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LNG IN KOREA opportunities for growth ABARE RESEARCH REPORT 03.4 ABARE KEEI Allison Ball Changwon
LNG IN KOREA
opportunities for growth
ABARE RESEARCH REPORT 03.4
ABARE
KEEI
Allison Ball
Changwon Park
Karen Schneider
Jaesung Kang
Jane Mélanie
Jaekyu Lim
Robert Curtotti

proudly produced for:

Australian Government Department of Industry, Tourism and Resources

© Commonwealth of Australia 2003

This work is copyright. The Copyright Act 1968 permits fair dealing for study, research, news reporting, criticism or review. Selected passages, tables or diagrams may be reproduced for such purposes provided acknowledgment of the source is included. Major extracts or the entire document may not be reproduced by any process without the written permission of the Executive Director, ABARE.

ISSN 1037-8286

ISBN

0 642 76489 1

Ball, A., Schneider, K., Mélanie, J., Curtotti, R., Changwon Park, Jaesung Kang and Jaekyu Lim 2003, LNG in Korea: Opportunities for Growth, ABARE and KEEI, ABARE Research Report 03.4, Canberra.

Australian Bureau of Agricultural and Resource Economics GPO Box 1563 Canberra 2601, Australia

Telephone +61 2 6272 2000 Internet www.abareconomics.com

Facsimile +61 2 6272 2001

ABARE is a professionally independent government economic research agency.

Korea Energy Economics Institute 665-1 Naeson-Dong, Euiwang-Si, Gyunggi-Do, 437-713, Korea

Telephone +82 3 1420 2114 Internet www.keei.re.kr

ABARE project 2835

Facsimile +82 3 1422 4958

foreword

Natural gas has played an increasingly important role in meeting Korea’s rapidly growing energy demand since its introduction in the mid-1980s. This trend is likely to continue, with forecast strong growth in natural gas consumption over the next decade and beyond. With limited domestic reserves, Korea has relied exclusively on imports of liquefied natural gas (LNG) to meet its natural gas requirements. LNG will continue to meet the majority of Korea’s projected demand although, over the longer term, pipeline natural gas imports could provide a complementary source of gas supply.

A critical issue for Korea is that natural gas supply plans have not kept pace

with projected demand and a significant gap between demand and supply could develop over the next decade. Failure to resolve the issues surround- ing long term LNG procurement soon could leave Korea vulnerable to gas supply shortfalls in the coming years.

The key objective in this report is to assess the potential growth in natural gas demand in Korea and, in particular, the role that LNG could play in that market. Korea’s current and projected gas supply situation over the medium

to longer term is also reviewed. To meet future Korean natural gas demand,

potential sources of LNG supply in the Asia Pacific market are examined as

is the feasibility of pipeline natural gas supply options.

The study was undertaken jointly by ABARE and the Korea Energy Economics Institute.

BRIAN S. FISHER Executive Director ABARE

August 2003

SANG-GON LEE President KEEI

LNG in Korea: opportunities for growth

iii

acknowledgments

The authors wish to thank several colleagues for their valuable contributions during the preparation of the report: in ABARE, Vivek Tulpulé and Lindsay Fairhead; in the Department of Industry, Tourism and Resources, Paul Kay; and in the Australian Embassy, Seoul, H.E. Colin Heseltine, Australian Ambassador to the Republic of Korea, Anthony Aspden, Sian Ferguson, Kim Hye-Young and Bill Brummitt.

Many organisations in Korea provided information and valuable comments on the study. In particular, the authors are grateful for contributions from the following: the Ministry of Commerce, Industry and Energy; the Korea Gas Corporation; the Korea Electric Power Corporation; POSCO; SK Corporation; the Korea South-East Power Company; the Korea Southern Power Company; LG-Caltex Oil Corporation; and LG International Corporation.

