Utilities increasingly invest in LNG

Tokyo Gas, Chubu Electric, other Japanese utilities aren’t waiting for gas to arrive, but are signing up to develop LNG projects

Jeannette Lee

Researcher/writer for the Office of the Federal Coordinator

In their quest to lock up supplies of liquefied natural gas for years to come, key Japanese utilities have signed on as small sponsors of big LNG ventures.

Tokyo Gas, Chubu Electric and other companies that heat and power the world’s third-largest economy are less content these days to simply contract with the latest LNG mega-project and wait for the first cargo to pull into port. Instead, they are buying small shares in ambitious gas developments and liquefaction facilities in Australia and North America.

LNG’s long path to consuming countries starts with the exploration and development of gas fields, through production and liquefaction before tankers bring it to port. Japan’s utilities, among the world’s biggest buyers of LNG, believe that by increasing their involvement in the upstream and midstream links of the chain, they can do more to help bring home reliable supplies at prices they deem fair.

In exchange for spending what can amount to hundreds of millions of dollars to own slivers of LNG projects, the utilities may gain:

•Insider access to project plans, spending and technology.

•The chance to build relationships that smooth the way to long-term gas supply contracts.

•Protection against price upswings.

•A better understanding of project economics and market trends.

Depending on the nature of the project and partnership, the utility might even obtain a share of the gas reserves and some flexibility to decide where the LNG tanker delivers its cargo. (In Asia, the long-term purchase contracts commonly signed by utilities tend to prevent them from reselling or diverting the gas to other markets.)

“Becoming a producer ourselves leads to a stronger negotiating position on procurement and adds flexibility to our response to changes in demand,” Hiroshi Ozaki, president of Osaka Gas, one of Japan’s biggest LNG buyers, said in the company’s 2013 annual report.

Japan’s utilities have been importing LNG for more than 40 years, but it’s only in the past decade or so that multiple utilities have taken an investment interest in the sources of the gas they buy.

In Australia, at least seven Japanese utilities own small stakes in LNG projects. Two of those projects are already operating, while four are under construction.

In addition to owning a share of the project, the utilities also are buying much of the production. Total LNG purchases by the utilities from those Australia projects comes to about 17 million metric tons a year, or 2.25 billion cubic feet of gas a day on average — equal to about one-fifth of Japan’s total LNG demand in 2013.

Of course, there are downsides.

Diving in upstream and midstream entails risks. Many LNG projects are among the most expensive and complex energy ventures in the world. They can easily go over budget, encounter delays or simply sit on the planning table for lack of economic viability. For Japan’s utilities, the constant pressure to secure reasonably priced fuel for an energy-poor nation makes these risks increasingly worth taking.

To Australia via Alaska

As Darwin’s majority owner, the company rounded up seasoned oil and gas players from an international field: Santos of Australia, INPEX of Japan and Italy’s Eni. Phillips, which merged with Conoco in 2002, also brought in two other minority partners that had not traditionally participated on the ownership side of LNG ventures.

Tokyo Electric Power (TEPCO) and Tokyo Gas had been LNG customers of Phillips since receiving their first shipments of Cook Inlet gas from the liquefaction plant in Nikiski, Alaska, on the Kenai Peninsula in 1969.

The company identified the two Japanese utilities early on in the gas marketing process as obvious potential customers for Darwin and, after two years of discussions, the parties agreed that TEPCO would buy 2 million metric tons per annum (almost 100 billion cubic feet per year, or 12.5 percent of the utility’s annual LNG purchases at the time) and Tokyo Gas would buy 1 mtpa* (almost 50 bcf per year). Together, the two utilities would be purchasing nearly all the gas the Darwin plant could produce each year from start-up in 2006 to 2023.

But more was at work during the Darwin negotiations than the usual wrangling between buyers and sellers. The two Japanese utilities, whose main lines of business dealt with the gas after it landed ashore, were also looking to invest in gas exploration, production and liquefaction. Darwin was their chance.

Together, the utilities formed a joint venture, Tokyo Timor Sea Resources, to take what today is a 9.2 percent stake in the offshore gas and condensate field. In addition, Tokyo Electric ultimately settled on a 6.13 percent share of the midstream segment of the project — the single-train LNG plant — while Tokyo Gas took on 3.07 percent.

In explaining why they sponsored the project, the companies issued a joint statement in June 2003 saying that “involvement in the whole LNG business chain” would ensure “a stable and economic supply of the fuel and city gas feedstocks.”

The gamble appeared to work. Buyer contracts are proprietary, but Tokyo Electric was pleased enough about one highly unusual feature of its Darwin agreement to discuss it publicly. In an interview with global energy market analysis firm ICIS Heren, Tokyo Electric revealed its success in convincing ConocoPhillips to agree in 2005 to a flexible-destination clause, a first for a Japanese utility.

Partnership pays off

Buyers chafe against the clauses, which bar them from profiting from price differences between markets. Arbitrage isn’t the only reason a buyer might want to sell off its gas: Maybe the cargo can be replaced by cheaper gas from the local gas market or by LNG from the spot market. Or the buyer might not need the cargo right away because of lower-than-expected demand, plant outages, or other unforeseen circumstances.

