Lng Market Structures in the Pacific Basin and Their Impact on North West Shelf Australia Lng’S Approach to Customers

Paper PS1-7

LNG MARKET STRUCTURES IN THE PACIFIC BASIN AND THEIR IMPACT ON NORTH WEST SHELF AUSTRALIA LNG’S APPROACH TO CUSTOMERS

LES STRUCTURES DU MARCHE DE GAZ NATUREL LIQUEFIE DANS LE BASSIN DU PACIFIQUE ET LEUR IMPACT SUR LA FAÇON DONT NORTH WEST SHELF AUSTRALIA LNG APPROCHE SES CLIENTS

John Banner (President) Paul Siffleet Damien Beng North West Shelf Australia LNG Pty Ltd Level 29, QVI Building, 250 St. George’s Terrace, Perth Western Australia 6000

ABSTRACT To date, LNG import markets have been established in three countries within the Pacific Basin region: Japan, Korea and Taiwan. China will join these countries in 2006 when the Guangdong terminal receives its first cargo from NWS Australia LNG. The internal market structures for LNG within the existing importing countries varies markedly, each requiring a distinctive marketing approach and product offer. A high level of understanding of individual market dynamics within the Pacific Basin and an ability to adapt customer approach accordingly will become increasingly important for future marketing success. NWS Australia LNG undertakes a rigorous analytical approach in order to develop a clear understanding of the issues impacting on its customers and to tailor LNG sales contracts to meet individual requirements. In particular, NWS Australia LNG has adopted a more communicative relationship with all of its customers and seeks to work closely with them to ensure both customer satisfaction and participation in the growing LNG market.

RESUME A ce jour, les marchés d’importation du GNL ont été établis dans trois pays de la région du Bassin du Pacifique: Le Japon, la Corée et Taiwan. La Chine joindra ces pays en 2006 lorsque le terminal de Guangdong reçoit son premier cargo de la compagnie “NWS Australia LNG”. Les structures du marché intérieur pour le GNL dans le cadre des pays importateurs actuels varient sensiblement, chacune nécessitant une approche en marketing et une offre de produit distinctives. Un haut niveau d’interprétation de la dynamique des marchés individuels dans le cadre du Bassin du Pacifique et une aptitude à adapter la façon d’aborder les clients en conséquence deviendront de plus en plus importants pour le succés du marketing à venir. NWS Australia LNG entreprend une approche analytique rigoureuse afin d’y voir clair en ce qui concerne les questions ayant un impact sur ses clients et afin d’adapter des contrats de vente pour satisfaire aux besoins individuels. En particulier, NWS Australia LNG a

PS1-7.1 Paper PS1-7 adopté des relations plus communicatives avec tout ses clients et cherche à travailler en étroite collaboration avec eux pour garantir à la fois la satisfaction du client et la participation dans le marché du GNL en expansion.

INTRODUCTION The Pacific Basin LNG market is in an exciting growth phase with the potential to surpass the rapid expansion trade of the early 1970s when imports commenced to Japan and the mid-1980s when Korea joined the trade. Just as those earlier periods of growth had their own significant drivers – such as the ‘oil shocks’ of the 1970s and the ‘clean air’ policies of the 1980s – so the current forecasts for growth in LNG consumption have a common theme. Globally, gas is regarded as the key transition fuel of the 21st century because of its environmental benefits in reducing greenhouse gas emissions and underpinning ‘clean air’ policies. The US Government’s Energy Information Administration (EIA) predicts that world gas consumption will nearly double by 2020, with its share of the total energy supply increasing from 23% in 1999 to 28% in 20201 and that, by 2030, developing countries (such as China) will account for more than 60% of the increase in world energy.

