access to gas by lng challenge

8/22/2019 Access to Gas by Lng Challenge

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ACCESS TO GASTHE LNG INDUSTRYS BIG CHALLENGE

Frank HarrisCo-Head, Global LNG

Wood Mackenzie

Edinburgh, Scotland

Gavin LawCo-Head, Global LNG

Wood MackenzieHouston, USA

www.woodmac.com

ABSTRACT

Historically the major commercial challenges in the LNG business have been at the

market rather than the upstream supply end of the value chain. In the early years of theindustry, securing foundation customers for projects was a key challenge and, in the last

two to three years, the difficulties associated with the permitting and approval of regas

terminals, particularly in North America, have been seen as a significant obstacle for the

major players in the LNG business.

However, with the demand for LNG forecast to treble over the next 15 years and the

growing presence of the major resource holding National Oil & Gas Companies

(NOGCs) in the LNG business, the next big challenge for the major International Oil

Companies (IOCs) will be to secure access to upstream gas reserves to feed the next

generation of LNG supply projects.

The LNG supply landscape is becoming increasingly complex. There are moratoria

on new LNG projects in key producing countries such as Egypt and Qatar, continuing

problems with gas supplies from Indonesia and the emergence of new players such as

Gazprom. IOCs in the LNG business now face a tough choice participate in the

development of proven gas reserves belonging to the NOGCs or explore for gas to

support new LNG projects themselves. Working with the NOGCs is a relatively safe

strategy but competition is intense and returns are coming under increasing pressure,

while exploration offers potentially greater returns but comes with significant risks.

This paper will examine the upstream LNG supply landscape and the positioning and

strategies of the key players therein as they look to secure access to gas reserves. The

paper will also consider the potential implications that access to upstream gas reserves

has for the balance of power between the NOGCs and IOCs and for the sustainability of

growth in the industry itself.


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INTRODUCTION

In the first half of this decade the LNG industry tended to focus on shipping and

regasification as the big potential bottlenecks within the LNG value chain. There was an

implicit assumption that there would always be an adequate supply of LNG available to

meet rapidly increasing demand, the problems were going to be building enough tankersto transport the LNG and developing the regasification terminals required to deliver it

into downstream gas markets.

However, in the last 18 months or so, there has been something of a sea change. The

shipbuilding industry has increased its ability to produce LNG tankers through the

expansion of production capability at existing yards and the entry of Chinese shipyards

into the business. The outlook for the development of new regasification capacity,

particularly in the USA, now looks a lot less problematic than it did two or three years

ago. While there will always be specific areas of the world in which developing

regasification terminals will remain hugely challenging, for example Italy and California,

many within the industry are now turning their attention to the previously unthinkable; anapparent excess of regasification capacity in key markets, not least the US Gulf Coast.

As a result, the big focus of attention within the LNG industry is now supply. Firstly,

the seeming inability of proposed new LNG supply capacity to be developed according to

plan, and therefore to keep pace with forecast demand. It seems as if each week brings a

fresh news story about delays to yet another LNG supply project. There are a multiplicity

of reasons for these delays, ranging from an over-heated market for EPC contractors to

on-going geo-political uncertainty. Secondly, there are growing concerns about the

removal of gas that had been counted on by the industry to support future LNG

developments. Indeed, several key gas exporting countries including Egypt, Qatar and

Trinidad now have either explicit orde facto moratoria in place on the development of

new gas/LNG export projects, motivated in no small part by a need to retain reserves to

support the growing demand for gas in their domestic markets.

As a result, many within the industry are increasingly concerned about whether

demand will be constrained by a lack of supply, both in the short-term and perhaps more

worryingly, in the long-term. People are now openly questioning whether or not the

industry can access sufficient gas to support the growth of the LNG business that is built

into most participants forecasts. The conventional wisdom that there would always be

sufficient LNG supply to meet demand is increasingly being questioned.

At the LNG14 Conference in Doha in 2004 much of the informal discussion centred

around who would get access to the next LNG project in Qatar. In contrast, almost three

years later, a lot of the informal discussion in the industry is about where players are

exploring for gas to support new LNG projects. In some cases this exploration is

intended to discover and/or to prove-up gas to gain Government sanction for new LNG

trains in those countries with moratoria. We characterise this as moratoria-busting

exploration. In other cases, exploration is intended to further develop existing LNG

plays, Nigeria being a good example, or to underpin potential new LNG plays, as is

currently happening in Papua New Guinea. The second half of this paper discusses the

implications of and issues relating to LNG-related exploration.


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The last couple of years have also seen the emergence of an additional supply-related

concern for the International Oil (and gas) Companies (IOCs). Buoyed by the

combination ofinter alia high oil prices and growing experience of the LNG business, a

number of National Oil & Gas Companies (NOGCs) have either begun to make it less

attractive for the IOCs to access their gas resources or have shut-off access altogether,

through so-called resource nationalism. In some cases, NOGCs are now choosing tocollaborate on LNG developments to the exclusion of IOCs. This creates some major

issues for the IOCs in terms of their ability to access gas to support their growth strategies

and further reinforces the need for IOCs to explore.

