THE LIQUEFIED NATURAL GAS INDUSTRY

INTRODUCTION

At the dawn of the 21st century, the world has renewed its interest and concern over energy. Energy supply, security, and prices are dominant themes in the news media and the subject of political debates around the globe. Oil prices remain stubbornly above $50 per barrel (bbl), natural gas prices have reached record highs in most markets, and even coal prices have climbed along with the price of many other basic commodities. Energy demand grows inexorably with the growth of the world economy, and China and India have emerged as major, rapidly growing consumers. Concerns over global warming have not abated, but the promise of alternative renewable energy is proving slow to realize. Nuclear power appears to be on the verge of a revival, but the problems of waste disposal and proliferation remain unsolved. Speculation as to whether the world has seen peak oil production abounds, and many of the same commentators assume that natural gas may not be far behind in reaching its production peak. In this context, the global energy industry faces new challenges. Remaining reserves of oil are concentrated in increasingly fewer countries, not all friendly to the principal consuming nations. State oil companies have grown in importance as high prices and ready access to technology have increasingly enabled them to operate independently of the major and large independent oil companies on whom they traditionally depended. These same private oil companies are

now struggling to grow protably, even with access to large cash ows, as their access to oil reserves becomes more constrained and as the competition from other producers, including from the state oil companies of the emerging new oil markets, proves erce. While the natural gas industry has suffered from some of the same pressures, it has evolved somewhat differently than oil. With a more benign emissions prole than other hydrocarbons, broader resource distribution throughout the world, and a more complex market structure, natural gas has become the increasing focus of the oil and gas industry. Long gone are the days when the geologist returned home to report the good news and the bad news about his recent exploration endeavorsthe bad news being that he didnt nd oil, but the good news being that he didnt nd natural gas. In the 1970s, the era of the last worldwide concern over limitations to commodity production, natural gas was seen as being a fuel of limited scope, too precious to consume in many applications. In fact, some producers took to describing natural gas as the noble fuel, worthy of being sold at a premium. Government policies among the developed nations encouraged this perception. But what a difference a decade makes. By the early 1980s, natural gas prices were falling in the primary markets, and a glut of the fuel, earlier disguised by political considerations, quickly emerged. Low prices, coupled with its clean-burning characteristics, quickly made natural gas a favored fuel. At the beginning of the 21st century, natural gas is one of the fastest-growing sources of primary energy. This growth is expected to continue for at least the next several decades. Although oil remains the largest component of primary energy, accounting for about 37% of total world energy demand in 2004, its share has slipped from over 40% in the early 1980s, while the share of natural gas has increased from 19% to nearly 24% in the same time frame.1 Natural gas use is nearly on par with coal and is projected to become the secondmost widely used fuel after 2020.2 Despite the strong growth in consumption, especially over the past decade, the worldwide reserves of natural gas have grown faster than consumption and, at current rates of production, are sufcient to last almost 70 years. By contrast, the worlds oil reserves now represent just over 40 years of consumption at current production rates. In 2005, world natural gas marketed production grew 2.1% to 2,819.4 Bcm (99.5 Tcf).3 Lower prices, coupled with the advent of competition in traditional gas and power markets, promoted higher gas use. Advances in combined-cycle gas turbine (CCGT) technology in particular have enhanced the economics of generating electricity from gas, as lower capital costs and

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markedly higher operating efciencies of the CCGTs have given natural gas a competitive edge over coal, along with superior emissions characteristics. To meet this growing demand, there has been a steady rise in the share of natural gas that is traded internationally. Compared to other fossil fuels, natural gas is expensive and more technically challenging to transport over long distances, by pipeline or by ship as LNG. As a result, the global natural gas industry has evolved as a series of regional and even local markets. Yet despite this, natural gas exports rose 9% in 2004, to 680 Bcm (24 Tcf), representing 25% of total world consumption. Pipeline deliveries accounted for 74% of these exports; the balance was delivered as LNG.4 LNGs shares of overall world natural gas consumption, now around 6.6%, and of the world natural gas trade have risen steadily since the rst deliveries in the mid1960s. As regional demand begins to exceed regional supply, the resulting demand pressure appears certain to lead to a signicant expansion of the LNG industry in the coming decades. Even by low estimates, global LNG trade is forecast to double between 2000 and 2020.5 Tens of billions of dollars will need to be invested in order to make this supply available. In contrast to the oil industry, however, LNG represents a more technically, nancially, and commercially challenging energy delivery system, well suited to the strengths and competencies of the major oil and gas-producing companies. There is no world price for natural gas or LNG, and many end-use markets remain essentially closed to competition, under the control of regulated utilities. Simply having access to large untapped reserves of natural gas does not ensure that these reserves will be monetized easily or quickly. These dynamics have resulted in a growing interest in this industry by national governments on both the producing and consuming sides, as well as by the energy industry and investment communities, who perceive the challenges as allowing more opportunity for investments, access to reserves, and production growth. By way of anecdotal evidence of this trend, in 2005 ExxonMobil added 1.7 billion barrels of oil equivalent (BOE) to its reserves. About 95% of this total was attributable to gas reserves associated with the companys LNG projects in Qatar. In simple terms, the LNG industry involves identifying large reserves of natural gas with little or no prospect of securing local markets, producing then liquefying the natural gas at very low temperatures (163C), shipping the LNG in specially designed tankers to markets, and storing and regasifying (or vaporizing) it before injecting it into a pipeline grid, at which point it becomes indistinguishable from pipeline gas for the end user. In its liquid form, natural gas shrinks to less than 1/600th of its gaseous state, making its transportation and storage more efcient. However, little is simple about LNG. Bridging the gap between supply and demand is one

The LNG industry is based largely on a series of virtually self-contained projects made up of interlinking chains of large-scale facilities, requiring huge capital investments, bound together by complex, long-term contracts, and subject to intense oversight by host governments and international organizations at every stage of the process.

of the energy industrys most challenging and intricate problems. The LNG industry is based largely on a series of virtually self-contained projects made up of interlinking chains of largescale facilities, requiring huge capital investments, bound together by complex, long-term contracts and subject to intense oversight by host governments and international organizations at every stage of the process. Ironically, this effort is applied to the simplest hydrocarbon, methane, and involves no chemical or other changes to the commodity, except to its temperature, from the time it is produced until it reaches the nal consumer.

