DRIVING FORCES IN THE DEVELOPMENT OF AN LNG SPOT MARKET

Given the increase in LNG spot sales, the question arises: is a global LNG market developing?

A spot market, in the sure sense of the term, aims to match short-term surpluses held by a supplier with unfilled demand of the buyer. It is a permanent dynamic or tension between supply and demand for the commodity for immediate delivery. The price of the goods is continuously quoted, on the basis of supply and demand. A spot market needs the following prerequisites to be fully efficient: ■ Large number of players, without any leading player who could manipulate

prices.

■ A fluid market with little or no bottleneck; transport of the commodity should not hinder its availability, in place or time.

■ At least one place where the goods can be delivered to fulfil open deals.

7 6 5 4 3 2 1 0

Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01

Japanese LNG price Import crude oil price (1) US LNG price

$/MBtu

European LNG price (2)

(1) average import crude oil price in Japan. (2) Algerian LNG received in France.

Source: US DOE/EIA, World Gas Intelligence, IEA.

LNG spot transactions do not yet constitute a real LNG spot market, in the sure sense of the term. LNG spot transactions are still marginal at 8% of global LNG trade.

The recent growth in LNG spot sales was made possible through spare capacity in liquefaction plants, the availability of at least a few LNG tankers and spare capacity in receiving terminals.

Spare capacity at liquefaction plants

There is a good deal of spare LNG capacity - capacity that is not contracted, or contracted but not taken. Spare capacity was estimated at 17 bcm in 2000 and 12 bcm in 2001, the decrease being mainly due to the seven-month shut down of the Arun plant in Indonesia. This spare capacity exists for several reasons. In newly built plants, it exists because contracts are still in their development stage. In existing plants, spare capacity was produced by de- bottlenecking and in some newer plants - thanks to cost reductions - not all of the initial capacity has had to be sold in advance to guarantee financing. Most spare capacity is in the Middle East and in Africa. In the Middle East, three new liquefaction plants have been put on stream since 1996, Qatar’s Rasgas, Qatargas and Oman LNG, adding a total of 20 Mt capacity per year. In Africa, Nigeria has added capacity of 5.3 Mt per year. All contracts linked to these liquefaction plants are in their build-up stage:

■ Abu Dhabi: 4.3 Mt contracted long-term in 2001, out of 5.5 Mt/year capacity (78%).

■ Qatar: 10.16 Mt contracted long-term in 2001, out of 13.4 Mt/year capacity (76%).

■ Oman: 3.29 Mt contracted long-term in 2001, out of 6.6 Mt/year capacity (50%).

■ Nigeria: 4.4 Mt contracted long-term in 2001, out of 5.3 Mt/year capacity (83%).

By comparison, in 2001, the other exporting countries contracted from 84% to 93% of their total liquefaction capacity on a long-term basis. Australia and Brunei contracted their total capacity.

Current spare capacity is the result of a build-up of long-term contracts and will therefore disappear when the contracts have reached their plateau level. Most

new greenfield investments are still linked to long-term contracts, and capacities are seldom deliberately earmarked for spot trade.

On the other hand, debottlenecking of existing plants will continue, while new plants and extensions to existing ones will be built around the world, regularly adding spare capacity not yet booked. Five plants, Atlantic LNG in Trinidad and Tobago, Nigeria LNG, Qatargas, Oman LNG and Australia’s North West Shelf, are currently being expanded, and many owners of liquefaction plants are discussing additional expansions.

There is also a new tendency by LNG producers to build plants without having full capacity booked under long-term contracts. This development is due to the substantial fall in building costs, especially for expansions. These savings allow the financing of the project to be secured by long-term contracts without committing the plant’s total capacity. For example, both Qatar’s RasLaffan LNG and Oman LNG committed to project construction without full-capacity sales. This had two benefits. The principal buyer, in both cases Korea Gas, did not have to wait for the seller to line up other buyers before the projects were begun. Second, the projects made subsequent sales based on not-yet committed capacity - Oman LNG to Japan and to the Indian Dabhol project, and RasGas to India’s Petronet project. Malaysian producers are also building an extension to their LNG plant, Tiga, without full commitment for the production. Shipping issues

The current shortage of LNG carriers is restricting spot LNG trade. This situation has persisted since 1999, even though a number of new LNG carriers have entered service since then. The fleet consisted of 128 vessels at the end of 2001, but only five or six are available on an ad hoc basis for spot trade. This is a serious bottleneck. However, it is likely that there will be a surplus of LNG tankers in a few years. At the end of January 2002, shipbuilders had no less than 53 firm orders for LNG tankers on their books, with options outstanding on a further 23. Until these ships are delivered, LNG transport will be tight, but by 2004, the situation will ease up and many ships should be available for spot transactions.

