LNG TRADE-Conclusion: Supply diversity cuts risk exposure

May 7, 2007
Consumers of LNG must have a broadly diversified supply base to minimize consequences of any potential supply disruption.

Consumers of LNG must have a broadly diversified supply base to minimize consequences of any potential supply disruption. Expanding the number of suppliers often increases risk exposure, which can be most effectively moderated by pulling supplies from widely varied sources.

Part 1 of this article (OGJ, Apr. 16, 2007, p. 57) examined the risks faced by the US as it expands sources of its natural gas supplies, as well as efforts made to address these risks.

This concluding part completes the examination of the US situation before turning toward Europe’s still-increasing dependence on Russia as it primary gas supplier.

US supplies

Qatar Petroleum (QP) signed a 5-year $10 billion agreement with ExxonMobil in 2003 for the Qatargas II project, part of the world’s largest LNG shipping facility being built at Ras Laffan. It also prompted the Qatargas III and IV projects to be sanctioned in 2004 with ConocoPhillips and Shell, respectively, each of which plans to deliver large quantities of LNG to Europe and the US.

These projects hold great strategic significance in terms of potentially difficult-to-secure natural gas supplies over the next decade.

Qatar, itself an OPEC member, is a small state sandwiched between two main OPEC powers, Saudi Arabia and Iran, in one of the most politically unstable regions of the world. It will require a long-term, high profile military presence from the US in the Arabian Gulf to maintain the integrity of these projects.

Any change in politics in Qatar from its current pro-US position, or more extreme stances from OPEC, could potentially jeopardize or interrupt LNG supplies. Future warfare in the Persian Gulf between other nations could cause the Straits of Hormuz, a major petroleum shipping chokepoint and exit to the gulf, to close temporarily.

Events such as vessel collisions or terrorist attacks on LNG shipping in the Straits of Hormuz could also have short-term effects on LNG supplies, causing price spikes for natural gas customers.

Such scenarios are not difficult to develop and suggest that dependence on a few very large LNG suppliers would provide only limited security of supply for consumers.

The US belief that building tens of new regasification facilities in North America (Canada, US, and Mexico) will, on its own, solve the security of supply issue misses part of the problem. Inadequate access to LNG shipping and strategic stocks of LNG could cause future supply interruptions even with extensive onshore LNG regasification capacity in place.

Construction of several new LNG receiving facilities along the Atlantic and Pacific coasts and reinforcement of gas pipeline transmission and distribution networks to interconnect with vulnerable market areas are clearly essential. The US, however, needs to educate states that believe their security of supply can be established remotely by contracting supplies from LNG receiving facilities outside their own backyard that they are fooling themselves.

Areas such as New England and California, already vulnerable because of their locations at the end of long pipeline networks, would become even more vulnerable if political disputes with major LNG suppliers lead to supply interruptions to North America (the same case can be argued for Germany in Europe).

To improve its security of gas supply, the US need look no further than developing a modern liquefaction plant in Alaska to bring its gas reserves to the California market.

The Alaska Gasline Port Authority and Sempra LNG have been trying to advance such an LNG solution, which would offer more flexibility of destination than the very expensive alternative of building a pipeline from Alaska to the Lower 48 states across Canada. Political wrangling among the Alaska state government, US federal government, Canada, and the major oil companies holding the gas resources on the North Slope over tax credits for a trans-Alaska gas pipeline project has led to polarized positions in the pipeline-vs.-LNG discussion.

The 1920 Jones Act, requiring water transport between US ports to use only vessels owned by US citizens, constructed in the US, and manned by North American crews also impedes pursuit of the LNG option for Alaska’s gas resources.

It has been 30 years since an LNG tanker was last built in a US shipyard. The capital costs of building such a vessel today in a US yard would likely be more than double the costs of building it in an Asian yard. Operating costs for US-owned and manned LNG carriers would also be substantially higher than for foreign vessels.

Many consider it unlikely that Congress would grant an Alaskan LNG project a waiver to the Jones Act. But without such a waiver, it will be difficult for an Alaskan LNG project to compete commercially in exporting LNG to California.

It is in the interest of US gas consumers to resolve these issues quickly and move forward with either a pipeline or, preferably, an LNG facility. There are plenty of other LNG producers around the Pacific Rim keen to supply the western North America gas market when proposed facilities are finally built (Fig. 1).

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Alaska needs to progress an LNG facility soon to take a share in this market, providing a stable supply alternative to the West Coast in the event of supply interruptions from countries such as Russia, Peru, and Indonesia.

European dependence

Germany, Europe’s largest gas consumer, seems intent to take delivery of even more Russian gas since former Pres. Schroeder joined Gazprom, with Gazprom expanding equity positions in some German utilities and showing interest in doing so in other EU countries, given its pursuit of Centrica in the UK.

