Supply and Demand Plan for Natural Gas, 2000 Among the consumptions by the city gas companies, the residential heating and the cooking are the most common use of natural gas, followed by industrial and commercial uses. In 1999, about 60% of natural gas supplied by the city gas companies was consumed by the residential customers, though the share would be reduced as increases in the consumption of the industrial customers of natural gas Expansion of Natural Gas Use Natural gas demand in Korea is likely to grow at a slower pace than before since it is entering the stage of saturation. Recently, however, natural gas finds its own markets in such areas as cogeneration, cooling, and natural gas vehicles. In fact, these markets are challenges that the Korean gas industry should tackle to maintain a high rate of demand growth. Thus far, gas consumption in the three areas has been insignificant. Before the 1990s, fuels used for cogeneration were mostly coal and heavy oil. Natural gas joined the cogeneration market in the 1990s, but was limited only to large buildings, except the district heating services that use the waste heat from power generation. Later on, gas consumption for cogeneration extended to the industrial sites and small district heating services. As shown in Table 2.2, the amount of natural gas consumed for cogeneration was thousand tons in 1995, but increased to thousand tons in It is expected to increase to thousand tons this year and reach around 1.3 million tons in The rapid increase in gas demand for cogeneration is attributed to continued efforts from both governmental and private sectors to increase the efficiency of gas use as well as to reduce air pollution. Natural gas cooling is a quite new business area in Korea. It started to attract interests from the government and the domestic gas industry in the late 1980s. Gas cooling is quite attractive to the Korean gas industry with high seasonal fluctuations (turn down ratio of the city gas demand is around 5.6) since it can reduce investment in storage tanks considerably. It also serves to reduce the investment of power plant for peak load of electricity. Because of cooling demand in summer, electricity load usually peaked in summer. For these reasons, the government and gas industry have supported to promote PS1-8.4

5 gas cooling in the 1990s in several ways. The government together with KOGAS has provided financial incentives or a tax break for installation of the gas cooling system. As shown in Table 2.2, gas consumption for cooling tripled from 49.4 thousand tons in 1995 to thousand tons in It is expected to increase to 151 thousand tons this year and reach 187 thousand tons in NGV was introduced into Korea in the early 1990s as a part of environmental protection program. Recently, the Korean government set a long-term plan to replace the diesel-fueled buses with the gas-fueled ones. As a first stage of the plan, pilot automobiles ran from January to December The one-year pilot run turned out to be successful. Encouraged by the success, the first three gas-fueled buses with two gas recharge stations started to run their regular routes; one bus in Ansan from July 1998 and two buses in Incheon from September In 1999, additional 15 gas-fueled buses started to run in the Seoul metropolitan area. Table 2.2 Natural Gas Demand in Cogeneration and Cooling Unit: 1,000 Tons, Number of Buses Cogen ,269.1 Gas Cooling NGV - Source: KOGAS Pilot Run Began 18 (2 Stations) 1,500 (30 Stations) 5,000 (100 Stations) According to the government plan, the 1,500 gas-fueled buses would run in the cities where the 2002 World Cup games are going to be held. The 30 natural gas recharge stations are also going to be built to fuel the buses. Until 2002, 5,000 diesel-fueled buses would be replaced with gas-fueled buses in the World Cup game holding cities where air pollution is serious. The number of gas-fueled buses will be increased further to 15,000 by the end of 2007 by the government plan, and the number of gas recharge stations would also be increased to SUPPLY OF NATURAL GAS AND INFRASTRUCTURES 3.1. Stability of Natural Gas Supply The most crucial issue in the Korean gas industry is how to secure stable supply of natural gas at a reasonable price. Korea started to use LNG in 1986 by importing it from Indonesia based on a 22 year-long contract with a volume of 2 million tons per year as shown in Table 3.1. As gas demand increased rapidly, two additional long-term contracts were made with Indonesia in 1991 and PS1-8.5

6 Table 3.1 Quantity of LNG Imported Based on Long-term Contract LNG Unit: 1,000,000 Tons Piped gas Indonesia Malaysia Brunei Qatar Oman Russia Total ) Note: 1) 7 million tons of pipeline natural gas are expected to be imported from East Siberia in around 2010 if the Irkutsk pipeline project is successfully implemented. Source: KOGAS One delivers 2 million tons of LNG per year for 21 years starting The other one delivers 1 million tons of LNG per year for 21 years starting Korea signed another long-term contract with Malaysia in 1993, which delivers 2 million tons of LNG per year for 21 years starting Brunei was also added in the list of LNG exporters to Korea in 1997 delivering 0.7 million tons of LNG per year for 17 years. Recently, Korea started to participate in the international LNG projects to extend her business areas as well as to secure the stable gas supply. The Qatar and Oman projects are the two projects that KOGAS invested. By the contracts with two Middle countries, Korea would imports 4.8 million tons of LNG per year from Qatar and 4.06 million tons of LNG per year from Oman. In this way, Korea diversified import sources of LNG into 5 countries, three of them are Asian countries and the other two are Mid-East countries. To strengthen the stability of gas supply, and to secure the supply of gas to meet the growing demand, Korea started to investigate the possibility of bringing in natural gas from East Siberia through pipelines. In the several East Siberian gas projects Korea considered, the Irkutsk project turned out to be most economically viable in the prefeasibility studies. Korea hopes to bring in about 7 million tons of pipeline gas per year from eastern Siberia in around 2010 and thus strengthen the nation s security of energy PS1-8.6