Almost all the LNG vessels in use, whether chartered by sellers or buyers, are dedicated to specific projects and routes on a long-term basis. But a new trend is emerging with so-called “free ships”, that are not engaged in any specific business and so can provide the flexibility required for spot trading.

Over the past two years, orders for new LNG tankers have increased as major oil companies, independent ship owners and LNG purchasers responded to the lure of low prices. LNG ship prices have fallen dramatically, down to an average of $170 million for a 135,000 cm vessel, from $250 million ten years ago. Companies like Shell and BP have placed orders for LNG carriers which are not designated for specific import or export contracts. Independent ship owners have also placed orders for LNG carriers which are not chartered for long- term trade.

On the purchasers’ side, a number of Japanese, US and European electricity and gas companies have decided to order LNG vessels, for fob contracts and for spot purchases. This is not simply to take advantage of low ship prices, but is in line with a policy to make procurement more flexible and better matched to each market’s individual needs. Having the means to arrange delivery allows buyers a much freer choice of suppliers. Several buyers have invested in more shipping than they will need in order to lift their volumes contracted on a long-term basis. They are now in a position to purchase additional cargoes of LNG or to use their ships to deliver LNG cargoes to other markets.

Regasification terminals

In 2000, the major bottleneck to expanded LNG trade in the United States was limited importing capacity. With the scheduled reopening in 2002 of two previously mothballed plants, Cove Point, Maryland, and Elba Island, Georgia, US importing capacity will reach nearly 32 bcm/year at the end of 2002. There are plans to enlarge the capacity at existing plants. There are also many new regasification projects planned or under consideration in North America: in the Gulf of Mexico, North Carolina and Florida. To avoid siting problems for the new terminals, especially in California, there have been proposals to site them just outside US borders, notably in Baja California, Mexico, and in the Bahamas. There is also a project to build an offshore regasification terminal in the Gulf of Mexico, and to convert LNG tankers by installing regasification facilities onboard them.

In Europe, some LNG terminals have no spare capacity (La Spezia in Italy and Huelva in Spain), others have limited spare capacity (Fos-sur-mer in France, Barcelona and Cartagena in Spain), while Zeebrugge in Belgium, Montoir-de- Bretagne in France, and Marmara Ereglisi in Turkey, do have available spare capacity. In all countries with existing LNG terminals except Belgium, there are projects to build new terminals, some of which are more likely to be realised

than others: two projects in France at Fos and Le Verdon; eight projects in Italy at Marina di Rovigo, Brindisi, Taranto, Vado Ligure, Muggia-Trieste, Corigliano, Lamezia Terme and Rosignano Marittimo; three projects in Spain at Bilbao, El Ferrol and Valencia; two in the United Kingdom at Milford Haven and on the Isle of Grain. A new terminal in Turkey at Izmir has recently been completed. The legislation on access to LNG terminals will be the determining factor for the building of new terminals. Current proposals within the frame of the EU Gas Directive require LNG receiving terminals to offer third-party access. The financing of the new terminals remains, however, an open issue. Italy is the first country to have adopted a specific legislation encouraging the financing of new LNG terminals. It allows a priority of access to the sponsor of the new terminal and a higher rate of return than is now applicable to the transmission network (see Annex on Italy).

The current eligibility threshold for choosing one’s supplier in EU member states is 25 mcm/year, or 40,000 cm of LNG, about the size of a “small” tanker. A new entrant with a small gas market will have to pay high storage costs if he wants to supply his customers with LNG.

Japan has ample spare capacity at its regasification terminals. South Korea is going to expand the capacity of its two existing terminals and build a new one.

A global LNG market?

There is now some, but not a great deal of, spare capacity in liquefaction plants and regasification terminals. The number of free tankers is growing. More players are participating but the total is still limited at around sixty. Traditional long-term LNG contracts are gradually being complemented by LNG transactions that are more flexible in timing and location. These spot transactions, which represented 8% of global LNG trade in 2001, will develop further but they will not soon replace long-term deals entirely, as these deals will still be needed to secure new-project investment. In any event, chances are that a global LNG market, such as those for oil or coal, will gradually emerge.