Deregulation of Asia's gas markets creating LNG supply-demand uncertainties

TOKYO�A report by an influential Japanese think-tank has cast serious doubt on the stability of the future LNG supply-demand balance in Asia. The report, by the Institute of Energy Economics Japan (IEEJ), contends that not only will LNG supply far exceed demand by 2010, but also deregulation of natural gas and electric power utilities in Japan, South Korea, and Taiwan will lead to the emergence of a host of small-lot buyers for whom pricing, and not supply stability, will be paramount.

Regional LNG demand has substantially recovered from the decline that followed the economic crisis of 1998. At the same time, India and China have, since the second half of 1998, made full-scale moves to establish LNG import infrastructures. As a result, Asia's LNG demand is likely to grow to more than 100 million tonnes in 2010. (IEEJ's regional low-demand case now puts demand at 105 million tonnes in 2010, while its high-demand case places demand at 112 million tonnes.)

The report also notes, however, that the combined liquefaction capacities of existing LNG plants and projects under construction or in the planning stages total 190 million tonnes/year. Even if the residual reserves in Indonesia's Arun gas fields were shut down, this would only reduce liquefaction capacity by a mere 12 million tonnes/year, leaving potential total LNG capacity in the region at 178 million tonnes/year, far exceeding projected demand.

Market opening
A number of the region's top LNG consumers�most notably Japan, South Korea, and Taiwan�have initiated moves towards deregulating their gas and electric utilities.

In Japan, for example, under the amended Gas Utility Industry Law, gas supplies to large industrial users are liberalized. At the same time, town gas companies are now obliged to initiate specific wheeling rules and charges for third-party users. And under the amended Electric Utility Industry Law, independent power production has been introduced, as has the partial liberalization of electricity retailing.

As a result of these measures, a number of foreign companies, trading houses, and large industrial users have announced moves into Japan's electricity retail business.

In South Korea, LNG demand growth has come largely as a result of competitive pricing. This has been achieved via so-called "internal compensation," however, whereby utility Korea Electric Power Co. pays a higher price for the LNG it uses. Therefore, if the government does proceed with its plans to break up and sell off the state utility (OGJ Online, May 31, 2000), LNG suppliers will obviously find it much harder to maintain competitive prices.

To exacerbate the situation, the government is also looking to privatize Korea Gas Co. (KOGAS), the nation's sole LNG importer. Clearly, the split-up of KOGAS will lead to competition among several LNG importers and wholesalers.

Taiwan's state-owned electric utility, Taipower, meanwhile, has been choosing its LNG suppliers through competitive bidding since last year. As a result, at least one private consortium�whose owners include TotalFinaElf SA, Royal Dutch/Shell Group, and ExxonMobil Corp.�has signed a memorandum of understanding to import 4 million tonnes/year of Australian LNG starting in 2003, by-passing the state-owned oil and gas company Chinese Petroleum Corp.

Market fallout
This regional deregulation, contends the IEEJ report, has led to increasing uncertainty over the outlook for LNG demand and to a proliferation in smaller-lot LNG buyers. Taken together, these factors are threatening LNG's price competitiveness over rival fuels, says IEEJ.

Deregulation also marks a fundamental change in the Asian LNG market, which has traditionally been marked by LNG procurement on the part of large utilities whose primary concern is a stable supply. For the small-lot buyers, pricing, and not supply stability, will be paramount, says the institute.

Moreover, although China and India have made significant moves towards full-scale importation of LNG, worries remain about their ability to pay for these imports in hard currency. The report notes that these two countries' economies are less developed than Japan's, South Korea's, and Taiwan's were by the time they started LNG imports (per capita gross domestic product in 1990 dollars stands below $1,000 for China and India, compared with $3,000-10,000 for Japan, South Korea, and Taiwan when they began importing LNG).

All this is likely to lead to a radical shift in the way LNG buyers and sellers conduct business, says IEEJ. For a start, it is likely to lead to increased flexibility in take-or-pay clauses, allowing for adjustments in short-term supply and demand. Contract terms�typically at least 15 years�are also likely to be shortened, allowing for contract volumes to be more quickly and accurately reviewed, predicts the institute. At the same time, buyers are likely to purchase LNG from existing fields where debt servicing has been completed, allowing for more favorable terms.

The report notes that, in 2010, seven major LNG contracts are set to expire, and buyers are likely to take advantage of the buyer's market that is expected to be in force at that time in order to push for substantially better terms.

Supply considerations
LNG suppliers are also changing their modus operandi. They are becoming increasingly aware of the need to reduce costs to strengthen competitiveness.

A number of them, such as Oman LNG LLC and Malaysia LNG Tiga Sdn. Bhd., have begun to initiate LNG projects at their own risk before securing buyers for all of the project output. Producers are also carrying out small-scale, low-cost projects (in the 3 million tonne/year, $800 million range), because demand can be secured more easily.

The report warns, however, that increasingly flexible LNG deals and competitive bidding can increase the difficulties involved with starting up capital-intensive greenfield projects, thus posing a pitfall that demand may not be met. It notes that such projects currently under planning account for well over a third of total projected supply in 2010.

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