7 supplies. Korea, with China, and Russia, has agreed to study the feasibility of the Irkutsk project for development of the gas field and transportation of natural gas through pipelines. The study will be started in the early of Expansion of Gas Supply Facilities Timely construction of supply facilities to serve consumers is as important as stable supply of natural gas. To meet ever-increasing gas demand in Korea, the third LNG terminal at Tongyoung is being construction, which will be completed by 2002 in addition to existing the two terminals at Pyungtaek and Incheon. The third Tongyoung terminal will serve end users in the southern industrial regions more promptly. Table 3.2 shows status and long-term construction plan for supply facilities of LNG in Korea. At present, there are 20 LNG storage tanks in operation, whose capacity in total is 2 million kl (each tank with 100,000 kl capacity). Both Pyungtaek and Incheon terminals have 10 storage tanks respectively. According to the long-term plan of KOGAS, Tongyoung terminal will start to operate in 2002 with the storage capacity of 0.42 million kl, expanding total storage capacity up to 3.1 million kl. With the three terminals, total storage capacity will be increased to 4.88 million kl in 2005 and reached 5.60 million kl in This capacity is around three times of the 1999 level. Table 3.2 Long-term Construction Plan for Gas Supply Facilities Capacity of LNG Storage by Terminal (million kl) Total Pyungtaek Incheon Tongyoung Trunkline Length (km) Under 2, Construction 2, , Source: Ministry of Commerce, Industry, and Energy, Korea, The 5th Long-term Supply and Demand Plan for Natural gas, 2000 In parallel with construction of additional terminal and storage facilities, trunk lines will also be extended to west coast, south coast, and Kangwon Province in the northeastern region by With extension of trunk lines to these areas, construction of major trunk lines in Korea would be completed. By the end of 1999, a total length of 2,094 km trunk lines are in operation. It is expected to extend to 2,227 km by the end of In 2002, it will increase to 2,435 km. PS1-8.7

8 4. STRUCTURAL REFORM FOR KOREAN GAS INDUSTRY 4.1. Restructuring of Power and Gas Industries in Korea Privatization of public corporations and deregulation had been discussed in the government from the late 1980th in Korea. However it has been one of the primary policies of the government since the new government inaugurated in The new government led by President Kim, Dae-Joong has initiated economic reforms to overcome the economic crisis in Restructuring of energy industry and privatization of public energy corporations has been included in the reform plans for the public sector. In the electricity industry it is in the implementing stage, and in the natural gas industry it is in the planning stage. In the electricity industry, six power generation groups are to be separated from Korea Electric Power Corporation (KEPCO), which is the integrated monopoly in the Korean electricity industry so far. From next year, an initial form of competition for power generation would be introduced, and it will be extended to the wholesale trading, and later to the final sales to the consumers. The electricity generated by separated companies will be trade in Korea Power Exchange (KPX), which will be monitored and regulated by Electricity Committee, the independent regulatory agency for power electricity market in Korea. Table 4.1. Plan of Gas Industry Reform in Korea Year Main Contents Government announced a plan for gas industry reform Separate KOGAS business areas into two. - One company that takes over operating supply facilities succeeds the name KOGAS. - Three companies are in charge of importing and wholesale marketing - Among the three, one company will remain KOGAS subsidiary, though it will be sold to private sectors eventually. - The other two companies will be sold to other private sectors by the end of Adopt an open competition in wholesale market in Adopt a mandatory open access to gas grid in Adoption of competition in retail market will be implemented by stage thereafter Source: Ministry of Commerce, Industry, and Energy, Korea, Basic Proposal for Restructuring Natural Gas Industry in Korea. October In the natural gas case, a similar step would be introduced by the year 2003, according to the Government plan. By the proposal announced in October 1999 as shown in Table 4, the business areas of Korea Gas Corporation (KOGAS) will be divided in two groups. One is importing and wholesale marketing, and the other is construction, operation and maintenance of all natural gas supply facilities, which include LNG PS1-8.8

