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February 2014

Vol. 19, No. 8 Week of February 23, 2014

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

Overseas investment to grow

Unlike the United States, energy security for Japan doesn’t start at home. With meager fossil fuel reserves of its own and no gas pipeline connections to other countries, Japan meets more than 95 percent of its gas demand with LNG imports.

The archipelagic nation was the world’s largest LNG consumer even before an earthquake and ensuing tsunami in March 2011 caused a meltdown of the Fukushima Daiichi nuclear plant and prompted Tokyo to shut down the country’s nuclear power plants. Since the accident, Japan has ramped up its imports of oil, coal and LNG to fill in the gaps left by shuttered nuclear facilities. As of 2012 about half of the country’s electric power came from LNG, according to the U.S. Energy Information Administration.

Natural gas consumption in 2012 was about 4.4 trillion cubic feet, up 24 percent from 2010 mostly as a result of the nuclear disaster.

But as Darwin demonstrated, Fukushima wasn’t the catalyst for Japanese utilities acquiring equity stakes in foreign LNG projects.

The push for ownership is one of several strategies designed to avoid gas shortages and high prices following the expiration of long-term LNG contracts inked in the 1970s and 1980s with exporters based primarily in Southeast Asia, according to the U.S. Energy Information Administration.

With Japan’s Prime Minister Shinzo Abe pushing for greater competition and lower electricity prices, the utilities are under pressure to keep costs down and push hard for better deals before passing higher fuel costs on to consumers. Given the high level and expense of Japan’s energy needs now and into the future, some of largest electric and gas utilities appear poised to expand their presence at the owners’ tables of LNG projects.

Australia, with its proximity to Japan and promise as a dependable, long-term source of LNG, has been a magnet for investment by utilities, but it’s by no means the only country the utilities are targeting.

Tokyo Gas seeks to take majority stakes in medium-sized LNG projects in Southeast Asia or Africa, according to an article by Bloomberg News in October 2013. This would be a major new strategic move for one of Japan’s top importers.

Shigeru Muraki, an executive vice president at the utility, told Bloomberg that Tokyo Gas is interested in plants that can produce as much as 3 million metric tons per annum of LNG — about the same size as Darwin LNG. The utility can have more operational control through ownership in mid-sized projects, rather than large ones, he said. Tokyo Gas already holds small shares in big Australia projects with LNG capacity ranging from about 4 mtpa to 16 mtpa.

Osaka Gas likewise has plans to “aggressively enter this upstream stage of the natural gas value chain,” the company said in its 2009 report on corporate social responsibility.

In 2008, the company bought into its first overseas LNG plant with a 10 percent share of the $10 billion Freeport LNG import terminal on Quintana Island, Texas. Like many underutilized U.S. import terminals, Freeport LNG now wants to get into the export business, moving some of the nation’s shale gas riches to overseas markets. The U.S. Department of Energy has signed off on Freeport’s export application, but the project sponsor is still waiting for approval from the Federal Energy Regulatory Commission for its construction and operation plans.

Utilities not the only players

LNG project ownership can help not only the utilities’ bottom lines, but puts them in a position to potentially generate business for Japan’s other industries. Muraki of Tokyo Gas has mentioned the possibility of teaming up with other Japanese companies such as engineering contractors JGC Corp. or Chiyoda Corp., and plans to expand its LNG shipping fleet.

Japan’s financial institutions are also involved. The Japan Bank for International Cooperation states that one of its top priorities is “obtaining natural gas by supporting the acquisition of interests and development of LNG-related projects as well as imports.”

JBIC’s assistance includes hundreds of millions of dollars in loans to Osaka Gas to buy equity in Gorgon LNG and Ichthys LNG, both under construction in Australia. The Japan Oil, Gas and Metals National Corp., tasked under Japanese law with securing a stable supply of oil and natural gas, is another financing source for the utilities, as are private banks.

Japan’s oil and gas companies and commodity traders have a longer history than the utilities of backing overseas LNG projects and tend to take larger stakes.

The Japanese energy company INPEX is operator and majority owner of the Ichthys LNG project under construction in Australia. Mitsubishi, a conglomerate known globally for its autos and electronics, is also a major import agent for Japan’s utilities and is backing LNG projects in Russia, Malaysia, Brunei, Oman, Indonesia and Western Australia, according to its 2013 annual report.

Mitsubishi and fellow conglomerate Mitsui last year each took an ownership stake in the Cameron LNG export plant in Lake Charles, La., proposed by a Sempra Energy subsidiary. That project is waiting on U.S. government approval and a final investment decision.

Korea, China stalking projects, too

Korea Gas Corp., the world’s largest single LNG importer, is also using project ownership to seek more control and oversight of its gas supply and to buy it at better prices. Like neighboring Japan, South Korea has little in the way of domestic fossil fuel resources and has had to reduce its nuclear capacity in recent years.

With its core business on the distribution side, South Korea’s sole LNG importer brings in 35 mtpa of LNG annually. The government-owned company has an effective monopoly over the purchasing, import and wholesale distribution of natural gas, according to the U.S. Energy Information Administration.

