Time to Step on the Gas – Philippines LNG
A majority of the Philippines’ electricity is currently generated from coal, but the main island of Luzon has developed a steady power supply on the back of gas production from Shell’s offshore Malampaya gas field since 2001.
The Philippines economy continues to grow at a rapid rate, with growth in 2017 recorded at 6.7%. To maintain this level of growth the Philippines electricity supply will certainly need to keep pace. However, the 7,641 islands across the country’s archipelago have historically been plagued by power shortages and blackouts. A majority of the Philippines’ electricity is currently generated from coal, but the main island of Luzon has developed a steady power supply on the back of gas production from Shell’s offshore Malampaya gas field from 2001. Since Malampaya came onstream, there have been no other significant gas finds in the Philippines. Hence, with gas supply from Malampaya expected to decline into the first half of the next decade, it appears doubtful that the Luzon electricity market will be adequately suppled in the future. Attention is now focusing on importing Liquefied Natural Gas (LNG) to fill this hole, and a number of international players are circling with intent. But the question needs to be asked; where will this leave domestic electricity users?
The Philippines faces a number of different challenges for securing stable electricity supply for both the residential and industrial markets. The country lacks significant fossil fuel resources, relying heavily on importation of coal, crude oil and oil products. As a developing country, infrastructure is often not mature or remains undeveloped in many regions. Finally, as an archipelago with population centres distributed across the main islands, electricity demand is widely spread. Historically the country has relied on coal to produce electricity, comprising approximately 35% of the installed capacity. However, renewable natural resources in the form of hydro and geothermal also comprise a significant proportion (26% of installed capacity). Oil and natural gas round out the supply mix with 17% and 16%, respectively.
The main island of Luzon has a population of 53 million, out of the nation’s total of 101 million. Peak electricity demand for the island was estimated by the Department of Energy (DOE) in 2016 at 9.7 MW. Natural gas provides 23% of Luzon’s electricity via five gas-fired power stations, all located around Batangas City. Four of the stations are owned by First Gen Corporation subsidiaries and comprise 2,175 MW of installed capacity. The remaining plant is owned by the Korea Electric Power Corporation (KEPCO) and has installed capacity of 1,21 MW. All of the plants are combined cycle gas turbine plants, except for First Gen’s Avion plant, which is an open cycle gas turbine plant. Under Philippines electricity regulations, an intermediary of Independent Power Producer Administrator (IPPA) manages the contracted power output between the plant operator and the National Power Corporation, who subsequently sells the electricity to the end-user. First Gen holds the IPPA for the gas-powered plants it owns on Luzon. However, the IPPA for the KEPCO-owned plant is South Premiere Power Corporation, a unit of the Philippines conglomerate San Miguel Corporation.
Natural gas is supplied to Luzon from a single large offshore gas field. The Malampaya gas field is located approximately north-east of the island of Palawan. The field was discovered in 1989 by Shell in 820 m water depth in Block SC 38. Published estimates cite the field originally held 2.7 Trillion standard cubic feet (scf) of gas and 85 million barrels (bbl) of condensate. Field development originally included subsea wells tied back to a production platform in 43 m water depth. In 2015, a second compression platform was installed to extend the production plateau and increase gas recovery. The gas is sent to an onshore gas plant near Batangas City via a 504km subsea export pipeline. The field currently produces approximately 430 Million scf per day of natural gas and 15,000 bbl per day of condensate. Shell operates the field and holds a 45% interest. Chevron hold 45%, whilst the remaining 10% is held by the Philippines National Oil Company (PNOC).
There have been public statements from Shell and the DOE regarding the decline and shut-in of the Malampaya field. The DOE has stated that it expects output to be less than a third of the current rate by 2024, which is when the SC 38 license expires. This would mean that the field would come off production plateau in 2020 or 2021. Shell on the other hand declared production should be able to support 60% to 100% of the current rate in 2022. The company has also stated it expects field production to continue past license expiry to between 2027 to 2029. It is likely that in 2024, with field production low and limited remaining gas recovery, the financial returns from Malampaya will not meet Shell’s internal investment hurdles and the company will not renew the SC 38 license.
