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ACCESS TO GASTHE LNG INDUSTRYS BIG CHALLENGE

Frank Harris Co-Head, Global LNG Wood Mackenzie Edinburgh, Scotland Gavin Law Co-Head, Global LNG Wood Mackenzie Houston, USA www.woodmac.com

ABSTRACT Historically the major commercial challenges in the LNG business have been at the market rather than the upstream supply end of the value chain. In the early years of the industry, securing foundation customers for projects was a key challenge and, in the last two to three years, the difficulties associated with the permitting and approval of regas terminals, particularly in North America, have been seen as a significant obstacle for the major players in the LNG business. However, with the demand for LNG forecast to treble over the next 15 years and the growing presence of the major resource holding National Oil & Gas Companies (NOGCs) in the LNG business, the next big challenge for the major International Oil Companies (IOCs) will be to secure access to upstream gas reserves to feed the next generation of LNG supply projects. The LNG supply landscape is becoming increasingly complex. There are moratoria on new LNG projects in key producing countries such as Egypt and Qatar, continuing problems with gas supplies from Indonesia and the emergence of new players such as Gazprom. IOCs in the LNG business now face a tough choice participate in the development of proven gas reserves belonging to the NOGCs or explore for gas to support new LNG projects themselves. Working with the NOGCs is a relatively safe strategy but competition is intense and returns are coming under increasing pressure, while exploration offers potentially greater returns but comes with significant risks. This paper will examine the upstream LNG supply landscape and the positioning and strategies of the key players therein as they look to secure access to gas reserves. The paper will also consider the potential implications that access to upstream gas reserves has for the balance of power between the NOGCs and IOCs and for the sustainability of growth in the industry itself.

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INTRODUCTION In the first half of this decade the LNG industry tended to focus on shipping and regasification as the big potential bottlenecks within the LNG value chain. There was an implicit assumption that there would always be an adequate supply of LNG available to meet rapidly increasing demand, the problems were going to be building enough tankers to transport the LNG and developing the regasification terminals required to deliver it into downstream gas markets. However, in the last 18 months or so, there has been something of a sea change. The shipbuilding industry has increased its ability to produce LNG tankers through the expansion of production capability at existing yards and the entry of Chinese shipyards into the business. The outlook for the development of new regasification capacity, particularly in the USA, now looks a lot less problematic than it did two or three years ago. While there will always be specific areas of the world in which developing regasification terminals will remain hugely challenging, for example Italy and California, many within the industry are now turning their attention to the previously unthinkable; an apparent excess of regasification capacity in key markets, not least the US Gulf Coast. As a result, the big focus of attention within the LNG industry is now supply. Firstly, the seeming inability of proposed new LNG supply capacity to be developed according to plan, and therefore to keep pace with forecast demand. It seems as if each week brings a fresh news story about delays to yet another LNG supply project. There are a multiplicity of reasons for these delays, ranging from an over-heated market for EPC contractors to on-going geo-political uncertainty. Secondly, there are growing concerns about the removal of gas that had been counted on by the industry to support future LNG developments. Indeed, several key gas exporting countries including Egypt, Qatar and Trinidad now have either explicit or de facto moratoria in place on the development of new gas/LNG export projects, motivated in no small part by a need to retain reserves to support the growing demand for gas in their domestic markets. As a result, many within the industry are increasingly concerned about whether demand will be constrained by a lack of supply, both in the short-term and perhaps more worryingly, in the long-term. People are now openly questioning whether or not the industry can access sufficient gas to support the growth of the LNG business that is built into most participants forecasts. The conventional wisdom that there would always be sufficient LNG supply to meet demand is increasingly being questioned. At the LNG14 Conference in Doha in 2004 much of the informal discussion centred around who would get access to the next LNG project in Qatar. In contrast, almost three years later, a lot of the informal discussion in the industry is about where players are exploring for gas to support new LNG projects. In some cases this exploration is intended to discover and/or to prove-up gas to gain Government sanction for new LNG trains in those countries with moratoria. We characterise this as moratoria-busting exploration. In other cases, exploration is intended to further develop existing LNG plays, Nigeria being a good example, or to underpin potential new LNG plays, as is currently happening in Papua New Guinea. The second half of this paper discusses the implications of and issues relating to LNG-related exploration.