Even though LNG has represented a major source of natural gas and a signicant share of primary energy for decades in Japan and other areas of the world, it was for many years considered a high-cost niche segment within the energy industry. Given the numerous hurdles and uncertainties that faced each project and the need to coordinate the multiple disparate elements involved, many projects failed to achieve realization or collapsed before they had run their course, often at a cost in the tens or even hundreds of millions of dollars. Skeptics warned of impending disasters that would threaten the safety, economics, or operations, and in some parts of the world, the public and the media attacked the industry on safety grounds. Each project took years to develop and had to chart new territory, so that it took decades for the industry to reach a critical mass of well-functioning projects and prove that the technical and commercial model could be successful. Conventional wisdom held that even the successful LNG projects had marginal economic returns, and many energy companies avoided the LNG sector or exited it as quickly as they could. For the rst few decades, the industry had relatively few participants and was loosely known as the club. Yet club members were already cognizant of what the rest of the world is only now realizing that well-executed LNG projects can generate highly protable and stable nancial returns over many decades. Notwithstanding the hurdles, the industry has proven its reliability and stability under a variety of market and economic conditions, accompanied by a safety record second to none for an operation of its scale and scope. Currently, demand growth and high energy prices, coupled with advances in

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technology, are driving more planned and proposed LNG projects than at any point in history. There is no question now about the important, growing role that LNG plays in meeting global natural gas demand.

THE GLOBAL NATURAL GAS INDUSTRY

Although the ancient Greeks, Romans, and Chinese made limited use of natural gas, it was only in the 20th century that it became a signicant source of energy, thanks to technological advances in long-distance, highpressure pipeline transportation that permitted it to be widely distributed and allowed it to substitute for town gas produced from coal, which had been introduced to many cities in the late 19th century. World demand has grown steadily throughout the 20th century and has more than doubled since 1970. The U.S. Department of Energys (DOE) Energy Information Administration (EIA) has projected that world gas consumption will grow nearly 70% between 2002 and 2025.6 Natural gas is used extensively for heating and cooking in residential and commercial settings and as a process fuel and feedstock for industrial consumers. However, while the number of customers for these applications continues to grow, overall consumption growth is muted as equipment efciencies improve. The future of gas demand reects the future of electricity demand. The electric power sector is expected to account for more than half of the growth in gas demand, because of the environmental benets and efciency of natural gas, compared with other energy sources. Technological advances in CCGT power plants have shifted the economics of power generation away from coal in favor of natural gas, even with gass higher prices. Historically, gas-red power generation was primarily used for peak generation in simple-cycle gas turbines or when prices justied, as a direct substitute for residual fuel oil in steam boilers, since the variable costs of generating baseload electricity using other fuels, such as coal and nuclear, were lower.

The age of the gas turbine

Until the 1970s, coal and oil were the principal fuels used to generate electricity. However, the use of oil for electricity generation has been shrinking in the wake of the oil shocks of the mid-1970s. This, in turn, contributed to the rapid expansion of nuclear generation from the 1970s through the 1980s. By the mid-1980s, public opposition and escalating construction costs brought nuclear development to an abrupt halt in many countries. At the same time,

environmental concerns associated with greenhouse gas emissions began to slow the development of coal-red generation. Many countries also began a process of liberalizing their wholesale electric markets, and this brought an increased focus on the overall costs and efciencies of the power generation technologies, with costs no longer guaranteed recovery as they had been under the classic utility regulatory environment. Lower-capitalcost technologies with shorter construction times began to win favor. The stage was now set for the emergence of natural gas. The rst gas-red generating units, built in the United States during the 1960s, were small turbines and relatively inexpensive to build, but they were often inefcient and depended on high-cost natural gas supplied through gas distribution utilities. Gas supply was often curtailed during periods of peak gas demand. As a result, these peaking units were employed to provide a rapid source of power only during periods of peak demand, which largely occurred during the summer months. With the exception of Japan, natural gas was rarely used for power generation outside the United States, since it had to be imported and these imports were expensive and often raised issues of supply security. Moreover, many countries adopted policies prohibiting the use of natural gas in power generationincluding the United States, through the Fuel Use Act of 1978. Japan was an unusual case, where natural gas was used widely by the large power utilities in direct substitution for oil in classic, steam turbine power plants. This served two purposes: Japan could diversify its energy supply, shifting from overdependence on Middle East oil to sources closer to home; and the baseload nature of the Japanese power utility demand helped to underwrite the success of the early LNG exports project by assuring a stable, secure, and nancially appealing market. With the introduction of CCGTs in the 1980s, the removal of prohibitions on the use of gas for power generation, and the introduction of competition in wholesale electric markets, the boom in gas turbine generation was under way. (In a combined-cycle plant, a gas turbine is combined with a steam turbine, which uses the waste heat from the gas turbine to increase efciency.) Modern CCGT plants have thermal efciencies approaching 60%, compared to efciencies of closer to 40% in modern coal-red power plants. During most of the 1980s, annual sales of gas turbines hovered around 300400 units, with an average size of only 30 megawatts (MW), reecting their use in peaking applications. By 1990, annual sales exceeded 600 units, soaring to 900 units by mid-decade and 1,500 units in 2000. Turbine size increased dramatically as well, reaching up to 500 MW. Deregulation has also put in play other factors supporting the popularity of CCGTs. The introduction of wholesale competition in the power sector is

