OPINION: Characteristics of the LNG market and the need for transaction change - By: Kenji Matsuo

Editor?s note: The paper, which was presented on the fourth Indonesia ? Japan Energy Round Table in Jakarta on September 29, 2003, is published with permission from Mr. Kenji Matsuo.

Thank you Mr. Chairman.

I am Kenji Matsuo from the Tokyo Electric Power Company, which is also known as ?TEPCO?. It is my great honor to have an opportunity to speak in front of such a distinguished audience. Today, I would like to make a presentation about LNG usage, and future prospects for LNG trade in this period of dramatic change from utilities? point of view.

TEPCO?s began importing LNG from Alaska 34 years ago, and currently, our total LNG contract amount is approximately 16 million tons per year. We purchase LNG from seven projects, located in South East Asia, the Middle East, Alaska and Australia, and we use this LNG as fuel for our power plants. This 16 million-ton level of LNG has not been reached in one day. It has been steadily built over time on a growing base of achievements.

We, the buyers, have our own reasons for introducing LNG into our fuel procurement mix. TEPCO uses LNG to meet the demand for environmental considerations, such as the reduction of sulfur and nitrogen dioxide. In addition to this demand, it is also our intention to diversify fuel resources to promote supply security.

Now, I would like to describe these reasons and give you a more detailed background. Let us consider the current situation in LNG trade. First, Japanese power utilities are very reluctant to build new oil burning power plants after being faced with two consecutive oil crises in 1970?s. Second, due to technological improvements, highly efficient combined gas turbine power is now a reality. As a result of these developments, LNG power plants, along with nuclear power plants, were selected to be the next generation of power production facilities built in order to meet the steep rise in electricity demand in 1970?s and 1980?s. Third, South East Asian countries, Middle Eastern counties, and Australia, which are close to Japan, have developed gas fields to meet Japan?s growing LNG demand. From an energy security point of view, we place a high value on LNG as a stable energy source. Last, it is important to note that high safety standards for LNG facilities and operators throughout the LNG chain? have been established, taking into full account the hazardous nature of LNG. For these four reasons, with the expansion of LNG usage, long-term contracts incorporating take or pay clauses came into being.

As a result, an optimal balance of energy sources, including nuclear, coal, oil and LNG has been achieved. In the meantime, Japanese utilities entered a new era of structural reformation during the early 1990?s. We are now faced with a decline in power demand caused by economic recession, the liberalization of power and gas markets, and global warming issues. The trend toward market liberalization is proceeding faster than we anticipated. In 2004, customers who use more than 500kW will become a deregulated market. In 2005, all of our industrial and business customer markets will be deregulated. At this time, 60 percent of TEPCO?s demand will come from markets with competing suppliers of electricity. In this new environment, new competitors such as the PPS, plan to build their own power plants and sell their own power directly to their customers.

Meanwhile, electric utilities will be entering the gas business. This is a major development, and unfortunately, I don?t have the time to even begin discussing it here.

In the midst of these structural changes, however, we must again, review and reevaluate our strategy to provide a stable supply of electricity, especially in light of our recent nuclear issues, and the power crisis in the United States of America.

In this era of change, LNG trade also has to adjust to the dimensions of our current environment. We can conclude that the importance of LNG among the various energy sources will not change for TEPCO, and will continue to occupy an important position in the future. However, LNG has to be a competitive tool for us in this current drive towards deregulation, and also needs to increase its flexibility as buffer, a role that is currently being played by oil power.

Thus, we have to be a bit cautious about LNG?s ability to respond to these requirements. If sellers cannot meet the needs of their buyers, it may be that buyers become less competitive and, long term, LNG buyers will lose the competitiveness, having a negative impact on LNG trade.

I would like to suggest how LNG trade might expand in light of these circumstances.

First of all, buyers have difficulty in estimating their future requirements for LNG due to deregulation. Also, we hesitate to make long-term commitments even when anticipate additional demand. As I mentioned before, as we downsize oil burning power plants, LNG power plants are expected to meet short-term fluctuations in power demand as well as medium term fluctuations. It will be necessary to respond to short-term demand fluctuations with short notice. Making LNG a more flexible resource can insure future commitment from buyers.

