Evaluation of Kovykta Gas Export Options: Investor s Perspective

Transcription

1 Evaluation of Kovykta Gas Export Options: Investor s Perspective P. V. Stupin, and Yu. D. Kononov I. INTRODUCTION The Kovykta gas condensate field located in the north of Irkutsk region is one of the world largest natural gas resources. Gas reserves of the field allow the production of bcm per annum. In accordance with the gasification plan of Irkutsk region, no more than 3-4 bcm will be consumed within the region, while the most of the gas produced is intended for export. Three options of export gas pipeline construction are suggested: 1) export of the piped gas to the Northeast China; 2) export of the piped gas via the Unified gas supply system (UGSS) of the country, which requires the construction of a pipeline in the western direction so that it could be connected to the UGSS in the area of Proskokovo; 3) export of liquefied natural gas (LNG) to the Asian-Pacific region (APR) countries, which requires the construction of a pipeline to Nakhodka, where a gas liquefaction plant with an annual capacity of bcm will be set up. Each option is characterized by a high degree of information uncertainty with regards to both capital investments and market conditions. The available estimates of production costs vary in the range of $14-16/ 1000 m 3. The range of estimates of capital investments in transportation and gas liquefaction is even broader as indicated in Table I 1. Average annual operation costs for gas transportation ($/1000 m 3 /1000 km) are assumed as follows: for the option P.V. Stupin, and Yu. D. Kononov are with Melentiev Energy Systems Institute, Siberian Branch of the Russian Academy of Sciences, Irkutsk, Russia ( kononov@isem.sei.irk.ru). 1 Here and below all cost estimates and prices are given in 2005 dollars (without considering inflation). of export to China; for the option of export via UGSS; for the LNG export option. The LNG plant with a capacity of 24 mtpa is assumed to provide the required LNG production. The LNG plant will consist of 8 production lines. LNG will be transported by 14 LNG carriers with a capacity of 135 thousand m 3 each. TABLE I CAPITAL INVESTMENTS IN GAS PIPELINES AND LNG PLANT Option Length (km) Capital investment (billion dol.) Export to China Export via UGSS Export to APR (LNG) Below is presented an attempt at comparative analysis of the Kovykta field development options. The comparison accounts for the inherent uncertainty of external conditions and is based on the criterion of maximum return on investment. II. DESCRIPTION OF MARKET CONDITIONS FOR KOVYKTA GAS EXPORT Currently Japan, Korea and other APR countries are supplied primarily with LNG priced in accordance with the contract price system that links the gas price to that of oil in the linear fashion: P LNG = α + β P oil, (1) where P LNG the LNG price (CIF) in dollars per ton of oil equivalent, P oil the price of imported oil in dollars per ton of oil equivalent, α = 28-36, β =

2 TABLE II ASSUMED PRICE DYNAMICS FOR THE GAS EXPORT OPTIONS Units Imported oil $ / bl LNG in APR (China excluded) Piped gas in Northeast China Piped gas in UGSS (Eastern part) $ / 1000 m $ / 1000 m $ / 1000 m Formation of the buyer (rather than seller, as is currently the case) market, reduction of capital costs required for LNG production and transport as well as the development of LNG infrastructure will make for a substantial decrease of its cost dependence on the oil price. Therefore, it can be assumed that in the existing contract price formula (1) both coefficients will gradually decrease. China that is less dependent on gas import than Japan, Korea or Taiwan succeeded in contracting LNG supplies on more favorable terms. Dependence on the world oil prices in that contract formula is 2.9 times lower than in the standard contracts, while the constant component is almost 3 times higher [1]. In the future the difference in LNG prices between that in China and that in other APR importer countries can be expected to go down. The official forecasts of piped gas prices in China are not published. In the study on prospects for nuclear energy development that was performed by experts from IAEA in 2001, the forecasted gas price for thermal power plants was taken to be $145/1000 m 3 in It is close to the expected price of self-repayment for gas supplied from the Tarim basin to Shanghai via the gas pipeline that is 4000 km long. According to the information of International Energy Outlook 2002, Petro China suggested to supply gas to Beijing from the neighboring Ordos basin at the price of $112/1000 m 3. This value exceeds the price level of approximately $85-100/1000 m 3 at which gas competes with coal. The piped gas in some areas of China is likely to compete first of all with LNG, which import volumes are estimated by Asia Pacific Energy Research Center (APERC) to become 56 mtpa by the year In this case account should be taken of extra costs of LNG regasification ($10-15/1000 m 3 ) and its delivery to consumers. The future price of Russian gas contracted on the long-term basis will depend, however, on both economic and political factors. Besides, it is very likely that considerable natural gas reserves can be discovered in the provinces adjacent to Northeast China. Hence, with caution we assume the import price of piped gas to be $60-70/1000 m 3 lower than that of LNG. Based on the assumptions made and the latest forecast of the world oil prices of the US Department of Energy (the reference case and adjusted high oil price scenarios [2]), the following price dynamics as presented in Table II is accepted for the subsequent evaluation of Kovykta gas export options. We suppose that dynamics of sales volumes will follow the pattern presented in Fig. 1, according to which the maximum level of 30 bcm per year can be reached for China, UGSS and APR export options in 10, 4, and 8 years respectively. 98