700

600

500 Oil

400

300 Quadrillion Btu Quadrillion Natural Gas

200 Coal 100 Nuclear Other 0 1999 2000 2001 2005 2010 2015 2020 2025

Figure 1: Source EIA, World Consumption by Fuel Type 1999-2025

The EIA forecast appears conservative in light of the latest BP Statistical Review of World Energy 2003 which shows that natural gas already accounts for nearly a quarter of global primary energy consumption. The Pacific Basin will take centre-stage in this scenario of growth and demand is expected to soon rival that of North America. While the three existing LNG markets of Japan, Korea and Taiwan – and the new entrant to the industry from 2006, China – all have similar underlying reasons for buying LNG, they are all at quite different stages of market development. Typically all gas and power markets are conceived in a highly regulated environment to support the development of distribution and transmission infrastructure and the aggregation of demand. LNG is no exception, as was evident in the early development of the Japanese market. According to the classic Western economic models, deregulation

PS1-7.2 Paper PS1-7 and privatisation of energy markets is a natural progression, and this process has certainly unfolded in Europe and North America over the past two decades – generally in situations where there is ample available energy supply. The forces of deregulation are now spreading to the Pacific Basin, although under very different timeframes and local circumstances. Therefore, far from being a homogenous entity, the Pacific Basin LNG industry is today a complex and diversified market which is undergoing some dramatic and far-reaching changes. For LNG marketers, the key to success in the Pacific Basin is to keep abreast of fast- moving market dynamics, to leverage off one’s competitive advantages and maintain the ability to meet Buyer’s specific requirements. Fundamentally, the market continues to be one built on long term supply contracts that require buyers and sellers to enter into long term relationships.

NORTH WEST SHELF AUSTRALIA LNG North West Shelf Australia LNG Pty Ltd (NWSALNG) markets LNG on behalf of Australia’s North West Shelf Venture, which is currently the country’s sole LNG production and export project. The Venture is owned by six internationally recognised companies, each with an equal 1/6th share: BHP Billiton Petroleum (North West Shelf) Pty Ltd; BP Development Australia Ltd; ChevronTexaco Australia Pty Ltd; Japan Australia LNG (MIMI) Pty Ltd; Shell Development (Australia) Pty Ltd; and Woodside Energy Ltd. Australia commenced LNG exports in 1989 from the North West Shelf Venture, which has since grown to become the third largest LNG supplier in the Pacific Basin. The North West Shelf Venture comprises three LNG processing trains and associated infrastructure located near Karratha in Western Australia with a production capacity of 7.5 million tonnes per annum. A US$1.2 billion expansion of the North West Shelf Venture’s facilities will see the addition of a fourth processing train that will lift production capacity to 11.7 million tonnes per annum by mid-2004. A second separate Australian project, Bayu-Undan is currently under construction whilst a third potential project, Gorgon, is under consideration. Eight of Japan’s largest utilities (Tokyo Electric Power Co. Inc, Chubu Electric Power Co. Inc, Kansai Electric Power Co. Inc, Chugoku Electric Power Co. Inc, Kyushu Electric Power Co. Inc, Tokyo Gas Co. Ltd, Osaka Gas Co. Ltd and Toho Gas Co. Ltd) were the Ventures first customers and purchase the bulk of its annual production. The North West Shelf Venture has also recently signed a long-term contract to supply China’s first LNG import facility at Guangdong and a medium-term LNG contract with Korea. Drawing on the expertise, operating and marketing experience of its six owners, NWSALNG is a focal point of Australia’s LNG marketing efforts in the Pacific Basin, and fulfils a number of key functions. These include in-depth analytical coverage of key markets, development of new marketing strategies, supporting customer relationships, all phases of marketing negotiations and contract management.

PS1-7.3 Paper PS1-7

NWSALNG’s marketing strategies in the Pacific Basin are premised on a number of key competitive advantages which the Group seeks to maximise in building its market share and further broadening its customer base. These distinctive competitive advantages are: • The North West Shelf Venture is a brownfield project that does not carry the same risk profile as a greenfield project. • The North West Shelf Venture has a proven track record of reliability and efficiency of supply over a 15-year plus period. In this time NWS has never missed a delivery and in August 2003, the Venture celebrated its 1,500th cargo to Japan; • Australia offers security of LNG supply, with its LNG Project located in a stable political, economic and social environment; • The North West Shelf Venture operates the only liquefaction facility in the world with 100% private ownership, giving it significant credibility as an independent, unaligned supplier in an industry often dominated by a significant level of State ownership.

While many of Australia’s competitors in the Pacific Basin have very large gas reserves, Australia itself also has a significant gas reserve base (estimated at over 100 Trillion cubic feet) in the country’s north and north-west.