In addition, the authors gratefully acknowledge the information and insights provided by Gavin Harper, ChevronTexaco, Seoul; Jeff Feltham, North West Shelf Australia LNG, Perth; Damian Deveney and Rob Mitchenall, Shell Pacific Enterprises Limited, Seoul; and Sean Rodrigues, Woodside Energy, Perth.

ABARE and KEEI also gratefully acknowledge the support of Chevron- Texaco, North West Shelf Australia LNG and Woodside Energy for the trans- lation, publication and launch of the Korean language version of the study in Seoul on 28 August 2003.

ABARE’s contribution to the report was funded by the Australian Department of Industry, Tourism and Resources.

iv

ABARE research report 03.4

contents

Summary

1

1 Introduction

8

Objectives in the study

9

2 Energy and natural gas consumption in Korea

11

Energy consumption

11

Natural gas consumption

17

Natural gas supply

21

Gas pricing

27

3 Factors affecting Korea’s future natural gas demand

31

Environmental issues

31

Security of energy supply

33

New sources of demand

34

Energy market reform

36

4 Projecting natural gas demand in Korea

45

Analytical framework

45

Reference case projections

51

5 Alternative policy scenarios

57

Electricity and gas sector deregulation

57

Impacts of a gas supply disruption

62

6 Natural gas supply considerations

67

Pipeline natural gas

67

Can pipeline natural gas compete with LNG?

72

Natural gas supply and demand balance

73

Supplying LNG to Korea

76

7 Conclusions

82

LNG in Korea: opportunities for growth

v

Appendix

A

Structure of the global trade and environment model (GTEM)

84

References

91

boxes

1 Korea’s LNG supply shortfall in winter 2002–03

24

2 Gas price setting procedures in Korea

28

3 Economic reform under the Roh Moo-hyun administration

38

4 Assessing the costs of electricity generation

39

5 Entry of private LNG importers into the Korean gas market

43

6 Benefits of deregulation in the electricity and gas sectors

58

7 LNG supply disruption to Korea in 2001

63

8 A ‘gas-for-peace’ deal with North Korea – implications for pipeline projects

70

9 Alternative natural gas supply and demand balance

75

10 Australian LNG supply

81

figures

A

LNG consumption, by sector

2

B

Monthly LNG consumption, by sector

3

C

Projected natural gas consumption, reference case

4

D

Potential gas demand and supply balance

6

1

Total primary energy consumption

11

2

Fuel mix in primary energy consumption

13

3

Final energy consumption, by sector

14

4

Motor vehicle registrations

15

5

Final energy consumption in key sectors, by fuel

15

6

Energy imports, by fuel

17

7

City gas demand, by sector

19

8

LNG monthly consumption, by sector

20

9

City gas monthly consumption patterns, by sector

20

10

LNG imports

21

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ABARE research report 03.4

11 LNG import terminals and pipeline network

25

12 Average LNG and crude oil import prices

27

13 Fuel mix in district heating systems, 2000

34

14 Electricity generation costs

40

15 Indicative long run marginal costs for power generation

41

16 Deviation from the reference case in a GTEM simulation

47

17 Alternative projections for share of gas fired power generation

48

18 Residential consumption of coal, gas and electricity

50

19 Annual growth in energy consumption, reference case,

2001–15

52

20 Primary energy consumption, by fuel, reference case

52

21 Total primary energy consumption by fuel, reference case

53

22 Annual growth in gas consumption, by sector, reference case, 2001–15

54

23 Gas consumption, by sector, reference case

54

24 Projected unmet gas demand, reference case

55

25 Change in energy prices following deregulation, 2015

59

26 Change in production and exports of energy intensive goods following deregulation, 2015

60

27 Change in energy consumption following deregulation,

2015

60

28 Gas consumption by sector following deregulation, 2015

61

29 Fuel mix in electricity generation following deregulation,

2015

62

30 Change in gas and electricity price following a gas supply disruption, 2005

64

31 Change in GNP following a gas supply disruption,

2005

65

32 Change in sectoral output following a gas supply disruption, 2005,

65

33 Gas consumption following a gas supply disruption, 2005

66

34 Possible gas pipelines to Korea

67

35 Potential natural gas demand and supply balance

74

36 Alternative natural gas demand and supply balance

75

LNG in Korea: opportunities for growth

vii

37

Proved recoverable reserves in countries exporting LNG to the Asia Pacific market, 2002

