Small-Scale LNG Business Is Viable; The Norwegian Experience.

Dr. Eric Jarlsby, a Norwegian energy consultant based in Stavanger, says small-scale LNG business in limited markets has proven to be viable, citing the experience of Norway in this field. The following are excerpts from a paper he presented to the IRAEE international conference, Energy & Security in the Changing World, held in Tehran on May 25-27, 2004, in a session on LNG and GTL chaired by APS Energy Group President Pierre Shammas (excluding many images, figures and graphs).

1. Introduction: "This paper reviews the concept of small-scale LNG distribution...being developed in Norway. A conceptual framework for the paper is drawn from the field of competitive strategy, in that natural gas is described as a product that has a competitive domain and faces certain challenges in competing for a share of the total energy market.

"Subsequently, current developments in small-scale LNG distribution in Norway are reviewed in terms of what has been done, the economic rationale and observations to date. It is shown in generalised terms how the concept of LNG-based supplies can lower barriers to market entry and competition for natural gas, with a view that observations from Norway may be of interest also in other parts of the world.

2. The global competitive domain of natural gas: "Natural gas has for a number of years been a favoured fuel for the world. Its share of total energy consumption has risen steadily over the years, and reached 24.3% of global primary energy consumption in 2002...

"Natural gas as a share of total energy consumption lags behind in the Asia Pacific region, and particularly in China with a gas share of only 3%. In contrast, Iran covers more than 50% of its energy needs with natural gas, according to BP's statistics. Large differences exist also between two European nations which both are rich in natural gas:

"The Netherlands, with nearly 40% of energy needs covered by gas; in contrast to Norway, with only 8%. Even this modest figure for Norway overstates the use of natural gas in the ordinary sense, since most of this gas is used to power offshore oil and gas production as well as to feed one large methanol plant.

"When considering the reasons for these large differences in natural gas use, the issue of reserves inevitably comes to our mind. Natural gas reserves are not equally distributed around the world, and this is a quite obvious explanation for the big difference seen between the Middle East and the Asia-Pacific region, and between Iran and China. However, the differences in relative use of natural gas must have other reasons besides differences in reserves. Consider that the reserves of crude oil are more unevenly distributed in the world than those of natural gas, when related to energy consumption in various regions, while exhibiting much less variations in energy market share than does natural gas.

"Two supplementary explanations are offered for why the relative use of natural gas varies so much across the world. First, the different competitive position of gas compared to oil for final applications; and second, logistical barriers.

"...First, energy is needed for transportation. Second, we need energy for providing the hot and the cold for productive purposes and for our personal comfort. Third, we need energy to obtain light and to run all the electrical equipment that modern life has become so dependent on. These three basic applications usually require energy to be delivered in quite different forms... Natural gas has the unusual property of being both a primary energy and an end-user product, requiring only little processing on its way from the reservoir to the kitchen... The energy product upstream has a larger role in meeting the energy application downstream.

"There are three major forms of energy which provide to the final applications: Oil products, natural gas and electricity. Traditionally they are marketed by three different sets of companies, so that the competition between energy products is usually also competition between companies. It is therefore relevant to describe the position of natural gas in the energy markets in terms otherwise applied to competition between companies, as is done in the present paper.

"In end-user markets, natural gas competes with oil products and electricity, and to a lesser extent with renewables and district heating. From a competitive point of view, both oil products and electricity enjoy the advantage of having large segments of application in which they have been the dominant energy product right from the outset. Electricity has no substitutes when it comes to turning on the lights, the computers and the vacuum cleaners. The oil products strongly dominate the markets for transportation fuels, although there are attempts to provide alternatives in the form of natural gas and electrical batteries for vehicles.

"Such favourable access to a large market for energy applications is an advantage that natural gas never enjoyed. There are no end-user energy applications that can be served by natural gas only, or where natural gas has had a dominant position from the early developments of such applications...This puts natural gas sellers in a position of having to challenge other - and usually more established - forms of energy in order to gain market entry and market share.

"The demand for heat as an energy application includes heat for production purposes, cooking and to warm buildings, for those of us who live in climates where this is often necessary. Generating heat is the predominant end-user application for natural gas. Using natural gas for generating heat has many advantages, and is often promoted by national authorities for environmental and other reasons. Here, natural gas faces competition from oil products, renewable fuels, coal and even electricity.

"The competitive challenge for natural gas is augmented by the fact that the demand for heat tends not to grow in many parts of the world. The World Energy Outlook by the lEA (2002) projects increases in global primary energy demand of 1.7% annually over the three first decades of this century. They expect energy demand for transportation to grow faster than the overall demand for energy, and they also expect the demand for electricity to grow faster than overall energy demand. This leaves the demand for heat to grow less strongly than overall energy demand, which has indeed been the case for some time already in the OECD area. That again poses a challenge for natural gas, which primarily caters to this demand that provides little or no growth.