3 Annual sales volume, bcm Year Fig. 1. Probable dynamics of sales volumes. III. AN OUTLINE OF THE APPROACH EMPLOYED FOR THE RISK-AWARE RATIONAL CHOICE OF GAS EXPORT OPTIONS The assessment of comparative financial viability of large-scale gas export projects bears natural complexity due to several reasons, among which are the following. First, the exporter, upon exercising one of the available options and thus committing herself to a predefined pattern of capital and gas resources allocation induced by the pipeline construction, becomes highly vulnerable in her dependence on further behavior of the importer due to exporter s very limited ability to adapt to inevitable changes. Limited flexibility is caused by both large volumes of investment outlays and available resources of the field. Consequently, the implementation of an alternative project option previously rejected based on the initial analysis becomes virtually impossible. It is natural thus to develop and employ an approach that has enough of expressive power to account for the issues risen above. The approach we suggest aims primarily at support of decisions on elaboration of the rational export policy when resources of the specific natural gas field are allocated based on the risk-adjusted expected return on investment. The key steps of the approach are: 1) determination of the considered alternative options and scenario generation; 2) calculation of the expected internal rate of return (IRR) for all the alternatives with subsequent ranking; 3) consideration of the risk of alternatives and proper adjustment of the expected return values. Each stage is described in greater detail below. First, the set of considered options and associated design characteristics, as well as forecasted values of the factors common to all the options (most notably, dynamics of oil prices during the relevant time frame) are determined. The approach allows interval representation of all model input data. The next step involves the calculation of the forecasted cash flows for each option. Due to the interval nature of estimates, we apply interval arithmetic [3] for cash flow calculation. The next step is the calculation of the expected IRR value based on the interval estimates of cash flows. The expected value is calculated as a weighted mean of the infimum (inf) and supremum (sup) limits of IRR intervals induced by the previously defined cash flows. We believe that the highly general problem statement dealt with in the work does not lend itself to evidencebased probability judgment construction (this view is further elaborated in [4]). However, it is still possible to make reasonable assumptions on whether infima of suprema of the intervals are more likely to realize. The method allows the expected value calculation based on interval values of the coefficient λ that is used to encode the information on likelihood; yet for the sake of simplicity of presentation we will limit ourselves to the approximate point estimates. Thus, the expected value is calculated by Hurwitz s formula: ( λ) IRRexp = 1 inf( IRR) + λsup( IRR), (2) where IRR exp the expected IRR value accounting for the degree of possibility for the optimistic and pessimistic scenarios to realize, which is determined by the coefficient λ [0,1], inf(irr) and sup(irr) the infimum and supremum limits of the range of possible IRR values for the 99