In summary, it is our opinion that accessing gas resources and developing sufficient

LNG supply are the key challenges faced by the industry. This paper considers whether

the concerns about supply are valid and the potential implications for players within the

LNG industry.

THE IMPORTANCE OF SUPPLY

In the Short-term, Supply is Struggling to Keep Pace with Demand

The demand for LNG has almost doubled in the last decade, increasing from 73

mmtpa in 1996 to 141.5 mmtpa in 2005 and growth shows no sign of slowing. Indeed,

Wood Mackenzie forecasts that demand will more than treble between 2006 and 2020,

increasing from 157 mmtpa in 2006 to 488 mmtpa in 2020, driven in particular by the

rapid expansion of demand for LNG in the US and the continued development of new

importers such as India and China. There is also considerable upside to our demand

forecast from those countries that are actively considering LNG imports but which have

yet to finalise their plans. These countries are excluded from our base forecast due to the

current uncertainty about the timing and level of their imports.

However, while LNG demand remains robust, there are growing signs that LNG

supply capacity is struggling to keep pace, at least in the short-term. Figure 1 compares

Wood Mackenzies Global LNG demand and supply forecasts as of November 2006

(supply being split out by the current status of each liquefaction project/train).


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0

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2005

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2007

2008

2009

2010

2011

2012

2013

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2015

2016

2017

2018

2019

2020

mmtpa

Existing Under Construction Probable Possible Demand (Nov-06)

Figure 1. Global LNG Supply and Demand (2005-2020)

The overall tightness of supply and demand is readily apparent, although through to

2010, the combination of existing capacity and capacity currently under construction is

broadly sufficient to satisfy demand and in some years there is ostensibly a few mmtpa of

surplus capacity. However, events such as disruption to supplies of gas feedstock,

unplanned outages at LNG supply facilities and/or further construction delays could

lower available supply and temporarily constrain demand and, in the last two to threeyears, we have witnessed many such events. For example, Nigeria LNG trains 4 and 5

and Atlantic LNG Train 4 have seen reduced production due to feedstock issues, North

West Shelf and Qatargas have been hit by technical problems with liquefaction plant and

Snohvit and Sakhalin have seen construction delays of a year or more.

Near-term demand could also be higher than forecast as several countries including

Brazil and Pakistan have recently proposed plans to import LNG before 2010 using

floating regasification vessels. In summary, we expect the LNG supply demand balance

to be extremely tight through to 2010 and there is a strong possibility that at times

demand will be constrained by a lack of supply. Readers should also note that the LNG

demand forecast shown in Figure 1 is significantly lower in the period 2006 to 2010 thanour initial 2006 forecast. Annual demand was reduced by up to 20 mmtpa, largely

because of a lack of available supply.

From 2011 onwards, new supply capacity (i.e. over and above capacity currently in

construction) will be required in order to satisfy demand and Wood Mackenzie splits new

supply out into two categories:

Probable supply is defined as supply from those projects that are in an advanced

stage of development and where the developers are expected to take the final

investment decision (FID) within 12 months; and


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Possible supply is defined as supply from projects that have been proposed or are

expected to be proposed but where the timeline is less well defined and the timing

of FID is speculative.

In our opinion the most important message to draw from Figure 1 is that, by 2011,

supply from the Probable category will be required in order to satisfy forecast LNG

demand i.e. sufficient investment in LNG capacity has not yet been made to meet

forecast demand in 2011. In simple terms this means that supply is only just about

keeping pace with demand. As the lead time for the construction of a new LNG supply

project is currently approximately 48 months, it means that assuming FID is taken

imminently and that there are no delays in construction, the capacity should be ready just

about in time to meet demand in 2011. However, any delays to the development of

projects in the Probable category could mean that some demand goes unmet and demand

will be constrained by supply.

Over the last couple of years we have seen significant delays to the development and

FID of a number of Probable projects for a variety of reasons which are discussedsubsequently. Realistically, we expect further delays to some of these projects, making

the probability of a supply-constrained world from 2011 look increasingly real. By 2012

the picture is worse still, as significant supply from the less well-defined Possible

category will also be required in order to meet demand and the scope for delays to these

projects is higher still. In addition, the likelihood of delays to the development of both

Probable and Possible capacity means that the apparent excess of potential supply over

demand which appears in Figure 1 from 2013 onwards is unlikely to materialize in

reality.

Further evidence of how supply has not been developed as originally planned can be

found in an analysis of historic forecasts of LNG supply. Figure 2 compares WoodMackenzies forecasts of future LNG supply as made in 2004, 2005 and 2006.

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2004

2005

2006

2007

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2009

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2011

m

mtpa

J an-04 Oct-05 Oct-06

Figure 2. Comparison of Wood Mackenzie LNG Supply Forecasts


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It is interesting to observe how forecast LNG capacity additions in the short-to-

medium term have changed over the three year period considered. In January 2004, the

estimate of capacity for five years hence (2009) was 307 mmtpa. At that time one would

have expected this forecast to be reasonably accurate for two reasons. Firstly, because

existing capacity is a known quantity and the estimates of the timing of completion of

capacity in construction were thought to be relatively robust. Secondly, in theory fiveyears was sufficient time to allow the developers of a proposed LNG project in the

relatively advanced stages of development (a Probable development) to take FID and then

construct the project. As such, the expectation was that the actual capacity in 2009

should have been pretty close to the forecast.

