KoreaJapan Energy Business Forum Rationalization of LNG Contracts

Korea-Japan Energy Business Forum Rationalization of LNG Contracts November 26, 2015 LEE, Ho-Mu Korea Energy Economics Institute

Natural Gas in Korean Energy Sector l Fast-grown Primary Energy Source l l l 3 rd largest energy source: 16. 9% after oil, coal (2014) Demand peaked in 2013 World’s Highest Gas Price: $16/MMBtu Natural Gas (LNG) Import & Average Price -1 Nov/26/15 Korea-Japan Energy Biz Forum

Korea as a Big LNG Importer l 99% Dependent on Import l l Imported 37. 1 MMt and paid $31. 4 B in 2014 Second largest LNG importer (17. 0%) l l KOGAS: currently world’s largest single LNG buyer Main Supply Sources l Qatar accounting for 1/3, US & Australia on the rise -2 Nov/26/15 Korea-Japan Energy Biz Forum

Characteristics of Demand l Balanced between City Gas & Power Generation l High Seasonality: Heating in Winter l Demand Spurred by Power Sector l Gas-fired plants built as quick fixes on power supply crunch in 2000 s -3 Nov/26/15 Korea-Japan Energy Biz Forum

Domestic Gas Market l Monopolized Import, Wholesale & Retail Markets l KOGAS: Monopolistic in import & wholesale supply l l l Supplies big power stations and city gas companies Direct importers: allowed only for their own use Local distributors (city gas companies): local monopoly Production & Import LNG Shipping Domestic Production § KOGAS imports more than 90% of total demand §- 4 Several direct importers Nov/26/15 Wholesale Retail Receiving Terminal Transport Unloading/ Storage Tank Lorry Regas/ Send-out Trunk Lines § KOGAS: legal monopoly Alternative Gas End-Users Direct Supply Large Consumers Import for Own Use LDCs Local Dist. Pipelines § 34 Local Distribution Companies (LDCs): local § Access to facilities: trunk line monopoly (r. TPA), terminal (n. TPA) Korea-Japan Energy Biz Forum General Consumers § Direct Import: power companies & large industrial consumers

LNG Market – Overview Global Gas Trade 2000 -13 l Rapid Growth since 2000 l l l Outpaced other forms of gas trade Led by Asian countries Biggest Buyers in Northeast Asia l 2 of every 3 cargoes landed in Northeast Asia in 2014 l l Source: IGU(2015) More than 70% if India counted in Japan & Korea consume the half of world’s LNG -5 Nov/26/15 Korea-Japan Energy Biz Forum

LNG Market – Supply & Demand l Slowing Demand Growth in NE Asia l l l Surge of New Supply l l l Importing countries have demand uncertainties Liquefaction Capacity Korea’s demand shrinking both under Construction Source: IHS(2015) in power and in city gas sector Australia: 86 MMt/yr in 2017 US: 62 MMt/yr under construction Buyer’s Market Ahead l Supply glut up to 2020, or longer (mid-2020 s) -6 Nov/26/15 Korea-Japan Energy Biz Forum

Conventional LNG Contracts l Designed to Recover Huge Investment l l l Vertically-integrated multi-billion USD projects Contracts with risk-sharing schemes required when financing the projects Typical Terms l l l Oil-indexation: directly indexed by simple formulae Long duration: more than 15 years Take-or-pay: minimum level of payment guaranteed Destination clause: diversion or re-sell only with permission Unclear or no clause on price-review or re-negotiation -7 Nov/26/15 Korea-Japan Energy Biz Forum

Conventional LNG Contracts l Importers Cried Foul l “Asian Premium” with high oil price l l l Double whammy (oil, LNG) for 2010 -14 Destination clause for price discrimination Effective obstacle to an efficient domestic gas market l -8 Nov/26/15 Long-term LNG contracts with TOP define similar rigid domestic markets in importing countries Gas Prices in Regional Markets Korea-Japan Energy Biz Forum

LNG Market – Getting Flexible l Cargoes with Flexible Terms Rising l Short-term or Spot Trade l l US LNG Export l l l Uncontracted volumes, re-exports, commissioning Short-term & Spot Trades cargoes… No destination clause Less take-or-pay costs Aggregators l Able to offer various types of contracts with their portfolios -9 Nov/26/15 Korea-Japan Energy Biz Forum 출처: GIIGNL (2014)

Difficulties with Renegotiation l Renegotiation: Mission (Almost) Impossible l l l Relevant clauses are vague at best: “meet and negotiate in good faith” Some contracts without price re-opener Some Working for Buyers l l Matter of when the contract was sealed Cheap LNG from mid-2000 contracts l l - 10 Nov/26/15 CNOOC – Northwest Shelf KOGAS – Sakhalin 2 Korea-Japan Energy Biz Forum

New Contracts with Favorable Terms l More Effective than Renegotiation l l l New contracts should reflect buyer’s market Less steep slope, lower TOP level, … What If Demand Shrinks? l l New contracts needed only when demand increases or existing contracts expire Annual LNG Import by Existing Contracts Korea: demand falls, major contracts end in 2024 - 11 Nov/26/15 Korea-Japan Energy Biz Forum

Options for More Rational Contracts l Dialogue among Stakeholders l l l Making good use of existing fora High price with rigid terms benefits no one in the long run Regional Cooperation l 2015 Korea-Japan-China Summit “agreed to strengthen cooperation on LNG” l l l Establishing dialogue at the governmental level as the first step Business-level cooperation: joint purchase? Domestic Efforts l l Gas market liberalization Can we stand tremendous deficit of KOGAS? - 12 Nov/26/15 Korea-Japan Energy Biz Forum