RREEF Research

February 2011

Liquefied Natural Gas Market in Europe

Table of Contents:

What is Liquefied Natural Gas?

What is Liquefied Natural Gas? ........................................ 1 Structure of the LNG Value Chain ....................................... 1 LNG Supply in Europe ............. 2 LNG Demand in Europe ........... 6 Conclusion ............................... 7

Prepared by: Stella Yun Xu Assistant Vice President San Francisco USA (415) 262-7715 [email protected]

Production by: Michelle Woods

Infrastructure funds are increasingly targeting energy investments amid rising worldwide demand for energy. World energy consumption is expected to increase by 49% from 2007 to 2035.1 Specifically, electricity is the fastest growing form of end-use energy consumption. Natural gas is an important fuel for electricity generation and is less expensive than oil as a primary energy source. Global natural gas consumption is expected to increase by 1.3% per year on average, from 108 trillion cubic feet in 2007 to 156 trillion cubic feet in 2035 and use in the electric power sector increases by 1.6% per year.2 Liquefied Natural Gas (LNG) is natural gas that is stored and transported in liquid form at a temperature of -162o C. Liquefying natural gas provides a means of moving it long distance when pipeline transport is not feasible. LNG takes up 600 times less space than regular natural gas at ambient temperature and pressure, which makes it easier to store than natural gas and efficient to transport over long distances. Natural gas is turned into a liquid using a refrigeration process in a liquefaction plant. During the liquefaction process, water and other substances such as mercury, carbon dioxide and heavier hydrogen are removed from the wet gas. As a result, LNG has higher methane content and is considered “cleaner” than pipeline gas.3 Natural gas can be transported by specially designed cryogenic sea vessels (LNG carriers) or cryogenic road tankers. Afterwards, LNG is heated and made gaseous again in the regasification plant. Storage capacity is vital in these plants to cover supply or demand disruptions. Finally, large compressors are used to pump the gas into the pipelines.

Structure of the LNG Value Chain LNG projects are among the most expensive energy projects. LNG plants typically cost more than comparable energy projects for a number of reasons, including remote locations, strict design and safety standards, large amounts of cryogenic material required, and a historic tendency to overdesign to ensure supply security. Estimates of LNG plant costs are difficult to pinpoint since costs vary widely depending on location and whether a project is greenfield or expansion of an existing plant.4 The high level of complexity and formidable costs associated with the setup of the LNG value chain often lead to long-term contracts and considerable vertical integration within the industry. As such, most LNG projects are highly dependent on the successful execution of all the elements in the value chain.5 Exhibit 1 shows the allocation of costs within a LNG supply chain. Within the cost structure, the largest component is the liquefaction plant where significant economies of scale can be achieved. A large portion of capacity expansion is expected to come through expansion of existing liquefaction plants in the coming years.

1

International Energy Outlook 2010, US Energy Information Administration, July 2010 International Energy Outlook 2010, US Energy Information Administration, July 2010 3 Palm, Thomas Fredrik, The future of LNG in Europe and the potential impact on the market power of the gas suppliers, May 2007 4 http://www.eia.doe.gov/; US Energy Information Administration Independent Statistics and Analysis 5 Palm, Thomas Fredrik, The future of LNG in Europe and the potential impact on the market power of the gas suppliers, May 2007 2

In recent years, costs throughout the LNG Exhibit 1 value chain have declined. According to LNG Chain Cost Distribution the Gas Technology Institute, liquefaction (million USD) costs have decreased 35% to 50% over Liquefaction the past ten years. The price of LNG 47% vessels has also nearly halved over the past decade. The main cost driver within Regasification 15% transport is the distance to the market. Regasification plants or receiving terminals are generally less expensive than liquefaction plants and costs have also Shipping fallen in recent years. However, the cost of 38% these plants show wide variation and are Source: Palm, Thomas Fredrik, The future of LNG in Europe and the very site-specific. Typically, these plants potential impact on the market power of the gas suppliers, May 2007 range from $100 million to more than $2 billion. The most expensive items in these terminals are the storage tanks, which can account for one-third to one-half of the cost. The tank type, in turn, is dictated largely by location and local regulatory requirements.6 The industry is also trending towards large storage tanks to achieve economies of scale. As a result, LNG, once perceived to be a high-priced niche supply, is now seen as a scalable energy commodity.