KEY MARKETS—JAPAN Overview and History Japan was the pioneer of the Pacific Basin LNG trade, with its decision to commence LNG imports in 1969 driven by a desire to reduce its dependence on imported oil and introduce a clean-burning and environmentally friendly fuel to ease the pollution problems in its crowded cities. Today, Japan remains by far the largest LNG importing country in the world, dwarfing its nearest rivals in both the Pacific and the Atlantic Basin. In 2002, Japan imported 53.1 million tonnes of LNG, a small decline from the 54 million tonnes imported in 2001. Overall, Japan’s share of the world LNG trade has declined from 65% a decade ago to around 48%, reflecting the rise of the other Pacific Basin buyers and the growth of the Atlantic Basin trade. Japan, compared to other LNG markets in the region, can be regarded as the most mature with domestic energy market deregulation and privatisation at an advanced stage. The unique structure of Japan’s energy market and the early evolution of its LNG import industry help to explain the important characteristics of this market from an LNG supplier’s perspective. LNG purchasing is dominated by a group of 9 large power and gas utilities plus a number of small city gas importers which, between them, account for around 40% of world consumption. Acting as consortia, LNG contracts were successfully negotiated with a number of suppliers. An underlying characteristic of all the contracts is the security of supply. The early contract structures were also ideally matched to the unique structure of Japan’s energy market which is characterised by a relatively low level of penetration by

PS1-7.4 Paper PS1-7 gas, which accounts for just 13-14% of primary energy supply. The Institute of Energy Economics, Japan (IEEJ) predicts that gas will increase its share to 15.8% by 2020.

Current and Emerging Trends One of the overarching issues impacting on Japan’s LNG industry in recent times has been the country’s economic performance over the past decade. GDP growth has averaged 0.4% per annum between 1998 and 2002 while the country has recently experienced deflation – which has impacted directly on power generation requirements, one of the key end-users of LNG. The Japanese Government, in response to these problems, has attempted to implement economic reform and deregulation policies. Strategic planning in Japan is premised on a long-term view. This means that energy market deregulation – which will enable progressively smaller consumers to select their own energy suppliers and has seen the introduction of Independent Power Producing (IPP) plants – will continue to unfold in the context of the Japanese approach to business. Policy-makers in Japan have been all too aware of the recent issues associated with deregulation in the US and UK energy markets, and they believe that measured progress to deregulation and competition will help to avoid the possibility of a future energy crisis. Despite the impact of economic slowdown and a changing energy market environment due to deregulation, Japan can still be regarded as a solid long-term growth market for natural gas consumption.

45 Million LNG Tonnes

30 1990 1995 2000 2005 2010 2015

Figure 2: Source IEEJ, Japan LNG Consumption 1990 - 2015

NWSALNG predicts that natural gas demand will grow by approximately 1 million tones per annum between 2003 and 2015 to a total of approximately 66 million tones. This demand will be driven by the pressure to switch to environmentally friendly fuels. In order to meet its Kyoto Protocol commitments, Japan must reduce greenhouse gas emissions in 2008-12 by 6% from 1990 levels. The most effective way to achieve this is

PS1-7.5 Paper PS1-7 greater utilisation of nuclear power. However, as in North America and parts of Europe, the construction of new nuclear power plants faces stiff public opposition. Energy market deregulation and competition is also driving significant changes in other areas of the Japanese market, with utilities moving outside of their traditional service areas and demanding more flexible fuel procurement contracts with greater flexibility. This has been evident in the more aggressive approach to the renewal of LNG contracts over the past few years, as the buyers, uncertain as to the level of future competition, seek to optimise their position. Full market liberalisation is currently scheduled to occur by 2007, which will give home customers full choice among utility suppliers. In a slow-growth market, the major utilities have been forced to optimise their fuel procurement planning and become more profitable through cost management. This has seen utilities such as Tepco, Tokyo Gas and Osaka Gas Co sharing LNG facilities and infrastructure, and acquiring their own ships for transportation. For example, by the end of 2004, Osaka Gas, the second largest city gas company, will own four LNG vessels – significantly changing the traditional responsibility of the LNG supplier for transportation. Japanese Buyers have become more sophisticated in other areas too, implementing price risk and hedging strategies in their LNG procurement and seeking contract portfolios with varying degrees of flexibility, duration and optional volumes. In addition, new contracts are now being signed with individual utilities rather than large consortia as in the past. There has been a stronger and publicly stated emphasis on competitive pricing, as was evident during negotiations for the 1.1 million tonne per annum signed between Tokyo Gas and the Sakhalin-2 Project in May 2003. This contract featured FOB terms and an emphasis on price due to Sakhalin’s relative proximity. Tokyo Gas noted that the deal was part of a deliberate program of diversifying supply sources and reducing procurement and logistics costs2. While many aspects of Japan’s energy market reforms remain to be resolved, including the unbundling of power generation and transmission facilities and the issue of third-party access to LNG facilities, Japan will continue to be a major force in the regional LNG market for many years to come. With a large number of contracts (up to 19 million tonnes per annum) due to expire in the period 2009-2011, the next few years should see some significant contract negotiations unfold.

