The LNG Business For Iran & China - The Challenges & Rewards.

The following are extracts from a presentation by APS Energy Group President Pierre Shammas made to the Iran-China Co-operation Conference held on Kish Island, Iran, on Feb. 18-19, 2006.

Introduction: "...The China-Iran connection covers a whole spectrum of economic activities - dam-building, steel mills, ship-building, transport and dozens of other projects, and energy. More than 100 Chinese firms are involved in Iran, also co-operating to develop ports, jetties, airports in six cities, mine-development projects and, of course, oil and gas. Trade between the two countries in 2005 hit a new record of US$9.5 billion, compared with $7.5 billion in 2004.

"...[One] example of the huge rewards of China becoming the world's largest importer of LNG: It will have already developed itself as the largest and most competitive ship-builder in the world. Another example: It will have already developed itself as the world's largest consumer of clean gas and liquids from its own coal reserves. China's coal reserves are the third largest in the world next to those of the US and Russia.

"Iran and China may note that in promoting its shift to natural gas and its two LNG ventures - Oman LNG and Qalhat LNG - the sultanate of Oman had a gas development strategy based on three models adopted in the 1990s:

"(1) the model of Trinidad and Tobago (T&T), whose main challenge was high unemployment and needed new jobs for its nationals out of an expanding gas sector and gas-based industries, as well as jobs for Omanis in LNG maritime shipping - a sector which is acutely short of manpower on both sides of Suez, and Omanis are being trained in this field, taking into account Oman's history as a maritime shipping empire, hence the importance of Oman Shipping Co. (OSC) having its own LNG tankers and developing all-purpose fleets;

"(2) the model of Indonesia, whose priority was to generate foreign exchange earnings first to support LNG exports, followed by converting gas into chemicals; and

"(3) the model of Pakistan, whose priority was to develop a domestic market for natural gas, rather than the Dutch model which led to the Dutch disease; and in this particular respect Oman deserves special praise.

"LNG is natural gas cooled down to -162C, at which temperature it contracts into a liquid, which can be carried in tankers and delivered around the world, anywhere there are LNG-receiving/regasification terminals. These turn the liquid back into gaseous form for industrial use, feeding it into pipelines for distribution.

"Liquefication allows a vast amount of the gas to be transported in a single cargo. Methane, for instance, is 600 times less voluminous as a liquid than as a gas, so one shipment by an ultra-large tanker is the equivalent of almost 5% of the gas consumed in the US on an average day.

"LNG and other gas-to-liquid (GTL) fuels, transported by sea, allow producers to bypass the pipeline constraints which have traditionally tied natural gas within regional markets and provide an immense boost to globalise some of the trade in world gas production.

"Gas is an attractive alternative to oil or coal for another reason: the environment. Gas is the cleanest burning of the fossil fuels and is finding increasing favour globally in the struggle against the harmful emissions of greenhouse gases.

"Over the last 20 years, natural gas consumption has grown by more than 50% and is now the primary choice for power generation. More than half of the power stations operating around the world are gas-fired.

"The constantly rising demand for electricity around the world has spurred the expansion of the LNG industry. Indonesia is the world's biggest LNG exporter, but its capacity has declined in the past two years from a peak of 30 million tons per annum in 2004. Qatar, which has more than 910 TCF, the world's third largest reserve after Russia and Iran, is planning to take the lead by 2014 or before by raising its LNG export capacity to about 83 million tons/year. That will be equivalent to 2 million b/d of crude oil.

"The natural gas industry will have a far-reaching impact on the world economy, bringing new opportunities and risks, new inter-dependencies and geo-political alignments. Some analysts anticipate that the new interests and inter-dependencies brought by the LNG trade will bolster relations between producing and consuming countries.

"Others, however, worry that it will only lead to dependence on imports for yet another key commodity, which will create vulnerability to deliberate machinations, political upheavals, or economic problems. In a world as uncertain as the one we live in today, with the potential for widespread political and economic upheaval in the Greater Middle East, such concerns carry some weight. One can well envision scenarios in which the future large LNG exports could be subject to some kind of interruption, even if only short lived.

"The best response to such security concerns is to develop the global LNG business and ensure that ample supplies come from many countries. Encouraging LNG projects in various countries is a safeguard against undue dependence on too few ventures. The key to expanding and globalising LNG trade is through short-term deals - mainly spot market transactions during peak demand seasons. Spot trade depends of surplus LNG. Most trains built since the 1980s have been de-bottlenecked to produce surplus LNG. There are now about 14-15 million tons/year of surplus LNG trading on spot or short-term basis worldwide.