However, by October 2005 our estimate of 2009 capacity had fallen dramatically

from 307 mmtpa to just 249 mmtpa, reflecting the reality of developing supply. In just 22

months, the estimated start-up of some 58 mmtpa of capacity had slipped beyond 2009. A

similar result is observed if one compares the estimate of 2010 capacity made in October

2005 with that made a year later. The initial 2005 estimate of 301 mmtpa had fallen to

264 mmtpa, again reflecting the challenges associated with developing supply and theresulting delays to project start-up. So, accepting that in recent years the industry has

been and is continuing to struggle to develop new supply, the two obvious questions are

why, and are these reasons short-term phenomena or long-term issues?

There are many reasons why developing supply has proved challenging, some are

country or location specific whilst others have impacted the industry as a whole. Some of

the major issues include inter alia:

EPC pressures: In the last couple of years the industry has seen the cost of

developing LNG projects increase by a factor of two to three. This has led to

some significant delays in taking FID as developers attempt to manage the cost or,

in some cases, deferral of FID in the hope that costs will abate in a year or so.

These cost pressures can be partially explained by the general increase in the price

of commodities such as steel, however the major pressure on cost has resulted

from the limited amount of EPC resource available to build LNG plants. The

EPC sector has seen increased demand from the oil & gas sector, particularly

LNG, but also from the mining and minerals sector which has been enjoying a

boom. As a result of basic supply and demand economics, the cost of obtaining

EPC services has therefore increased but, just as importantly, the timeline for

developing an LNG plant has increased from circa 40 months to 48 months as

EPC contractors act to ensure that delivery estimates for new projects are realisticgiven the pressures on EPC resources. While we do not see pressure abating in

the near-term, in the longer-term EPC contractors should be able to expand

capacity and therefore increase the ability of the industry to develop new supply

in a more predictable fashion;

Moratoria: As noted in the introduction, in the last few years several key

countries have introduced official or de facto moratoria on the development of

new gas/LNG projects. As a result, capacity that had been factored into future

supply forecasts has at best been delayed until sufficient gas reserves are released

by the Government or NOGC to support the project, orin extremis removed from

the supply forecast all together;


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Environmental issues: Several high-profile projects (notably Gorgon and

Sakhalin) have faced significant pressure from environmental authorities which

have extended development and construction timescales and delayed the expected

start-up of production. It is likely that other projects in these locations, for

example the proposed Ichthys and Browse projects offshore Western Australia,

will face similar challenges. However, hopefully the industry will learn fromexperience and either deal with these challenges more effectively in future or take

a more realistic view of development timetables, meaning that supply is not

delayed unexpectedly; and

Politics: National and international politics will always impact the development

of LNG projects leading to considerable uncertainty about the timing and

availability of new supply in certain countries. Iran is perhaps currently the best

example. Wood Mackenzies current forecast of Iranian LNG exports in 2020 is

40 mmtpa but it could just as likely be zero if there is a major escalation of the

current nuclear stand-off with the West. Politics can also impact the development

of LNG supply because local political pressures can lead to the decision to divertgas resources to local rather than export markets. Politics can also impact

production from existing LNG plants. In Indonesia longer-term output from the

Bontang plant is extremely uncertain because Government policy is encouraging

the diversion of gas to local markets rather than to LNG exports. This is having a

major impact on the roll-over of existing contracts with Japanese buyers.

In summary, we believe that within say five years, the industrys ability to develop

LNG supply projects as planned should improve. EPC contractors will be able to

increase their capacity and hopefully some of the lessons learned about developing LNG

projects within environmentally sensitive areas will be applied to future developments.

In addition, developers are likely to be conservative and over-estimate developmenttimeframes with a view to bringing projects into service early rather than vice versa.

With more realistic development timelines there should be a lower likelihood of delays to

supply constraining demand. There will however always be random events and factors

that cause delays, such as political changes and these will remain outwith the industrys

control.

So, while the short-term outlook for supply looks bleak, we see scope for some of the

factors that have created the pressure on supply to abate. Therefore, in our opinion, the

major potential long-term challenge to developing supply will be whether project

developers can actually get access to the gas reserves required as feedstock.

Should Supply be a Concern in the Long-Term?

Assuming that some of the current issues associated with developing supply are

indeed relatively short-term in nature and will ultimately abate, is it right for the industry

to be concerned about supply in the longer-term? After all, surely there is more than

enough gas out there to allow all of the LNG capacity required in order to meet demand

to be developed?

In its 2006 Statistical Review of World Energy [1], BP estimated proved reserves of

natural gas at 6,348 tcf. Figure 3 illustrates that a significant proportion of these reserves

are concentrated in a small number of countries, a theme that we will return to in the

second half of this paper as it has important implications, particularly for IOCs.