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increasing the demand for these units. Gas turbines can be deployed rapidly, which reduces market risk, since developers can match their investment decisions more closely with uctuating market requirements. Capital costs are much lower, making nancing easier and reducing the risk that the developer may be left with stranded assets. During the 1980s and 90s, natural gas was cheap and there was a common consensus that it would remain cheap and plentiful for the foreseeable future. Finding a site for a gas-red power plant is easier than for a coal plant, which is widely viewed as dirtier, or for a nuclear facility, which the public considers too dangerous. Gas-red plants were often the only generation choice which could meet regional air quality restrictions. These developments contributed to a major increase in the use of gas for power generation between 1973 and 2000. From 1980 to 2000, oils share of the U.S. energy mix dropped from 46% to 39%, while natural gas rose from 19% to 23%.7 Between 1990 and 2004, natural gas-red power plants accounted for some 95% of all new power plants installed in the countrya total of over 100,000 MW of power capacity. Yet natural gas-red power is not the answer to everything. The bankruptcy of companies such as Calpine and Mirant demonstrated that single-minded bets on natural gas carried their own risksin this case, the risks associated with rapidly increasing fuel prices which could not be recovered in the wholesale power markets.

Competing against other fuels

While natural gas may continue to gain market share at the expense of other hydrocarbon resources, coal is ghting back, nuclear is showing new signs of life, and new renewable fuels are helping to change the energy mix. Still, expectations for the potential of renewable fuels and associated technologies are often overstated, and reducing coals environmental impact is a nontrivial undertaking. Oil, long the king of energy consumption, comprises the biggest share of global energy supply and will continue to do so for the foreseeable future. Oil is relatively cheap to ship globally, and international markets are well established. Transportation fuel demand, especially in India, China, and other emerging countries, will continue to expand. Natural gas does not yet economically compete with oil for transportation. Until technological breakthroughs occur and/or legislation passes favoring natural gas or other alternative transportation fuels, oil will continue to dominate these markets in most areas of the globe, and transportation use will continue to dominate oil demand, accounting for some 70% of the petroleum market.

In the past, the lack of infrastructure to transport and distribute natural gas was a barrier to increasing gas consumption. However, the 1970s oil shocks provided an impetus for the improvement of infrastructure, leading to the construction of major pipelines from the North Sea, Russia, and North Africa to Europe and to signicant expansion of existing networks in North America. In regions where natural gas pipeline infrastructure is not in place, oil continues to be used for residential and commercial heating purposes. Natural gas is slowly making inroads in developing countries, especially Latin America (Mexico), South America (Venezuela, Brazil, and Argentina), Eastern Europe and the former Soviet Union, and Asia (China, India, and Thailand). The EIA forecasts that gas use will grow 63% in Eastern Europe and the former Soviet Union over the 200220 period and will nearly triple in emerging Asia, including India and China. Gas demand will grow at a slower rate (1.3% annually) in the mature market economies, whose share of the global natural gas demand is expected to decline from 50% in 2002 to 43% by 2025.8 In places without indigenous supply, infrastructure, or existing consumers, electric power projects or industrial projects are often built rst as anchor customers to secure sufcient baseload gas demand and justify a supply project. Later, distribution networks are added to reach smaller consumers. This is the pattern followed by Japan in the 1970s and 80s. Another reason for the recent growth in popularity of natural gas is that it is the cleanest-burning fossil fuel. Its low carbon content per unit of energy, compared to oil and coal, contributes to its attractiveness. Following the Kyoto Treaty, many developed countries have adopted targets to reduce CO2 emissions and intend to enforce these targets through a combination of emission-trading regimes and nes for noncompliance, further improving the comparative economics of natural gas. Although coal, nuclear, and hydro have historically been the dominant fuels for power generation owing to their low costs, the improved economics of natural gas-red power generation, coupled with its environmental benets, will allow gas to capture new markets where gas infrastructure can be built and gas can be delivered on a cost-effective basis. New gas-red power plants have the lowest capital costs per megawatt of any power plant and are easier to site than most other types of plants. The coal industry is moving to address the concerns associated with emissions. New technologies are more fuel efcient and produce fewer and cleaner emissions. Power companies are looking at the development of carbon sequestration as a way to address CO2 emissions. While these are

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expensive solutions, government policy (especially in the United States) will favor them to further energy supply diversity and security. The advantage of natural gas over nuclear energy has much to do with public perception. There are widespread safety concerns about nuclear power because of the perceived risks, such as radiation leaks, long-term spent fuel disposal, and nuclear proliferation; by contrast, public opinion of natural gas-red generation is typically positive or neutral. The negative sentiment associated with nuclear power makes constructing new plants difcult. Nuclear facilities have enormous capital costs, and even though new technologies and standardization of designs could lower the costs of constructing new plants, natural gas does not stand to lose market share to nuclear. The greatest potential for nuclear additions would be through government policies aimed at removing risks associated with siting the plants and a desire to ensure energy supply diversity. Public perception may also be shifting as peoples concerns over the negative impacts of global warming overcome the more speculative and sensationalist aspects of nuclear power with its lower emissions footprint. With the exception of hydroelectricity, renewable sources have historically not been economically competitive with fossil fuels. Hydroelectric power generation is restricted to certain areas and is subject to variations in weather. Major hydroelectric power projects carry their own environmental risks and can force the migration of local populations, as was seen in the Three Rivers project in China. New construction is more likely in locations remote from local populations, but the cost of long-distance power transmission is another factor. Solar power and wind power have clear environmental benets over natural gas for power generation. The economics of wind energy have changed as costs decline, and wind increasingly appears competitive with other fuels, often aided by favorable government tax treatment. Largescale wind farms, virtually nonexistent before the 1990s, are becoming increasingly common in North America and Europe. As wind becomes cheaper to build, its incremental costs could be competitive with those of natural gas for power generation. Wind stands to be the fastest growing of all energy sources in the coming decades. However, the construction of massive wind farms, both onshore and offshore, is facing opposition in some communities. While wind will undoubtedly capture some of the natural gasred power generation market, natural gas is considered more reliable and economical and will remain the dominant fuel for new power generation over the next few decades. Solar power is also advancing but at a slower pace than wind, because the technological challenges appear to be more difcult to surmount. However, solar is developing natural niche markets in

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remote and isolated locations where other sources of electricity prove too expensive to deliver. While alternative energy has a rapidly expanding future, it still will not account for more than 9% of the global primary energy supply by 2020.