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The last couple of years have also seen the emergence of an additional supply-related concern for the International Oil (and gas) Companies (IOCs). Buoyed by the combination of inter alia high oil prices and growing experience of the LNG business, a number of National Oil & Gas Companies (NOGCs) have either begun to make it less attractive for the IOCs to access their gas resources or have shut-off access altogether, through so-called resource nationalism. In some cases, NOGCs are now choosing to collaborate on LNG developments to the exclusion of IOCs. This creates some major issues for the IOCs in terms of their ability to access gas to support their growth strategies and further reinforces the need for IOCs to explore. In summary, it is our opinion that accessing gas resources and developing sufficient LNG supply are the key challenges faced by the industry. This paper considers whether the concerns about supply are valid and the potential implications for players within the LNG industry. THE IMPORTANCE OF SUPPLY In the Short-term, Supply is Struggling to Keep Pace with Demand The demand for LNG has almost doubled in the last decade, increasing from 73 mmtpa in 1996 to 141.5 mmtpa in 2005 and growth shows no sign of slowing. Indeed, Wood Mackenzie forecasts that demand will more than treble between 2006 and 2020, increasing from 157 mmtpa in 2006 to 488 mmtpa in 2020, driven in particular by the rapid expansion of demand for LNG in the US and the continued development of new importers such as India and China. There is also considerable upside to our demand forecast from those countries that are actively considering LNG imports but which have yet to finalise their plans. These countries are excluded from our base forecast due to the current uncertainty about the timing and level of their imports. However, while LNG demand remains robust, there are growing signs that LNG supply capacity is struggling to keep pace, at least in the short-term. Figure 1 compares Wood Mackenzies Global LNG demand and supply forecasts as of November 2006 (supply being split out by the current status of each liquefaction project/train).

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600 500 400 mmtpa 300 200 100 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Existing

Under Construction

Probable

Possible

Demand (Nov-06)

Figure 1. Global LNG Supply and Demand (2005-2020) The overall tightness of supply and demand is readily apparent, although through to 2010, the combination of existing capacity and capacity currently under construction is broadly sufficient to satisfy demand and in some years there is ostensibly a few mmtpa of surplus capacity. However, events such as disruption to supplies of gas feedstock, unplanned outages at LNG supply facilities and/or further construction delays could lower available supply and temporarily constrain demand and, in the last two to three years, we have witnessed many such events. For example, Nigeria LNG trains 4 and 5 and Atlantic LNG Train 4 have seen reduced production due to feedstock issues, North West Shelf and Qatargas have been hit by technical problems with liquefaction plant and Snohvit and Sakhalin have seen construction delays of a year or more. Near-term demand could also be higher than forecast as several countries including Brazil and Pakistan have recently proposed plans to import LNG before 2010 using floating regasification vessels. In summary, we expect the LNG supply demand balance to be extremely tight through to 2010 and there is a strong possibility that at times demand will be constrained by a lack of supply. Readers should also note that the LNG demand forecast shown in Figure 1 is significantly lower in the period 2006 to 2010 than our initial 2006 forecast. Annual demand was reduced by up to 20 mmtpa, largely because of a lack of available supply. From 2011 onwards, new supply capacity (i.e. over and above capacity currently in construction) will be required in order to satisfy demand and Wood Mackenzie splits new supply out into two categories:

Probable supply is defined as supply from those projects that are in an advanced stage of development and where the developers are expected to take the final investment decision (FID) within 12 months; and

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Possible supply is defined as supply from projects that have been proposed or are expected to be proposed but where the timeline is less well defined and the timing of FID is speculative.

In our opinion the most important message to draw from Figure 1 is that, by 2011, supply from the Probable category will be required in order to satisfy forecast LNG demand i.e. sufficient investment in LNG capacity has not yet been made to meet forecast demand in 2011. In simple terms this means that supply is only just about keeping pace with demand. As the lead time for the construction of a new LNG supply project is currently approximately 48 months, it means that assuming FID is taken imminently and that there are no delays in construction, the capacity should be ready just about in time to meet demand in 2011. However, any delays to the development of projects in the Probable category could mean that some demand goes unmet and demand will be constrained by supply. Over the last couple of years we have seen significant delays to the development and FID of a number of Probable projects for a variety of reasons which are discussed subsequently. Realistically, we expect further delays to some of these projects, making the probability of a supply-constrained world from 2011 look increasingly real. By 2012 the picture is worse still, as significant supply from the less well-defined Possible category will also be required in order to meet demand and the scope for delays to these projects is higher still. In addition, the likelihood of delays to the development of both Probable and Possible capacity means that the apparent excess of potential supply over demand which appears in Figure 1 from 2013 onwards is unlikely to materialize in reality. Further evidence of how supply has not been developed as originally planned can be found in an analysis of historic forecasts of LNG supply. Figure 2 compares Wood Mackenzies forecasts of future LNG supply as made in 2004, 2005 and 2006.
400 350 300 250 mmtpa 200 150 100 50 2004 2005 2006 2007 2008 2009 2010 2011