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Proved

Reserves

(Tcf)

0-50

50-150

150-500

>500

Proved

Reserves

(Tcf)

0-50

50-150

150-500

>500

Figure 3. Summary of Proved Natural Gas Reserves

To put this reserves number into context, the 390 mmtpa of additional LNG supply

capacity that Wood Mackenzie forecasts could potentially be developed by 2020 would

require approximately 430 tcf of gas to allow the capacity to produce at 100% for 20

years. This is in addition to the approximately 200 tcf that would be required to allow the

installed liquefaction capacity in 2007 to produce for another 20 years. It therefore

appears prima facie that there is more than enough gas out there to support the forecast

requirement for LNG over the next 20 years or more, so why the concern?

One possible explanation for the increased concern about gas availability is the fact

that some resource holding countries now appear to be taking a much longer-term viewabout these resources. For example, one of the explanations given for the current

moratorium in Qatar is that Qatar Petroleum wanted to ensure that the North Field was

being developed in a manner that was consistent with 100 years of production rather than

25. So while there are more than enough reserves to support growth over the next 20

years, the view changes somewhat if one takes a 100 year view.

Perhaps more importantly, while there is a seemingly huge amount of gas reserves out

there, a significant amount of the reserves are either not accessible and/or unsuitable for

development as LNG projects. There are a variety of reasons for this, with some of the

key ones outlined below. In some cases there may be more than one reason why a

particular reserve is not available for LNG:

Domestic requirement: a number of the large gas resource holding countries are

seeing demand from their domestic sectors increase significantly. As a result,

many have either reduced the amount of gas available for export or imposed

moratoria on new exports, at least in the short-term, to ensure domestic security of

supply. A number of countries have a three thirds policy, one third of gas

reserves for the domestic market, one third for export and one for strategic

reserves. As a result, unless significant additional reserves are proved-up, existing

gas reserves will likely remain off-limits to new LNG projects;


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Proximity to other markets: some reserves are sufficiently close to large

demand centres, albeit often located in other countries, that pipeline exports are

more economic than LNG exports. For example it is more economic to supply

Algerian gas into Southern Europe via pipeline than as LNG. Perhaps more

significant is the fact that it is more economic to develop the 520 tcf of gas in

Russias Yamal peninsula to supply Europe via pipeline than it would be to usethe gas to underpin LNG projects;

Gas quality: some large gas reserves contain levels of CO2 that make them

extremely difficult or uneconomic to develop as LNG projects because of the cost

of dealing with the CO2. For example, the development of the natural gas

contained in the 222 tcf Natuna D-Alpha field in Indonesia has long been held

back by the fact that the field comprises an average of 71% CO2;

Reserve size: many gas reserves are just too small to support a typical LNG

project and cannot easily be aggregated with nearby reserves. For example there

are several fields in Vietnam with reserves in the 0.5 to 2.5 tcf range, none of

which can underpin an LNG project;

Distance from the sea: some gas reserves are located so far away from the sea

that the cost of the pipeline required to transport the gas to the liquefaction plant

makes the project uneconomic. For example, the 37 tcf Kovykta field in Eastern

Siberia is over 2,000 km from the Pacific coast and, as result, the gas is much

more likely to be transported straight to N.E. Asian markets via a pipeline than

piped to the coast for conversion to LNG before being shipped to N.E. Asia.

Similar logic applies to the circa 300 tcf of gas reserves in Central Asia; and

Geopolitical reality: some gas reserves are located in countries where geopolitics

make the likelihood of that gas being developed as LNG in the foreseeable future

highly unlikely. For example, international politics have so far managed to keep

any of Irans 900+ tcf of gas from being processed into LNG.

It should also be noted that some of the gas reserves which are potentially available

for development to support LNG projects are uneconomic based on existing technology

and market pricing. These reserves are likely to be ignored until easier reserves have

been monetised. In summary, the amount of gas resources actually available to support

LNG developments is somewhat lower than initially apparent and some of the available

gas would be extremely difficult to develop. As a result, exploring for new gas reserves

that may be easier to develop is a potentially attractive option.

Interestingly, concerns about access to gas supply is not just an issue for the LNG

industry, it is a concern for the gas industry as a whole. Detailed analysis undertaken by

Wood Mackenzie using its proprietary Global Gas Model indicates that there is a global

deficit of existing gas supply relative to forecast gas demand (Figure 4).


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0

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GasSupply(bcm)

Existing Commercial Reserves Techical/YTF Reserves Demand

Figure 4. Global Gas Supply/Demand Balance

In other words, even after factoring in all existing commercial gas supply sources,

i.e. sources that are already contracted to domestic markets or export projects as well as

gas supply sources that are expected to become commercial within five to ten years, there

is insufficient gas to meet forecast total global demand for gas. In order to meet demand,

additional known gas sources will need to be developed (referred to as technical

reserves in Figure 4) and exploration will also be required to discover and prove-up

additional reserves (referred to as yet-to-find (YTF) reserves in Figure 4).

In summary, three important messages emerge from our analysis:

Firstly, although the world has an extremely significant amount of proven gas

reserves, for a multiplicity of reasons, a lot of this gas is not currently suitable

and/or accessible for development as feedstock for LNG projects;

Secondly, Wood Mackenzies modeling of the global gas sector indicates that

additional gas reserves (over and above those already earmarked to supply local

markets or to feed LNG and pipeline projects) will need to be developed in order

to satisfy global gas demand; and

Thirdly, in light of points one and two above, there is a strong signal to the LNGindustry to develop additional gas resources to support the development of LNG

projects. This could involve commercialising existing known gas resources that

are potentially suitable and available for development as LNG as well as

exploration for new gas resources.

