After the EU in January 2015 restricted sulfur emissions by vessels in the English Channel, North Sea and Baltic Sea to 0.1% from around 1%, the market for LNG bunkering caught the eye of fuel suppliers in the region. For Russia, bordered in the northwest by the Baltic Sea, sales of eco-friendly LNG marine fuel provide an opportunity to increase sales to Europe, not just for state-run Gazprom but also for little-known private investors interested in getting a foothold in the promising market.
One newcomer is LNG Gorskaya, an affiliate of engineering company Metaprocess, which developed gas-to-liquids technology for energy companies and has supplied gas processing equipment to independent producer Novatek. The project involves construction of a three-train floating LNG plant at the port of Gorskaya in St. Petersburg, which will process 1.968 billion cubic meters of natural gas per year into 1.26 million metric tons of LNG. The three trains are scheduled for launch at the end of 2017, 2019 and 2021, respectively. LNG Gorskaya plans to have its own fleet to deliver LNG to customers in Europe and bunker customers' vessels in the Gulf of Finland.
In an interview with Nefte Compass, LNG Gorskaya Chief Executive Kirill Lyats, who is also the owner of Metaprocess, explains why the LNG bunkering market remains attractive despite the oil price drop and how a private small-scale LNG project can operate in Russia where export rights are only given to three majors -- Gazprom, Rosneft and Novatek.
Q: It is no secret that the LNG bunkering market gained attractiveness thanks to EU regulatory restrictions in the Baltic. What will the market look like in the years ahead? Is it under pressure from low oil prices?
A: Low oil prices do have an impact. Because of them, shipowners are switching to LNG fuel less actively. While in 2014 most existing vessels were planned to be switched to LNG fuel, and new LNG-fueled ships were to be built, now most shipowners prefer to equip their vessels with scrubbers -- devices removing polluting gases with absorbents that are then buried in waste landfills. But in 2021 restrictions will be imposed on nitrogen oxide emissions, which scrubbers cannot reduce. Also, burying absorbents raises environmental concerns and most ports refuse to take them. I am sure that the European community will be calling for a halt to the use of such absorbents. By 2025, the LNG bunkering market in the Baltic Sea alone is often estimated to reach 16.5 million tons/yr. We think it can be bigger, some 20 million tons/yr. But even if all shipowners switch to LNG fuel, 30 million tons/yr is the maximum for the Baltic. Still, we know that similar restrictions will be imposed in the European part of the Mediterranean Sea in 2021, which will increase the market volume. Besides, we are looking at the changes in cargo shipments from the Middle East to Europe. On this route, a new type of large carrier has been recently approved, with fuel tanks of 20,000 tons of LNG. Production of such vessels will begin in 2020, which will boost consumption, because they will squeeze smaller vessels out of the Mediterranean into the Baltic. By that time we already will be there with our bunkering centers.
Q: In terms of pricing, how does the current environment impact the LNG bunkering market?
A: The oil price drop does have an effect -- the LNG bunkering price has gone down from what we saw one or two years ago -- but the correlation is not exact. The oil price affects the price of LNG itself, but the price of the bunkering service doesn't change, because it depends on expertise and infrastructure. Even if the LNG price has decreased to $280/Mcm from $360/Mcm, the bunkering price remains at €100 ($113). This price doesn't change in the long term and provides business margins to providers of these services.
Q: What are the key challenges for LNG bunkering projects in Russia?
A: In Russia, the development of the market is hindered by the law on gas exports. This is what hinders the gas market in Russia in general, and particularly LNG. Export liberalization will certainly spur the development of the LNG market, because LNG buyers are all abroad, not in Russia. In order to encourage investors to build facilities, the government should give the opportunity to export LNG to everyone who is ready to invest their own money, without stripping the state budget like some Russian LNG producers do.
Q: Do you see any real steps towards further LNG export liberalization?
A: I don't see any such steps now, but the government should take them. We've lost a large market share in Europe [due to the pipeline export monopoly], because the lack of competition [between Russian suppliers] leads to Gazprom's rigid overseas policies. As for LNG, when I worked in [engineering company] United Heavy Machinery Plants, American [investors] came to us in 1998. They wanted to build what now is called Baltic LNG. They wanted to build a plant in Ust-Luga. And if we hadn't the gas export monopoly of Gazprom, the plant could have been built and Russia could be supplying LNG to Europe. It could have been a large plant, with a 10 million ton/yr capacity. But no one was interested [in export liberalization]. Now we see that all large projects of Gazprom are not finished. Without private investments, free entrepreneurship, we can't expect anything good of the gas industry.