Implications for NWSALNG’s Marketing Approach Despite the impact of economic slowdown, deregulation and changing market structures, Japan remains the number one market for LNG projects, with both greenfields and existing projects competing fiercely to secure new long-term Japanese contracts to underpin their revenue streams. LNG from Australia will continue to be a very important part of Japan’s LNG procurement portfolio, with the two countries benefiting from a significant bank of trust, mutual respect and goodwill built up over two decades. The North West Shelf has invested significantly to ensure the reliability of supply to its Japanese customers – an investment that has paid off with the Venture’s outstanding track record of reliability.

PS1-7.6 Paper PS1-7

NWSALNG is keen to extend and expand its relationship with existing and new Japanese customers, and will continue to propose and explore innovative new business approaches with buyers as their needs evolve. The new contracts signed last year with its existing customers, as well as Tohoku Electric and Shizuoka Gas Company, reflected the changing needs of the utilities, and were structured accordingly. These contracts, and other previous new contracts which underpinned the North West Shelf’s Train 4 expansion project, were tailored to individual utilities rather than consortia (as in the early days of the venture) and were generally for smaller volumes.

KOREA Overview and History Korea is the world’s second-largest LNG market with the decision to commence LNG imports motivated by a desire to reduce the country’s high level of dependence on imported oil and improve air quality in urban areas. However, the early phases of the Korean LNG market were characterised by a centralised and monopolistic import structure, directly linked to the Government’s policy of encouraging the switch from oil to natural gas. Korea Gas Corp (KOGAS), the state-owned gas utility firm, was established in 1983 with responsibility for all gas importation and distribution and with the objective of setting up a stable supply channel of gas as an alternative energy source to replace petroleum. Security and diversity of supply were the key issues for KOGAS in procuring LNG supplies, given Korea’s geographical position with respect to its northern neighbour and limited domestic resources. LNG imports commenced in 1986, initially under a 20-year, 2 million tonne per annum contract with Indonesia. LNG imports have reached 17.6 million tonnes in 2002, confirming KOGAS’ status as the world’s largest single LNG Buyer. It has also seen KOGAS very quickly establish itself as one of the world’s most diversified LNG Buyers. The country’s major suppliers in 2002 were Indonesia, Malaysia, Qatar and Oman. The strong percentage growth of LNG imports, which has eclipsed Japan on an annual basis now for many years, is a direct reflection of the country’s status as one of Asia’s ‘Tiger’ economies. Following the 1997/98 Asian financial crisis, Korea vigorously sought to implement economic reforms, particularly in its ailing banking sector. This enabled it to recover relatively quickly from the impact of the crisis, with GDP growth averaging 4.4% between 1998 and 2002. The Korean market is distinctive in a number of other respects. Korean LNG demand is highly seasonal, with strong winter-time demand falling to lows each summer. Unlike other Asian markets, Korean LNG demand is dominated by heating demands in the residential-commercial sector which means that it is essentially a cold-weather market. Power generating companies maintain a relatively more even base load demand for LNG throughout the year with less of a summer air conditioning peak as experienced in Japan. Korea’s significant oil-fired power generating capacity also enables it to use fuel- switching to optimise fuel procurement prices (LNG prices generally lag oil prices by 3 months). As a consequence LNG demand increases in periods of rising oil price and vice versa. This can at times exaggerate the demand spikes further and add volatility to the Korean LNG market.

