OPINION: LNG marketing development, a global perspective, By H. Baharuddin (Part 2)

Let?s take a look at some of the realities that are developing in our industry, in addition to all of the optimism.

1. Steady erosion of capital costs for liquefaction and transportation facilities as technological developments have combined to significantly reduce costs to produce and transport LNG.

2. Increasing diversity among potential suppliers as more and more deposits of ?stranded gas? become economical to develop and ship.

3. Continued development of increasingly efficient CCGT technology has resulted in lower costs for power generation facilities, much shorter construction time, higher efficiency and lower pollution.

4. As LNG production and shipping technology has reduced costs of supplies (and increasingly put pressure on suppliers to decouple gas prices from crude prices), incentives for gas turbine driven power generation have markedly increased.

5. Major difficulties are still faced in the development of new gas markets, as large amounts of expensive infrastructure are required to get gas to markets. Thus, power generation will continue to drive LNG consumption.

6. Capital requirements to fund projected expansions and construction of new facilities will be enormous if in fact the growth is achieved. Major pressure will be put on capital markets to fund these projects and innovations in financing will be required if these projects are to succeed. For instance:

a. The U.S. is forecasting 20 new LNG import terminals by 2010; this will require some 10 billion U. S. dollars to implement

b. Qatar is estimating that over 5 billion U. S. dollars will be spent in that country alone over the next 8 years, bringing its LNG export capacity to 35 mtpa, the largest in the world.

c. Oman Train 3, Chiyoda and Foster Wheeler have been selected to build Train of 3.3 million, with estimated cost of $600 million.

d. Over 10 billion U. S. dollars are required to fund the expansion in the LNG shipping fleets.

e. It has been estimated that Asia will require a total of 200 billion U. S. dollars over the next 10 to 15 years to build gas infrastructure to support rapidly growing economies; at least 100 billion U. S. dollars will be spend for LNG terminals and pipelines to support a tripling in demand.

f. It has been estimated by one well-known consultant that between $118 billion and $150 billion will be needed for China alone over the next 20 years to fully develop the Country?s gas sector.

g. At least 50 billion U. 5. dollars have been identified for power generation facilities alone during this same period.

h. New and expanded LNG plants will also require enormous capital support. Attempting to quantity the number of new LNG facilities is difficult, as new projects/expansions seem to be announced every day, but a conservative estimate indicates that some 10 to 15 new trains have been identified for projects with targeted markets, and at least 15 new ?speculation? trains have been discussed. Since these are a mixture of expansions and grass roots facilities, it is difficult to estimate costs, but some 20 to 25 billion U.S. dollars for LNG plant facilities would not be too far off the mark.

i. Thus, in this very cursory analysis, some $300 to $400 billion U. S. dollars would be required to fund the growth that has been discussed in various parts of the world. Clearly, all of this growth will not materialize, but enough of it will to cause major headaches for the world?s financial community, as well as for our LNG industry.

7. Lower LNG facilities and transportation costs, coupled with excess gas supplies, are creating serious pressure on LNG prices in the Region. This trend is expected to continue into the near future. Lower prices will mean lower project returns and will challenge the industry to find ways of innovative financing to support construction of these facilities.

8. Increased competition as more suppliers enter the market is creating pressure to change the classic terms and conditions of LNG sales and purchase agreements, in particular the requirements for increased flexibility with supplies. In the early stages of the industry, take-or-pay contracts were the fundamental provision of any contract and were an absolute given for serious consideration of any project. As the industry has matured, more suppliers have come into the industry as well as new buyers; it has become apparent that take-or-pay contracts would preclude many projects from proceeding and appropriate adjustments have been made for the buyer?s benefit that have offered both flexibility on delivery scheduling and comprehensive escape provisions in case of lower demand; in other words, the supplier now has to accept part of the market (volume) risk as well as the price risk. Maybe the day will come when the buyers will accept more and more of the price risk as well.

Finally, what do all of these trends mean for our industry, particularly in the Asia Pacific Region? In a word, uncertainty.

1. Massive capital requirements to fund projected growth opportunities will require creative and innovative concepts. How, for instance, will you finance an LNG train or trains over a five year period and compete on price with an incremental expansion? How can you finance a ship over 20 years, to minimize transportation costs, with only a 5 to 10 year contract to support its service? When will suppliers and buyers be able to agree on the flexibility to use LNG vessels in backhaul arrangements to further reduce transportation costs? These and other questions must be answered if the industry is to satisfy the appetite for gas.

2. What role will the buyers play in future arrangements with suppliers? As pressure on lower prices and increased flexibility in contracts mounts, the classic arm?s length isolation of supplier and buyer characteristic of the old contracts will no longer be possible. Financing will be more difficult; project returns will be increasingly marginal and the buyers will have to enter into more ?partnership? type agreements with the suppliers in order to satisfy the economics across the entire LNG chain.

This means more upstream ownership of reserves by buyers and more downstream ?participation? in market income streams by the suppliers to offset marginal economics pressed on the parties because of price and flexibility requirements. It means the possible creation of buyer consortiums or supplier consortiums in order to spread the risks. In many ways, the marriages between buyers and suppliers will be even more impossible to break. How will these agreements be structured? How will the different risks be assumed and mitigated by both parties as they now have economic interests in different aspects of the business? Real challenges for those of you who want to succeed in this brave new world.

3. The classic economic definition of a buyer?s or seller?s market will now ? more than ever ? be meaningless, if ever they did have a meaning in the LNG industry, as supplier and buyer partnerships are created across all aspects of the gas business, from upstream to final markets. Unless prospective buyers and sellers can successfully forge such partnerships, ?markets? as such will not be meaningful, until the day comes when all gas ? like it is in the U. S. ? is sold as a pure commodity, where price alone controls access to the market.

I have attempted to identify just a few of the mysteries that face our industry as it goes into this new phase of business. No doubt those of you still in the game have other concerns or observations that I have not even thought of. (*)