77

tables

A Total primary energy consumption, 2002

2

B LNG imports, by source, 2002

3

C Projected natural gas demand and supply

5

1 Major energy and economic indicators

12

2 International comparison of major energy and economic indicators, 2000

12

3 Total primary energy consumption, 2002

13

4 Electricity generation, by fuel

16

5 Electricity plants and capacity, 2001

16

6 Energy import indicators

17

7 LNG consumption, by end use

18

8 City gas consumption, by region

19

9 LNG imports, by source

22

10 Existing mid and long term LNG contracts

23

11 LNG receiving terminals

26

12 Planned expansion of LNG storage tanks

26

13 Planned expansion of gas pipeline network

26

14 Wholesale gas price for power plants, January 2003

27

15 Wholesale price for city gas, January 2003

29

16 Retail price for city gas, Seoul area, January 2003

29

17 Mid to long term projections for district heating supply

35

18 Fuel costs for electricity generation, 2000

39

19 Cost estimates for new generating plants

40

20 Regions and sectors in GTEM in this study

46

21 Projected share of electricity generation, by fuel, reference case

49

22 GDP and primary energy consumption, reference case

51

23 Revision of special consumption taxes on fuel sources

53

24 Contracted gas supply and projected shortfall, reference case

56

25 Projected energy consumption following deregulation,

 

2015

61

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ABARE research report 03.4

26 Sakhalin gas reserves

69

27 Potential natural gas demand and supply balance

74

28 Alternative natural gas demand and supply balance

75

29 LNG trade in the Asia Pacific, 2002

76

30 Existing LNG plants, Asia Pacific market

78

31 LNG plants under construction and planned, Asia Pacific market

79

32 Indicative LNG transport costs to Korea from various exporters, 2001

80

LNG in Korea: opportunities for growth

ix

summary

Since its introduction in 1986, natural gas has played an increasingly impor- tant role in meeting rapidly growing energy demand in the Republic of Korea (Korea). This trend is likely to continue, with forecast strong growth in natural gas consumption over the period to 2015. With limited domestic reserves, Korea has to date relied exclusively on imports of liquefied natural gas (LNG) to meet its natural gas requirements. LNG will continue to meet the major- ity of Korea’s projected demand, although pipeline natural gas imports could provide a complementary source of gas supply over the medium to longer term.

An important issue for Korea is that gas supply plans have not kept pace with projected demand and a significant gap between demand and supply could develop over the next decade. Procurement of LNG supplies over the longer term remains uncertain in Korea as the government is delaying entering into new long term contracts until plans to liberalise Korea’s domestic gas market are progressed. Failure to address this issue soon could leave Korea vulner- able to gas supply shortfalls over the medium term.

The key objective in this report is to assess the potential growth in natural gas demand in Korea over the period to 2015 and, in particular, the role that LNG could play in that market. Korea’s current and projected gas supply situation over the medium to longer term is also reviewed. In this context, potential sources of LNG supply in the Asia Pacific market are examined, as well as options for pipeline natural gas supply to Korea from the Russian Federation.

Energy overview

Energy consumption in Korea has increased by more than 7 per cent a year over the past two decades, driven by rapid growth in economic output and rising personal incomes. Total primary energy consumption in 2002 reached 209 million tonnes of oil equivalent, compared with 44 million tonnes of oil equivalent in 1980. Oil is the main source of energy in Korea, accounting for 49 per cent of primary energy consumption (table A), although its share has been declining in recent years.

