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Timor Leste as a Potential LNG Exporter: Why not?

By John F. Imle, Jr., energy consultant
As presented at the International Energy and Mineral Resources Conference
5 – 7 March 2003, Dili, Timor Leste.

Click here for the slide show which accompanies this paper.

Mr. Imle has provided additional slides on LNG marketing and Timor Leste's situation.

BENEFITS OF BECOMING AN LNG EXPORTER (slide 2)

Timor Leste is indeed a blessed young nation.  You have oil and gas resources, which will generate revenues for many years.  But these resources offer much more than that.  These resources offer a value-added potential that could transform Timor Leste into a self-sustaining, vibrant economy built on the high-tech industry of transporting and liquefying natural gas for export to world markets. 

I am here today to discuss the possibility of building a liquefied natural gas (LNG) plant in your country.  Attracting this investment would be a huge challenge for the people of Timor Leste, requiring vision, unity and commitment.  But the benefits would be massive, both in the near term and for the next generation. 

An LNG plant in Timor Leste would provide some $1.5 to $2 billion U.S. dollars of foreign direct investment.  Perhaps half of that – US $750 million to $1 billion -- would be spent here in Timor Leste.  After the initial investment, there would be operating expenditures of some US$60 million a year – at least half spent in Timor Leste -- for the life of the plant, at least 20 years and possibly as long as 40 years. 

Thousands of direct and indirect jobs would be created, both during construction and later for operations and maintenance.  Most of these jobs would eventually go to Timor Leste citizens.  With ongoing technical and management training, in time, Timor Leste citizens would take over higher-level supervisory and management jobs.

In addition to the plant itself, there would be a need for many locally-owned businesses to support such a large operation.  Typically, this “multiplier effect” doubles or triples the number of total jobs created.

In my 40-year career in the energy business, I’ve seen time and again how major investments can bring lasting prosperity to developing countries. I’ve seen children of farmers become electricians, plant operators and more. I’ve seen bright young college graduates become middle managers and executives with world-class skills.  And, just as importantly, I’ve seen entry-level unskilled workers find a way to support their families through their own labors, so they can buy not only the essentials of life but luxuries such as mopeds and TV sets. Without employment, where would these people find hope?

As people’s income level rises, so do their energy needs.  At no added investment, Timor Leste could have natural gas available for local use, since the gas would already be pipelined onshore for processing and export. If managed correctly, domestic gas could replace virtually all need for imported oil for transportation, power generation, industrial and household fuel. This alone would bring significant economic and environmental progress to the nation.

Finally, going beyond the tangible benefits of investment, jobs and infrastructure, a large, high-tech industrial enterprise enhances national pride and self respect. 

With so much to gain, Timor Leste faces a once-in-a-lifetime opportunity.

A WORTHWHILE GOAL (slide 3)

Attracting international companies and investors to build an LNG plant is not easy.  Timor Leste must compete with Australia and with floating LNG plant proposals to win this investment for conversion of Timor Sea gas into LNG.

I will discuss how, compared to Australia, Timor Leste enjoys more advantages than disadvantages.  Your single main disadvantage is your newness as a nation and the absence of a financial performance record.  I will provide some suggestions for addressing this problem.

THE GLOBAL LNG TRADE (slide 4)

Like oil, LNG is a commodity traded globally. Unlike oil, however, LNG facilities don’t get built unless there is a buyer committed to a 20-year contract.  It is very expensive to build both the liquefying plant at the export end of the chain and the facility for receiving and re-gasification at the buyer’s end.  These facilities simply must be “guaranteed” by long-term contracts.

The global LNG business began in the 1960s.  It has become an extremely competitive business and is most often dominated by big players – major energy companies and major exporting countries.  In fact, Indonesia is the largest LNG exporter in the world.

Indonesia’s entry into the LNG business in the 1970s was an exception to the “big player” rule. The Bontang LNG plant in East Kalimantan was conceived and constructed as one of Indonesia’s earliest LNG projects. The operating company that produced the first gas for Bontang was a small U.S. independent. 