Jan-04

Oct-05

Oct-06

Figure 2. Comparison of Wood Mackenzie LNG Supply Forecasts

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It is interesting to observe how forecast LNG capacity additions in the short-tomedium term have changed over the three year period considered. In January 2004, the estimate of capacity for five years hence (2009) was 307 mmtpa. At that time one would have expected this forecast to be reasonably accurate for two reasons. Firstly, because existing capacity is a known quantity and the estimates of the timing of completion of capacity in construction were thought to be relatively robust. Secondly, in theory five years was sufficient time to allow the developers of a proposed LNG project in the relatively advanced stages of development (a Probable development) to take FID and then construct the project. As such, the expectation was that the actual capacity in 2009 should have been pretty close to the forecast. However, by October 2005 our estimate of 2009 capacity had fallen dramatically from 307 mmtpa to just 249 mmtpa, reflecting the reality of developing supply. In just 22 months, the estimated start-up of some 58 mmtpa of capacity had slipped beyond 2009. A similar result is observed if one compares the estimate of 2010 capacity made in October 2005 with that made a year later. The initial 2005 estimate of 301 mmtpa had fallen to 264 mmtpa, again reflecting the challenges associated with developing supply and the resulting delays to project start-up. So, accepting that in recent years the industry has been and is continuing to struggle to develop new supply, the two obvious questions are why, and are these reasons short-term phenomena or long-term issues? There are many reasons why developing supply has proved challenging, some are country or location specific whilst others have impacted the industry as a whole. Some of the major issues include inter alia:

EPC pressures: In the last couple of years the industry has seen the cost of developing LNG projects increase by a factor of two to three. This has led to some significant delays in taking FID as developers attempt to manage the cost or, in some cases, deferral of FID in the hope that costs will abate in a year or so. These cost pressures can be partially explained by the general increase in the price of commodities such as steel, however the major pressure on cost has resulted from the limited amount of EPC resource available to build LNG plants. The EPC sector has seen increased demand from the oil & gas sector, particularly LNG, but also from the mining and minerals sector which has been enjoying a boom. As a result of basic supply and demand economics, the cost of obtaining EPC services has therefore increased but, just as importantly, the timeline for developing an LNG plant has increased from circa 40 months to 48 months as EPC contractors act to ensure that delivery estimates for new projects are realistic given the pressures on EPC resources. While we do not see pressure abating in the near-term, in the longer-term EPC contractors should be able to expand capacity and therefore increase the ability of the industry to develop new supply in a more predictable fashion; Moratoria: As noted in the introduction, in the last few years several key countries have introduced official or de facto moratoria on the development of new gas/LNG projects. As a result, capacity that had been factored into future supply forecasts has at best been delayed until sufficient gas reserves are released by the Government or NOGC to support the project, or in extremis removed from the supply forecast all together;

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Environmental issues: Several high-profile projects (notably Gorgon and Sakhalin) have faced significant pressure from environmental authorities which have extended development and construction timescales and delayed the expected start-up of production. It is likely that other projects in these locations, for example the proposed Ichthys and Browse projects offshore Western Australia, will face similar challenges. However, hopefully the industry will learn from experience and either deal with these challenges more effectively in future or take a more realistic view of development timetables, meaning that supply is not delayed unexpectedly; and Politics: National and international politics will always impact the development of LNG projects leading to considerable uncertainty about the timing and availability of new supply in certain countries. Iran is perhaps currently the best example. Wood Mackenzies current forecast of Iranian LNG exports in 2020 is 40 mmtpa but it could just as likely be zero if there is a major escalation of the current nuclear stand-off with the West. Politics can also impact the development of LNG supply because local political pressures can lead to the decision to divert gas resources to local rather than export markets. Politics can also impact production from existing LNG plants. In Indonesia longer-term output from the Bontang plant is extremely uncertain because Government policy is encouraging the diversion of gas to local markets rather than to LNG exports. This is having a major impact on the roll-over of existing contracts with Japanese buyers.

In summary, we believe that within say five years, the industrys ability to develop LNG supply projects as planned should improve. EPC contractors will be able to increase their capacity and hopefully some of the lessons learned about developing LNG projects within environmentally sensitive areas will be applied to future developments. In addition, developers are likely to be conservative and over-estimate development timeframes with a view to bringing projects into service early rather than vice versa. With more realistic development timelines there should be a lower likelihood of delays to supply constraining demand. There will however always be random events and factors that cause delays, such as political changes and these will remain outwith the industrys control. So, while the short-term outlook for supply looks bleak, we see scope for some of the factors that have created the pressure on supply to abate. Therefore, in our opinion, the major potential long-term challenge to developing supply will be whether project developers can actually get access to the gas reserves required as feedstock. Should Supply be a Concern in the Long-Term? Assuming that some of the current issues associated with developing supply are indeed relatively short-term in nature and will ultimately abate, is it right for the industry to be concerned about supply in the longer-term? After all, surely there is more than enough gas out there to allow all of the LNG capacity required in order to meet demand to be developed? In its 2006 Statistical Review of World Energy [1], BP estimated proved reserves of natural gas at 6,348 tcf. Figure 3 illustrates that a significant proportion of these reserves are concentrated in a small number of countries, a theme that we will return to in the second half of this paper as it has important implications, particularly for IOCs.
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Proved Reserves (Tcf) 0-50 50-150 150-500 >500

