LNG terminals

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The Cabinet Committee on Energy (CCOE) has rejected a request of LNG terminal developers to allocate gas transmission and distribution capacity in advance. The Petroleum Division has maintained that it would be allocating capacity on a short term basis a (3-months window) on a first-come-first-basis. Any advance long-term allocation of transmission capacity would be violating market competition principles. Gas terminals developers are not sure of the availability of adequate pipeline capacity. A dead end seems to have reached. In the following, we propose a framework through which may help bring about a competitive gas market system and remove bottlenecks in the way of new LNG terminals.

The government has announced an LNG terminal policy based on open market basis under which contrary to the earlier two LNG terminals, no off-take guarantees or sovereign guarantees will be provided. Almost all risks are on developers and investors. However, there is a price for every risk. Risks are to be measurable for investors. High Risks may discourage or prevent the investments or may increase the price of the resulting products and services. Energy markets and commodities are lot different from other commodities like sugar or wheat flour or metals etc. Involvement of intervening infrastructure and cross subsidies make it quite complicated. Hence, often an elaborate set of market rules are provided and requisite adjustments are made.

Currently, the gas sector is totally regulated and the whole pricing structure is based on it. Open market is a totally different ballgame. Open market system cannot be brought about in one go .There would be a transition period that should ensure constant supplies and reasonable prices until a full market framework prevails. Secondly, market and capitalism require excess supply of commodity and the associated infrastructure. Currently, international market of LNG is expected to assure competitive supplies but there are problems and uncertainties in the associated infrastructure like pipeline capacity.

Two LNG terminals are at an advanced stage of planning and there are three more terminals in the planning process. As the projects approach near implementation, the realities and limitations emerge. The LNG demand is increasing (while local gas production is decreasing and is expected to reach an almost zero level by the next 10 years) which is reassuring and even enticing for the investors which is perhaps the only positive side of Pakistan market. Pipelines capacity is limited to 1200 mmcfd according to the Sui companies. A North-South gas pipeline is at a planning stage and may take 2-3 years to complete. Gas terminals are at an advanced stage of development and can come online in less than 24 months. Even the North-South pipeline may not be enough beyond 2026-7 and extra gas pipeline capacity may be required. This provides expansion opportunities for the existing Sui companies or other new investors. Problems provide opportunity, as they say. Sui companies are in the best position to fill the immediate and the mid-term gap. However uncertainties prevent them to do so.

The Petroleum division recently put forward to the CCoE a proposal for gas market reform and restructuring and ultimate privatisation of the two Sui companies requesting induction of a Transaction advisor. The roadmap had been earlier prepared by a World Bank group of consultants. Their proposal revolves around a standard recipe of integrating the transportation and separating distribution function for which the existing companies have to be reorganized as smaller DISCOs or provincial DISCOs. It is a tall order. Companies’ management and labour union resist restructuring and privatisation. And the two companies are listed on stock exchange which creates unique issues in the required merger and divestment activity. Sui companies’ privatisation has been long on agenda of the successive governments. Political and policy issues have prevented it. Also the debate of restructuring first–privatisation later and vice versa, has also prevented progress in this respect.

What to do? There has been a grave LNG crisis and we are still passing through it. In the coming years, the problem would intensify; hence the need for an early action. Restructuring or privatisation is uncertain and may consume almost five years for a stabilized operation. Gas Reforms would have to be separated from restructuring of transmission and distribution. Tariff structure reforms may be brought about without losing much time in the following manner:

1. Infrastructure (pipes) may have to be separated from gas supply business. This can be easily done. As such, gas losses are a matter of problem for the gas T&D companies. Their earning is based on RoA (Return on Assets) and reimbursement of variable costs. They will continue to earn this, despite separating gas supply business. However, gas contract liabilities would have to be transferred to a third entity.
2. Annual Revenue requirement of Sui companies may have to be changed to unit distribution cost (UDC-Rs/MMBtu) system. Ample historical data is available; besides, cost-plus arithmetic can continue with some adjustments or can be tied to some inflation index like CPA. UDC can be revised periodically. There is already a mechanism for allowing UFG losses that may remain as it is. There may be several variants of UDC depending on peculiar situations of customer size.
3. On TPA to the gas pipelines, the 3-month window on first-come-first served–basis, appears to be contradictory with the Take-or-Pay requirements. It can be one at a time not both. It can be Take and Pay, at a lower capacity utilization rate of 60% which may enhance the pipeline tariff. Take or Pay rates are usually computed at 80-90% capacity utilization.
4. Local gas may have to be reserved for residential and commercial sector and small industry for which pipeline capacity share may be reserved and the remaining in left for the bulk consumers such as industry, electricity and fertilizers etc. The government companies may be allowed to retain this business initially.
5. Except for the residential and commercial sectors, cross –subsidies may have to be replaced by a taxation or surcharge system and a balancing fund is to be created to adjust excess surcharge with the deficit.
6. Bulk consumers like industries, power, CNG and fertilizers sectors etc may be given to private LNG suppliers. Subsidies to fertilizer/agriculture sector may have to be separated from gas sector or financed from the proposed Tax fund. CNG prices may be linked to petrol prices and announced on the line of petrol and diesel prices. The resulting proposed tax should go the tax fund.
7. Gas Terminals should also have a Rs/MMBtu terminal tariff. Fortunately, data from the regulated terminal are available; same can be charged to the new terminals. 44 USC/MMbtu of the existing LNG terminals, although regulated, are only notional. Actual rates have varied and have gone up to 2 USD per MMBtu in the months when capacity utilization has been less. Developers may be allowed to retain 30-50% share for their own gas supplies operations. The rest should be available to the other gas importers and traders.
8. Imported LNG can be priced on the basis of the existing Oil import price regime. Petroleum products import is open to licensed oil companies and is priced on the relevant price index, PLATT or otherwise. Same can be done with LNG import price .It can be linked with JKM, JERA or a combination. Importers can earn profit based on their efficiency and network linkage below the JKM index. Controlled or regulated system like power sector may be under this regime. There could be free imports under bilateral price agreements for non-regulated sectors like industry.
9. Private traders/gas retailers may be licensed. There may be a last resort supplier – a government company which may import LNG filling the market gap as it may emerge from time to time. All legacy import contracts may be transferred to this company. Its deficit is to be financed from the tax fund.
10. There are some other issues related with Port Qasim Authority. Their charges are unduly high and quite unknown charges such as ‘Royalty’ are charged. These need to be looked into.

The aforementioned framework would remove many uncertainties that prevail today towards establishing LNG Terminals and in the introduction of a competitive gas market. The proposed tax fund replacing cross-subsidies is not something new. Throughout Europe, energy taxes are used in supporting various energy causes such as green taxes etc. Privatisation, although desirable, is not a prerequisite for such a scheme of things. A simulation of the proposed model would be required to implement it.

(The writer is former Member Energy, Planning Commission)

Updated 11th February 2021 on Business Recorder