Russia provided some 23% of the gas consumed by the European Union in 2004, but 33% of the gas consumed by Germany. This may well provide Germany with lower prices in the short-term, but will also make it more vulnerable to supply interruptions and price hikes moving forward.

If Gazprom also gains control of consuming utilities, it is easy to see that Russia will increase its supply dominance and prices will move higher.

The gas supply interruptions in January and February 2006, caused by Russia’s dispute with Ukraine, and the January 2007 pipeline dispute with Belarus, have, however, prompted even Germany to look at alternatives to diversify its gas supply.

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The Northern European (Trans-Baltic or Nord Stream) offshore pipeline linking Russia directly to Germany is Russia’s preferred solution, avoiding Poland and Belarus, and Germany sanctioned this project in 2006 (Fig. 2). While removing some of the risk associated with supply interruption caused by disputes between Russia and intermediate countries, the Northern European line locks Germany even more firmly in Russia’s supply grasp and seems shortsighted.

Some German energy companies are now openly seeking LNG import supplies and may build their own LNG receiving terminal at Wilhelmshaven.

Developing alternatives

The Nabucco gas pipeline offers a potential new route for natural gas from Iran and the Caspian region to reach Western Europe through Turkey. At 3,200 km in length, Nabucco, as currently envisaged could move some 30 billion cu m/year to Turkey, delivering 15 billion cu m/year to Austria with the balance taken by countries along the route. Russia, however, will likely do all in its power to stop the Caspian states from supplying major volumes of gas to Western Europe.

The Nabucco project-together with other new pipelines from Algeria and Libya across the Mediterranean, the proposed Turkey-Greece-Italy interconnector, the Trans-Balkan corridor, and the Langeled line from Norway to the UK (Fig. 3)-offers diversity of supply. But these pipelines are still ultimately linked to a few large producers: Iran, Algeria, Libya, and Norway.

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This supply base is insufficient to provide true security of supply and avoid market manipulation.

LNG plays a large role in avoiding overdependence on unreliable gas suppliers. Belgium, France, and Spain have long realized this and have invested heavily to expand their LNG regasification infrastructure. The UK, Italy, and Netherlands are in the process of joining them.

Those terminals, however, should have a wide range of supply sources, ideally not influenced by Russia, Algeria, Qatar, and Iran, which are likely to control most of the pipeline gas for potential supplied to Europe beyond 2020. They should also be integrated with expanded underground gas storage capacity, which could minimize the effects of short-term gas supply interruptions.

A key factor in the high geopolitical risks associated with natural gas is the heavy concentration of reserves and supply infrastructure in a relatively small number of producing countries. There is a danger that shortsighted policies will enable these major gas suppliers to flood the EU markets with cheap gas in the short-term, giving them the control necessary to gradually price out smaller competitors and then begin raising prices on their own.

Political hurdles

Limited third-party access to domestic gas markets stands as another impediment to supply diversification. Those countries most resistant to deregulation in practice (France, Germany, and Italy) feature former monopoly national holding companies obstructing the path of new entrants to their markets, despite EU directives toward gas liberalization. Such policies allow very little customer choice in determining suppliers.

This situation may change during 2007, as and when compliance with the second EU gas directive is reviewed, but access to gas customers through monopoly owned pipeline networks remained difficult in France and Germany in 2006.

Development plans in France call for more LNG receiving terminals, not to be controlled by Gaz de France (GdF) and Total (former monopoly holders). First development will likely occur at Le Havre and Le Verdon, but Dunkirk and St. Nazaire are also earmarked for future development.

French company, Poweo, and Austria’s Verbund are planning a 412-Mw combined cycle gas turbine at Le Havre to be fueled by gas from a new LNG terminal. GdF operated a 0.5 billion cu m/year LNG plant at Le Havre between 1965 and 1989, and this may be the site used. 4Gas, formerly PetroPlus of the Netherlands, started environmental impact assessment and safety case planning for Le Verdon in third-quarter 2006.

Political ends

EU leaders met in October 2006 with Russian Pres. Vladimir Putin in Helsinki to seek guarantees that Russia would not interrupt gas supplies for political reasons. The meetings insulted the intelligence of most gas consumers in the EU, showing the naiveté of EU politicians regarding global energy markets and monopolistic suppliers.

If Russia or a small group of countries succeeds in capturing the European gas market, it is likely that they will individually or as a cartel exercise that power to extract higher prices.

Russia wants to maintain the impression that it has no intention of exploiting a dominant gas supply position in Europe. Both history and recent events suggest otherwise.

Even if Germany fails to heed this risk, other EU countries will be more attentive and when Russia does threaten to close the pipeline valves on Germany it can be certain that its European partners will charge above-market prices for relief gas.

The UK’s recent experience remedying its winter gas shortages at a high price serves as a cautionary tale in this regard.