NATURAL GAS RESOURCE DEVELOPMENT

Natural gas supply
Historically, natural gas reserves that were remote from markets were viewed as a nuisance that potentially impeded the development of oil reserves. These remote gas reserves are often termed stranded. As the options for monetizing natural gas have expanded, however, some previously stranded reserves discovered decades earlier are nally being developed. For many of the major energy companies, increasingly denied access to oil reserves or being forced to settle for onerous nancial conditions to develop them, gas is becoming the new oil. In addition to technology improvements in exploration and production, the energy industry has doubled worldwide natural gas reserves between 1980 and 2000, and reserves continue to climb. At present consumption levels, there is enough gas to last through the next seven decades.

Natural gas resources

Proponents of the gas era point to the large size of the worlds natural gas resource. At the end of 2005, world gas reserves totaled 6,112 Tcf (173 trillion cubic meters [Tcm]), equivalent to 1,107 billion bbl of oil, just slightly less than proven petroleum reserves of 1,293 billion bbl.9 Proven natural gas reserves will last for 70 years at current production levels, and prospects to increase total reserves are excellent as the energy industry increasingly focuses on natural gas. By contrast, the global oil resource base would be depleted in 40 years at todays production rates, and the prospects for signicantly expanding the resource base seem less certain. While gas resources are ample on a global basis, they are not evenly distributed. They are often far from major demand centers and have not been developed. About 75% of the worlds reserves are located in the former Soviet Union and the Middle East. However, consumption is dominated by North America and Europe (including Russia), accounting for at least 56% of global gas consumption. The comparative ratio of reserves to production (R/P ratio), which indicates the number of years that it would take to deplete

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proven reserves at current production levels, also highlights this regional disparity. For example, proven reserves in the Middle East would last for 257 years, and there is clearly room to prove up additional gas resources with relatively little effort. By contrast, the R/P ratio in North America is less than 10 years, and regional hydrocarbon basins have been explored extensively and are considered mature. However, R/P ratios alone do not tell the full story of the ultimate resource base, since the U.S. R/P ratio has varied between 9 and 13 years for several decades, illustrating the ability of the industry to nd new reserves, often in response to economic signals. The imbalance between the location of gas resources and gas markets necessitates a major expansion in the international gas trade, by long-distance pipelines and in the form of LNG. However, building the infrastructure to move natural gas long distances requires multibillion-dollar investments. This raises the question of whether incremental gas supply can be delivered long distances to markets at competitive prices or whether high prices will moderate gas demand growth below current expectations. The power sector in particular, faced with gas supply and price concerns, may reevaluate the potentials of clean coal and nuclear technologies.

Pipelines
One of the rst modern commercial applications for natural gas was in streetlamps in the eastern United States and northwestern Europe in the 19th century. When nations became electried, gas lamps became obsolete, and natural gas did not play a major role in the energy picture until pipelines were constructed to transport the fuel from producing areas to consumers. Although natural gas had been transported in wooden pipelines in other areas of the globe much earlier, the rst metal natural gas pipeline was built in 1872. Stretching ve and a half miles, it brought gas from a producing well to the town of Titusville, Pennsylvania. These rst metal pipelines were extremely inefcient. It was not until after World War II, when pipeline technology dramatically improved, that natural gas became a major part of the energy mix. In Europe, the foundation of the gas transmission system was laid between 1970 and 1975, fueled by the giant gas discovery in Groningen, The Netherlands.10 The pipeline industry groups natural gas pipeline systems according to three denitions: gathering systems, transmission lines, and distribution pipelines. For the most part, in this book, the term pipelines refers to transmission pipelines, which transport natural gas from supply areas to markets. These long-haul pipelines are usually between 16 and 48 inches in diameter and can extend for thousands of miles, operating at high pressures

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maintained by compressor stations along the route. In mature markets, such as the United States and Europe, a complex web of transmission pipelines connects to other transmission pipelines, storage facilities, large end users, and distribution systems. Gathering systems generally comprise smaller-diameter pipelines that take gas from the wellhead to central processing facilities, where impurities are extracted. However, offshore gathering systems may be physically indistinguishable from transmission lines. Gathering-line pressures can vary signicantly, usually as a function of the wellhead pressure of the producing well. Distribution pipelines also tend to be smaller in diameter and disseminate natural gas to consumers in market areas. Distribution lines normally operate at medium to low pressures. While very large consumers, such as a steel mill or an electric generator, may be directly connected to a transmission pipeline, the vast majority of medium to small consumers obtain their gas through a distribution system, which is often run by a local distribution company (LDC). From an environmental and safety perspective, pipelines pass with ying colors. Aside from the initial impacts associated with construction, the pipelines themselves have very little environmental impact. Thanks to safety and security systems that detect corrosion or leaks, most problems can be identied and corrected before they become signicant. Although accidents happen from time to time, the system is considered one of the safest modes of transportation. Pipelines remain the major mode of transporting the worlds natural gas to consumers, accounting for over 90% of natural gas deliveries. The United States alone has over 180,000 miles of interstate pipelines.11 As natural gas demand grows, the number of major international pipeline projects continues to increase. The industry has faced and met increasingly complex challenges of distance and terrain and long, deep underwater crossings. Some existing and proposed pipeline projects are nearly four thousand miles long and cost billions of dollars to build. Generally speaking, an offshore pipeline is more expensive than a similar onshore one. Despite technical advances, it is not always possible or desirable to link supply to market by a pipeline, because of terrain, right-of-way issues, politics, and/or distance. Sometimes geographical features, such as underwater faults or coral reefs, may prevent construction, or a planned pipeline may interfere with an environmentally protected area or other public infrastructure already in place. Landowners may not allow (or be required to allow) the pipeline to be built on their territory. A route may traverse politically unstable regions

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or countries that are on unfriendly terms with the supplying or consuming country. These factors may prevent a pipeline from being built or may render it uneconomical.