PS1-7.7 Paper PS1-7

The Korean energy market itself is also quite different from Japan’s. Unlike Japan, Korea developed an extensive gas transmission pipeline network right from the outset servicing all its major metropolitan areas. Following the launch of the nationwide LNG supply project in 1990, KOGAS began providing LNG to major cities with populations of over 50,000. KOGAS currently supplies natural gas to 26 city gas companies and 17 power generating firms, with demand projected to increase at 5% a year over the period 2001 – 153. Given that long-term contracted volumes currently fall short of forecast demand especially for winter supply, it is not hard to see why Korea has in recent times been a major player in the short-term or spot LNG market. Spot buying has been an essential part of its LNG procurement strategy, along with some new medium term and short term contracts.

Current and Emerging Trends The outlook for Korean LNG demand is extremely positive, with demand for natural gas expected to grow significantly over the next decade in line with the economic growth outlook and further penetration of city gas sectors. The introduction of an Air Quality Preservation Law to address serious pollution problems in the major population and economic hub of Seoul has strengthened the case for gas. Moreover, while Korea is a non-Annex 1 country under the Kyoto Protocol, the Government has declared its commitment to voluntarily reduce greenhouse gas emissions. Korea’s extensive gas distribution network continues to expand, underpinning continued growth in residential demand. Overall gas demand is forecast to double by 2010, lending weight to the prospect of major pipeline schemes to import gas from Russia. Long-term forecasts see LNG demand rising to 28-30 million tonnes by 2015 with this incremental demand requiring additional long-term contracts.

15 Million Tonnes LNG 10

0 1990 1995 2000 2005 2010 2015

Figure 3: Source KEEI and MOCIE, Korea LNG Consumption 1990 - 2015

PS1-7.8 Paper PS1-7

However, the outlook is complicated by the impact of deregulation and privatisation in Korea. The Korean Government announced a privatization process for KOGAS in 1998 following the Asian Financial Crisis, with the Government reducing its stake and bringing in foreign investors – which now own almost one-third of the utility. In 2002, KOGAS decided to expand the current 15% cap for foreign share ownership in the domestic market to 30%. However, the privatisation process has since been put on hold as the Government searches for an appropriate overseas model. KOGAS, as a State-controlled monopoly, has been unable to sign up new long-term LNG contracts until the impasse over privatisation is resolved. In turn this has had the effect of dramatically escalating Korea’s short-term LNG requirements, forcing KOGAS to engage in a significant winter purchasing drive on spot markets to meet its seasonal requirements. The completion of storage tanks at the new Tongyeong terminal will increase its inventory capacity and is planned to provide 15 days worth of buffer stock. However, even with the increased storage capacity the need for need for seasonal LNG supplies is likely to persist into the foreseeable future. One area where the Government has freed up the market to some degree is in permitting companies other than KOGAS to import LNG for their own use. This led to the tender by steel giant Pohang Iron and Steel (POSCO) and its partner SK Power for a 1.3 million tonne per annum LNG import contract through a proposed new 1.7 million tonne per annum terminal to be built at Kwangyang. Indonesia was announced as the winner of this tender. Other independent LNG importation proposals are also on the table, including an innovative scheme for Kepco to build new power plants in Indonesia in exchange for LNG from that country.

Implications for NWSALNG’s Marketing Approach Korea represents an important strategic market opportunity for Australia, given Korea’s traditional emphasis on security and diversity of LNG supply. NWSALNG’s track record of reliable and competitive supply is a key selling point for its push into Korea, and was an important part of the medium-term contract with KOGAS announced in early 2003. While spot sales from the North West Shelf had been negotiated previously, this represented an important breakthrough for Australia in the Korean market. NWSALNG will continue to propose and explore innovative business opportunities in the Korean market, with a view to building on its recent success. A key to this process is understanding the Korean Government’s policies on energy reform and customer’s needs for competitive supply that can help manage the seasonal requirements. Future success in the Korean market will depend to a large extent on the possibility of de-linking the procurement process for new LNG contracts from the deregulation agenda. This may require some innovative arrangements and flexibility from the seller’s perspective; it may also require a reassessment of the short-to-medium term gap between LNG supply and demand in Korea.

PS1-7.9 Paper PS1-7

NWSALNG has established strong relationships with Korean stakeholders at many levels; the challenge will be to convert this into new supply contracts as part of this exciting market opportunity, both in the short term and in years to come as the deregulation process unfolds.