Figure 3. Summary of Proved Natural Gas Reserves To put this reserves number into context, the 390 mmtpa of additional LNG supply capacity that Wood Mackenzie forecasts could potentially be developed by 2020 would require approximately 430 tcf of gas to allow the capacity to produce at 100% for 20 years. This is in addition to the approximately 200 tcf that would be required to allow the installed liquefaction capacity in 2007 to produce for another 20 years. It therefore appears prima facie that there is more than enough gas out there to support the forecast requirement for LNG over the next 20 years or more, so why the concern? One possible explanation for the increased concern about gas availability is the fact that some resource holding countries now appear to be taking a much longer-term view about these resources. For example, one of the explanations given for the current moratorium in Qatar is that Qatar Petroleum wanted to ensure that the North Field was being developed in a manner that was consistent with 100 years of production rather than 25. So while there are more than enough reserves to support growth over the next 20 years, the view changes somewhat if one takes a 100 year view. Perhaps more importantly, while there is a seemingly huge amount of gas reserves out there, a significant amount of the reserves are either not accessible and/or unsuitable for development as LNG projects. There are a variety of reasons for this, with some of the key ones outlined below. In some cases there may be more than one reason why a particular reserve is not available for LNG:

Domestic requirement: a number of the large gas resource holding countries are seeing demand from their domestic sectors increase significantly. As a result, many have either reduced the amount of gas available for export or imposed moratoria on new exports, at least in the short-term, to ensure domestic security of supply. A number of countries have a three thirds policy, one third of gas reserves for the domestic market, one third for export and one for strategic reserves. As a result, unless significant additional reserves are proved-up, existing gas reserves will likely remain off-limits to new LNG projects;

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Proximity to other markets: some reserves are sufficiently close to large demand centres, albeit often located in other countries, that pipeline exports are more economic than LNG exports. For example it is more economic to supply Algerian gas into Southern Europe via pipeline than as LNG. Perhaps more significant is the fact that it is more economic to develop the 520 tcf of gas in Russias Yamal peninsula to supply Europe via pipeline than it would be to use the gas to underpin LNG projects; Gas quality: some large gas reserves contain levels of CO2 that make them extremely difficult or uneconomic to develop as LNG projects because of the cost of dealing with the CO2. For example, the development of the natural gas contained in the 222 tcf Natuna D-Alpha field in Indonesia has long been held back by the fact that the field comprises an average of 71% CO2; Reserve size: many gas reserves are just too small to support a typical LNG project and cannot easily be aggregated with nearby reserves. For example there are several fields in Vietnam with reserves in the 0.5 to 2.5 tcf range, none of which can underpin an LNG project; Distance from the sea: some gas reserves are located so far away from the sea that the cost of the pipeline required to transport the gas to the liquefaction plant makes the project uneconomic. For example, the 37 tcf Kovykta field in Eastern Siberia is over 2,000 km from the Pacific coast and, as result, the gas is much more likely to be transported straight to N.E. Asian markets via a pipeline than piped to the coast for conversion to LNG before being shipped to N.E. Asia. Similar logic applies to the circa 300 tcf of gas reserves in Central Asia; and Geopolitical reality: some gas reserves are located in countries where geopolitics make the likelihood of that gas being developed as LNG in the foreseeable future highly unlikely. For example, international politics have so far managed to keep any of Irans 900+ tcf of gas from being processed into LNG.

It should also be noted that some of the gas reserves which are potentially available for development to support LNG projects are uneconomic based on existing technology and market pricing. These reserves are likely to be ignored until easier reserves have been monetised. In summary, the amount of gas resources actually available to support LNG developments is somewhat lower than initially apparent and some of the available gas would be extremely difficult to develop. As a result, exploring for new gas reserves that may be easier to develop is a potentially attractive option. Interestingly, concerns about access to gas supply is not just an issue for the LNG industry, it is a concern for the gas industry as a whole. Detailed analysis undertaken by Wood Mackenzie using its proprietary Global Gas Model indicates that there is a global deficit of existing gas supply relative to forecast gas demand (Figure 4).

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3,500 3,000 Gas Supply (bcm) 2,500 2,000 1,500 1,000 500 0 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 Demand

Existing Commercial Reserves

Techical/YTF Reserves

Figure 4. Global Gas Supply/Demand Balance In other words, even after factoring in all existing commercial gas supply sources, i.e. sources that are already contracted to domestic markets or export projects as well as gas supply sources that are expected to become commercial within five to ten years, there is insufficient gas to meet forecast total global demand for gas. In order to meet demand, additional known gas sources will need to be developed (referred to as technical reserves in Figure 4) and exploration will also be required to discover and prove-up additional reserves (referred to as yet-to-find (YTF) reserves in Figure 4). In summary, three important messages emerge from our analysis:

Firstly, although the world has an extremely significant amount of proven gas reserves, for a multiplicity of reasons, a lot of this gas is not currently suitable and/or accessible for development as feedstock for LNG projects; Secondly, Wood Mackenzies modeling of the global gas sector indicates that additional gas reserves (over and above those already earmarked to supply local markets or to feed LNG and pipeline projects) will need to be developed in order to satisfy global gas demand; and Thirdly, in light of points one and two above, there is a strong signal to the LNG industry to develop additional gas resources to support the development of LNG projects. This could involve commercialising existing known gas resources that are potentially suitable and available for development as LNG as well as exploration for new gas resources.