LNG INDUSTRY DEVELOPMENT

Historical background
Petroleum products were rst transported by tankers in the 1860s, but a century passed before natural gas was transported by ship.12 One reason for this delay was the rapid evolution of the global oil industry, spurring the long-haul transportation of petroleum. Another reason was the signicant technical challenges of transporting natural gas on oceangoing tankers. It is relatively easy to store, load, and transport oil or other petroleum products, but natural gas has to be turned into a liquid at very low temperatures, then stored and transported in this form. Two 17th-century physicists, Robert Boyle and Edme Mariotte, are credited with discovering that air is compressible; this led to insights into how gas might be pressurized and condensed. Numerous subsequent experiments were conducted to establish the optimum method of reducing the volume of natural gas, and it was determined that increasing the density of gas could be achieved by extreme pressure, extreme cooling, or a combination of the two. Compressed natural gas was generally considered too difcult and dangerous to be transported around the world because of the lack of suitable materials to contain the high pressures and the risk of explosion in the case of a sudden release of gas. However, with extreme cooling to below its boiling point (in this case, 163C), natural gas could be reduced in volume by a factor of over 600 times, then stored and shipped at normal atmospheric pressure. In its liquid form, natural gas exhibits an unusual property known as auto-refrigeration, whereby continuous evaporation draws heat away from the liquid and does not require anything more than insulation to maintain the gas in liquid form as long as the evaporated gas, known as boil-off, is removed from the storage tank. The process of cooling natural gas to extremely low temperatures began as a means of extracting helium from natural gas for use in U.S. military balloons in the early 1900s. Shortly thereafter, through advances in metallurgical techniques, metals, notably aluminum and steel alloys, were produced in Europe and the United States that would not become brittle at extremely low temperatures, as most metals do. Storage facilities could thus be built for the supercooled liquid.

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Godfrey Cabot devised the rst conceptual scheme for LNG in 1914, when he patented a barge-based system to demonstrate that waterborne transportation of gas was technically feasible. However, he never pursued the idea. In 1939, the rst commercial LNG peakshaving plant was built in West Virginia. Two years later, the East Ohio Gas Company built a second facility in Cleveland. This peakshaving plant operated without incident until 1944, when the facility was expanded to include a larger tank. However, World War II created a shortage of the best available stainless steel alloys (stainless steel could withstand the very cold temperatures without fracturing as mild steel does when exposed to LNG), and a storage tank was built using steel with inadequate nickel content. In 1944, the tank ruptured and natural gas leaked into the sewer system and into peoples homes, where it ignited, killing 128 peoplethe largest disaster in LNG history. Subsequent investigations resulted in new standards for the materials used with LNG, preventing this from happening in the future. However, this incident put LNG development on hold, and commercialization of the technology was not attempted again until a decade later. In the 1950s and 60s, William Wood Prince, president of the Union Stock Yards of Chicago, was faced with escalating electricity rates and began to study the liquefaction of natural gas in Louisiana and the possibility of barging it up the Mississippi River to Chicago. The British Gas Council was also looking to transport natural gas to supplement gas supplies in areas thinly stretched by manufacturing and household use. The Union Stock Yards subsequently joined forces with Continental Oil Company and the British Gas Council to turn an old World War II dry bulk carrier into an LNG ship, the Methane Pioneer. This vessel was used to transport LNG from Lake Charles, Louisiana, on the Gulf of Mexico, to Canvey Island, in the United Kingdom, in 1959, in what was the rst maritime shipment of LNG. After a major natural gas discovery in Algeria, the United Kingdom and France signed contracts with Algeria in 1961 and 1962, respectively, and the rst commercial-scale LNG In many countries, an chain with a liquefaction plant at Arzew, Algeria, and receiving terminals in France LNG project is the largest and the UK, became operational in 1964.

investment ever undertaken, and a countrys future creditworthiness may hang in the balance. Unfullled commitments for any reason can lead to millions of dollars of losses.

During the 1960s and 70s, liquefaction plants were built in Alaska, Libya, Brunei, Abu Dhabi, and Indonesia, as well as Algeria. Import terminals were developed in Japan, France, the United States, and Italy, later joined by terminals in Belgium, Spain, Taiwan, and Korea. However,

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owing to an oversupply of gas in the Atlantic markets in the 1980s, only two new export projects (in Australia and Malaysia) were added in that decade, while expansions continued in Indonesia. Most of the capacity added in the 1980s was designed to serve Asian LNG markets, which were growing rapidly and did not have the same access to domestic gas or pipeline imports as Europe or North America. In the early 1990s, demand was catching up with supply in the Western hemisphere. Consequently, a rebirth of LNG projects was targeted toward those markets, and the rst output from Qatar, Nigeria, Oman, and Trinidad occurred between 1996 and 2000.

The essential ingredients of an LNG project

Unlike many other energy delivery systems, LNG has tended to be organized on a project basis, involving the development of not only upstream infrastructure and gas production, gathering, and liquefaction facilities but also shipping and import terminals. This reects the very high capital investment needed for each unit of energy delivered, as well as the historical separation between the LNG suppliers (large international oil companies, both private and state owned) and the LNG buyers (principally gas and electric utilities, both private and state owned). As the industry matures and as the traditional sellers move downstream while the buyers move upstreamthese challenges may lessen but will be replaced by others, though perhaps not as severe. Between the start of the commercial LNG business in 1964 and the year 2000, the industry grew at a very deliberate pace, adding fewer than 20 projects in a dozen countries. During this time, it remained a closed industry dominated by a handful of players and strong bilateral contracts. For many years, every new project announcement was met with skepticism and predicted failure, even when the existing projects could demonstrate years of successful trade. There is good reason for doubt, as each new project faces substantial risks and challenges. The principal reason for the apparently slow pace of development of the business is the scale of requirements (and, consequently, the requisite investments), which have few parallels in any industry. Except for a few long-distance pipelines and nuclear power, no other type of energy project consistently rivals LNG in costs. In many countries, an LNG project is the largest investment ever undertaken, and a countrys future creditworthiness may hang in the balance. Unfullled commitments for any reason can lead to millions of dollars of losses. To mitigate participants nancial risks, each project weaves together a complex web of contracts and agreements. The challenge of managing a project where buyer and seller have