The possible end of the Malampaya production plateau in 2020/21, and the resulting production decline will have an impact on the gas-powered electricity sector on Luzon. This is highlighted by the six Gas Sales Agreements (GSA) that the Malampaya field interest holders have currently signed with both First Gen and KEPCO for a combined delivery of 2,700 MW baseload, with an additional 500 MW for mid-merit and peaking supply. Filling the Luzon power supply gap will require investment in natural gas importation or higher cost alternatives. This may also have a follow-on effect to other islands as coal and/or oil imports are redirected to Luzon. The Philippines government has recognised the potential impact of Malampaya coming off plateau and is seeking to progress LNG imports to maintain supply for the Luzon gas-powered plants. However, despite signing a Memorandum of Understanding (MOU) with Shell for an LNG import terminal as early as 2012, and the DOE declaring in 2014 they wished to double the share of natural gas for power, progress has been slow in addressing the now rapidly approaching gas supply crunch.
In 2017, after government-level partnership talks with LNG-producing nations fell through, the government opened an unsolicited bid round for LNG import and regasification on Luzon. Bids on the estimated US$2 billion terminal were due by the end of the calendar year. The scope proposed by the DOE and PNOC was two phases, both located in Batangas City. Phase 1 comprised a small Floating Regasification Storage Unit (FRSU) capable of supporting 200 MW online by 2020, with the potential to subsequently scale up to 800 MW. Phase 2 included development of an onshore import terminal with larger storage and increased regasification facilities. One issue to note with installation of an FRSU in the Philippines is the high incidence of typhoons that make landfall on the archipelago. Four of the five strongest recorded typhoons since 1960 have hit the Philippines in the past 8 years.
The bidding process has turned out to be anything but straight-forward. Seven groups submitted bids for the LNG import terminal prior to the original deadline, but PNOC rejected a number of bids on the basis of qualification criteria. The list of companies that submitted applications included Lloyds Energy Group, CNOOC, Korea Electric Power, Energy World Corporation, PT Jaya Samudra Karunia and PT PGN/PT Bosowa Corpindo. The PT PGN/PT Bosowa Corpindo bid was in a consortium with local partner MOF Corporation. After the year-end deadline, a number of additional companies sent letters of interest in the project. These included First Gen, Tokyo Gas and a partnership of Resiro and local partner Cleanway. Major oil companies including Shell and Total, as well as Malaysian National Oil Company PETRONAS have also expressed interest in the project, but did not submit formal proposals. In January 2018, the Asian Development Bank also announced it had become a transaction advisor on the project to PNOC.
PNOC and the DOE have publicly stated that they want construction on Phase 1 to begin in 2018. However, since the project has yet to be awarded, this schedule appears unlikely. Thu, delays in LNG importation, coupled with the possible earlier decline in Malampaya gas output present the very real scenario of a supply gap for gas-powered electricity in Luzon in 2020 or 2021.
The joker in the pack may be a company publicly stating they will be importing LNG into Luzon by the end of 2018. Australian stock exchange-listed Energy World Corporation (EWC) is one of the companies that submitted proposals for the Batangas import terminal at the end of 2017. In a press release in February of this year, EWC declared their 3 Million tonnes per annum (Mtpa) LNG import terminal on Pagbilao Island in Quezon to be 90% complete and an associated power plant would be operational and capable of supporting 400 MW of power online by the end of 2018. EWC said that imported LNG into their plant would initially be from the spot market, with longer term supply possible from their Sengkang LNG export plant in Eastern Sulawesi, Indonesia.
There are questions to be raised regarding the start-up and viability of EWC’s terminal. The original timeframe for start-up of the LNG import terminal in Pagbilao was 2015, and with an already 3-year delay, further deferment in project start-up would not be unexpected. EWC’s Sengkang LNG plant has been subject to even greater delays, with start-up originally planned for 2009. No start-up timeline for this plant is currently proposed by EWC, and given Indonesia’s increasing LNG demand, any LNG production would likely be retained for domestic consumption. The 3 Mtpa capacity of the Philippines import terminal under construction by EWC can support approximately 3,000 MW of gas-fired power. EWC is constructing 650 MW of capacity at its linked power station. To make a dent in the Luzon power market EWC would need to build a number of additional power plants or build a gas export pipeline to support the existing plants in Batangas. Given the delays in advancing the existing projects, progressing either of these options before 2020 or 2021 appears unlikely.