"Short-term LNG allows some countries to start this business on a small scale in the initial years and then, after gaining experience, to expand their intake/regasification capacity as local demand for natural gas grows. The key to spot and short-term LNG trade is the brand LNG business. This means LNG coming from any source or sources and depending on its supplier company. Shell International Gas, a leader in the LNG business, has pioneered the brand LNG business, starting with the Shell-led North West Shelf (NWS) venture which it leads. There, Shell has managed to produce surplus LNG and sell it in any market on CIF basis with the liquid methane carried by its own tankers. It has sold NWS LNG to as far a market as Turkey or Spain. Shell now has surplus LNG for its brand LNG business from various parts of the world, including Nigeria and Oman.

"All the major players in this business have developed their own brand LNG trade, such as BP, ExxonMobil, Total; trading companies such as Mitsui, Mitsubishi and Itochu of Japan; gas/power utilities, such as Gas de France, Osaka Gas , Union Fenosa Gas (a 50-50 UF of Spain & ENI of Italy), etc.

"LNG is non-toxic, non-reactive, environmentally friendly, and easy to transport. It is economically viable. LNG is a flexible pipeline as it can go anywhere you want.

"In 2002, only 12 countries shipped 5.4 TCF/year of natural gas - and that was equal to 113 million tons/year of LNG - to 12 LNG-importing countries, up from less than 4 TCF/year - about 84 million tons/year - shipped in 1997. LNG trade accounted for about 6% of world natural gas consumption and about 26% of total international natural gas trade in 2002.

"In 2004 the volume of seaborne trade in LNG was 129.9 million t/y. Of this, short-term and spot trades accounted for 15.5% (21.13 million tons/year) in 2004. Short-term or spot trades in LNG in the first quarter of 2005 rose 10.1% over the first quarter of 2004.

"World demand for LNG was strong through most of 2005. If the same 10.1% rate of increase in total seaborne trade of LNG occurred in the other three quarters of last year, then the 2005 volume of world LNG trade would have risen to more than 131 million tons/year.

"In the late 1950s and early 1960s I happened to be personally involved in the world's very first phase of LNG business development, and that was in France, in Italy and in Algeria. (The world's very first phase of LNG development as a super-cooled methane occurred in USA and that was...in the 1940s, but an explosion ended that experiment). When it was taken up in France, I was hired as a translator and I had to know whatever A to Z in LNG had been developed by then.

"Methane transported to distant markets must be super-cooled to liquid form and pumped into specially designed tankers, then warmed back up to its gaseous state at a receiving terminal before being piped to the user. LNG can be used in its liquid form as well and Japan has the most advanced technology in that respect.

"Except for a few academics on retainer at the more backward energy companies, virtually no educated scientist disputes that the earth has grown warmer over the last few decades - largely as a result of increasing atmospheric concentration of carbon dioxide produced by the burning of fossil fuels.

"The carbon lodged in the atmosphere over the last 150 years has already taken a toll: disappearing glaciers, a thinning Arctic icecap, dying coral reefs, increasingly violent hurricanes. Here I point to the fact that most of the oil refining capacity in USA is concentrated in regions exposed to hurricanes, and no new grassroots oil refinery has been built in USA since 1976.

"Even so, given robust political leadership and technological ingenuity, the worst consequences - widespread drought and devastating rises in sea levels - can be averted if society moves quickly to slow and then reverse its output of greenhouse gases. This will require a fair, cost-effective programme of carbon controls at home and a good deal of persuasion and technological assistance in countries like China, which is building old-fashioned, carbon-producing coal-fired power plants at a frightening clip.

"Every spring, a thick yellow cloud travels north from China to cover a major part of Japan. This cloud is getting darker and more dangerous to the health of people breathing the air under it. The risks of cancer have risen, in Japan as well as in China. LNG is one of the answers to this problem in China.

"LNG is extremely complex to transport, requiring an elaborate system of cooling plants near gas deposits, double-hulled tankers and reheating facilities in the markets where the fuel is consumed. Because its coastal sea waters are mostly shallow, China can develop extra-large, barge-like tankers to take LNG with each ship having the capacity of more than 250,000 CM. The cost of shipping the LNG from distant sources to China can thus be reduced. This is just one idea I am proposing for the Chinese side.