LNG in Korea: opportunities for growth

1

Korea depends on imports for more than 97 per cent of its non-nuclear energy requirements. In conjunc- tion with its reliance on oil, this has led to a strong emphasis on energy security and supply diversification policies. In this context, natural gas was introduced into the Korean market in 1986 in the form of imported LNG.

A Total primary energy consumption, 2002 Korea

 

Mtoe

%

Coal

49.1

23.5

Oil

102.7

49.1

LNG

23.6

11.3

Nuclear

29.8

14.2

Renewables

3.9

1.9

Total

209.1

100.0

Source: KEEI (2003a).

Natural gas consumption in Korea

Natural gas use in Korea has grown at an average annual rate of 19 per cent since 1990, albeit from a small base, and represented more than 11 per cent of primary energy consumption in 2002. In 2002, natural gas consumption was 18.1 million tonnes (25.0 billion cubic metres). The rapid growth has been a result of active government policies to encourage natural gas use, expansion in gas infrastructure, including gas distribution networks and elec- tricity generation plants, and rising personal incomes that have induced a shift in preferences to clean and efficient fuels.

Rapid growth in city gas consumption in Korea over the past decade is the

main source of the sharp rise in LNG demand (KEEI 2003a; figure A). The city gas sector accounted for 62 per cent of Korean LNG consumption in 2002, while electricity generation comprised 33 per cent. Within the city gas sector, the majority of demand is from the residential sector and is

driven by strong demand for heat- ing and, increasingly, space cool- ing. This has led to strong seasonal fluctuations in LNG consumption in Korea (KEEI 2002a, 2003a; figure B). In the electricity sector, LNG accounted for 11 per cent of total power generation in 2001 and is used primarily as a peak load fuel.

A LNG consumption, by sector Korea 15 Other Electricity generation City gas 10 5 Mt
A LNG consumption, by sector
Korea
15 Other
Electricity generation
City gas
10
5
Mt
1986
1990
1994
1998
2002

Currently all natural gas demand in Korea is met by imported LNG

2

ABARE research report 03.4

and Korea is the world’s second largest importer of LNG after Japan. The majority of LNG imports are on the basis of long term take or pay contracts from Indonesia, the Middle East, Malaysia and Brunei (table B). Korea also uses the spot market extensively to meet winter demand peaks and any shortfalls in contracted supply. From late 2003, domestic gas supply will begin from a small field in the East Sea but supply from this project will meet only around 2 per cent of Korea’s current gas demand.

Factors affecting future natural gas demand

While natural gas demand is ex- pected to continue to grow strong- ly in Korea, a range of issues will affect the extent and profile of future demand, including environ-

mental considerations, energy security issues and new sources of gas demand. One of the most important factors will be the anticipated liber- alisation of domestic electricity and gas markets. While the deregulation and privatisation plans for these sectors developed by the previous government have stalled under the current administration, some form of liberalisation is likely to occur over the medium term.

B Monthly LNG consumption, by sector Korea

Other Electricity generation 2.0 City gas 1.5 1.0 0.5 Mt Dec Dec Dec 2000 2001
Other
Electricity generation
2.0
City gas
1.5
1.0
0.5
Mt
Dec
Dec
Dec
2000
2001
2002

B LNG imports, by source, 2002 Korea

 

Mt

%

Qatar

5.2

28.9

Indonesia

5.0

28.2

Oman

4.1

22.8

Malaysia

2.3

12.9

Brunei

0.8

4.3

Australia

0.2

1.0

Other

0.3

2.0

Total

17.8

100.0

Sources: KOGAS (2003); BP (2003).

Electricity market liberalisation is likely to increase competitive pressures on power generators and provide incentives for cost minimisation. Based on fuel costs alone, LNG is generally less competitive than other energy sources. However, gas fired electricity generation could compete more effectively when the total cost of generation is considered because of its lower capital and operating costs. This suggests a more robust future for gas use in power

LNG in Korea: opportunities for growth

3

generation in a deregulated, competitive market, especially to meet peak demand.