TAIWAN Overview and History Taiwan began using natural gas for power generation relatively recently, with the State-owned Chinese Petroleum Corp (CPC), the country’s sole natural gas supplier, commencing LNG imports in 1990 through the only receiving terminal at Yung-An in southern Taiwan. Natural gas consumption has grown rapidly since then, underpinned by Taiwan’s relatively high economic growth rate (a GDP growth rate of 3.4% between 1998 and 2002) and by the Government’s commitment to promote the use of natural gas as part of its environmentally friendly economic, industrial and energy policy. Oil currently dominates Taiwan’s energy mix, accounting for 49% of total energy consumption – underlining concerns about the country’s soaring level of carbon emissions. In a highly regulated market structure, LNG imports have grown rapidly since 1990 to reach 5.1 million tonnes in 2002, which is used to supply Taiwan’s gas-fired power stations via a domestic pipeline network and for reticulation to residential, commercial and industrial customers. The gas-fired power stations account for around 23% of the country’s installed generating capacity. Taiwan’s existing LNG imports are supplied under long-term contracts with Indonesia and Malaysia.

Current and Emerging Trends The Taiwanese Government has outlined plans to double LNG imports by 2010, with the share of generating capacity reliant on gas forecast to rise to over 33%. The focal point of this strategy is the State-owned electricity utility Taipower’s new 4GW Tatan Power Plant, currently under construction in the northern Taoyuan County. Tatan will begin operations in 2004, initially using liquid fuel but subsequently switching to natural gas and requiring an estimated 1.7 million tonnes per annum of LNG.

PS1-7.10 Paper PS1-7

6 Million Tonnes LNG Tonnes Million

0 1995 2000 2005 2010 2015

Figure 4: Source MOEA, Taiwan LNG Consumption 1991 - 2020

Taiwan is an attractive market prospect, with the level of future LNG demand dependent on a number of key issues: • economic growth, which in Taiwan is directly linked to the state of the global economy; • the country’s nuclear policy, with Taiwan’s legislature still debating the merits of completing the stalled fourth nuclear power plant as it decommissions older ones. The Government’s eventual stance on inter-fuel policies will be an important factor in determining future LNG demand; • the extent of Taiwan’s power infrastructure and LNG/natural gas importation and distribution system. Plans to improve Taipower’s regional power transmission network have been impeded by protests from local residents and questions over the application of the funds in Parliament. The second northern LNG receiving terminal should help alleviate the relatively stretched LNG storage facilities, which currently only have enough for 5-7 days consumption; this makes it difficult for LNG to compensate for any power shortages occurring in other sectors, such as hydropower – which has been impacted recently by insufficient rainfall; and • the longer-term implications of deregulation and privatization policies for CPC and Taipower. Deregulation has been proceeding in a measured fashion in Taiwan, although it has become clear that conventional Western models may not be applicable to the Taiwanese situation. As deregulation proposals have still to be worked out, the timing of implementation may be further delayed. The award of the 25-year contract to supply 1.7 million tonnes per annum of LNG for the new Tatan power station in July 2003 to CPC following a tender process by Taipower is a key milestone for the Taiwanese LNG market. The outcome of the tender process has thrown into sharp relief some important features of this emerging market.

PS1-7.11 Paper PS1-7

The LNG to be supplied by CPC for Tatan will be sourced from Qatar, commencing with 690,000 tonnes in 2008 and building to a plateau level of 1.7 million tonnes per annum by 2011. The award of this contract and construction contracts for the Tatan Project’s six generators signals a potentially significant boost to the natural gas market in Taiwan. The fact that the tendered prices for the EPC contract to build the power station (won by Mitsubishi Heavy Industries) and gas supply (won by CPC) both came in well under Taipower’s expectations may cause the utility and energy planners to reconsider the role for gas in the future energy mix in Taiwan.

Implications for NWSALNG’s Marketing Approach Australia and Taiwan are significant trading partners, with total two-way trade totaling Aus$8.1 billion in 2002. Taiwan is a major importer of coal, aluminium, iron ore, copper and petroleum from Australia, its 9th largest import trading partner, while Australia imports large quantities of computers, computer components and telecommunications equipment from Taiwan. While Taiwan is not currently a destination for LNG from the NWS, NWSALNG remains keen to develop supply opportunities. However, these will remain dependent on the pace of energy market reform in Taiwan as well as the level of growth of new gas demand.