Through the years, Bontang has grown from a single processing “train” to eight or nine trains.  A “train” is one complete unit of LNG liquefaction equipment.  [Note:  Definitions for common LNG terminology are attached to the end of this text.]  At Bontang, many producers sell gas to the plant but none of them owns an interest in the plant. They participate in the LNG marketing, but the plant belongs to Pertamina.  Bontang and the industrial development of East Kalimantan are a good example of a grass-roots LNG success story.  Beginners can become big players. 

Clearly, the LNG buyer is crucial. The market for LNG from Timor Leste would almost certainly be in the growing nations of South and East Asia.  The region’s major LNG exporters are Indonesia, Malaysia, Brunei and Australia.  Major buyers are Japan, South Korea, Taiwan, and most recently, China (slide 5). In the future, this customer group may include India.  Timor Leste’s main competitors for these markets would be Australia’s northwest shelf and Indonesia.  Both have established LNG facilities.

For anyone considering a venture into this highly competitive business, it is essential to remember that a new LNG plant must be able to sell its LNG at a price in line with the most recent prices negotiated by other LNG buyers and sellers in the region. 

TIMOR SEA GAS TODAY

Bayu Undan (slide 6)

Turning now to the Timor Sea natural gas reserves and LNG projects, we are all aware that the Bayu Undan gas recycling and oil recovery project is under construction.  It is scheduled for start-up in early 2004.  When oil production begins, there will of course be an immediate economic benefit to Timor Leste from the oil revenues.

The Bayu Undan gas reserves of about 3 trillion cubic feet (TCF) would be transported to Darwin by pipeline and processed by an LNG plant with a capacity of about 3 million tons per annum (mtpa).  This plant would consist of a single train.  The operator has announced a 17-year gas contract with a Japanese buyer.  According to press reports, the LNG plant in Darwin is “on hold” until Australia ratifies the Timor Sea Treaty.

Greater Sunrise (slide 7)

The Greater Sunrise field has gas reserves estimated at 7 to 9 TCF or higher.   LNG output could be any volume up to about 10 mtpa.  Depending upon the output requirement, this could require anywhere from one to three LNG trains.

At this time, there has been no announcement of a buyer for Sunrise LNG output, and there has been no firm commitment to an LNG plant. The operator has said an LNG plant in Darwin is not economically viable. I agree with that conclusion based on my own examination of public information.

There has been much discussion about a floating LNG facility. I have serious concerns about the cost and operating effectiveness of such a plant. Unfortunately, there isn’t enough public information at this time to examine the economics of such a project.  We do know, of course, that a floating plant has not been tried anywhere.  I would expect an onshore plant in Timor Leste to be more cost-effective to the operating company and certainly more beneficial to Timor   Leste.

A floating LNG plant would, of course, provide very little employment benefit to Timor Leste.  And, as the Northern Territory government and many others in Australia have made abundantly clear, the indirect benefits of landing gas ashore have a huge positive economic impact on the plant’s host country. Timor Leste should be as committed to getting the Sunrise gas to its own shore as is Australia for bringing it to theirs.

The momentum toward a floating plant seems to have slowed in recent months. This suggests to me it would be timely for Timor Leste to raise the issue of an LNG plant on its own soil.

“TimorLNGCo” ASSUMPTIONS (slide 8)

The remainder of my discussion will address the possibility of a Timor Leste LNG plant built for the purpose of buying Greater Sunrise gas offshore, transporting it ashore via pipeline, liquefying and selling it for export.  For convenience, I’ll call this proposed project “TimorLNGCo.”

I have assumed that an LNG plant for Greater Sunrise built in Timor Leste would be a two-train plant with a capacity of 6.6 mtpa contracted for 20 years initially.  This would require a little over 6 TCF of gas reserves, which is easily within the capacity of Sunrise.  An LNG output rate of 6.6 mtpa corresponds to a daily gas production rate of about 800 million standard cubic feet per day (MMSCF/D), also easily within the capability of Sunrise. 

Keep in mind the primary consideration throughout this analysis:  LNG output must be price competitive.

FIVE CRITICAL VARIABLES FOR “TimorLNGCo” ECONOMICS (slide 9)

The first three critical variables for such a facility include gas purchase costs from the Sunrise field operator, pipeline construction costs and, of course, plant construction costs.  These are all fairly obvious.