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disparate interests and are both subject to scrutiny from and/or involvement of their host governments cannot be overestimated. Other considerable barriers to successful project execution are the many commercial, technical, and legal challenges. Addressing these challenges requires the coordination of dozens of experts, including lawyers, engineers, contractors, shipowners, bankers, government representatives, and consultants. The complex issues involved in developing an LNG project will be discussed in detail in chapter 9. The following is a summary of some of the main issues, emphasizing the major conditions necessary for development to proceed. The rst consideration is to ensure that the physical locations, resources, and commercial conditions are favorable. Sufcient gas reserves. By the time an LNG project is under consideration, the existence of ample low-cost gas reserves has usually been conrmed. A project must have dedicated proven reserves that allow the project to operate at its design level for 2030 years, with an additional reserve margin to protect against unexpected production declines. This helps ensure the nancial viability and the nanceability of the project. The cost of producing the reserves must be fairly low to make the LNG project economical. If the gas is too expensive to produce, it will be left in the ground. The presence of liquid hydrocarbons, along with the gas, can also improve project prospects, as this can create an additional, high-value revenue stream for the project. Long-term commitments from buyers. While a liquefaction facility may have varying degrees of its capacity reserved for short-term or spot trades, the capital costs required in order to build a facility usually dictate that a downstream buyer or buyers, who will contract for the majority of the plants output, must be secured. This ensures a stable off-take for the supplier. In most contracts in the LNG industry, the buyer takes most of the volume risk with limited exibility, while the seller takes most of the price risk, with limited opportunity to revisit those terms. This traditional structure is now being modied, as the industry matures and the options and opportunities for buyers and sellers expand. Unlike the oil business, where the production prole tends to build gradually over time and the commodity may be shipped relatively inexpensively to any number of markets on tankers that can be contracted on relatively short notice, liquefaction plants generally produce large quantities of LNG shortly after they come on line, and access to LNG tankers and market outlets is more limited and can be signicantly more expensive. Under ideal conditions, production and consumption should be maximized as early as

The Liqueed Natural Gas Industry 17

possible and maintained at this level for the duration of the project. For this reason, it is preferable to market LNG to buyers with access to wellestablished gas markets. In countries with small or nonexistent natural gas markets, an LNG sales contract might be anchored by an electric generating plant or an industrial buyer that can consume large volumes of the gas, with smaller customers added later, as a distribution network is built out from the terminal. Access to capital. Any LNG project requires access to sizeable shareholders with the ability to fund major capital investments, either on an equity basis or through borrowings. Project (or limited recourse) nancing can play a major role in securing the funding for LNG projects, even those involving the largest oil and gas companies. Successful project nancing requires a well-constructed project concept with robust and stable commercial arrangements, which can ensure the repayment of billions of dollars of nancing over many years in a potentially volatile energy price environment. Strong relationships. Although the hardest to dene in concrete terms, the relationships, reputations, and experience of the various stakeholders are among the most important aspects of an LNG project. Strong relationships between project sponsors, customers, governments, lenders, and contractors are a key to long-term project success. The reason that trust and relationships are so important is simple: in an enterprise spanning many decades, subject to many evolutionary changes unimagined at the outset, the underlying commercial and legal agreements may be inadequate to ensure the projects success, and the relationship between the parties provides the only guarantee that the business can address the inevitable problems that will arise. These relationships are especially important at the outset, when the project is least dened and the parties are preparing to spend signicant sums of money without any assurance that the project they are envisioning will in the end achieve commercial reality. It can take years to build these types of trusting relationships and reputations, and for prospective new entrants, breaking into the LNG industry can be more challenging as a result. Technical details. All physical links in the LNG chain require technical analysis, including feasibility studies, engineering designs, project execution, and operational plans. These will determine the technologies that are used; the size, compatibility, and integration of each component of the facilities; and any additional infrastructure that is required. Unique logistical challenges have been faced (and overcome) on each project. Planning for these sometimes-tangential details may be projects in

18

their own right. For example, when the Nigeria liquefaction plant was being constructed, it was necessary to house over 10,000 people at a remote site where there were no existing accommodations. Such related undertakings can cost the project millions of dollars. Commercial issues. At the outset of a proposed project, the most important work involves agreeing on the commercial terms. This involves the project structure and ownership of various components of the project, including shareholders agreements and project development agreements; negotiating and structuring a set of end-to-end contracts covering the production of natural gas at the wellhead, all the way to sales to the end users; dening the host governments role and share in the revenues; negotiating the contracts for the plant design and construction; and nancing the project. Safety and siting. Safety is of paramount importance in the LNG industry. The assets are so expensive that any repairs required by a major accident could amount to tens of millions of dollars plus the loss of signicant revenues. A major accident could mar the industrys reputation and set back any proposed projects. Finally, insurance costs are a major expense for project investors, and an accident could drive them so high that protability might be signicantly reduced. Lenders will require an independent technical analysis of the facilities design, as well as conrmation of their compliance with regulatory requirements and good industry practice. For all of these reasons, companies go to great lengths to design safety into the facilities from the outset and to provide continual training and resources for employees working on and around LNG facilities and ships, to ensure LNGs safe transportation and storage. These considerations are most acute for regasication terminals, since the most desirable locations from an infrastructure standpoint are often near densely populated areas. There is widespread misunderstanding with regard to the safety of these terminals. In an era when the threats of global terrorist activities have dramatically increased, siting new terminals or moving tankers near populated areas has become even harder, particularly in the United States. In the case of a greeneld project, both supplier and buyer must control sufcient land to accommodate their respective facilities and must ensure legal compliance with safety and environmental conditions. To accommodate tanker access, these sites must have access to waterways that are either already of sufcient depth or capable of being dredged to accommodate the LNG tankers. Expansions of existing facilities generally do not create the same level of concerns.