In addition to holding minority equity stakes in about half a dozen LNG projects under construction and proposed in Africa, the Middle East, Australia and North America, KOGAS has pounced on new fields in East Africa and the Mediterranean Sea, buying up blocks alongside more established producers like Italy’s Eni.

In December 2013, a KOGAS executive told the Alaska Journal of Commerce that investing in a gas project in Alaska as well as buying the fuel is a possibility someday. “At this moment, actually, the timing is a little bit far away,” said Kwon Young, executive vice president and resources business division chief operating officer.

China’s big national oil and gas companies, rather than its utilities, are investing in LNG projects and purchasing the gas. They tend to hold larger — albeit still minority — shares in LNG projects than either the Korean or Japanese buyers.

In June 2013, China National Petroleum Corp. agreed to purchase a 20 percent stake in the $27 billion Yamal LNG project in the Russian Arctic. Yamal, which reached a final investment decision in December 2013 with production start-up targeted for 2017, is just one of several projects drawing China’s interest.

The nation’s largest refiner, Sinopec, is the foundational buyer and owns a 25 percent stake in Australia Pacific LNG, which is under construction and scheduled to start exporting gas in 2015. (ConocoPhillips holds a 37.5 interest in Australia Pacific LNG.)

Sinopec is also scoping out the investment potential of projects in British Columbia.

“The Chinese companies are new to this game and want to learn the biz,” Herberg said. “CNPC and Sinopec want to gradually be able to lead these projects on their own.”

Europe’s utilities are not following their Asian counterparts into LNG project investments, in part because they depend less on LNG as a percentage of the overall fuel mix. FACTS Global Energy consultant Nelly Mikhaiel noted that Japan’s extreme dependence on LNG makes anything that enhances security of supply an attractive prospect.

Profit and success not guaranteed

Profitability is another attraction of investment in LNG projects. Project sponsor agreements often include ownership rights for a share of the gas, giving the utilities protection against upswings in price, which hurt them as buyers.

“If the markets soar, as they are now soaring, they will earn some of the high cost back in the way of profits,” Zach Allen, an analyst at energy advisory firm PanEurAsian Enterprises, told The Wall Street Journal in April 2012.

Tokyo Gas, for one, forecasts a $25.7 million increase in its operating income from investments abroad for the fiscal year ending March 2014. The projected earnings will come from the Pluto LNG project and a Barnett basin shale gas project in Texas.

“The best part of the value chain is having a stake in the upstream production and liquefaction,” Herberg said. “That’s where a big chunk of the money is to be made.”

But as with any investment, nothing is guaranteed. Following the 2011 earthquake, Tokyo Electric, which owns and operates the Fukushima Daiichi nuclear plant, lacked the finances to maintain its 15 percent equity share in the licenses for the Wheatstone gas field and 11.25 percent interest in the proposed Wheatstone liquefaction terminal in Australia. (Wheatstone is under construction and scheduled to go online in 2016.)

In June 2012, Mitsubishi along with one of the world’s largest shipping companies, Nippon Yusen Kabushiki Kaisha, came to TEPCO’s rescue by joining the project, effectively knocking Tokyo Electric’s share down to less than 1 percent of both the gas reserves and LNG plant.

Under pressure from the South Korean government, KOGAS is trying to scale back its ownership stakes in Australian and Canadian projects. A Wall Street Journal article in 2013 reported that Seoul wants its national energy companies to improve their financial standing by selling unprofitable, non-core overseas assets. The country’s energy giants have amassed large debt loads in the past five years in acquiring energy resources abroad.

Aside from adverse events at home, there is risk that the projects themselves won’t go well for any number of reasons: The cost of materials might skyrocket, labor costs might increase, poor weather could put construction on hold, demand might fizzle, fellow suppliers might push down prices by flooding the market, or there might not be as much gas as originally expected.

“The risk is that you get into a poor project in terms of profitability and you don’t make money after investing a lot of capital,” Herberg said.

Relationships build projects

The international oil and gas companies heading LNG projects are willing to welcome their customers as fellow project sponsors for good reason: Without buyers, there is no project.

“Rarely can the projects get under way without long-lasting commitments from these customers to buy cargoes annually for 15-25 years,” Herberg said. “For majority owners, when they bring in a really small partner who’s also a buyer, what that generally does is make the investor a reliable buyer.”

The upstream partnership “in a sense cements a partnership for the supply contract,” Herberg said, “and it all fits together better.”

Mikhaiel thinks the increasing involvement of LNG customers as project sponsors ultimately makes overcoming the differences between buyers and sellers “quicker and more trouble-free.”

Asian LNG buyers, in particular, have been pushing hard for changes in the traditional formula that yokes the cost of natural gas in their region to the global price of oil. Producers, however, are resisting the change, arguing they need the high, oil-linked prices to finance the mega-billions of upfront capital costs and provide their desired rate of return.

“The LNG industry is built on cooperation,” Mikhaiel said. “If you have got the buyer with a seat at the table of a sellers consortium, and all parties are cognizant of what’s driving each other, this can only facilitate understanding since the views of the other party will always be expressed in a timely fashion.”

Part 1 of this story appeared in the Feb. 16 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.






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