The challenge for developers is to create a resource capture strategy that

successfully combines commercialisation of known reserves with exploration.


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COMMERCIALISATION OF KNOWN GAS AND/OR EXPLORATION

In terms of securing access to the gas reserves required to allow the development of

new LNG projects and to support future growth, the IOCs have two seemingly simple

options to consider commercialise existing known gas reserves, to the extent that they

are available for LNG projects, or explore for new gas reserves. However, determiningthe correct balance of the two options is far from simple. IOCs must consider many

factors including inter alia:

The suitability and accessibility of known reserves for monetization as LNG;

The terms offered by the NOGCs for assisting in commercialising known

reserves;

The level of participation that the IOC will have and the role of the NOGC in the

value chain;

The level of competition between IOCs to access NOGC reserves and the likely

impact on returns;

The potential risks and rewards from exploration;

The availability of suitable exploration acreage; and

The implications on overall portfolios.

In the real-world, IOCs do not choose between the options per se, rather they create

portfolios of LNG supply projects, some of which monetise known gas reserves and

others which are based on successful exploration. In either case, NOGCs may or may not

be involved. We now consider each option in turn before looking at the portfolios that

some of the key players in the LNG business have developed.

Commercialisation of Known Resources

It is a somewhat depressing fact for the IOCs that 56% of the worlds proven gas

reserves are located in just three countries (Figure 5) Russia, Iran and Qatar, countries

in which the gas sector is dominated by a strong NOGC Gazprom, NIOC/NIGEC and

Qatar Petroleum respectively.


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27%

14%3%

4%15%

37%

Russia Iran Qatar Saudi UAE Other

Figure 5. Global Proved Gas Reserves

While historically Qatar Petroleum has been happy to collaborate with the IOCs in the

development of large gas projects, the future outlook is less certain. Even assuming that

the current moratorium on the development of new gas projects is lifted, there are no

guarantees about IOC participation in future developments or the terms of that

participation. NIOC and NIGEC in Iran have always been somewhat wary of co-

operation with IOCs and there are constitutional restrictions on foreign ownership ofupstream gas reserves. In addition, geo-political realities make the involvement of US

players in Iranian LNG projects impossible. Perhaps most depressing of all, Gazprom, the

worlds largest gas resource holder, recently decided to develop the super-giant Shtokman

field (~125 tcf) on its own without the involvement of IOCs and indicated that, at least

initially, it would focus on supplying the gas to Europe via pipeline rather than as LNG to

North America which had been the original development plan. Recent events at the

Sakhalin 2 project seem to indicate that the scope for IOCs to participate in Russian LNG

projects will be extremely limited. In summary, the ability of IOCs to access known

gas resources in the three key gas resource holding countries looks limited.

In our opinion while there will always be some scope for IOCs to participate in thedevelopment of known reserves controlled by NOGCs, the outlook appears increasingly

challenging:

NOGCs are increasingly reducing, or in some cases removing altogether, gas

reserves available for supply to export projects including LNG. As previously

discussed, in many cases NOGCs are holding back gas to ensure that they can

satisfy growing domestic demand for gas;

NOGCs are choosing to co-operate with each other on the development of large

gas projects rather than involve IOCs, witness recent cooperation agreements

between Gazprom and Sonatrach and the potential involvement of Petrobras andQatar Petroleum in Venezuelan LNG projects;


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NOGCs are becoming increasingly technically sophisticated and have less need

for the technical capabilities for which they were originally dependent upon the

IOCs. A similar statement could be made about their ability to market gas. In

addition, they increasingly have strategic desires to have greater control of the

LNG value chain from wellhead to market, witness Qatar Petroleums

investments along the integrated value chains for the Qatargas-2,3 and 4 and RL3projects;

Current and forecast oil price levels mean that NOGCs have greatly improved

access to capital, something that IOCs have traditionally provided, particularly in

those countries with significant levels of sovereign risk that found it difficult to

access global capital markets; and

The terms of participation in NOGC projects are becoming stricter partly

reflecting a desire to retain more value for the host nation but also increased

competition between IOCs to access gas reserves. This type of competition had a

significant impact on the expected returns from the Gassi Touil LNG project in

Algeria which are currently expected to be only circa 13%. This compares to theforecast 43% return from the Egypt LNG project that is underpinned by gas

reserves discovered by BG and Petronas as part of an exploration programme.

Interestingly the fiscal terms for these reserves were relaxed as, at the time, the

Egyptian Government wanted to encourage gas exports.

In addition, as noted previously in this paper, some of the known reserves that are

not controlled by NOGCs, are unsuitable for development as feedstock for LNG projects

for a variety of reasons. As a result, IOCs are increasingly looking to exploration as an

alternative way of securing the gas reserves required to underpin LNG projects.

Exploration

As it becomes more difficult to access and commercialise known gas reserves to

support LNG developments, as well as potentially commercially less attractive, it is

logical that players should increasingly look towards exploration as an alternative.

