THE FUTURE OF LNG IN SOUTH AMERICA: ONE PIECE OF A COMPLEX JIGSAW PUZZLE

• Jurisdiction: Derecho Internacional

Mining and Oil and Gas Law, Development, and Investment - Book 2
(Apr 2007)
CHAPTER 17A
THE FUTURE OF LNG IN SOUTH AMERICA: ONE PIECE OF A COMPLEX JIGSAW PUZZLE
John P. Cogan, Jr. ¹
Vera Neinast
Gustavo Torres
Attorneys - Global Projects
Akin Gump Strauss Hauer & Feld LLP
Houston, Texas

Abstract

Natural gas presents one of the fastest growing primary sources of energy for the planet. Growth in the supply and demand for natural gas in South America confronts unique geographic, political, market, and legal forces. These forces create both challenges and opportunities for developers, producers, lenders, consumers, and their lawyers. Development of a viable liquefied natural gas (LNG) sector would solve a major piece of the overall energy puzzle for the region. The purpose of this paper is to examine the forces in play with respect to South American LNG development and the legal issues which surround them, with a view to inserting a robust LNG sector as a major piece of the solution to the overall South American energy puzzle.

Introduction

Understanding the future of the natural gas market in South America is like solving a jigsaw puzzle, with liquefied natural gas (LNG) as a significant piece. First, one must consider the broader principles and interactions that drive energy supply and demand across the region (i.e. like deciding where on the puzzle board a piece of the puzzle is most likely to fit). Second, one must compare the contours of each individual piece (e.g. LNG, pipeline gas, other hydrocarbons, alternative sources of energy) to see where the LNG piece will precisely fit. An optimist would say that, after this process is completed, the pieces should go easily into place. A pessimist would note that many jigsaw puzzles take years to complete, if they ever are.

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Natural Gas in its Normal, Gaseous State (Pipeline Gas)

Average Annual Increases in Industrial Natural Gas Consumption, 2003-2030, by Region and Country

On the demand side, natural gas is the fastest growing fuel source in South America with regional demand increasing on average by 3.9 percent per year mostly driven by industrial demand. On the supply side, Venezuela currently ranks among the top ten countries worldwide in terms of natural gas reserves. Significant reserves in Bolivia, Peru, and Trinidad & Tobago suggest that vigorous exploration could lead to additional increases in South America's proven natural gas reserves. For example, Brazil's deep offshore fields are thought to have great potential.

However, while gas reserves are increasing, there is one unavoidable truth which shapes any discussion about South American natural gas: the reserves are not located within easy reach of potential markets. Great distance and geographical obstacles, including The Andes and the Amazon forest, make the transportation of natural gas from the wellhead to the region's main industrial centers challenging and expensive.

Many analysts envision a South American natural gas pipeline grid as a means to move supply to areas of demand within the region with relative ease--but the realities of the South American experience are such that natural gas pipeline grid will only be possible if, beyond the physical challenges, the political and financial challenges facing the region can be overcome. Moreover, the development of energy infrastructure does not come without a hefty price tag. The International Energy Agency has forecast that meeting regional demand could require a $1.3 trillion investment by 2030.

Parts of South America do have some natural gas pipeline infrastructure in place. The Southern Cone, for example, already has pipelines linking Argentina, Bolivia, Brazil, Chile and Uruguay, and other trans-South American pipelines are under discussion. For example, Venezuela and Brazil signed an accord on January 18 of this year to develop a 5,000 km gas pipeline through the Amazon. This would be the first segment of a transmission line that would link Brazil to Venezuela's plentiful gas supply.

Natural Gas Consumption in Brazil and Other Central and South America, 2003-2030

The pipeline projects necessary to move remote gas reserves to market will take considerable financial resources, and would need to address many geopolitical, environmental, health, and safety concerns. How well the region can address these concerns--particularly in the eyes of potential investors--will be a critical factor in the success of this endeavor. Gas projects in

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South America are increasingly cross border in nature and, if properly managed, could foster a greater degree of regional cooperation and harmony. Such a climate could provide the assurance needed to address sustainability concerns for a variety of stakeholders.