"Why is the demand for heat not growing? There are two important reasons applicable to much of the OECD area. First, industrial production is stagnant. It is the service sectors of our economies which tend to grow, not the energy intensive industries. This puts constraints on demand for energy for industrial steam boilers and other forms of heat used in production. Second, buildings are becoming more efficient in terms of heat requirements and temperature management. This is an area in which large energy efficiencies can be obtained without requiring major developments of new technology. The European Union amongst others has recognised this, and issued a directive on the energy performance in buildings. Measures taken in this respect can have considerable effect on energy consumption. However, energy savings will obtain gradually over a large number of years, since buildings have a long life and improvements are usually applied to new buildings and major refurbishments... Cooling is usually provided by installations which run on electricity, not natural gas.

"The lEA in its World Energy Outlook (2002) expects natural gas to be the fastest-growing fossil fuel, doubling overall gas consumption between 2000 and 2030. This may seem a bit odd, as natural gas primarily serves the category of final energy applications which shows the least tendency to grow.

However, the lEA expects over 60% of that increased gas demand will go to power generation, which is not a final energy application. Just as with the heating and cooling segment of energy demand, the electricity generation sector will accept gas as its fuel only in competition with a number of alternative forms of energy.

"From the viewpoint of energy efficiency, there are pros and cons to the increased use of natural gas for electricity generation. On the positive side, gas is a more efficient and less environmentally burdensome way of generating electricity than most of the available alternatives. On the negative side, using electricity to provide for final applications is usually less efficient than using natural gas directly, where this is a viable alternative. It therefore remains an important challenge for the providers of natural gas to gain competitive advantage against other forms of energy in the markets for final energy applications.

3. Recent LNG developments for domestic supply in Norway: "Entry barriers are an important factor in competitive advantage. The remaining parts of this paper will address entry barriers facing natural gas as a product seeking market entry, and how they are being dealt with in Norway. The developments were designed to address particular challenges in that country, bearing in mind that circumstances are different elsewhere.

"It is however believed that the experiences being gained in Norway can have relevance also for other parts of the world, in particular where traditional, pipeline-bound transportation will be costly and natural gas will face strong competition from more established forms of energy.

"Due to the developments of offshore oil and gas fields, there are a few locations in onshore Norway where large natural gas pipelines are located. Typically, these pipelines have been installed only in order to bring natural gas onshore for processing and re-exporting to the larger markets in Continental Europe. Therefore, the large pipelines only cover short distances onshore near the western coast, and do not form an integrated onshore grid. However, they provide the opportunity for taking out some gas and distributing it locally.

"An LNG production plant which has been installed near one of the major export pipelines...has been operational since May 2003. It can produce 60 tonnes of LNG per day, corresponding to 75,000 standard cubic metres. In other words, this is not a large system in terms of gas quantities. Deliveries from the terminal are made by tanker trucks, which are super insulated to keep the gas liquefied at -162 deg C. A truckload is 50 cubic metres of LNG, or 30,000 standard cubic metres of gas.

"One of the locations to which (trucks) may deliver is a receiving terminal for LNG, located in an industrial park some 100 km from the production plant. The tank capacity for this particular terminal is 80 cubic metres, corresponding to 50,000 standard cubic metres of gas. The- 3 - tanks also come in sizes both larger and smaller than this...(A) vaporisation unit...is used for transforming the liquid cold gas to ordinary gas at ambient temperature, so that the customers will receive natural gas in normal gaseous state by a small local pipeline grid. The vaporiser takes heat from the surrounding air, so that no commercial energy normally is needed in order to re-heat the cold gas.

(A figure shows the process of installing the tank of a receiving terminal at another location, where the main gas customer is a factory for pet food. Another figure shows an important component of the small-scale LNG distribution system. This is the smallest LNG tanker ship in the world, and was delivered in early 2004. The cargo capacity is 1,000 cubic metres of LNG, so 600,000 standard cubic metres of gas. The large ocean-going LNG vessels are 100-150 times as large as this in terms of cargo capacity. This small vessel is built for a rather different purpose, which is to make small deliveries at coastal locations that cannot be easily reached by pipeline. The terrain showing in the background gives an indication why this is the case).

4. Natural gas as a new component of the national energy system: "Norway is rich in energy resources, particularly oil and gas. With an oil production in excess of 3m b/d and a population of only 4.5m, it is one of the world's major oil exporters. There are also several large pipelines exporting natural gas to other European countries. Oil and gas have been produced since 1971, but only offshore.