The challenge for developers is to create a resource capture strategy that successfully combines commercialisation of known reserves with exploration.

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COMMERCIALISATION OF KNOWN GAS AND/OR EXPLORATION In terms of securing access to the gas reserves required to allow the development of new LNG projects and to support future growth, the IOCs have two seemingly simple options to consider commercialise existing known gas reserves, to the extent that they are available for LNG projects, or explore for new gas reserves. However, determining the correct balance of the two options is far from simple. IOCs must consider many factors including inter alia:

The suitability and accessibility of known reserves for monetization as LNG; The terms offered by the NOGCs for assisting in commercialising known reserves; The level of participation that the IOC will have and the role of the NOGC in the value chain; The level of competition between IOCs to access NOGC reserves and the likely impact on returns; The potential risks and rewards from exploration; The availability of suitable exploration acreage; and The implications on overall portfolios.

In the real-world, IOCs do not choose between the options per se, rather they create portfolios of LNG supply projects, some of which monetise known gas reserves and others which are based on successful exploration. In either case, NOGCs may or may not be involved. We now consider each option in turn before looking at the portfolios that some of the key players in the LNG business have developed. Commercialisation of Known Resources It is a somewhat depressing fact for the IOCs that 56% of the worlds proven gas reserves are located in just three countries (Figure 5) Russia, Iran and Qatar, countries in which the gas sector is dominated by a strong NOGC Gazprom, NIOC/NIGEC and Qatar Petroleum respectively.

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27% 37%

3%

15% 4% 14%

Russia

Iran

Qatar

Saudi

UAE

Other

Figure 5. Global Proved Gas Reserves While historically Qatar Petroleum has been happy to collaborate with the IOCs in the development of large gas projects, the future outlook is less certain. Even assuming that the current moratorium on the development of new gas projects is lifted, there are no guarantees about IOC participation in future developments or the terms of that participation. NIOC and NIGEC in Iran have always been somewhat wary of cooperation with IOCs and there are constitutional restrictions on foreign ownership of upstream gas reserves. In addition, geo-political realities make the involvement of US players in Iranian LNG projects impossible. Perhaps most depressing of all, Gazprom, the worlds largest gas resource holder, recently decided to develop the super-giant Shtokman field (~125 tcf) on its own without the involvement of IOCs and indicated that, at least initially, it would focus on supplying the gas to Europe via pipeline rather than as LNG to North America which had been the original development plan. Recent events at the Sakhalin 2 project seem to indicate that the scope for IOCs to participate in Russian LNG projects will be extremely limited. In summary, the ability of IOCs to access known gas resources in the three key gas resource holding countries looks limited. In our opinion while there will always be some scope for IOCs to participate in the development of known reserves controlled by NOGCs, the outlook appears increasingly challenging:

NOGCs are increasingly reducing, or in some cases removing altogether, gas reserves available for supply to export projects including LNG. As previously discussed, in many cases NOGCs are holding back gas to ensure that they can satisfy growing domestic demand for gas; NOGCs are choosing to co-operate with each other on the development of large gas projects rather than involve IOCs, witness recent cooperation agreements between Gazprom and Sonatrach and the potential involvement of Petrobras and Qatar Petroleum in Venezuelan LNG projects;

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NOGCs are becoming increasingly technically sophisticated and have less need for the technical capabilities for which they were originally dependent upon the IOCs. A similar statement could be made about their ability to market gas. In addition, they increasingly have strategic desires to have greater control of the LNG value chain from wellhead to market, witness Qatar Petroleums investments along the integrated value chains for the Qatargas-2,3 and 4 and RL3 projects; Current and forecast oil price levels mean that NOGCs have greatly improved access to capital, something that IOCs have traditionally provided, particularly in those countries with significant levels of sovereign risk that found it difficult to access global capital markets; and The terms of participation in NOGC projects are becoming stricter partly reflecting a desire to retain more value for the host nation but also increased competition between IOCs to access gas reserves. This type of competition had a significant impact on the expected returns from the Gassi Touil LNG project in Algeria which are currently expected to be only circa 13%. This compares to the forecast 43% return from the Egypt LNG project that is underpinned by gas reserves discovered by BG and Petronas as part of an exploration programme. Interestingly the fiscal terms for these reserves were relaxed as, at the time, the Egyptian Government wanted to encourage gas exports.