CHINA Overview and History China is widely considered the most important emerging market for natural gas in the world, as it is for a number of other commodities including imported minerals such as iron ore, nickel and copper to underpin its booming raw materials and construction sector. Shell has forecast that the Chinese natural gas market will be equivalent in size to the Western European gas market by 20154, helping to explain the importance of China in its global investment strategy. With a population of 1.27 billion in 2001 growing at just under 1% a year, average GDP growth of 7.8% between 1997 and 2001 and a leadership focused on continuing economic liberalization and sustainable growth, it is not hard to see why China is rated the most significant new force in the world economy5. This outlook was further enhanced by the accession of China to the World Trade Organisation (WTO) in 2001, which accelerated the liberalisation of its economy and reinforced its commitment to full participation in global trade.

PS1-7.12 Paper PS1-7

700

Central & South America 600 Africa MiddleEast

500 Other Asia

South Korea Japan

400 CHINA

10^15 Btu 10^15 300 Former Soviet Union

Western Europe 200 Eastern Europe

100 North America

0 1999 2000 2001 2005 2010 2015 2020 2025

Figure 5: Source EIA, World Energy Consumption by Region 1999-2025

Overall China is forecast to account for 20% of world energy demand by 2025, compared with 8% currently. The key issue from an energy policy perspective is that China is still heavily reliant on coal which amounts to 67% of its total consumption of primary energy. Because increasing coal consumption is creating major environmental concerns for the Chinese Government, particularly in the rapidly growing, economically dynamic centres of Eastern Coastal China, the country’s energy policy is geared towards the development of its gas sector. This includes both the development of indigenous gas resources and its LNG import strategy, commencing with the Guangdong Project. The Chinese Government is prioritising the development of indigenous resources principally through the 3,900-kilometre West-East pipeline from the Tarim Basin to the Xinjiang region – a joint venture between PetroChina, Shell, ExxonMobil and Gazprom. When finished the pipeline will be China’s second-largest infrastructure project, second only in scale to the Three Gorges Dam. Even with more domestic reserves becoming available, the scope of future demand is likely to more than exceed available gas reserves, which in world terms are relatively small. This will make imported gas an essential component in the future. A recent study has predicted that LNG demand in eastern China will be between 12 and 15 million tonnes per annum by 2010, making this one of the fastest growing LNG markets this decade6. Under a highly regulated process, the first steps towards LNG importation commenced in 2001 with the announcement of the first import terminal at Guangdong. In mid-2002, Australia’s North West Shelf Venture won China’s first LNG supply contract, for the supply of 3.3 million tonnes per annum of LNG to Guangdong over a 25- year period – a contract with an estimated value of Aus$25 billion. At the same time the

PS1-7.13 Paper PS1-7

Chinese Government also announced approval to build a second LNG import terminal at Fujian, which will be supplied by Indonesia. The partners in the Guangdong import terminal, CNOOC, BP and several end-user reticulation and power utilities, have commenced work on the terminal. The US$882 million project will comprise the LNG terminal and storage facilities. The LNG import requirements for Phase 1 of the Project – which will supply gas to power plants in Guangdong and Hong Kong and towngas companies in five Guangdong cities and Hong Kong, are anticipated to increase to 3.7 million tonnes per annum from the original 3.3 million tonnes. Gas sales agreements have been signed with end-users and commercial deliveries for Phase 1 are scheduled to commence during the second half of 2006. The Phase 2 expansion, comparable in size to the initial project, is expected to take place a few years after completion of Phase 1. This is planned to meet increased requirements from existing Phase 1 users as well as new distribution companies and power producers.

Current and Emerging Trends In addition to Guangdong and Fujian import terminals, other terminals are being actively considered in the economically dynamic Shanghai region and Zhejiang Province; in the future, the northern provinces are also likely to be attractive targets for LNG imports as they too move to cleaner fuel. The drive towards cleaner fuels in the huge and rapidly growing Chinese energy market will underpin surging long-term gas and LNG demand, the latter because the main areas for gas demand along Eastern Coastal China are separated by very large distances from indigenous supply sources. The Chinese Government has not agreed to the targets set by the Kyoto Protocol process, but is making proactive efforts to reduce emissions. The Chinese Government is also investigating opportunities for distributed gas consumption including Compressed Natural Gas (CNG) for cars and more widespread urban usage. While there is currently limited domestic gas distribution and transmission infrastructure, this situation is certainly being addressed in the Eastern Coastal provinces (the focal point of China’s economic growth) and more broadly through the East-West pipeline. There is also scope for future pipeline schemes to bring gas into China from vast Russian reserves. Implications for NWSALNG’s Marketing Approach As a new entrant to the LNG industry, China represents an exciting prospect for LNG suppliers, and the award of the Guangdong contract represented a very significant milestone for both the North West Shelf Venture and Australia. The keys to Australia’s success in this landmark process included: • NWSALNG’s ability to deliver not just a competitive LNG supply tender, but a comprehensive package to support the development of a new industry in China. This included significant elements of technology transfer, assistance with the development of Chinese LNG shipping capacity, Chinese equity participation in the North West Shelf Venture assets and resources and “The Australia-China