The Liqueed Natural Gas Industry 19

External advisers. Legal issues are present from the outset of a proposed project. Lawyers are instrumental in the drafting of contract and project terms. The contracts and agreements associated with an LNG project are complex, especially when it comes to allocating and mitigating the parties risks and addressing contingencies for unforeseen circumstances. Lawyers also must advise onand in certain cases help decidethe applicable law that will govern each element of a project. Legal issues are a major component of every project. Each project will also involve the input of a variety of other technical advisers who will provide expert support to the project sponsors. These include consultants who will help prepare the necessary environmental impact statements, evaluate the gas reserves and markets, and make provisions related to shipping alternatives, insurance, safety, and security, among other tasks. The project sponsors, buyers, and nanciers will all seek independent evaluations of the various aspects of the project as part of their own due-diligence exercise, leading up to the nal investment decision (FID). Government regulations. In most aspects of an LNG project, government regulations can play a signicant rolethough much more so downstream of the liquefaction facility. Most liquefaction plants are constructed in relatively remote locations and often in countries that do not have well-developed environmental, safety, or other regulatory guidelines. In these cases, the project sponsors will utilize regulations from other countries or guidelines issued by the World Bank or best practices promulgated by industry associations. Adopting these guidelines is often a prerequisite to securing international nancial support for the project. Downstream beyond the liquefaction plant, the degree of government scrutiny and involvement will rise. The LNG tankers are subject to a variety of regulations and conventions issued by the International Maritime Organization (IMO), the tankers ag state, and the maritime regulatory bodies of the countries in which the tanker is expected to load and unload its cargo. The regasication terminals also are subject to stringent regulatory guidelines in their host countries, governing safety, security, and environmental aspects of the terminal and the vessels calling on it. In addition, the importing country may exercise economic regulation over the import terminals, requiring open access and the ling of tariffs governing the terminals use. In particular, this will be the case when the LNG terminal is owned by a public utility.

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Alternative methods of monetizing natural gas resources

LNG is not always the best choice for gas monetization. Given a large, remote gas eld, a producers best option may be to leave the gas in the ground. Often, gas reserves are too expensive and/or too far from a viable market to warrant the huge costs of development. However, declining costs, rising prices, improving technology, and expanding markets are leading developers to reexamine some of their remote reserves. Options for monetizing gas that are available to gas resource holders and developers include the following: Local market. Depending on the location of the gas eld and its proximity to developed areas, gas can be monetized by selling it into a local market. National governments generally prefer such a scheme, since it allows the development and internal use of a state resource. A steady supply of local gas can encourage industries that use natural gas as a feedstock (e.g., methanol and fertilizer production) or whose operations require large quantities of cheap power (e.g., aluminum smelters). It also promotes investment in infrastructure and creates jobs in the host country. Many large gas nds are in areas that are too remote or inhospitable to make use of the gas as a local energy source. In these cases, some method must be found to monetize the gas as an export commodity. Sometimes, at the insistence of the host government, the development of gas export projects will go hand in hand with supply to local markets. Conversely, host nations can contract gas developers to build infrastructure to supply internal markets with gas, and the developers are then given the right to build gas export facilities in parallel. LNG or pipeline? In the development of gas reserves, the choice between LNG or pipeline development can be relatively simple, as the LNG project in Trinidad illustrates. In Trinidad, there were signicant reserves of stranded gas, and there were no nearby markets of any sizeand none that could be reached economically by pipeline. On the market side, Japan is an example of a country with little or no indigenous gas reserves, concentrated population centers on the coast, and no nearby pipeline-accessible sources of gas (at least not when the early Japanese import projects were being developed). It goes without saying that ready access to the ocean is an essential ingredient of any successful LNG project! Beyond this, the tradeoffs and decisions become more complex. Economic trade-offs. In its early evolution, LNG was seen as a high-cost option and the last choice for countries with potential access

The Liqueed Natural Gas Industry 21

to pipeline gas. Now that LNG technology has matured and costs have come down, LNG can generally compete with pipeline deliveriesat least over longer distances (generally greater than 2,000 kilometers) and even over shorter distances where there are major impediments to pipeline construction. Today in Japan, LNG remains the preferred import approach because of the disconnected nature of the Japanese markets, which would make it difcult to bring a large pipeline to the country and arrange for onward transmission and distribution. Japans markets are viewed as prohibitively expensive and too legally complex to integrate into a single grid, foreclosing the pipeline option. Security advantages. LNG has security advantages that can override economics. On the one hand, LNG is generally transported across international waters, so that only the seller and buyer governments are involved. On the other hand, unlike ships, pipelines are not vulnerable to the vagaries of weather and are simpler to maintain. Pipelines can provide a secure and stable method of delivering set volumes of gas on a year-round basis. Pipelines often have to cross several international boundaries, which means that several governments may be involved, increasing the relative complexity of development. This may also raise the potential of supply interruptions through diversion of gas volumes, attack on the infrastructure, or having the intermediary country close the valve for political reasons. Gas buyers and sellers in a pipeline trade are essentially hostage to events in the countries crossed by their pipeline. A good example is the potential gas trade between India and Iran. The most obvious and economical method for bringing Iranian gas to Indian markets One of the major reasons would be via an onshore pipeline across that countries have decided southern Pakistan, a scenario fraught to import LNG has been to with obvious political difculties. LNG projects are not entirely immune to diversify their energy supply these kinds of difculties. For example, portfolios. They may be to historical distrust between Bolivia and diversify away from another Chile led to the demise of a scheme to export Bolivian LNG from a facility energy commodity, as in the located on the Chilean coast. case of Japan, which initially One of the major reasons that countries have decided to import LNG has been to diversify their energy supply portfolios. They may be to diversify away from another energy commodity, as in

imported LNG to lessen its reliance on oil, or to reduce reliance on any single gas supplier, as in the case of European nations.