In addition, as noted previously in this paper, some of the known reserves that are not controlled by NOGCs, are unsuitable for development as feedstock for LNG projects for a variety of reasons. As a result, IOCs are increasingly looking to exploration as an alternative way of securing the gas reserves required to underpin LNG projects. Exploration As it becomes more difficult to access and commercialise known gas reserves to support LNG developments, as well as potentially commercially less attractive, it is logical that players should increasingly look towards exploration as an alternative. However, it is important to bear in mind that while exploration can potentially be more attractive than commercialising known gas reserves it also carries significant potential risks. Figure 6 compares the relative risks for IOCs in discovering gas reserves for LNG compared to projects where they assist in commercialising already discovered reserves. Sub-surface risk broadly encompasses the technical challenges associated with exploration while Above Ground risk relates to those factors that can impact the monetisation of gas once it reaches the surface, such as politics, NOGC intervention, government take and gas marketing.

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Mauritania Exploration

Sub-Surface Risk

Australia Exploration Pluto

Egypt Exploration MLNG Tiga Gassi Touill

EG LNG RasGas/ Qatargas Qatargas 3/4 Iranian LNG

Above Ground Risk

Figure 6. Balancing Sub Surface and Above Ground Risks The capture of resources for an LNG project, whether through the drill-bit or across the negotiation table, can be considered in terms of the type of risks which are being encountered. During the 1980s, 1990s and early 2000s, assisting NOGCs with the development of their abundant reserves provided the IOCs with the opportunity for significant commercial returns with relatively low technical and above ground risks. However, as the number of IOCs searching for LNG supply project opportunities has increased and as the NOGCs have evolved and developed their skills, capabilities and aspirations, the level of above ground risk has increased for the IOCs. Companies are now increasingly competing for access to NOGC held gas and having to give away commercial value to be successful. In addition, as previously noted, the NOGCs are also increasingly taking a bigger, more integrated role in the project. In light of the increasingly competitive environment for access to discovered reserves, the alternative for the IOC is to secure the gas resources through exploration. While the sub-surface risks may be considerably higher than circumstances where the gas is already proven (i.e. the gas resource may not actually exist or may be unsuitable for LNG), the IOC is capable of selecting locations where the above ground risk favours timely development and returns are potentially more attractive than those where the reserves have already been discovered.

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One factor that has reduced the above ground risk is the enhanced marketability of the final product. Historically the market for LNG was limited to a handful of long term offtakers and the discovery of gas reserves was often the start of a lengthy process of commercial validation, marketing and negotiation. The lead times (from discovery to first LNG) for projects like Gorgon (Australia) and Alba (Equatorial Guinea) which were discovered in the 1970s or early 1980s will be more than 20 years, while for projects such as Pluto (Australia) which was discovered in 2005, the lead time could be as little as 6 years. In light of the earlier analysis in this paper, with LNG markets requiring significant incremental volumes for the foreseeable future, the ability to commercialise discovered reserves quickly is greatly enhanced. While LNG may not be a true commodity like oil, the level of demand is such that securing offtakers may no longer be the rate determining step of the past. In addition, in light of the difficulties associated with discovering large oil reserves which would have a material impact on the reserve bases of the major IOCs, the prospects for making large scale discoveries of gas are looking increasingly attractive and the prospects for large discoveries are still significant in many parts of the world. The history of exploration for gas is relatively short and it is not that many years ago that gas was largely considered an inconvenient by-product of oil development. With the marketability of gas now at an all time high, the attractiveness of exploration for large scale gas reserves to support LNG projects is increasingly compelling. However not all exploration opportunities are the same and a key question for the explorationist is where to explore? Where to Explore? In trying to characterize LNG exploration opportunities, we have identified three broad categories:

Moratorium Busters: Exploration in countries or provinces where large scale gas developments have occurred (including LNG) but where concerns over the domestic market requirement have resulted in moratoria on the sanctioning of new export projects until sufficient additional gas resources are proven-up (eg. Egypt). While the sub-surface risk may be lower in these areas compared to unproven gas provinces, due to the fact that productive hydrocarbon fairways have been proven and established, there is an above ground commercial risk that any reserves discovered will be insufficient to break the moratorium and thus may be reserved for the domestic market; Expansion: Exploration in countries or provinces where large scale gas developments have occurred (including LNG) and any further discoveries will be used to build upon existing developments, either brownfield or greenfield. While this kind of exploration may have lower sub-surface risk than unproven gas provinces, the above ground risk may be elevated by two factors. Firstly, the government/NOGC may attempt to increase the fiscal take relative to early projects and increase its overall involvement; and secondly, the concurrent development of multiple LNG projects may put a significant strain on the countrys physical and administrative infrastructure and as a result projects are likely to be delayed. This second factor may have a significant impact on future projects in Nigeria; and

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Frontier: Wildcat exploration in countries or provinces where gas development is limited and/or non-existent, such as Mauritania. These targets carry considerable sub-surface, technical risk. However, should the resources for an LNG development be discovered, it is likely that both the fiscal terms and government attitude will expedite the rapid development of the resource.