4 considered option. Based on the analysis of market conditions for Kovykta gas export that was summarized above, for further calculations we set the pessimism-optimism coefficient values as follows: λ = 0.25 for export to China; λ = 0.75 for export via UGSS; λ = 0.5 for LNG export to APR. Here the lower is the value of λ the more pessimistic is investor s attitude toward market uncertainty resolution, and vice versa. The calculated intervals and the expected values obtained from them are instrumental in providing insights into relative efficiency of the options and the sensitivity of the recommended option to the possible resolution of uncertainty. The final step of the calculation process is the risk-adjustment of expected IRR values. In general, the IRR value adjusted for risk is determined as R IRR IRRexp R =, (3) where IRR R the risk-adjusted IRR value of the option, IRR exp. the calculated expected IRR value, R the risk measure determined as R = h R, R +, k, (4) ( ) where the function h is Hurwitz s formula (4) with its arguments being the coefficient k [ 0,1] and the values of the negative (R - ) and the positive (R + ) components of the risk measure: (,, ) ( 1 ) h R R + k = k R + kr +. (5) The understanding of semantics of the variables R -, R +, и k can be further facilitated by a simplified graphical representation of a possible case for the relations between the interval IRR values that characterize the efficiency of options (Fig. 2). In Fig. 2, possible IRR ranges for the three options are represented in the form of intersecting squares (1, 2, 3). On the area occupied by the squares we can distinguish between three zones, each with a distinct semantics: A) risk zone, B) neutrality zone, C) zone of market opportunities. The infimum and supremum edges of zone B that is formed as a result of intersection of all the considered ranges are the infimum and supremum edges of zones A and C, respectively. Let us approach the zones of risk and extra market opportunities in greater detail. In the risk zone (A) the farther is the infimum edge of the IRR interval of the option from the maxmin value, the more risky is thought to be that option. The maxmin value is some guaranteed minimum (inf(b)) or, which is the same, max(inf IRR), where the maximum is determined for all the considered options. In Fig. 2, the infimum edge of range 1 will be such a value. Hence, option 1 can be considered to be riskless with respect to other options. Therefore, the negative component of the risk measure can be calculated by the formula ( ) R = inf IRR max inf IRR. (6) At the same time it is obvious that a wider range of IRR values makes for the possibility of achievement of better financial outcomes (zone C). Hence the necessity to take into account the positive component of the risk measure, R +. It is determined in much the same manner as the value R - with the only difference that the minimax value is applied here as the base one. In Fig. 2, it is associated with the infimum edge of range 2, the extra market opportunities of which with respect to other options are equal to zero. Fig. 2. A possible case of IRR intervals for the options compared. 100

5 Correspondingly, the value of R is determined by the formula ( ) R + = sup IRR min sup IRR. (7) Thus, the coefficient k in formula (4) means the investor s risk propensity, or the extent of risk compensation (zone A) by means of extra opportunities owing to favorable market conditions (zone C). If k = 0, the investor compares options only in terms of the negative component of the risk measure. If k = 1, comparison is made on the base of the positive component only. In further calculations the value of k is assumed to be It implies investor s moderate riskaversion due to large investments and high degree of market uncertainty. Thus, the calculations are completed by ranking the options with respect to IRR R and as a result the option recommended by the method is determined. Below are presented the results of the study carried out by means of the described methodological approach that was applied to the comparative analysis of Kovykta gas condensate field export development options. The key purpose of the analysis is to get a preliminary assessment of the financial efficiency of options of export gas pipeline construction. In so doing, the following conditions for project financing were assumed. The share of borrowed funds for each option will be 50% of the required investments and the credit is granted for 10 years starting from the first year of gas supplies to consumers; the period of gas pipeline construction, during which the debt is not serviced, is taken equal to 3-4 years. The interest rate is determined as a sum of the base rate equal to 6% for all options and the risk premium associated with the external factors. The risk premium is varied as follows: 2-8% for export to China; 2-2.5% for export via UGSS; 2-6% for LNG export to APR. In the calculations taxation is taken into account as an excise rate (30% for exported natural gas, 15% for natural gas consumed domestically in Russia) and as profit tax (24%) and property tax (2%). IV. RESULTS OF COMPARATIVE ANALYSIS OF KOVYKTA GAS EXPORT OPTIONS Table III presents the calculation results indicating the risk-adjusted IRR values and also the ranges of possible IRR values for each option. Ranking based on the criterion of the maximum IRR reveals that the option of connecting Kovykta gas to UGSS is believed to be the most preferable. TABLE III RISK-ADJUSTED IRR VALUES FOR KOVYKTA GAS EXPORT OPTIONS Option IRR IRR interval (%) (%) Export to China Export via UGSS Export to APR (LNG) The impact of the adjustment for risk on IRR can be traced when comparing the results that either take or don t take into account the risks associated with corresponding options. The results of such analysis are shown in Table IV, where the IRR of the most preferable option (the option Export via UGSS ) is taken for 100%. The comparison indicates that as investment risks get considered, the most preferable option stands out more distinctly and can thus be identified in a more reliable and transparent way (riskadjustment makes the option of export to APR far less competitive). TABLE IV IMPACT OF RISK-ADJUSTMENT ON THE COMPARATIVE EFFICIENCY OF OPTIONS Option Comparative efficiency, % (w/o risk) Comparative efficiency, % (w/ risk) Export to China Export via UGSS Export to APR (LNG) The value of adjustment for risk and hence the result of option ranking depend on the value of coefficient k that expresses the trade-off an investor is willing to accept to offset the risks by opportunities. The results of the corresponding sensitivity analysis are 101