The importance of supply stability of LNG is undeniable. In the context of this perspective, buyers and sellers must work together to insure that LNG maintains its dominant role in the future. Recently, we have found the LNG spot trade market to be highly useful, and it has helped us to meet shortfalls on short as an alternative to nuclear power.

Taking into account all of these factors, we can see that it will be beneficial for all, if the character of LNG trade changes to better accommodate the buyer?s rapidly changing circumstances.

Here, I would like to list some examples that we expect to see in the near future.

I mentioned before that long-term contracts provide for the bulk of our energy supply, but this does not mean that the current terms and conditions of these long-term contracts should continue without modification. Buyers will no longer be in a position to makes inflexible long-term contracts for LNG both of current and newly one. I would like to suggest that it is critical that buyers introduce the concept of short-term commitment and optional volume to help them meet medium-term demand fluctuations. It is also important to expand the upward and/or downward flexibility of annual volume purchases on a short-notice basis. Furthermore, it is also important for supplier side, regardless of existing or grass root projects, to offer the attractive pricing to buyers. This will be beneficial for LNG trade expansion.

On the other hand, sellers have recently been assuming more risk for project start-ups expecting potential LNG requirements near future. We can see the cycle of LNG surplus in the LNG market as follows. If this risk take activity on the part of sellers continues, surplus LNG will be available to the global LNG market. In this situation, sellers will strengthen their marketing to obtain a medium or long-term commitment from the buyer?s side. Looking farther into the future, eventually, a large amount of surplus availability will decrease gradually and medium and long-term contract volume will increase. Then, sellers will make a decision to go ahead to start new LNG project if they have a confidence that there is a certain volume of LNG purchase commitments from buyers and potential demand in the LNG market. Then surplus LNG will be offered on the LNG market. When a surplus of LNG exists in the market, sellers will naturally engage the strategy of selling the surplus on LNG spot markets.

Traditionally, we have thought of LNG markets as being independent of one another. Recently, we can see some indication that the Asian Pacific market, the European and the North American markets will be linked through the Middle Eastern LNG projects. There is a possibility that the markets in Asia Pacific and the west coast of north America will be begin to influence each other and the development of the LNG markets over these areas could be realized, if LNG terminals on the west coast are realized. I think this tendency is going to be accelerated by the steep growth of natural gas demand in the world.

Basically, the increased number of LNG vessels will contribute to the integration of regional LNG markets. It is anticipated that an increasing number of new LNG ships will be on-line due to shipbuilding cost reductions, and which hopefully, will be able to maintain a high standard of safety. TEPCO will soon deploy a new F.O.B. LNG ship for the transport of Malaysian LNG to the extension of the contract. After the introduction of our F.O.B. ship to support Malaysia LNG, TEPCO will also introduce a second and more LNG ships under F.O.B. terms for the Darwin and Sakhalin LNG project.

We plan to employ our LNG ships for F.O.B. trades taking into consideration price advantages and increased flexibility. We expect that the combination of TEPCO controlled LNG ships and surplus LNG volume will expand the spot LNG market, and contribute to the competitiveness and enhanced flexibility of LNG trades. TEPCO will be able to play a role in this expansion of spot trades.

In conclusion, I would like to make a brief summary of my presentation. Sellers are requested to introduce more attractive conditions into current long-term contracts in order to support the buyers? changing environment. There is no doubt that spot trades will have a certain role in the LNG market and that the expansion of spot trades will provide benefits to both sellers and buyers, though, there are still several problems to be resolved. First, it is quite important to maintain high safety standards for both sides while handling LNG spot cargoes. Especially, upon entering into high traffic areas such as Tokyo bay, we must cooperate with marine authorities and local authorities and meet rigid regulations. Second, there still remains the destination clause issue that is now currently under discussion.

Last, we maintain an opinion that LNG is not a commodity, but is a unique commercial good that has several restrictions through LNG production, transportation, storage and usage of LNG. The expansion of LNG trade will heavily depend on not only the continuation of our current excellent safety record, but also on the realization of competitiveness and flexibility. We must continue this approach in order to expand diversified LNG trades.

It goes without saying that LNG will play a major role among variable energy sources in the world. Sellers and buyers have to promote mutual understanding, cooperation and trust toward this goal. I would like to end this presentation with my hope that the Indonesia and Japan energy round table can play an important role in promoting this communication and mutual trust.

Thank you very much for your attention. (end of paper)