Q: Despite legislative restrictions you still plan to launch the LNG Gorskaya plant. How do you intend to work in such conditions?
A: We have several options. There are companies which have the right to export LNG -- Gazprom and Rosneft, including their subsidiaries, and Yamal LNG [the operator of Novatek's Yamal LNG project]. We can sell LNG via either Gazprom or Rosneft. This is the first option. The second option is to change the routes [of our clients] to make St. Petersburg the endpoint. This will allow them to get our LNG as fuel, which will not be deemed as export -- we will bunker foreign customers, but in Russia. We have already signed such an agreement with a shipping company which is now building 18 LNG-fueled vessels. Its ships now run from Germany's Hamburg to Finland's Kotka, but the product it ships is then sent to Russia anyway. We agreed with them to change the endpoint to St. Petersburg, where we will bunker the ships. Eighteen vessels will consume 300,000 tons of LNG per year. And the third option is roaming agreements with foreign partners. In other words we will serve their clients and they will serve our clients.
Q: You want to build three floating LNG facilities each with capacity of 420,000 tons/yr. How much will it cost? Will you seek partnerships with strategic or financial investors for the project?
A: The first of the three facilities will cost 16 billion rubles ($230 million). The entire plant costs 48 billion rubles. We are open to all offers, but for now we have investors who provide financing.
Q: Who are these investors? Are they funding the project with their own or borrowed funds? Does the project require external financing from banks? When is the project expected to break even?
A: The project is financed by private investors, using both their own and borrowed funds. External, I mean foreign, financing is not planned at the moment. The payback period for the first plant is 4.5 years.
Q: Do you consider cooperating with gas producers within this project? For instance with Gazprom which has LNG projects in the Baltic as well. Do you see any potential synergies with Gazprom's proposed Baltic LNG project?
A: We don't see any synergies. First, they moved the launch date to 2021, while we want to begin operations already by 2018. Second, Baltic LNG is a large LNG project. The example of Sakhalin Energy [the operator of Gazprom-led Sakhalin-2 LNG plant] shows that the bunkering business is unprofitable for large producers. It takes the same amount of time and money to fill a small and a large tanker with fuel, but the efficiency is different. If Baltic LNG is built with the capacity of 10 million tons/yr, it will hardly bother building a fleet of small bunkering vessels that will roam around the Baltic Sea and bunker ships with LNG.
Q: But Gazprom says it has ambitions on the LNG bunkering market both in the Black and Baltic Seas. Hasn't it approached you with offers to cooperate?
A: After Shtokman [Gazprom's offshore upstream and LNG project shelved in 2012], I think all Gazprom ambitions cannot be taken seriously.
Q: Do you have agreements with gas producers to feed the future plant?
A: We do have preliminary agreements. I cannot say with whom, because this is confidential information, but we will buy gas from independent producers. Gazprom told us from the start that in this location it recommends we should conclude a gas supply agreement with independent producers.
Q: You have signed a contract with General Electric (GE). Will you use its liquefaction technology?
A: No, the technology is ours. GE has developed equipment based on the technology of Metaprocess.
Q: With a Western equipment supplier, do you have concerns over possible expansion of sanctions to hit LNG projects?
A: No, we don't. The contract has already been signed, which means sanctions cannot be applied to it. But even if a total ban on everything is introduced, we will build the plant using Russian-made equipment. We have initially made a design with Russian equipment in mind. Russian equipment will be less efficient, but we will do it.
Q: The project involves bunkering operations in foreign ports as well. What will be the geography of your operations? What ports have already agreed to cooperate?
A: We intend to provide bunkering services in all countries of the Baltic and North Seas. At some ports we will use our own LNG storage facilities, while at others we will use facilities of our partners or apply the roaming scheme. We are now in talks with four German, two Finnish and one Swedish port to place our floating bunkering stations there. At ports, we will keep our storage vessels. We will bring LNG from Gorskaya to these storage vessels, from where bunkering vessels will take LNG to bunker customers' ships. We think some LNG will come to these ports from abroad as well. We also negotiate swap deals with foreign LNG producers to minimize export costs.
Q: How much Gorskaya-produced LNG will be offered in Russia and how much at other ports?
A: We don't expect there will be enough clients among Russian shipowners in the first stage. That is why we estimate that no more than 30% of LNG will be used in Russia and some 70% will be distributed in foreign ports. But if more shippers agree to change their routes' endpoints to St. Petersburg, the proportion can change.