The next two variables are much more difficult to quantify, but perhaps more important.  One is the local tax structure for the TimorLNGCo enterprise.  The other is the cost of capital, which is an expression of perceived country risk.  The tax structure is wholly under your control.  And concerning country risk, you have a direct influence as well.

The interaction of these five main variables determines the bottom line:  LNG export price at the plant site.  It must conform to expectations of the global LNG market.  To succeed, Timor Leste would simply have to be a low-cost seller of LNG.

COMPETITIVE ADVANTAGE COMPARISON (slide 10)

I have compared each of these critical variables for a plant built in Timor Leste versus a plant built in Darwin.  I believe Timor Leste is either advantaged or equal to Darwin with one exception, the cost of capital.

Let me discuss each item briefly.

The price of gas from Sunrise would depend on field development economics.  I have assumed the gas price would be the same regardless of the destination of the gas.  I’ve also assumed the gas would be produced under the same tax and royalty arrangements, regardless of its destination.  Therefore, the price of gas from Sunrise would remain the same for any development option.  And the gas production revenues for Timor Leste would also remain the same. (slide 11)

Turning to pipeline costs, a pipeline to supply two LNG trains can be laid to Timor Leste for less cost than one to Darwin.  The ocean route to Timor Leste lies in deeper water.  However, it is technically feasible with existing technology to install the required pipe size in those waters.  The pipeline to Timor Leste would be smaller diameter and much shorter in length, and that is the reason for the lower cost.  The deep-water installation can be done with existing pipe-laying equipment.  Two pipeline engineering consultants and two pipeline constructors have confirmed this independently. All four firms agree.

The cost of a pipeline to Timor Leste would be between one-half and two-thirds the cost of a similar-capacity pipeline to Darwin.  (slide 12)

On LNG plant costs, Timor Leste also holds the advantage.  An LNG plant in Timor Leste can be built for 5 to 10 percent less than the same plant in Darwin.  This could be done using modular construction techniques, where much of the fabrication is done overseas.  The modules would be assembled on-site using non-union labor.  These procedures could not be used in Australia.  Two global construction firms have confirmed this “discount” for plant construction in Timor Leste. (slide 13)

The next critical variable is tax structure.  This is totally within the control of Timor Leste.  TimorLNGCo would need special tax treatment to be competitive.  Obviously, if there is no LNG plant built in Timor Leste, there will be no plant taxes.  Therefore, a “tax holiday” would be a zero-cost method to attract foreign direct investment and job creation.  By “tax holiday,” I mean a total waiver of corporate tax on the TimorLNGCo entity for the first 10 years of its 20 to 40 year  life.  The nation of Trinidad, a commercially experienced country with a mature energy industry, has recently granted a 10-year “tax holiday” to promote the LNG industry there.  They did this in order to make Trinidad competitive with East Africa, Venezuela and Norway – other exporters all vying for the U. S. LNG market. (slide 14)

In addition to a “tax holiday,” all TimorLNGCo plant construction activities should be exempt from import duties, VAT or other levies.  There are precedents for these kinds of tax incentives, which are often needed to foster the development of new industries, especially in developing countries.  Again, these tax incentives would come at a zero cost to Timor Leste, since if the plant is built elsewhere, the opportunity to collect any taxes is lost forever.

COST OF CAPITAL, OR COUNTRY RISK (slide 15)

The final variable is cost of capital.  The cost of capital – another way to say “perceived country risk” – is the most difficult issue for Timor Leste.  I believe strongly that in the 1990s, when Timor Leste was overlooked as a potential LNG plant site, country risk was the overriding concern.  Much has changed since these early decisions were made.

Timor Leste’s responsible use of the revenues from Bayu Undan oil production will help build your “credit-worthy” reputation.  However, Timor Leste has had very little time to forge strong relationships with the global financial community, especially the multilateral lending agencies (MLAs).  This is a significant problem.  A project of this magnitude would almost certainly require investment by one or more MLAs.  These agencies provide more than money.  They provide expertise and guidance, so affiliating with them reduces risk for any venture undertaken in Timor Leste.  