"The other big energy resource is waterfalls, which has provided electricity for more than 100 years now. The abundance of this resource has lead to a relatively high consumption of electricity in two ways: First, for certain types of industrial production which require lots of electricity and where cheap access to it was decisive in locating those industries. Aluminium production from bauxite ore is an example. Second, electricity is used extensively for space heating in buildings in a way which is not common elsewhere in Northern Europe. Most houses built after 1970 rely on electricity for heating and don't installations for using heating oil or gas.

"The problem for Norway now is that electricity demand is outgrowing production. The rate at which this development takes place is hard to pinpoint precisely, because climatic conditions can cause quite large annual variations in both the production of hydroelectricity and the demand for space heating. Unfortunately these variations in precipitation and in electricity demand are not positively correlated, leading to large swings in net export or import requirements. Large water reservoirs and international transmission lines help absorb these discrepancies. As demand for electricity keeps growing relative to production capacity, there is the increasing danger of overextending the system and of large price fluctuations, as happened during the winter of 2002/2003. Opportunities for developing further hydroelectricity resources are limited and controversial due to environmental considerations...

"There are three small LNG production plants on the western coast, two of which started production in 2003. A number of small receiving terminals have been established, so far relatively close to the production plants. Marketing efforts are likely to result in receiving terminals being established also in the south east, where the largest concentrations of population and industry are found. Independently of the LNG system, local gas pipeline grids have been established around two towns in the south west.

"Plans for the future relate to the large export terminal for LNG which is planned in the far north. As a side benefit, the terminal can also provide the opportunity of making some LNG available for distribution in Norway and the neighbouring Nordic countries. Intentions have been announced by Statoil...of developing a coastal supply system with somewhat larger LNG ships than the one that exists, probably with 6-8000 cubic metres of cargo capacity. This would be accompanied by the establishment of larger receiving terminals along the coast of Norway and other Nordic countries.

5.Development of coastal shipping as an application for LNG: "There are currently three modern vessels in operation in Norwegian coastal waters which are powered by natural gas, albeit with the facility of alternatively being powered by diesel. The vessels are one passenger ferry and two supply ships for offshore oil and gas operations... There are plans for building more and larger passenger ferries for natural gas fuels.

"The propulsion systems for these ships are of the diesel-electric or gas-electric type. The actual propulsion power is provided by an electric motor which is powered by a generator and internal combustion engine running on natural gas or diesel. The ships have been operational for some time now, and with good results...

6. Small-scale LNG distribution - the economic rationale: "As an alternative to gas pipelines, an LNG-based gas supply system offers three basic advantages:

(1) Limited investment costs for small capacities;

(2) Locational flexibility;

(3) Storability.

"These advantages must be considered against some basic disadvantages of such a system compared to pipeline supply:

"On the basis of projects completed in Norway, investment costs for small-scale LNG production capacity can be indicated at US$ 20m per 100 tonnes (125,000 standard cubic metres) of daily production capacity. This would include its power generating capacity for the plant's requirements based on the available gas feed, LNG storage capacity for one week of production, and truck trailers for road transport.

"Complete receiving terminals with about 100 cubic metres of tank volume, holding 60,000 standard cubic metres of gas, cost in the order of US$0.5m.

"Tank volume and vaporiser capacity are the main cost-driving variables in receiving terminals. Indications are that scale economies in building bigger production plants and receiving terminals are not large.

"With an LNG-based supply system, therefore, the capacity to supply a limited quantity of natural gas across a distance can be established at a modest cost, where a gas pipeline would be much more costly.

"However, this advantage applies only as long as the quantities to be supplied are relatively small. Gas pipelines have the advantage that the total supply costs have little sensitivity to the volume to be transported, provided that the appropriate decisions on capacity are made during the project planning stage.

"LNG systems are different in this respect, for which reason LNG tends to be an appropriate solution for intra-regional distribution only as long as quantities are fairly small...

"LNG-based supply systems are clearly less cost sensitive to transportation distance than pipelines... An LNG-based supply system is therefore much less constrained in terms of geography than is the case for pipelines.

"Although constructed as permanent facilities, the small LNG receiving terminals...consist of equipment that can be relocated if requirements change. Some 70-80% of gross asset value can be recovered and put to alternative use.

"The storability of gas as LNG is useful for two reasons: First, gas needs to be stored onboard vessels if it is to be used as a transportation fuel. Alternatively, gas can be stored in a pressurised state (CNG), but LNG is the better storage method in terms of compression ratio and the weight of storage vessels.