However, it is important to bear in mind that while exploration can potentially be more

attractive than commercialising known gas reserves it also carries significant potential

risks.

Figure 6 compares the relative risks for IOCs in discovering gas reserves for LNG

compared to projects where they assist in commercialising already discovered reserves.

Sub-surface risk broadly encompasses the technical challenges associated withexploration while Above Ground risk relates to those factors that can impact the

monetisation of gas once it reaches the surface, such as politics, NOGC intervention,

government take and gas marketing.


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Above Ground Risk

Sub-SurfaceRisk

MauritaniaExploration

Iranian LNGQatargas 3/4

EgyptExploration

Gassi Touill

AustraliaExploration

RasGas/Qatargas

EG LNG

MLNG TigaPluto

Above Ground Risk

Sub-SurfaceRisk

MauritaniaExploration

Iranian LNGQatargas 3/4

EgyptExploration

Gassi Touill

AustraliaExploration

RasGas/Qatargas

EG LNG

MLNG TigaPluto

Figure 6. Balancing Sub Surface and Above Ground Risks

The capture of resources for an LNG project, whether through the drill-bit or across

the negotiation table, can be considered in terms of the type of risks which are being

encountered. During the 1980s, 1990s and early 2000s, assisting NOGCs with the

development of their abundant reserves provided the IOCs with the opportunity for

significant commercial returns with relatively low technical and above ground risks.

However, as the number of IOCs searching for LNG supply project opportunities has

increased and as the NOGCs have evolved and developed their skills, capabilities and

aspirations, the level of above ground risk has increased for the IOCs. Companies are

now increasingly competing for access to NOGC held gas and having to give away

commercial value to be successful. In addition, as previously noted, the NOGCs are also

increasingly taking a bigger, more integrated role in the project.

In light of the increasingly competitive environment for access to discovered reserves,

the alternative for the IOC is to secure the gas resources through exploration. While the

sub-surface risks may be considerably higher than circumstances where the gas is already

proven (i.e. the gas resource may not actually exist or may be unsuitable for LNG), the

IOC is capable of selecting locations where the above ground risk favours timely

development and returns are potentially more attractive than those where the reserveshave already been discovered.


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One factor that has reduced the above ground risk is the enhanced marketability of the

final product. Historically the market for LNG was limited to a handful of long term

offtakers and the discovery of gas reserves was often the start of a lengthy process of

commercial validation, marketing and negotiation. The lead times (from discovery to

first LNG) for projects like Gorgon (Australia) and Alba (Equatorial Guinea) which were

discovered in the 1970s or early 1980s will be more than 20 years, while for projects suchas Pluto (Australia) which was discovered in 2005, the lead time could be as little as 6

years. In light of the earlier analysis in this paper, with LNG markets requiring

significant incremental volumes for the foreseeable future, the ability to commercialise

discovered reserves quickly is greatly enhanced. While LNG may not be a true

commodity like oil, the level of demand is such that securing offtakers may no longer be

the rate determining step of the past.

In addition, in light of the difficulties associated with discovering large oil reserves

which would have a material impact on the reserve bases of the major IOCs, the prospects

for making large scale discoveries of gas are looking increasingly attractive and the

prospects for large discoveries are still significant in many parts of the world. The historyof exploration for gas is relatively short and it is not that many years ago that gas was

largely considered an inconvenient by-product of oil development. With the

marketability of gas now at an all time high, the attractiveness of exploration for large

scale gas reserves to support LNG projects is increasingly compelling. However not all

exploration opportunities are the same and a key question for the explorationist is where

to explore?

Where to Explore?

In trying to characterize LNG exploration opportunities, we have identified three

broad categories:

Moratorium Busters: Exploration in countries or provinces where large scale

gas developments have occurred (including LNG) but where concerns over the

domestic market requirement have resulted in moratoria on the sanctioning of new

export projects until sufficient additional gas resources are proven-up (eg. Egypt).

While the sub-surface risk may be lower in these areas compared to unproven gas

provinces, due to the fact that productive hydrocarbon fairways have been proven

and established, there is an above ground commercial risk that any reserves

discovered will be insufficient to break the moratorium and thus may be reserved

for the domestic market; Expansion: Exploration in countries or provinces where large scale gas

developments have occurred (including LNG) and any further discoveries will be

used to build upon existing developments, either brownfield or greenfield. While

this kind of exploration may have lower sub-surface risk than unproven gas

provinces, the above ground risk may be elevated by two factors. Firstly, the

government/NOGC may attempt to increase the fiscal take relative to early

projects and increase its overall involvement; and secondly, the concurrent

development of multiple LNG projects may put a significant strain on the

countrys physical and administrative infrastructure and as a result projects are

likely to be delayed. This second factor may have a significant impact on future

projects in Nigeria; and


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Frontier: Wildcat exploration in countries or provinces where gas development

is limited and/or non-existent, such as Mauritania. These targets carry

considerable sub-surface, technical risk. However, should the resources for an

LNG development be discovered, it is likely that both the fiscal terms and

government attitude will expedite the rapid development of the resource.