Around the world, new nations, particularly those born out of conflict, are perceived to have higher country risk than long-established nations such as Australia.  Investors fear civil unrest and violence, as well as uncertainty and changes in tax structure and business law.  There is also the fear of other anti-business sovereign acts such as nationalization and confiscation.

For these reasons, the international financial community would impose a higher premium for financing Timor Leste projects – probably somewhere between 2 to 6 percent above finance costs available for Australia.  In fact, because you are such a new nation, the appropriate country risk premium cannot be calculated by conventional means. However, it is within the power of Timor Leste to gradually improve the perceptions of country risk.

Foreign companies investing their own money (equity) also must take into account a higher country risk premium.  Companies do this by setting a higher threshold for expected rate of return.  Any project planned for Timor Leste would have to meet or exceed that higher threshold. 

Having warned you of the difficulties of dealing with country risk, I don’t want to discourage you too much. I have seen very large equity investments in many emerging countries with similar “credit problems.”  Examples include Myanmar, Vietnam, Azerbaijan, Bangladesh and others. For example, to participate in a gas development project in Myanmar, the government was able to get project finance (secured only by the project), for its investor share. The country risk issue can be overcome with hard work and demonstrated financial responsibility.

MITIGATING COUNTRY RISK:  WHAT INVESTORS WANT  (slide 16)

Investors and their lenders look carefully and critically for “national attributes” such as rule of law and the absence of endemic corruption.  The international business community expects “transparency” in agreements.  I would define “transparency” as clear, publicly-available agreements with no hidden beneficiaries and with strong anti-corruption clauses. Investors want control of employment and assistance programs for communities surrounding their facilities, to build ties and improve the lives of the local people.

The international business community also wants to see improving economic conditions for the host country population at large.  This is an important indicator of a government’s commitment to its people and their well-being. Without this attribute, unrest and disruption are more likely. Your wise use or revenues from Bayu Undan will help demonstrate financial discipline to the world.

Let me emphasize that in order to attract serious foreign investment, Timor Leste will need strong ongoing affiliations with institutions such as the World Bank, Asia Development Bank and other MLAs.  Foreign companies want to see MLA participation.  Among the benefits, the most obvious is a reduction of capital required from the foreign companies.  But more importantly, MLA participation is a way of increasing global commitment to the success and stability of the host nation and the investment there.

When an MLA lends money for such projects, it is not necessarily a general loan to the nation.  It is usually for a project-specific element such as a pipeline.  This does not add directly to national debt but provides an alternative finance source that is repaid over time through project revenues.  These are revenues that would, of course, not exist without the project.

A good example within my personal experience is in Thailand.  In the 1970s, the World Bank financed the country’s first offshore pipeline to transport gas produced by foreign energy companies in the Gulf of Thailand.  The gas was purchased at the field by the owner of the pipeline (the Thai government) and then sold to the gas consumers onshore.  The World Bank loan was repaid from the pipeline company profits. This pipeline became a key contributor to the financial success of the state oil company, PTT.

Other sources of finance include the export/import banks of any nation in a position to buy LNG or to sell equipment and material for a project here. The United States, Korea, Japan, Taiwan and China immediately come to mind.

MECHANISMS FOR REDUCING COUNTRY RISK (slide 17)

I’d also like to describe some specific mechanisms for reducing country risk premiums.  These have become customary in large energy contracts in developing nations.   

Such large, long-term agreements are usually written subject to the law of some long-established nation – typically the United Kingdom, the United States or perhaps Singapore.

For large contracts, particularly when the revenues arise from foreign customers, distribution of these revenues is arranged through offshore trust accounts.  In this way, project lenders can be certain they are “first in line” for revenue collection.  This, of course, reduces their risk. This is the system that has been used successfully at the Bontang LNG plant for over 30 years.

Finally, foreign investors and lenders like to see foreign government political risk insurance provided by organizations such as MIGA of the World bank or OPIC, an agency of the U.S. government.

THE BOTTOM LINE:  LNG EXPORT PRICE (slide 18)

After our examination of the five key economic variables, the bottom line is the export price of LNG from TimorLNGCo versus other plants in the region. An initial-feasibility model was constructed to study many combinations of variables. The final model was run with the input I have discussed today:  the same gas price to the producer, lower pipeline and plant construction costs, a 2-percent country risk premium on equity investments, a 4-percent premium on commercial loans and a 10-year “tax holiday. These premiums do not represent the official views of lenders, but I think they are achievable sometime in the future.  The results?