"In Iran, Shahbahar can eventually become the centre for a capacity of more than 100 million tons/year of LNG within 20 years of steady construction work to grow from one venture to another. This capacity can be built by as few as five mega-ventures, with each to have a 20 million t/y potential out of three trains - or four larger trains. Such mega-ventures will involve such partners as some of the world's biggest players - international oil companies (IOCs), trading giants, gas/power utilities, and even Chinese provincial governments. Thus Iran can become the world's largest exporter of LNG - depending mostly on the markets of China, India and other Asian nations. If there is time I will explain the background of Iran's Kalingas project, which was to provide the US East and West Coats with LNG, and the Japan Kalingas project which was to depend on the Japanese market. The whole Kalingas/Japan Kalingas programme was cancelled at the beginning of the Islamic Revolution in early 1979. I was involved in that programme and I can explain it as it can serve for a similar programme for Iran now and through the coming years.

"Shahbahar can also become a world gas to liquids (GTL) export centre. Qatar wants to develop such a centre. But Shahbahar is a far more attractive place, potentially, than any inside the Persian Gulf. This is not only for security reasons, but for many other opportunities being offered outside the Strait of Hormouz.

"LNG gas is largely used to generate electricity. GTL, on the other hand, provides an alternative to oil as a transportation fuel. The GTL process transforms natural gas into diesel and other liquids which can be transported and sold using existing tankers, refineries and fuel stations. Diesel is much more commonplace in Europe than in the US, where consumers still think of it as a major polluting fuel for cars.

"Two German scientists, Franz Fischer and Hans Tropsch, developed the GTL process in the 1920s after first discovering a way of converting coal into a liquid fuel. GTL plants become competitive when crude oil prices climb above $25 a barrel, as they have in the last four years. And GTL producers contend that the fuel might attract a premium in countries looking for alternatives which reduce toxic diesel emissions. A report by the California Energy Commission has recommended blending GTL with existing fuel stocks to meet stringent fuel standards. One key aspect of the fuel is its low smog formation. Using GTL technology for consumer-friendly fuel is new. Methods of producing it have already gone through several incarnations.

"Germany during World War II developed methods to convert coal gas into synthetic fuel for its army. Decades later, apartheid South Africa adapted methods to convert coal, which was plentiful, into liquid fuel to survive economic isolation. The US flirted with the method after the oil shocks of the 1970s, but eventually withdrew most funding of synthetic fuel research when oil prices fell.

"Then, breakthroughs enabled companies to use cleaner-burning natural gas instead of coal to produce a fuel which emits far fewer pollutants than diesel made from crude oil. This gas-to-diesel fuel currently amounts to a minuscule portion of the overall global fuel production, with Shell operating the largest such plant in Bintulu, Malaysia, a pilot facility with an output of about 14,700 b/d. Total world oil production, by comparison, is almost 85 million barrels a day.

"GTL projects are taking off in Qatar above all for one reason. More than any other gas-rich country, Qatar has aggressively seized on new ways of monetising its natural gas. And its model is likely to be studied in a world which has more natural gas than oil, with global gas reserves expected to last 67 years compared with 41 years for crude oil.

"...We begin the LNG venture first by identifying and then proving the location, type and geological age of the reservoir or reservoirs, and the size and chemical composition of the reserves of natural gas which must be devoted for this venture and, at the same time, the market which is to consume this gas.

"Evidence of the size and chemical composition of the recoverable reserves devoted for this venture must be provided by an independent specialist firm whose report is easily bankable on either side of Suez, with the reserves to be proven sufficient at least for the first 25 years of the venture's life.

"By then the owner of the reserves and the company or consortium promoting the LNG venture will have formed a partnership company to pursue the project. This could either be an integrated upstream/downstream venture, which means the partnership company will be involved in the gas exploration and production (E&P) phase and the liquefaction and transportation phase, or be simply a downstream phase.

"The seller, i.e., owner of the reserves and the partner company will have to choose between selling the LNG on fob-Iran basis, which means responsibility for the maritime transport of the liquid methane falls on the buyer, or selling it on CIF-China basis which means the tankers will have to be provided by the seller venture. All these matters will have to be agreed upon and to be proven easily bankable at the early phase of the venture.

"By the time such a JV company has been formed, the buyer of the LNG will have been identified - as least, if not brought in as firm client committed to purchase the LNG under take-or-pay (ToP) clause. Such identification will have been made in a memorandum of understanding (MoU) or a letter of intent (LI), which is the first step before the buyer signs the final LNG sales and purchase agreement (SPA).