Figure 7 uses these categories to highlight those locations where LNG related exploration is either currently already underway or is anticipated in the near future.

? ? ? ?

Moratorium Busters Expansion LNG Plays Frontier LNG Plays

Figure 7 LNG Exploration Activity In addition to the question of where to explore, the IOCs are faced with the challenge of how to go about exploration. How to Explore? One of the key factors which impacts the timely and efficient development of a gas resource for LNG is the level of alignment between the partners involved in the development. In situations where the partners have full alignment in terms of their commercial objectives and expectations, projects can proceed quickly with minimal downtime for decision making. However, as the LNG business has flourished over the last few years, we have witnessed two key factors which have created partner misalignments:

Escalating costs have pushed some LNG projects to the economic margins. Since different companies have different investment thresholds a natural tension between partners can become a major impediment to decision-making and thus project progress; and

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As more companies develop global integrated portfolios of LNG assets, it becomes increasingly likely that different companies will imbue the same project with different levels of strategic significance. For one partner a specific project may be a pivotal element of its LNG strategy, for another it may be of marginal interest.

As a result of these potential misalignments between partners, it is increasingly important for the LNG explorationist to consider the partnering issues very carefully. In projects where companies have sole risked exploration, such as Woodside in Pluto, the company has been able to move the project forward quickly and efficiently, a feat which would have been much more challenging if it had involved partners with differing priorities. However, the downside of sole-risking exploration is the fact that costs and risks are substantially higher. While it would be unrealistic to suggest that IOCs should only explore and develop LNG projects on a solo basis, the timing for selecting the best partner(s) may be a key success factor. Consider the Ichthys project where INPEX discovered the resources and then selected Total as a partner to assist it in the development. Total was extremely keen to enter the Australian LNG space and, as a new entrant with no existing position, it is likely to be much more supportive of the development than a partner that had other Australian LNG options, for example Shell or Woodside. Having now considered both options commercialising known reserves and exploring for new reserves, it is interesting to review the positioning of some of the major players. Table 1 summarises the Probable and Possible LNG projects currently being pursued by several of the major LNG players in terms of whether they are based on commercialisation of known reserves or exploration.

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Table 1 Major LNG Players Portfolios Company Commercialising Known Resources Exploration MoratoriaBusters
Egypt, Libya, Trinidad Australia (Browse), Indonesia (Tangguh Exp.) Angola, Australia (Gorgon, Browse), Nigeria (OKLNG) Australia (Sunrise), Nigeria (Brass, NLNG) Australia (Gorgon, Scarborough), Nigeria (NLNG) Australia (Browse, Gorgon, Sunrise), Nigeria (NLNG, OKLNG) Egypt, Libya Algeria, Australia (Ichthys area), Malaysia (Bintulu Exp.), Nigeria, Russia (Sakhalin) Algeria, Nigeria, Yemen Venezuela Egypt, Trinidad

Exploration Expansion Plays

Algeria, Nigeria (OKLNG) Algeria, Australia (Browse), Oman, Russia (Sakhalin)

Exploration Frontier Plays

BG

Mauritania, PNG

BP

Chevron

Libya

Australia (Greater Gorgon Exp.), Nigeria (OKLNG) Australia (Timor Sea)

Venezuela

ConocoPhillips

Libya

Venezuela

ExxonMobil

PNG

Shell

Total

Australia (Ichthys), Nigeria (NLNG, Brass)

Libya

In summary, it appears that most players have adopted a portfolio approach, with their LNG strategies being underpinned by a combination of commercialisation of known resources and exploration. However, it is interesting to observe that the commercialisation of known resources is largely concentrated in two countries Australia and Nigeria . In addition, most players are undertaking significant exploration, but a lot of this activity is focused in a handful of countries notably Algeria, Egypt and Libya (Moratoria-busting), Australia and Nigeria (Expansion plays) with frontier plays only being pursued in Mauritania, Papua New Guinea and Venezuela. This suggests that, as has traditionally been the case in the oil & gas industry, frontier exploration is being undertaken by smaller players with a view to enticing in the big LNG players as and when their exploration efforts prove successful. It also indicates that there is potentially a lot of scope for additional exploration in frontier areas by the major players.