Whilst the majority of bids and interest in the LNG import terminal have been from overseas companies, the submission of a bid by First Gen is promising. As the major local user of natural gas in Luzon, it is in their interests to be involved in the import terminal planning, development and operation. If the import terminal is operated by a separate foreign company, there is the possibility of a disconnect between the utility and the global LNG market. Downstream customers may be required to either purchase natural gas from the terminal operator or pay a tariff for using the terminal to import LNG from other sources. There is also a danger that the incentives for a stand-alone foreign terminal operator may not align with the domestic utility or the Luzon power market. Any incumbent could be placed in an awkward position, paying higher costs for imported LNG or alternatively paying high tariffs for importing through the terminal. By owning a stake or all of the terminal, First Gen could avoid these issues and ensure that tariffs and import flexibility are on reasonable terms.
Other Philippines utilities or conglomerates could also investigate partnerships with First Gen or other foreign firms. Domestic companies Cleanway and MOF Corporation have already joined with overseas groups in the bidding process. With their IPPA role in the Ilijan CCGT plant, it may also be that San Miguel Corporation or other conglomerates seeking entry into the Luzon power market become involved in the bid process. If First Gen is the only local partner, they will hold a supply advantage over natural gas being imported into Luzon.
Beyond investing in some or all of an LNG import terminal, Philippines companies could also investigate securing upstream supply of LNG and importing some or all of their own natural gas needs. This would include either signing long term supply contracts or acquiring a stake in an upstream LNG project. Long term LNG contracts ensure a stable and secure supply of natural gas, necessary for running baseload power plants. Opportunities for long-term LNG contracts will be from greenfield LNG projects or existing plants that are increasing capacity or have contracts nearing completion. Producers in Australia and Qatar that are raising capacity may likely be more expensive but would offer greater security. Elsewhere new projects are expected to come online in eastern Africa after the discovery of large natural gas deposits in Mozambique and Tanzania. A large number of plants in the US and Canada are also proposed but the majority of these have immature financing.
In recent years, LNG pricing has appeared to be become more competitive in the low global oil and gas price environment, as shown in the following chart. Additionally, there has been a push from buyers to move away from oil price-indexing to gas market benchmarking. Recent sentiment has moved towards expectations of a global gas supply crunch in 2022 to 2024 on the back of growing global natural gas demand, driven mainly by growth in Asia. With natural gas supply tightening, oil-indexed pricing may become more attractive for LNG customers, but will regardless mean that LNG prices will likely rise into the next decade. This will have the knock-on effect of downstream buyers having to charge domestic power users higher prices or suffer lower margins themselves.
Upstream investment in LNG projects offers integration opportunities for Philippines companies already involved or seeking to gain a foothold in natural gas on Luzon. The chief benefit of holding an interest in such a project could be to offset periods of higher prices by owning a stake in supply. If a company has no upstream ownership, then as prices increase it would face higher costs for its LNG supply. Owning an upstream interest is a natural hedge that major oil companies have enjoyed for a long time from their refining divisions. As a utility that needs to secure supply, a company like First Gen prefers less price volatility, so that margins are more constant and reliable. Hence, hedging against higher LNG prices by owning a share in an upstream project could be an attractive option. Additionally, despite some recent gains, LNG prices are still relatively low on the back of the low oil price environment. The cost of investing in LNG projects is much lower now than it will be when supply tightens towards the possible crunch in 2022 to 2024.
Have the Philippines left it too late to secure the electricity future of Luzon using imported natural gas? Development of an LNG import terminal is still in the discussion stage with no ground as yet broken, and with the possibility in the near term of Malampaya coming off plateau. How the government and PNOC progress the next stages will be anyone’s guess. However, domestic companies need to make sure they are involved to ensure they have economically viable access to infrastructure and can connect to global LNG market.
Article by Adam Becis, Principal Reservoir Engineer