LNG

As an alternative to pipeline gas, LNG can play a key role in the development of gas markets in South America on both the demand and the supply side of the equation and whether or not a true regional pipeline grid comes to fruition. Within the region, depending on gas price points, it may be more profitable to liquefy gas and export it by sea (either back into the region or elsewhere) than to build many of the ambitious pipelines under discussion. Some studies suggest that for distances over 3,000 km it is more profitable to liquefy the gas and export it by sea. Terrain and politics also are obviously key determinants.

For South American nations with a potential for being net exporters of natural gas, LNG liquefaction projects can greatly enhance future economic growth. For those nations that are likely to remain net gas importers, LNG regasification projects can make the difference between prosperity and something less. However, before LNG becomes a viable component of the equation, much remains to be done in terms of developing viable financing structures, the proper regulatory environment, and strong contractual arrangements.

LNG project development requires very high up-front investment, takes considerable time and poses significant risk. Sound regional and country-specific economic policies and financial stability will be required to attract the necessary investment level. Transparent and consistent legislation and regulation is necessary to attract investors and their backers. Finally, a reasonable degree of cooperation among sovereign states, state-owned companies, and private entities within the region will be necessary to attract sustained interest in LNG development in South America. The region has the potential to play a significant role in both the Atlantic and Pacific basin LNG trades, as well as to develop a robust regional LNG market, provided that all of the necessary puzzle pieces fall into place for stakeholders.

Developing South American LNG Projects

Because of the infrastructure required to liquefy, transport and regasify LNG, LNG is a capital intensive industry. Often, the capital necessary to develop LNG infrastructure is not available in developing countries. Instead the investment must come solely or primarily from foreign sources. While there is a great deal of investor interest in the development of South American LNG projects at the moment, many potential investors are hesitating due to the relative immaturity of certain political, commercial and legal institutions on which the success of these projects depend. Lawyers have a key role to play in bringing maturity to these institutions.

The Political Landscape - To the Left of Certainty?

Since the 1980s the model of direct participation in energy development by state owned enterprises has begun to erode, particularly with respect to natural gas markets. The recurring debt crises of prior years dramatically reduced the capacity of South American state oil and gas companies to borrow on international markets. This scarcity of capital, coupled with the traditional

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operating inefficiencies of nationalized oil and gas companies, has led to problems in energy industry development.

Apart from a few cross-border gas export arrangements, such as Bolivia's shipping gas to Brazil and Argentina, South America is predominately composed of national markets, each governed by its own regulations. While the lack of development in promising inter-regional markets means there is room for growth, the challenges posed by political uncertainties make successful LNG development an uncertain proposition. In addition, a growing number of disparities exist today among South American nations in terms of scope and pace of gas market reforms. These disparities hinder the integration process that is necessary to capitalize on the region's natural gas reserves.

Moreover, due lack of true regional cooperation in energy fields and the rising tide of political nationalism, South America's movement towards energy integration seems to be heading in the wrong direction, unless one counts President Chavez's initiatives as a form of integration. Energy integration cannot occur without the cooperation of South America's two largest gas holders, Bolivia and Venezuela, which are leading a left-leaning movement toward nationalization. Thus, without major market reforms, it appears that South America has a long way to go before establishment of an integrated gas market.

The past decade, however, has been marked by movements toward greater democratization, as well as market structure and economic reforms in energy sectors. Many South American nations are looking to rebalance their growing deficits with their excess energy reserves. Argentina led the region in gas market reform in the early 1990s, and today the Argentine market is characterized by private company participation in all segments of the industry. In many other South American nations, reform has occurred at a much slower pace. State controlled gas companies remain a dominant force and nominally a vehicle of the state, but private participation is, in many cases, greatly...