6 presented in Fig. 3 (for k = 0.25). The plot clearly demonstrates an essential increase in the attractiveness of the options of export to China and APR as market conditions improve and propensity to risk increases. IRR R, % Low 0.25 Medium 0.75 High (0) (0.5) (1) Propensity to risk ( k [0, 1] ) Fig. 3. IRR sensitivity to investor s propensity to risk. V. CONCLUSIONS The main conclusion to be drawn from the calculations performed is the assertion of the reasonably high financial viability of all the studied options from the perspective of potential investors. Moreover, the options remain competitive (though at the discount rate of no more than 10%) even when the pessimistic scenario of external conditions is realized. The most preferable option that is preliminarily recommended for implementation is the connection of the Kovykta gas to UGSS (IRR = 18.6%). It is ahead of the options of LNG export to APR (IRR = 16.3%) and piped gas export to China (IRR = 13.8%) based on the criterion of riskadjusted investment return maximization. Furthermore, this option will improve reliability of Russian gas exports to the European countries and the western provinces of China (through Altai), thus compensating for the delay in development of the Yamal fields. However, inherent uncertainty of input data should also be born in mind. Despite the fact that the option of connection to UGSS is the most preferable and least risky, its potential to make use of favorable market conditions is extremely low. Fig. 3 shows that as the external conditions approach the optimistic scenario of their development, ranking of the options switches so that it becomes opposite to that postulated above: the option of export to China turns out to be more attractive. Nevertheless, the options of export to China and to a lesser extent LNG export to APR are less stable because of uncertainty associated with market prices and required volumes of capital investments (for the option of LNG export). Therefore, naturally assuming moderately conservative risk-aversion of investors, on the whole the option of connection to UGSS proves to be more profitable. Besides, the rational choice may depend on the flexibility an option allows, which would offset the existing risks. In the context of the ongoing growth of short-term LNG contracts market, the option of export to APR is obviously more flexible in comparison to piped gas export, in particular to China, where the behavior of consumers is uncertain to the greatest extent. Also, the results of the comparative efficiency analysis may significantly benefit and become more wellgrounded when explicitly accounting for possible flexibility of timing of putting the gas pipeline into operation and also when analyzing financing options in finer details. To conclude, it is reasonable to state that in addition to the arguments presented in the paper, the final choice of options will greatly depend on the government interests and the associated tax policy. VI. REFERENCES [1] Choi J., Jung G. C. New LNG projects in Asia and their effects on pricing // Proceedings of World Gas Congress [2] International Energy Outlook: June 2006: DOE/EIA-0484(2006). Washington, DC: Energy Information Administration / U.S. Department of Energy, [3] Moore R. E. Methods and Applications of Interval Analysis. Philadelphia: SIAM, [4] Stupin P.V. The theory of hints as an authentic language of information incompleteness formalization for the problem of the rational choice of a gas export option // Energy systems studies / Ed. by V.V.Tokarev; Irkutsk, ISEM SO RAN, (in Russian). 102