LNG Supply in Europe With indigenous natural gas production decreasing each year, the security of gas supply has become a major issue in European energy policy. Norway and the Netherlands have been important indigenous suppliers of natural gas to the region. The large Groningen gas field in the Netherlands has now been in production for approximately 40 years. Over the past decade, Norwegian production has rapidly increased with the establishment of the Troll and the Ormen Lange field. The UK, Germany and Italy also produce a limited amount of natural gas. Exhibit 2 shows that natural gas constitutes approximately 24% of primary energy consumption by fuel in the European Union (EU) as of 2009. Exhibit 3 shows the share of gas usage in primary energy consumption by country. Exhibit 3 2009 Share of Natural Gas in Primary Energy Consumption (%)

Exhibit 2 2009 EU Primary Energy Consumption by Fuel 50% Others 1%

Oil 36%

Renewables 9%

45% 40% 35% 30% 25%

Nuclear Electricity 14% Solid Fossil Fuels 16%

24%

20% Natural Gas 24%

15% 10% 5% 0% KL UK HJ TR IT RO IE BE LV LT LU SK EU ES AT DE DK CZ PT FR SI PL BG GR PI CH EE SE

Source: 2010 Eurogas Statistical Report, The European Union of the Natural Gas Industry

Source: 2010 Eurogas Statistical Report, The European Union of the Natural Gas Industry

Currently, natural gas is primarily supplied via pipelines from Russia, Algeria and Norway. Russia presently provides more than a quarter of Europe’s gas. For decades, the import dependency on Russia has been a critical issue regarding the security of gas supplies for Europe. Interruptions in gas deliveries from Russia in 2006 and 2009 acted as a wake-up call for the EU. On a macro level, the majority of the world’s energy reserves are located in regions with relatively low political stability and any turmoil or conflict can hinder gas flow. Additionally,

6

The Global Liquefied Natural Gas Market: Status & Outlook, Energy Information Administration, US Department of Energy, December 2003

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RREEF Research

pipelines from Russia and the Middle East have to cross several borders in order to reach Europe. Specifically, pipelines from the Middle East may be difficult to construct due to geopolitical issues and technical constraints. Diversification of gas import supply chain from gas-rich supply regions is critical to mitigate these various supply risks. LNG offers the region a key opportunity to diversify and reduce risk as it can be transported via international waters to reach destination. While there are new risks that could arise as LNG vessels often need to pass through congested straits, there should be a reduction in supply risk on the whole. Additionally, with LNG infrastructure in place, terminals can receive LNG from alternative producers in the event of unforeseen supply disruption or halt in production, providing flexibility where pipeline cannot. Increased access to LNG in recent years has eased Europe’s dependence on pipeline deliveries. Exhibit 4 shows that 19% of net gas imports to EU27 from non-EU country are in the form of LNG. Over half of LNG supplies entering EU27 come from Algeria and Qatar (see Exhibit 5). Algeria is the primary LNG-exporter to Europe with deliveries to France, Spain, Belgium, Italy and the UK. Export from Middle East such as Egypt and Qatar has mostly supplied Spain. In particular, the share of Qatari imports in the EU has significantly risen in recent years. Export from Nigeria began in 1999 and has primarily supplied Spain and France. Additionally, Europe also receives LNG imports from other sources such as Oman, Trinidad and Tobago and Libya. Exhibit 4 2009 Net Imports to EU27 from Non-EU Countries by Type of Transport Pipeline 81%

LNG 19%

Source: 2010 Eurogas Statistical Report, The European Union of the Natural Gas Industry

Exhibit 5 2009 Breakdown of EU27 LNG Supplies Others*