PS1-7.14 Paper PS1-7

National Gas Technology Partnership Fund” to promote educational, technological and community exchange programs; • The significant involvement of the Australian Governments, both Federal and State, in supporting Australia’s bid, assisting in preparing the entire package and promoting it to the Chinese Government and officials – all without having a direct ownership position in the LNG project; • The close political, economic and cultural ties between China and Australia that have developed since the two countries initiated diplomatic relations over 30 years ago. This includes bilateral trade approaching US$13 billion annually and a very close inter-Government relationship; • The direct equity involvement of the North West Shelf Venture in the Chinese shipping venture to facilitate technology exchange and meet the Chinese requirement to have ownership and control of its own shipping fleet; and • The Chinese Government’s overriding concern to achieve security and reliability of supply.

A key to Australia’s future marketing success in the Chinese market will depend largely on the successful implementation of the Guangdong LNG contract and maintaining its exemplary record for reliable and efficient LNG supply. For China, the Guangdong Project represents a reliable, long-term energy source to underpin the continued economic growth of the dynamic Guangdong/Hong Kong region. For Australia, it represents over Aus$25 billion in export revenue over a 25-year period. NWSALNG is investing enormous resources to ensure that the Guangdong LNG venture is a success; this will ensure that it retains pole position in the race to supply LNG to meet the country’s burgeoning energy requirements.

CONCLUSION: MAXIMISING COMPETITIVE ADVANTAGE While it represents the dominant component of the world LNG trade, the Pacific Basin LNG market continues to experience dynamic change and evolution. The three existing LNG markets are at very different stages of evolution in terms of energy market deregulation, structural change and economic growth. The new entrant to the trade, China, is laying the foundations for what is expected to be the fastest growing LNG market in the world. However, it is grappling with the problems and issues that are common in the formative stages of the development of new energy markets. The NWS venture is a long-term supplier to the Japanese market and, in the past two years, has been able to significantly broaden its customer base by securing China’s first LNG contract and a medium-term supply contract in Korea. This success has been possible by adjusting its marketing strategies, LNG contract structures and customer relationships according to the changing circumstances of each market. At no stage has anything been taken for granted, even though it has long-term contracts in place in the Japanese market. During the mid-to-late 1990s, the North West Shelf Venture worked hard with its Japanese customers to achieve new contract volumes and secure new customers.

PS1-7.15 Paper PS1-7

NWSALNG’s Chinese marketing efforts commenced in the late 1990s, many years before the Guangdong contract eventually became a reality. Its activities in Korea and Taiwan have been underpinned by a similar long-term vision and patience. In the future, the key to marketing success in the Pacific Basin will become even more dependent on tailoring strategies to individual markets as the region’s LNG market becomes more complex and diverse. It will also be vital to monitor critical interactions between these markets. This will be particularly important as new entrants, such as China, seek not only to select elements of more established markets to apply to their own emerging industries but also implement new initiatives that have the potential to change the way the LNG business operates in established markets.

SOURCES 1 Townsend, D., “The Gas Century”, Petroleum Economist, 2 December 2002 2 “Toyko Gas’ Sakhalin LNG Deal to Diversify Sources”, Dow Jones International News, 12 May 2003 3 “LNG in Korea, Opportunities for Growth”, ABARE Research Report 03.4 4 De Wit, P, Director of the Asia-Pacific division of Shell Gas & Power, quoted in “Cracking China”, Petroleum Economist, 2 May 2003 5 “China: Country Fact Sheet”, Economist Intelligence Unit, 21 July 2003 6 “Natural Gas in Eastern China, The Role of LNG”, ABARE Research Report 03.1

PS1-7.16