Figure 7 uses these categories to highlight those locations where LNG related

exploration is either currently already underway or is anticipated in the near future.

Figure 7 LNG Exploration Activity

In addition to the question of where to explore, the IOCs are faced with the challenge

of how to go about exploration.

How to Explore?

One of the key factors which impacts the timely and efficient development of a gas

resource for LNG is the level of alignment between the partners involved in the

development. In situations where the partners have full alignment in terms of theircommercial objectives and expectations, projects can proceed quickly with minimal

downtime for decision making. However, as the LNG business has flourished over the

last few years, we have witnessed two key factors which have created partner

misalignments:

Escalating costs have pushed some LNG projects to the economic margins. Since

different companies have different investment thresholds a natural tension

between partners can become a major impediment to decision-making and thus

project progress; and

Expansion LNG Plays

Moratorium Busters

Frontier LNG Plays

?

?

?

?

?

Expansion LNG Plays

Moratorium Busters

Frontier LNG Plays

?

?

?

?

?


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As more companies develop global integrated portfolios of LNG assets, it

becomes increasingly likely that different companies will imbue the same project

with different levels of strategic significance. For one partner a specific project

may be a pivotal element of its LNG strategy, for another it may be of marginal

interest.

As a result of these potential misalignments between partners, it is increasingly

important for the LNG explorationist to consider the partnering issues very carefully. In

projects where companies have sole risked exploration, such as Woodside in Pluto, the

company has been able to move the project forward quickly and efficiently, a feat which

would have been much more challenging if it had involved partners with differing

priorities. However, the downside of sole-risking exploration is the fact that costs and

risks are substantially higher. While it would be unrealistic to suggest that IOCs should

only explore and develop LNG projects on a solo basis, the timing for selecting the best

partner(s) may be a key success factor. Consider the Ichthys project where INPEX

discovered the resources and then selected Total as a partner to assist it in the

development. Total was extremely keen to enter the Australian LNG space and, as a newentrant with no existing position, it is likely to be much more supportive of the

development than a partner that had other Australian LNG options, for example Shell or

Woodside.

Having now considered both options commercialising known reserves and

exploring for new reserves, it is interesting to review the positioning of some of the major

players. Table 1 summarises the Probable and Possible LNG projects currently being

pursued by several of the major LNG players in terms of whether they are based on

commercialisation of known reserves or exploration.


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Table 1 Major LNG Players Port fol ios

Company Commercial-

ising Known

Resources

Exploration

Moratoria-

Busters

Exploration

Expansion

Plays

Exploration

Frontier Plays

BG Egypt, Libya,

Trinidad

Algeria, Nigeria

(OKLNG)

Mauritania, PNG

BP Australia

(Browse),

Indonesia

(Tangguh Exp.)

Egypt, Trinidad Algeria, Australia

(Browse), Oman,

Russia (Sakhalin)

Chevron Angola, Australia

(Gorgon, Browse),Nigeria (OKLNG)

Libya Australia (Greater

Gorgon Exp.),Nigeria (OKLNG)

Venezuela

ConocoPhillips Australia

(Sunrise), Nigeria

(Brass, NLNG)

Libya Australia (Timor

Sea)

Venezuela

ExxonMobil Australia (Gorgon,

Scarborough),

Nigeria (NLNG)

PNG

Shell Australia (Browse,Gorgon, Sunrise),

Nigeria (NLNG,

OKLNG)

Egypt, Libya Algeria, Australia(Ichthys area),

Malaysia (Bintulu

Exp.), Nigeria,

Russia (Sakhalin)

Total Australia (Ichthys),

Nigeria (NLNG,

Brass)

Libya Algeria, Nigeria,

Yemen

Venezuela

In summary, it appears that most players have adopted a portfolio approach, with theirLNG strategies being underpinned by a combination of commercialisation of known

resources and exploration. However, it is interesting to observe that the

commercialisation of known resources is largely concentrated in two countries

Australia and Nigeria . In addition, most players are undertaking significant exploration,

but a lot of this activity is focused in a handful of countries notably Algeria, Egypt and

Libya (Moratoria-busting), Australia and Nigeria (Expansion plays) with frontier plays

only being pursued in Mauritania, Papua New Guinea and Venezuela. This suggests that,

as has traditionally been the case in the oil & gas industry, frontier exploration is being

undertaken by smaller players with a view to enticing in the big LNG players as and

when their exploration efforts prove successful. It also indicates that there is potentially a

lot of scope for additional exploration in frontier areas by the major players.


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CONCLUSIONS

In our opinion, the LNG industrys current focus on, and some may go as far as to say

obsession, with supply is justified. Supply is an issue in the short, medium and long-term

and industry players are right to be concerned about it.

There is growing evidence that the industry will continue to struggle to develop the

new supply capacity required to satisfy forecast demand for LNG in the short-to-medium

term. The balance between forecast demand and supply already looks tight through 2010

and it will not take much in the way of unplanned outages or construction delays to

constrain demand. From 2011 through the middle of the next decade the outlook is quite

pessimistic as capacity from supply projects where the final investment decision (FID)

has not yet been taken will be required in order to meet demand. Given current

construction lead-times for liquefaction plants, there is barely enough time to construct

the plants in order to meet demand and we see many factors that could cause delays both

to FID and to construction. As a result, we see real potential for demand to be constrained

by a lack of supply through at least 2015, perpetuating the current Sellers Market. Thisis great news for those industry players with access to flexible LNG supply as a tight

market means high prices and better netbacks. However, the outlook for LNG purchasers,

especially those potential new importers of LNG that are less willing or able to pay

market prices looks much less attractive.