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the case of Japan, which initially imported LNG to lessen its reliance on oil, or to reduce reliance on any single gas supplier, as in the case of European nations. Exporters may favor the LNG option because, unlike a pipeline project, they can diversify their revenue sources by selling to multiple buyers and markets. Exporters reliant on a pipeline are at the mercy of a single market that has to be fully developed at some cost prior to construction. If demand slackens in that market, the asset remains stranded, whereas LNG may be able to nd other markets when demand patterns change. More exible schemes like LNG can get smaller commitments from a number of different buyers to reach the necessary threshold for project investment. Security of supply and security of markets are central themes in the 21stcentury energy marketplace. Options for monetizing gas that are available to gas resource holders and developers other than LNG or long distance gas transmission lines include the following: Gas to liquids (GTL). This term often is used to refer to the reprocessing of methane into longer-chain hydrocarbons that are liquid at atmospheric temperatures and pressures. The GTL process entails the generation of syngas, a mixture of CO and H2 derived by combining methane with H2O and/or O2 at high temperatures. This syngas is then subject to the FischerTropsch (FT) reaction or another similar process, in which the syngas is reacted in the presence of a catalyst to produce longer-chain hydrocarbons that are liquid at normal pressures and temperatures. These hydrocarbons can then be processed using standard rening techniques. The primary product to date has been a form of very clean diesel fuel, which can be handled and used in the same way as diesel rened from crude oil. GTL competes primarily against more traditional oil products, rather than LNG. An advantage of GTL is that it is stable, liquid under normal conditions (and therefore easily transportable), and very clean. Like oil and unlike LNG, GTL is a fungible commodity. These characteristics make GTL especially valuable in developed markets that are highly sensitive to environmental concerns. Because GTL competes against rened petroleum products for markets, it is highly sensitive to oil price, though usually capable of attracting a premium price for its environmental value, and may offer a portfolio benet to a gas resource holder who is otherwise largely captive to natural gas markets and pricing. With advances in technology and scale, capital costs for GTL projects have dropped signicantly, from more than $100,000/bbl of installed capacity to $25,000$30,000/bbl in mid-2005 (compared with around $15,000/bbl for conventional petroleum rening).

The Liqueed Natural Gas Industry 23

Rising oil prices starting in 2002 have made GTL increasingly more attractive to gas producers as a monetization method. As a result, gas-rich countries, such as Qatar, Iran, Russia, Nigeria, Australia, and Algeria, are examining or initiating demonstration-scale GTL projects. Furthermore, the development of a GTL project needs less gas reserves than an LNG project of comparable investment size and therefore can be appealing to countries with limited gas reserves. Compressed natural gas (CNG). For shorter-distance trades or for relatively small reserves (<2 Tcf [56.7 Bcm]), another monetization option is CNG. In a CNG scenario, natural gas is compressed to between 2,000 and 4,000 pounds per square inch (psi) and is transported to market aboard specially outtted ships. These ships are essentially oating pipelines. A number of different containment systems for the compressed gas have been proposed, each consisting of a series of high-pressure pipes into which gas is pumped at high pressure. An advantage of CNG is that it does not require expensive infrastructure in the host countries. Political risk in the (often developing) nations that hold much of the worlds gas reserves can raise the cost of capital for projects. The facilities for a CNG project in a host nation downstream of the pipeline consist solely of compression and (if necessary) gas-processing facilities, so that substantially less capital is at risk than for an LNG or GTL project. The most expensive assetsthe shipsare mobile. A drawback is that the lack of infrastructure in the gas-producing country means less tax revenue and fewer jobs. The major disadvantage of CNG vis--vis LNG is cost. CNG ships cost roughly the same as LNG ships but can deliver only about a quarter of the volume per ship. As more CNG ships are built, the cost is expected to go down, but the shipping cost will still be at a premium relative to LNG. The nature of the CNG trade, which requires a constant rotation of vessel deliveries to maintain a steady gas ow, is also somewhat of a drawback (although this could be mitigated by gas storage on the receiving end). The weight and complexity of CNG vessels could make maintenance difcult. Variations on the CNG theme have been proposed, mainly in the form of hybrids between CNG and LNG technologies. They take advantage of the fact that both pressurization and cooling reduce the volume of natural gas and make it easier to transport. However, no successful schemes have been developed to date. Independent players, rather than the oil and gas majors, are pursuing most of the projects currently under consideration. The technology is unproven in long-term service, which also raises issues of nanceability and market acceptance. Other factors that remain to be

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fully addressed are the acceptability of the high-pressure tankers into the importing countries and the siting of the facilities to unload them and connect them to the gas grid.

NOTES
1 2

BP. 2005. Statistical Review of World Energy 2005. London: BP. EIA. 2005. International Energy Outlook 2005. http://www.eia.doe.gov/oiaf/archive/ aeo05/pdf/0383(2005).pdf. 2004. Worldwide look at reserves and production. Oil and Gas Journal. 102 (47): 2223. Cedigaz. 2005. The 2004 Natural Gas Year in Review. EIA. International Energy Outlook 2005. Ibid., p. 3. EIA. International Energy Annual 2001. EIA. International Energy Outlook 2005, p. 37. BP. Statistical Review of World Energy 2005. Mabro, Robert, and Ian Wybrew-Bond. 1999. Gas to Europe: The Strategies of Four Major Suppliers. Cambridge: Oxford University Press. Interstate Natural Gas Association of America Web site. http://www.ingaa.org. Tusiani, Michael D. 1996. The Petroleum Shipping Industry. 2 Vols. Tulsa: PennWell.

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