"Second, an LNG storage can have a peak shaving function. This is not a strong consideration in Norway at this time, but is an important function of LNG plants elsewhere in the world, such as the Glen Mavis plant outside Glasgow, Scotland.

"The suitability of LNG supply systems for serving modest and widely dispersed demand at affordable investment cost is an important factor in lowering entry barriers into the natural gas sector. There are two separate aspects of this: First, barriers against establishing natural gas supplies in a region are lowered, with particular relevance for markets where sales are expected to grow slowly.

"Slow sales growth must generally be expected where natural gas enters a regional market for heat, and where more traditional fuels are already well established.

"Second, LNG lowers barriers to competition, by making it feasible for several suppliers of natural gas to compete for sales in a region, without being dependent on third-party access to pipelines. In certain locations in Norway sales contracts for natural gas have been made on the basis of LNG even where a gas pipeline grid is available.

"...The attractiveness of LNG...is to provide the opportunity to avoid committing large investment funds against sales in a distant and uncertain future. Decisions are staged and flexible, which reduces overall financial risk in this development.

"An LNG-based supply system creates real options, by leaving considerable optionality in whether and when to move to the next steps in developing the system... The system evolves from small-scale LNG supplies on truck towards an integrated pipeline system.

"No commitment to a future pipeline has to be made upfront, and it is an equally feasible outcome that the system will not move beyond gas being supplied in bulk as LNG.

7. Observations from Norway to date: "Although two of the existing three LNG production facilities have been in operation for less than 14 months, some observations can be made, which may be of interest also for considering such schemes elsewhere.

"First, it is observed that natural gas supplied as LNG can be a competitive fuel against alternatives, when investment returns of a normal commercial level are required. There is some dependency in this on the extent of taxation on the various energy products.

"In Norway, liquid fuel oils are subjected to taxation that is not applied to gas, which is justified on environmental grounds. Also, LNG will be competitive for some applications and not others. Very small customers are likely to be better served with LPG than LNG. Industries which have sharp variations in energy demand, as for instance some processors of fish caught seasonally, may be better served with heating oils than with LNG.

"Second, there is a potential for moving down the learning curve to reduce costs. Small scale LNG distribution takes place in several countries besides Norway, but is not a large segment globally.

"Suppliers of LNG-related equipment have been companies which otherwise supply other refrigerated gases for industrial purposes as well as equipment providers for LNG tanker ships. The early projects in Norway have required significant effort in developing relationships with equipment suppliers and adapting solutions to requirements.

"Third, in spite of being small, the market for natural gas has shown to be competitive where LNG is an option. It happens not just as a competition mainly on price for a well defined product, as may be the case in markets for gas and electricity carried on commonly accessible infrastructures.

"Sellers of natural gas supplied as LNG compete on the basis of value chains that are backward integrated, comprehensive and unique, and they can bring different sets of competencies into the marketplace.

"A certain rivalry can be seen between two alternative models for organising the natural gas sector. One alternative is to develop one or several companies which specialise in gas and operate on a national scale, or wider.

"Another alternative is to develop gas sales as an added business to the established regional energy companies. These firms are traditional suppliers of electricity owned by cities of regions, which have recently redefined themselves more broadly as providers of energy, infrastructure and sometimes telecommunications. They are historically accustomed to occupying a position of dominance and community service within their established domain, and it is not surprising therefore that they seek to secure dominance also of the gas business that might develop in their region.

"Fourth, there is a certain impatience in parts of the political community that developments in downstream gas tend to be slow if left to commercial players alone.

"The issue is augmented by the introduction of ED rules for third-party access to infrastructure, which is seen by many as a discouragement to such investments.

"An agent of the government is currently reviewing applications for support funds meant to encourage investments in infrastructure, primarily LNG terminals.

8. Conclusions:

"Two main points are made in this paper, both of which relate to the competitive position of natural gas in the wider array of energy on offer.

"More than other forms of energy, natural gas has to compete for its share of global energy. This share varies strongly between nations and regions, indicating a large potential for natural gas use to increase in some countries. However, natural gas faces competition from other, well-established forms of energy in all its applications, and it has its main applications within a segment of energy use which exhibits much weaker growth than energy use overall.

"The approach to supplying natural gas as small-scale LNG which has been reviewed in this paper, can have interesting implications for some regions in which natural gas may be introduced. It is designed to overcoming entry barriers stemming from logistical challenges, slow demand growth and uncertainty about the future potential.

"Small-scale LNG is flexible, can cover widely dispersed demand at modest investment cost, is suitable to relatively small volumes of gas, and allows for competition. It can work either as a market-opener to be replaced with pipeline supplies when the appropriate level of demand has been reached, or as a long-term but adaptable solution to supplying gas".