9 receiving terminals, storage tanks and trunk lines except distribution pipelines owned and operated by the city gas companies. For competition in the importing and wholesale marketing, there will be three subsidiaries of KOGAS established after the spin-off of KOGAS in the next year, which will be sold to private investors eventually. Private investors are to be allowed to invest on the company that will take charge of the facilities, though Government will retain proper shares of the company to regulate the natural monopoly of the facilities. Meantime, an open access to the facilities will be introduced in Korean natural gas market by By the proposal, competition on the importation and wholesale marketing will start in 2003, and it will be expanded to retail services of natural gas to customers Risks and Opportunities for Korean Natural Gas Industry In Korea, so far the government policy on energy had been important role for the national energy balance, the energy security, and the development of energy related infrastructures. Though the speed of growth in the demand has been reduced recently, demand for clean and cheap energy is growing substantially. As advance of information technology and wide use of computer, demand for power electricity will grow relatively faster than it was forecasted, and natural gas demand as a fuel for power generation will follow. Under the growing needs for energy and needs of energy investment, Korean government have committed to reform of energy business to enhance the market function instead of government involvement. Though the institutional arrangement would be completed within three or four years as scheduled by the government-restructuring plan, as directed in the framework of restructuring, Korea would have to wait to see the efficiency of market mechanism. In this sense, the energy business in Korea is now in transition. During the transition, as would be the cases in any transition, the business may face several challenges and find new opportunities. The role of government to orchestrate the transition should be mentioned first. Government concerns on the energy market should be expressed through the market mechanism. The regulation on the energy market must be transparent, and consistent to create a rational expectation of the players in the market. For these purposes, economic regulation on the energy business must be independent with the policy considerations. The competition in the domestic gas and electricity business can be interpreted in a several ways. Spot trading of electricity, introduced with restructuring of electricity industry, affect business natures of fuel supply to power generation as well as retail utility services. It induces a fuel competition for power generation, and also stresses the utility service providers to improve their customer relations. Korean energy companies may have to prepare for integrated energy service business as removal of entry barriers to the separated industries. An integrated energy company would come out as a result of restructuring, the business area of which would involve both gas and power. The key contents of the competitiveness for the company would be the quality of utility services with relatively low costs. The implication of the restructuring on the natural gas market in Korea cannot be examined without consideration of the international gas market, especially Asian LNG market. Korea is not the only one country for restructuring natural gas industry. Though the degrees and directions of restructuring are diverse, most LNG consuming countries in Asia have taken similar steps for deregulation or restructuring of the natural gas markets. PS1-8.9

10 The core of the deregulation is to enhance the market mechanism with restriction of government intervention on the market. As well understood in the LNG business, however, LNG trading is not flexible enough to support the deregulation in the LNG consuming countries. Though there have been several indications to improve flexibility in the LNG trading, still a long-term, take-or-pay contract is a dominant business practice in Asian LNG market. As long as the LNG trades are rigid, the deregulations in the LNG consuming countries would not have real gains from the domestic market reforms or deregulation. In the same way, however, as the market forces in the LNG consuming countries need more flexible terms of LNG trade, Asian LNG suppliers should prepare to reduce the rigid terms of contracts for marketing of their LNG. Through the interaction between the two forces, the industry would set the direction of development, in which both consumers and producers of natural gas would be better off. 5. CONCLUSION The rapid growth of Korean natural gas industry is unprecedented. Within 15 years since 1986, Korea became the second largest LNG consuming country with the construction of infrastructure required to supply to the most parts of the nation. The high economic growth, environmental regulation, and convenience of natural gas use have contributed the success of the natural gas industry. Korean government is preparing the market reform on the energy sector. Now the shape of the industrial structure is about to change substantially through times. In this sense, the Korea s gas industry is at the very important point in time. Introduction of free competition into Korea s gas industry not only can make the industry more competitive and efficient, but also can provide players in the gas industry opportunities to diversify their business areas. With the restructuring of natural gas market and introduction of competition, the industry would see the dynamics of market efficiency, through which it would gain a momentum to grow further. With respect to energy resources for basic needs of human well being, the natural gas would expand to find a potential role. Natural gas is in the center of the growth of the energy needs in Korea as are the cases in many nations. Consumer s choice for the clean and convenient fuel will boost up the demand for natural gas. To serve the development of the industry, however, the natural gas industry must be aware of the market environment. Restructuring of the energy industry in the consuming countries will reshape the structure of the industry within the domestic market as well as international trade. Thus, LNG trading mechanism must be evolved towards a flexible one, which make both producers and consumers better off in the deregulated market situation. Also, for the benefits of Northeast Asian country, the players involved in each country must discuss the development of natural gas resources in East Siberia of Russia and the construction of pipe line network connecting all the countries in the region. With a cooperative effort by producers and consumers of natural gas, the natural gas industry would serve the prosperity and the economic growth of the countries involved. PS1-8.10