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CONCLUSIONS In our opinion, the LNG industrys current focus on, and some may go as far as to say obsession, with supply is justified. Supply is an issue in the short, medium and long-term and industry players are right to be concerned about it. There is growing evidence that the industry will continue to struggle to develop the new supply capacity required to satisfy forecast demand for LNG in the short-to-medium term. The balance between forecast demand and supply already looks tight through 2010 and it will not take much in the way of unplanned outages or construction delays to constrain demand. From 2011 through the middle of the next decade the outlook is quite pessimistic as capacity from supply projects where the final investment decision (FID) has not yet been taken will be required in order to meet demand. Given current construction lead-times for liquefaction plants, there is barely enough time to construct the plants in order to meet demand and we see many factors that could cause delays both to FID and to construction. As a result, we see real potential for demand to be constrained by a lack of supply through at least 2015, perpetuating the current Sellers Market. This is great news for those industry players with access to flexible LNG supply as a tight market means high prices and better netbacks. However, the outlook for LNG purchasers, especially those potential new importers of LNG that are less willing or able to pay market prices looks much less attractive. While we see scope for some of the pressures that are currently constraining the development of new supply to abate in the medium-term, particularly the cost and availability of EPC resources, we still see supply-related challenges in the context of longer-term LNG projects. The world has huge gas reserves which prima facie could support the LNG industry for hundreds of years. However, a significant amount of these reserves are either inaccessible and/or unsuitable for development as LNG feedstock. The reasons for this are diverse but somewhat worryingly there has been a trend in the last 2 to 3 years for National Oil Gas Companies (NOGCs) to restrict access to gas reserves for use in export projects. Typically the motivation for this is to ensure that sufficient reserves are available to support rapidly growing domestic demand and to ensure strategic reserves are available for the future. Indeed, recent events in Qatar have highlighted the fact that major resource holders are increasingly taking a long-term view about reserves, looking at long-term national security of supply and economic growth potential and not just the potential for LNG growth. Against this backdrop of uncertainty about access to gas, Wood Mackenzies proprietary analysis indicates that additional gas reserves will have to be developed in order to meet forecast global demand for gas and therefore by implication, demand for LNG. With a clear signal that additional gas is required to support the future growth of the industry, players have two options: exploit known reserves to the extent that they are suitable and accessible for LNG and/or to explore for additional gas. The challenge is how best to combine the options given their respective risks and rewards.

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Historically, assisting with the commercialisation of known NOGC controlled gas reserves has been an attractive option for the IOCs. The level of technical risk was typically low as the gas had already been discovered and commercial risks were low-tomoderate. However, in recent years this option has either disappeared altogether in some countries or has become far less attractive in others. Somewhat depressingly, over half of the worlds gas reserves are located in just three countries Russia, Iran and Qatar each of which is dominated a strong NOGC. In our opinion the outlook for future foreign participation in the monetisation of gas reserves via LNG in all three countries looks limited at best. Recent events in Russia could be considered a harbinger for projects elsewhere, with gas reserves either being taken away from potential LNG projects or foreign players being excluded from projects altogether or their participation greatly reduced. Going forward we see greater cooperation between NOGCs and stricter terms for IOC participation as and where it is available. As a result, we are already seeing increased LNG-related exploration efforts by the IOCs and expect more to follow. In addition to the difficulties associated with commercialising known reserves, two additional factors are encouraging the increased focus on exploration. Firstly, the strong growth in LNG demand is making it easier and quicker to monetize suitable new discoveries as LNG. Assuming that Woodsides Pluto project is commissioned as planned in late 2010 or early 2011 it will have only taken 6 years to commercialise the gas, this compares to the 10 to 20 or more years that has been the historical norm. Secondly, major oil & gas companies are finding it increasingly difficult to make material oil discoveries and, as a result, exploring for gas has become more attractive given the number of significant prospects that are potentially available and the enhanced outlook for near-term monetisation. However, while exploration is becomingly increasingly attractive it still carries significant risks which has implications for exploration strategy. Players face a dilemma. Sole-risked exploration, if successful, means that the process of commercialising gas reserves is far easier as there are no problems associated with partner alignment. However, sole risking exploration and development involves more cost and as a result, we expect to see continue collaboration on LNG projects as recently seen at the Ichthys project where, following successful exploration, INPEX brought in Total to assist with development. Choosing where to explore is also critical and we categorise LNG related exploration into three groups Moratorium busters, Expansion plays and Frontier plays as the drivers for and characteristics of exploration in each group are different. Analysis of some of the key LNG players indicates that their future LNG strategies are underpinned by a combination of commercialisation of known resources and exploration. However, it is interesting to observe that the commercialisation of known resources is largely concentrated in two countries Australia and Nigeria. In addition, most players are undertaking significant exploration, but a lot of this activity is focused in a handful of countries notably Algeria, Egypt and Libya (Moratoria-busting), Australia and Nigeria (Expansion plays) with Frontier plays only being pursued in Mauritania, Papua New Guinea and Venezuela. This suggests that there is potentially a lot of scope for additional exploration in frontier areas by the major players or for farming into successful discoveries by smaller industry players. Given the continuing need to secure access to gas to support the LNG industrys growth and the challenges associated with accessing known reserves, we expect exploration to play an increasingly important role in the LNG business.
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ACKNOWLEGEMENTS Wood Mackenzie Global Gas Model Wood Mackenzie Global LNG Online Service The authors would like to thank their colleagues John Meagher, Andrew Pearson and Pamela Tannahill for their contribution to the preparation of this paper. REFERENCES CITED [1] BP Statistical Review of World Energy, June 2006

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