"The parallel - in many cases the most crucial - step is to select the liquefaction technology and secure its provider and, at the same time, secure the buyer of the LNG. All elements of the venture, from the allocated gas reserves to the liquefaction technology, its provider, the tankers and the buyer of the LNG must be easily bankable on either side of Suez.

"The bankability of any one of the elements of the LNG venture, from ownership of the allocated gas reserves to the final delivery of the re-gasified methane is a must from the very beginning of the venture. Qualified banks will have to be involved first as bidders for the contract to advise the venture's promoters on the way the financing of their project should be structured. No bank will ever finance any element of the LNG venture, be that the gas E&P phase down to the final delivery of the re-gasified methane, unless all the other elements have been proven to be bankable.

"This is not only because of the capital intensive nature of the project but also in view of the liquefaction technology chosen by the venture's promoters. The buyer company, be that an electric power utility or a gas supplying firm or a metal industry, will never commit itself to a firm SPA under the ToP clause unless it has accepted the liquefaction technology. This is because the LNG receiving and re-gasification terminal will be based on the same provider of the technology.

The Choice of Technology: "Selection of the liquefaction technology, or process, is one of the basic elements of the LNG business. The American company Air Products (APCI) is rated as the number one provider of liquefaction and re-gasification processes. This is the process of choice for most electric power and gas utilities which buy LNG on long-term basis. The APCI's propane pre-cooled mixed refrigerant cycle process is one of the most advanced technologies for venture owners to select.

"The choice of technology is so important that partners in an LNG seller venture can occasionally fail to agree on for years. As a result, an LNG venture can be delayed and thus blocked for years. This is what happened to the Nigerian LNG venture (NLNG) when Shell, the venture's technical leader, did not accept a European liquefaction process developed by Technip of France and Snam Progetti of Italy on which Shell's partners Total and ENI insisted for several years. In the end, it was Shell which won in that dispute by getting the APCI process to be used for NLNG. Now NLNG is expanding rapidly beyond its first two trains.

"The next most important element is the choice of the front-end engineering and designs (FEED) contractor. Often the choice is for the technically better - rather than financially cheaper - contractor. Such contractors are limited in number. All of them are qualified engineering, procurement and construction (EPC) contractors, which is the next element. The FEED contractor is important because it will design the infrastructure for the first train in such a way as to reduce the cost of the next trains.

"I will demonstrate the Model of the Spanish Egyptian Gas Co. (Segas) in Egypt: The third largest power utility in Spain, Union Electrica Fenosa (UF) in June 2000 signed a 25-year gas purchase agreement with the state-owned Egyptian General Petroleum Corp (EGPC). This was sealed at a meeting in Madrid between Egyptian President Hosni Mubarak and then Spanish Premier Jose Maria Aznar. It was the first LNG venture leader in Egypt to sign the EPC contract in late 2001. The winner of the $1 bn EPC job was a JV of Kellogg Brown & Root of the US, JGC of Japan and Tecnicas Reunidas (TR) of Spain. TR was a beginner at the source end of the EPC business. It joined the JV on the strength that the project's leader was a Spanish firm and it wanted to gain experience in this through the Segas venture.

"The EPC job covered the first of two 5 million t/y trains in Damietta, based on APCI's propane pre-cooled mixed refrigerant cycle process, and the infrastructure to reduce the cost of the next train. The first train came on stream in late 2004 and the first shipment left Damietta in January 2005. That was months ahead of schedule.

"The lead time for Segas was a little more than four years. The lead time for UF, from when it decided to go for the Segas venture until the first train came on stream, was more than six years. This was still relatively short, because the lead time for NLNG in Nigeria was more than 30 years.

"Damietta, Egypt's second most important trading port where a free industrial zone is growing rapidly, lies at the eastern end of the Nile Delta, about 50 km north-west of Port Said. The $1.4 bn Segas, the first to export Egyptian LNG, is a JV between EF's gas unit UFG (80%), EGPC (10%) and Egas (10%).

"Construction of the first train was completed months ahead of schedule in August 2004 and test operations were conducted in September. But plant operations were delayed due to feed-gas pressure and specification problems. There were problems with onsite power generators, which required Segas to carry out a phased shutdown of the plant to replace control elements.

"The shutdown was timed with the arrival of new equipment. But the Segas partners were all happy as the prices of gas and electricity in Spain and other markets were rising sharply before the train began delivering LNG.

"Once the LNG is regasified at the Spanish receiving terminal, the gas is fuelling UF's power plants in Spain. UF's 50% partner in its gas unit - Union Fenosa Gas (UFG) - is ENI of Italy which bought the stake in early December 2002. UFG has become a player in the fast-growing Spanish market for natural gas.

