Evolving Risks in the LNG Supply Chain

Deck: 

Some supplies may not make it to U.S. ports.

Fortnightly Magazine - January 2006

With the dramatic growth of the liquefied natural gas (LNG) trade worldwide and increased dependence on LNG as the gas fuel of the future, gas-utility companies at the end of the chain need to question whether the LNG chains are still safe, reliable, and well managed. But before diving in to some of the risks, it should be pointed out that historically LNG chains have been safe.

Since its start up in 1964, the LNG industry has proven itself to be well managed. This is because of many factors, including the following:

  • A large proportion of the world’s LNG projects have been managed in association with the major global oil and gas companies which have applied rigorous standards to safety design and management of plant operations through the chain.
  • The major contractors have played their part in building quality facilities with significant risk quality.
  • LNG is a clean fuel and as such is considered safer to produce than other fuels. Although there are areas of potential corrosion in gas treatment process upstream of the liquefaction process, the industry has shown itself to have a far better record of reliability and safety than other sectors of the energy industry. Insurance ratings bear this out.
  • The LNG shipping industry, which consists of approximately 174 tankers, has accumulated a safety record featuring well in excess of 40,000 cargoes delivered without mishap or major accident.
  • Long-term gas supply contracts have provided the framework of successful risk allocation and sharing in the LNG value chain with the bulk of LNG being sold to Japan and Korea.

However, despite an impressive track record, there is no room for complacency as the industry grows dramatically. Resources and technical services will be severely stretched during the next decade. And numerous factors can affect the level of supply risk in the LNG chain. For example, the LNG World Shipping newsletter of November 2005 reported that the LNG shipping industry is said to be having difficulties with a current skill shortage because of a surge in the number of LNG ships and the poor recruitment of cadets in the 1970s and 1980s. The current active fleet of LNG vessels is aging, with many vessels built in the 1970s still operating with steam plants.

These vessels will be more prone to engine failures before the new building orders are delivered into the market to replace the older vessels. The LNG supply chain is, therefore, at a larger risk of interruption, caused by mechanical breakdowns.

Furthermore, according to LNG World Shipping, some LNG ships with so called “membrane” tanks have been laid up for repairs. A 138,000m3 LNG carrier delivered in June 2004 has a membrane barrier leakage problem, according to an advisory note issued by a shipbuilder. The leakage is said to involve the permeation of nitrogen gas through the secondary barrier of the ship’s GTT membrane containment system in two of the four cargo tanks, the report said. Nitrogen, an inert gas, is injected into the inter-barrier space of membrane containment systems for monitoring and safety purposes, and a certain amount of permeation is allowed. In this instance, however, the escape of gas is said to have exceeded permissible levels.

The report says GTT Mark III membrane containment system utilizes a secondary barrier composed of Triplex, a 0.6mm-thick lining consisting of bound layers of aluminum foil and glass cloth. Triplex also is used as the secondary barrier material in the CS1 system, a third membrane developed by GTT to incorporate the best features of its NO 96 and Mark III membrane systems.

The delivery of the first ship ordered with a CS1 system has been delayed for 18 months because of permeation problems with the containment system. Allegedly, the glue and the gluing process used to bind the layers of the Triplex secondary barrier have given rise to the problems on the ship, which is under construction in France.

Of the current 127 LNG ships, 60 have been specified with Mark III membrane cargo tanks, according to the report.

Emerging Risks: New Technology and Coordination

Major expansion of traditional producing markets and infrastructure is underway in Qatar, Algeria, Australia, Nigeria, and Trinidad, with Qatar’s plans by far the most significant driver of the world’s LNG trade growth. Process units and ships are being scaled up for economic efficiencies, increasing the size of physical, marine hull, contingent business, liability, and contractual risks.

Project finance and insurance markets are meeting most of the challenges of the scale-up in risks and investment costs. Most LNG companies in these countries have multiple LNG liquefaction trains lined up, with each train dedicated to specific value-chain contracts. Separation of processing generally is good. However, risk studies show that discrete value-chain contracts could be interrupted by events emanating from adjacent process units, common utility systems, or shared infrastructure. Emerging LNG producing countries such as Peru, Yemen, Egypt, Russia (Sakhalin), Norway, Libya, Equitorial Guinea, Venezuela, Angola, and Iran all are creating new liquefaction capacity to be available in the next four years. Egypt has successfully started new LNG liquefaction projects this year.

New LNG technologies are being implemented on ships with onboard revaporization, offshore liquefaction ships, offshore revaporization terminals, new buoy unloading systems, and platform conversions. Such offshore systems generally will feature proven technologies, but some performance risk will be associated with technological innovations.

In addition, there has been an increase in LNG ship capacities from the 150,000 to 165,000m3 level to the 220,000 to 250,000m3 mega LNG carriers now under construction.

A total of 20 ships of the 210,000m3 Q flex size have been ordered to serve future Qatargas II and Rasgas III projects. Six additional ships of the so-called 250,000m3 Qmax size also are about to be ordered. Prices of these ships range from $250 million to $300 million (U.S.). Gas utilities, LNG terminal companies, oil majors, national gas companies—all are working together in the value chain for the first time. The terms and nature of LNG trades may change in response to increased volumes and flexibility of trades.

In North America alone, there are up to 50 new plans for LNG import terminals, of which around 10, at the time of writing, have received suitable FERC approvals. A handful of significant new LNG revaporization investors with substantial LNG tolling agreements have signed with new market entrants to the United States, where existing LNG terminals are being expanded to take into account the economies of scale and benefits of existing infrastructure.

The Supply and Demand Imbalance

In a period of such rapid growth, the greatest difficulty is ensuring that all the key elements in the supply chain expand at the same pace. At the moment there is more than enough shipping capacity available, as witnessed by idle LNG carriers awaiting orders. While allowing for one or two bottlenecks, there also is adequate reception terminal capacity available. Unfortunately, the same cannot be said for LNG liquefaction facilities. Recent difficulties with two or three existing production trains and traditional teething problems associated with the start-up of new trains have highlighted the tightness of the LNG supply side of the equation.

Looking to the future, the lack of adequate export terminal capacity will continue to be the major constraint in the upward spiral of LNG trade growth. Currently, approximately 100 million tonnes (mta) annually of new LNG production capacity is scheduled for completion by 2010, boosting global output potential to 270 mta. Approximately 20 mta is due to come onstream in 2006.

For the industry, this capacity cannot come quickly enough. Yet many are concerned that the big surge in LNG projects means there could be a shortage of experienced contracting, commissioning, and operational staff for LNG facilities. Furthermore, engineering procurement and construction (EPC) contracts and rig costs have increased dramatically in 2005, as have costs of materials and fabrication. Will these factors lead to delays in projects? A current project in Norway has missed its scheduled startup date, and other projects are suffering from very high cost overruns.

Meanwhile, although the industry continues to have an excellent safety record, mechanical incidents at a number of LNG liquefaction sites in 2005 led to the cancellation of approximately 30 LNG shipments in 2005. None of these incidents has been catastrophic in nature but remind us of the tight constraints in the overall supply chain.

Qualifications of LNG Value Chain Risk

Contractual, supply chain, operational, and insurable risks are interlinked and must be understood for an overall effective risk-management strategy.

It is important to quantify ultimate business interruption risks in all the above scenarios and match these with suitable contractual, insurance, and continuity management strategies. In some cases, widening of insurance capacity and availability may be necessary. The growth of the LNG trade will mean growing dependence on LNG for the gas utility companies. A full appreciation of all the risks in the LNG value chain and how they are changing is required for effective contract negotiations, insurance, and risk-management strategies, and operational/reliability audit reviews.