The European Union has been cracking down on destination clauses in LNG contracts among its member nations, yet they remain an irritating norm from the point of view of buyers in the Asia-Pacific market.

Tokyo Electric’s Darwin agreement allowed it to send LNG to destinations other than the companies’ terminals under certain conditions, with “full flexibility to deliver cargoes in Japan.” For deliveries outside Japan, TEPCO would first need to ink an agreement with ConocoPhillips to share any profits. The companies reportedly spent a long time hashing out the phrasing on the sharing provision.

Sponsorship of the project, combined with its position as a major buyer, allowed TEPCO to push hard for tweaking the destination clause in negotiating its LNG purchase contract. “The stakes of TEPCO and Tokyo Gas in Darwin LNG enabled us to obtain favorable terms,” a source at Tokyo Electric told ICIS Heren. “So did our buying power.”

Both sides credited their long, shared history in Alaska for helping them eventually shake hands on both the equity and purchasing sides of the Darwin deal. ConocoPhillips management said the relationship forged over the Kenai LNG export operation was “instrumental to the success of Darwin LNG” and “cannot be overestimated.”

TEPCO and Tokyo Gas, similarly, singled out their “close and reliable relationship” with the company dating to 1969 in Alaska — when they became the first Asian importers of LNG from North America — as the foundation for discussions leading to the Darwin equity participation and LNG sales agreements.

“Oil is like dating, but gas is like marriage,” Fereidun Feshraki of FACTS Global Energy said of the LNG buyer-seller relationship during a presentation in 2013 at the 17th Asia Oil and Gas Conference in Kuala Lumpur, Malaysia.

That much was evident in the Darwin deal, which pushed buyers and sellers even closer together.

A seat at the table

A typical case is the $54 billion Gorgon project being built in Australia. Gorgon is operated by Chevron in a joint venture with ExxonMobil and Shell, with three Japanese utilities in bit parts: Osaka Gas, 1.25 percent; Tokyo Gas, 1 percent; and Chubu Electric Power; an even more minuscule 0.417 percent.

As of March 2013, Osaka Gas had invested $287 million in the subsidiary it set up to hold its stake in Gorgon.

The 15.6 mtpa project — an average capacity of 2.1 bcf a day of natural gas — is scheduled to start delivering LNG in 2015. It includes development of gas fields off the Western Australia coast, an undersea pipeline to a liquefaction plant on Barrow Island and a carbon dioxide capture and underground storage operation.

Their small shares are no measure of the clout Japan’s utilities wield in the LNG world. They are some of the world’s biggest buyers and pay some of the highest prices. Taking ownership stakes gives them a varying degree of access to budgets, technology, engineering and other decisions made by the very companies selling them gas.

If a Japanese utility is sponsoring a project, chances are very good it’s buying gas from that same development in proportions far greater than its equity share. In the case of the $15.5 billion Pluto project in Australia, Kansai Electric and Tokyo Gas each hold a 5 percent ownership share, but are each taking about 40 percent of the gas from the 4.3 mtpa production facility over a 15-year span. The plant went online in 2012.

“They’d like to have a seat at the table to understand all the parameters of the project and make sure they’re getting their fair share,” Mikkal Herberg, research director for the energy security program at the National Bureau of Asian Research, said in a November 2013 interview.

That seat at the table, for small project investors, doesn’t include the power to take the lead on project decisions. What the utilities gain by taking equity stakes is the freedom to mingle with, and presumably influence to some degree, the companies that will be selling them the gas. (The utilities are small in comparison with the giant international energy companies that tend to spearhead LNG projects. Chevron, for example, was valued by investors at more than $200 billion throughout 2013, while Tokyo Electric was valued at less than $10 billion.)

“It can complicate issues for the majority owners if they (minority owners) want to have a say, but they are typically not going to have any say in spending, the capital program or technology,” Herberg said. “You tend to make decisions based on ownership shares and if you have a small share, you have very little say. They’re just going to pretty much be riding the coattails of the big players.”

Joining a project consortium also may help Japanese utilities follow more closely the efforts of their fellow LNG buyers.

“They are ideally positioned to learn about other buyers’ expectations on hot-button issues such as pricing (traditionally the most secretive and sensitive topic!) as well as their expectations on other topics such as destination flexibility, price revision clauses, upward and downward quantity tolerance provisions, gas quality, transportation, and the like,” Nelly Mikhaiel, a New York- based senior consultant at FACTS Global Energy, said in an email interview. “They can gauge what competing buyers want from a seller and determine how their own expectations as a buyer compare to others.”

Acting as a seller gives the utilities a read on what other sellers are offering, as well. “In other words,” Mikhaiel said, “They get an LNG market litmus test!”

*mtpa, million metric tons per annum

Part 2 of this story will appear in the Feb. 23 issue of Petroleum News. Editor’s note: This is a reprint from the Office of the Federal Coordinator, Alaska Natural Gas Transportation Projects, online at www.arcticgas.gov/japan-utilities-increasingly-invest-lng-projects.