The export price of LNG from Timor Leste could be 10 to 20 percent lower than from a comparable plant in Darwin.

This price would be competitive with recent LNG sales prices agreed to by exporters from the northwest shelf of Australia and from Indonesia. In short, the nation of Timor Leste can – if you desire -- join the ranks of the world’s LNG export nations. This is not a dream.  It is an achievable goal that could transform your nation.

NEXT STEPS FOR TIMOR LESTE (slide 19)

This once-in-a-lifetime opportunity may not be available much longer. Already the Bayu Undan gas is slated for processing in Darwin.  And the Sunrise operator seems to favor an offshore processing facility.  If the offshore decision is made, Timor Leste has lost its LNG plant opportunity forever.  If you want to pursue this project and its benefits, you must act now.

As substantial owners of the Sunrise resources, Timor Leste should encourage a full and fair evaluation of a “TimorLNGCo” project proposal.  As part of this dialogue, Timor Leste should make it clear the nation is willing to provide significant tax incentives and risk-mitigating inducements to encourage investment here.   

If the Sunrise operator is not interested, you have the option of pursuing an alternative.  You could seek an alliance with an independent and experienced project developer to lead the promotion of the TimorLNGCo concept. This entity could promote the concept and perform the needed pre-feasibility work.

Timor Leste should energetically pursue close affiliation with the MLA community. Your discussions with the MLAs should include investigation of the feasibility of major investments such as the one discussed here.

All these actions will enhance Timor Leste’s expertise in the field of LNG, resource development and finance.  This knowledge will serve you well, whatever the outcome.

In my energy industry career I have often seen how emerging nations can propel themselves forward with projects like this one.  I think I recognize a real opportunity for you here.  

The decisions are all up to you, the people of Timor Leste.  All I can do is offer my professional opinion and analysis.  Like everyone else in this room, I want Timor Leste to become a strong and prosperous nation.  Many people from many countries are interested in your success and willing to help you get there.  I urge you to use all the resources available to pursue what is in your national interest.

Returning to the title of this paper, “Timor Leste as an LNG Exporter:  Why Not?,” it would be sad to look back five years from now and have to say, “They didn’t know about the opportunity.”  That’s why I’m grateful for the invitation to speak with you today.

Common LNG / Gas Terminology

LNG

Liquefied Natural Gas

mtpa

million tons per annum

MCF/D

thousand cubic feet per day

MMBTU

million British thermal units

train

one complete unit of LNG liquefaction equipment; each train, depending on design, converts about 3 mtpa or more

LNG contract

long-term agreement to supply LNG at an agreed price, usually for 20 years

TCF

trillion (standard) cubic feet

FOB

Freight on Board at LNG plant site

CIF

Cost including freight at buyer’s location

MLA

multilateral lending agency (World Bank, e.g.)

horizontal rule

John F. Imle, Jr is an energy consultant with 40 years’ experience in the industry. He was formerly president and vice chairman of Unocal, a U.S. corporation with major oil and gas operations, particularly in Asia. He served on the Unocal board of directors for 10 years.

Trained as a petroleum engineer, Mr Imle served as a Unocal project manager for major offshore design and construction projects in Alaska and the North Sea. Later, he was the senior executive for all Unocal’s worldwide oil, gas and geothermal exploration and development activities. His executive experience includes major natural gas development projects and commercial gas arrangements in the United States, Thailand, Bangladesh, Myanmar and Indonesia (where Unocal’s gas was processed by the giant Bontang LNG plant). He has seen firsthand how large, carefully managed projects can bring prosperity and growth to developing nations and is convinced that foreign investment and job creation are essential foundations for political stability and nation building.

Imle, along with Sadeko Ogata, John Whitehead, and Robert Zoellick, is a founding co-chair of the Business Humanitarian Forum, a Geneva-based non-profit that promotes cooperation between the business and humanitarian community, particularly in post-conflict regions.
 

The Timor-Leste Institute for Development Monitoring and Analysis (La’o Hamutuk)
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