While we see scope for some of the pressures that are currently constraining the

development of new supply to abate in the medium-term, particularly the cost and

availability of EPC resources, we still see supply-related challenges in the context of

longer-term LNG projects. The world has huge gas reserves which prima facie could

support the LNG industry for hundreds of years. However, a significant amount of these

reserves are either inaccessible and/or unsuitable for development as LNG feedstock.The reasons for this are diverse but somewhat worryingly there has been a trend in the

last 2 to 3 years for National Oil Gas Companies (NOGCs) to restrict access to gas

reserves for use in export projects. Typically the motivation for this is to ensure that

sufficient reserves are available to support rapidly growing domestic demand and to

ensure strategic reserves are available for the future. Indeed, recent events in Qatar have

highlighted the fact that major resource holders are increasingly taking a long-term view

about reserves, looking at long-term national security of supply and economic growth

potential and not just the potential for LNG growth.

Against this backdrop of uncertainty about access to gas, Wood Mackenzies

proprietary analysis indicates that additional gas reserves will have to be developed in

order to meet forecast global demand for gas and therefore by implication, demand for

LNG. With a clear signal that additional gas is required to support the future growth of

the industry, players have two options: exploit known reserves to the extent that they

are suitable and accessible for LNG and/or to explore for additional gas. The challenge is

how best to combine the options given their respective risks and rewards.


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Historically, assisting with the commercialisation of known NOGC controlled gas

reserves has been an attractive option for the IOCs. The level of technical risk was

typically low as the gas had already been discovered and commercial risks were low-to-

moderate. However, in recent years this option has either disappeared altogether in some

countries or has become far less attractive in others. Somewhat depressingly, over half of

the worlds gas reserves are located in just three countries Russia, Iran and Qatar eachof which is dominated a strong NOGC. In our opinion the outlook for future foreign

participation in the monetisation of gas reserves via LNG in all three countries looks

limited at best. Recent events in Russia could be considered a harbinger for projects

elsewhere, with gas reserves either being taken away from potential LNG projects or

foreign players being excluded from projects altogether or their participation greatly

reduced. Going forward we see greater cooperation between NOGCs and stricter terms

for IOC participation as and where it is available. As a result, we are already seeing

increased LNG-related exploration efforts by the IOCs and expect more to follow.

In addition to the difficulties associated with commercialising known reserves, two

additional factors are encouraging the increased focus on exploration. Firstly, the stronggrowth in LNG demand is making it easier and quicker to monetize suitable new

discoveries as LNG. Assuming that Woodsides Pluto project is commissioned as

planned in late 2010 or early 2011 it will have only taken 6 years to commercialise the

gas, this compares to the 10 to 20 or more years that has been the historical norm.

Secondly, major oil & gas companies are finding it increasingly difficult to make material

oil discoveries and, as a result, exploring for gas has become more attractive given the

number of significant prospects that are potentially available and the enhanced outlook

for near-term monetisation. However, while exploration is becomingly increasingly

attractive it still carries significant risks which has implications for exploration strategy.

Players face a dilemma. Sole-risked exploration, if successful, means that the process ofcommercialising gas reserves is far easier as there are no problems associated with

partner alignment. However, sole risking exploration and development involves more

cost and as a result, we expect to see continue collaboration on LNG projects as recently

seen at the Ichthys project where, following successful exploration, INPEX brought in

Total to assist with development. Choosing where to explore is also critical and we

categorise LNG related exploration into three groups Moratorium busters,

Expansion plays and Frontier plays as the drivers for and characteristics of

exploration in each group are different.

Analysis of some of the key LNG players indicates that their future LNG strategies

are underpinned by a combination of commercialisation of known resources andexploration. However, it is interesting to observe that the commercialisation of known

resources is largely concentrated in two countries Australia and Nigeria. In addition,

most players are undertaking significant exploration, but a lot of this activity is focused in

a handful of countries notably Algeria, Egypt and Libya (Moratoria-busting), Australia

and Nigeria (Expansion plays) with Frontier plays only being pursued in Mauritania,

Papua New Guinea and Venezuela. This suggests that there is potentially a lot of scope

for additional exploration in frontier areas by the major players or for farming into

successful discoveries by smaller industry players.

Given the continuing need to secure access to gas to support the LNG industrys

growth and the challenges associated with accessing known reserves, we expectexploration to play an increasingly important role in the LNG business.


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ACKNOWLEGEMENTS

Wood Mackenzie Global Gas Model

Wood Mackenzie Global LNG Online Service

The authors would like to thank their colleagues John Meagher, Andrew Pearson and

Pamela Tannahill for their contribution to the preparation of this paper.

REFERENCES CITED

[1] BP Statistical Review of World Energy, June 2006

access to gas by lng challenge

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