"The first LNG shipment, 138,500 cubic metres, left Damietta aboard the tanker Cadiz Knutsen in the third week of January 2005. UFG had signed a 25-year SPA with Segas to take 3.2m t/y of LNG from the first train. Segas has secured short-term buyers of the remaining 1.5m t/y of the LNG output including the US market, with the US spot price at times having risen to $15/m BTU.

"In 2005, Segas sold 0.8 BCM of LNG to the US, a volume which in 2006 was to reach around 1 BCM. UFG in late 2004 said it expected to fill 34 LNG tankers from Damietta in 2005. Most of the gas was destined for industrial clients in Spain.

"UF, with no previous experience in the LNG business, has been advised and represented in the Segas project by Foster Wheeler of the US. Two competing FEED studies were done in 2001 by MW Kellogg Co. of the US and Chiyoda Corp., a JV which bid but failed to win the EPC job.

"Citibank was UF's financial adviser for the project. A consortium led by SN Technigaz, a unit of Bouygues Offshore of France, in September 2001 got a $73m EPC contract to build two 150,000 m3 storage tanks at the 1.2m sq-metre site of the Damietta plant by mid-2004.

"UF ordered two 138,000 m3 LNG tankers, one from Daewoo in South Korea and one from AESA (Astilleros Espanoles) in Sestao, with each having cost about US$155m. The first was delivered in December 2004. The second was delivered in early 2005. UF has also chartered two 140,000 m3 tankers, under 25-year contracts beginning from September 2004, from Spain-based ship owners Marpetrol-Knutsen and F. Tapias.

"UF has a US$240 million LNG receiving/re-gasification terminal built at Sagunto harbour, near Valencia on the Mediterranean. This has a storage capacity of 450,000 m3 and LNG vaporisation capacity of 5 BCM/year.

"UFG purchases the natural gas feed for the LNG plant from EGPC/Egas under a Brent crude oil-indexed pricing formula agreed in May 2004. The value of the natural gas has a dated Brent price cap of $24/barrel. This has guaranteed the profitability of Segas at a time of high gas prices in OECD markets.

"In March 2005 the Cairo government agreed to construction of the second 5m t/y train at Damietta with the signing of an MoU by ENI's Egyptian unit International Egyptian Oil Co. (IEOC), BP Egypt and Egas. Under the MoU, IEOC, BP Egypt and Egas committed themselves to providing the second train with 5.3 TCF/year of natural gas for a 20-year period. The three are also supplying the feed gas to the first train. In a statement ENI said the decision taken with the MoU "will allow access to the market with higher quantities of LNG at production costs even lower than the first train".

"BP said that the exact source of gas supplies for the second train was to be determined during the course of negotiations. Details of the BP-led LNG venture for the second train are to be finalised in the first half of 2006.

"Spain is one of the world's fastest growing markets for natural gas. So UFG is in a premium position to expand in Spain as well as in other parts of the EU market with the help of ENI. Demand for natural gas in Spain in recent years was rising by an annual rate of about 9%.

"Key term customers of Segas other than UFG are BG Gas Marketing (BGGM) of the UK Asian LNG Trading Co. Ltd. (Altco), a subsidiary of Petronas of Malaysia. The parents of these two firms are main partners in Egypt's second LNG venture at the Idku zone, just east of Alexandria (see below).

"Under a five-year SPA with Segas, each of Altco and BGGM has been lifting 725,000 t/y of LNG from Damietta since early March 2005. In September 2004 BG signed with Segas a five-year SPA for 225 MCF/day of LNG from Damietta over four years starting in the first quarter of 2005, plus 150 MCF/day for a further 12 months.

"The gas feed comes from the offshore Scarab/Saffron fields on the West Delta Deep Marine (WDDM) concession held by BG and Petronas, under another five-year accord signed with EGAS. As a result of these agreements, Altco and BGGM have been committed to lift 22 cargoes of 138,000 CM of LNG between 2005 and end-2008. The first cargo was loaded onto a tanker belonging to Altco on March 4, 2005. Some of the cargoes have gone to Lake Charles, Louisiana.

"Petronas has contracted to supply UK marketer Centrica with 3 BCM/year of LNG through the Dragon LNG terminal at Milford Haven in Wales starting in 2007. Until then, each of Altco and BGGM has been taking 725,000 t/y of LNG from Damietta for spot sales to Lake Charles, South Korea and other destinations. These are brand LNG transactions. It shows how far the brand LNG business has spread.