Similarly, the expected transition to a more efficient and competitive struc-

ture in the gas market has the potential to increase the relative competitive-

ness of natural gas and stimulate new demand. However, the delay in implementing gas market reform is having some serious implications for Korea’s long term gas supply security. This is because the Korean govern- ment is postponing entering new long term LNG supply contracts until the issue of reform has been progressed.

Projecting natural gas demand in Korea

The analysis of the potential demand for natural gas in Korea over the period

to 2015 presented in this report is based on results from ABARE’s global

trade and environment model (GTEM). The energy demand projections are based on an assumption that GDP growth in Korea will average 5 per cent a year between 2001 and 2015.

The

projections are also based on assumptions relating to the projected fuel

mix

in electricity generation. In Korea there is some uncertainty surround-

ing the role that natural gas may play in power generation over the outlook

period. The assumptions used in this study are from the Korea Power

Exchange (KPX 2002a). The share of gas in total electricity output is assumed to rise over the first half of the outlook period but to fall between 2007 and 2010 as a result of strong expan- sion in nuclear and coal fired

output. At 2015, the share of gas is 11 per cent.

C Projected natural gas consumption, reference case Korea

On the basis of these assumptions,

total primary energy consumption

is projected to expand by 3.5 per cent a year to reach 319 million tonnes of oil equivalent in 2015.

Natural gas is projected to remain

one of the fastest growing fuels in

Korea, averaging 5.0 per cent growth a year over the period 2001–15 to reach 33.3 million tonnes (45.9 billion cubic metres)

Electricity 30 Residential Commercial 25 Industry 20 15 10 5 Mt 2003 2006 2009 2012
Electricity
30
Residential
Commercial
25
Industry
20
15
10
5
Mt
2003
2006
2009
2012
2015

4

ABARE research report 03.4

C Projected natural gas demand and supply Korea

 

2005

2010

2015

Mt

Mt

Mt

Projected gas demand, reference case

23.9

24.2

33.3

KOGAS LNG contracts

19.4

14.6

11.9

POSCO/SK LNG contract

1.0

1.0

1.0

Projected domestic supply

0.4

0.4

0.4

Projected gas supply shortfall

3.1

8.2

20.0

or around 13 per cent of total primary energy consumption. The fall in over- all natural gas use between 2007 and 2010 reflects the assumed fall in gas fired power generation over this period (figure C). The strongest growth in demand for natural gas is expected to be in the residential and industry sectors.

Based on existing LNG import contracts, it is expected that there will be a gas supply shortfall of around 3 million tonnes in Korea in 2005 (table C). Taking into account the expiry of some existing contracts, supply in 2015 could be around 20 million tonnes lower than projected natural gas demand.

Natural gas supply considerations

In the absence of significant domestic reserves, there are two options for Korea to meet the anticipated gas supply shortfall –– to sign new LNG import contracts and to import pipeline natural gas. Additional short term solutions include increased LNG spot market purchases, cargo swaps with other coun- tries such as Japan, and midterm LNG contracts. Two midterm (seven year) contracts were recently signed with Australia and Malaysia, with supply to begin in late 2003.

Over the longer term, there is potential to develop pipeline natural gas supply to Korea. A pipeline from Irkutsk in eastern Siberia through northern China to Korea is currently the subject of a feasibility study, the results of which are expected by September 2003. The Korean government considers that supply from the Irkutsk pipeline could begin from 2008–10 and that it could deliver 7 million tonnes of natural gas a year for thirty years. However, construction of the 4100 kilometre, US$11 billion pipeline would have to begin rapidly to be operational within this timeframe. The commercial viabil- ity of the project also depends to a large extent on the commitment of China

LNG in Korea: opportunities for growth

5

to the pipeline –– without demand from China, there is unlikely to be suffi-

cient gas to justify construction of the pipeline on commercial grounds.

Korea’s decision to use pipeline natural gas will depend significantly on its competitiveness with imported LNG. Korea has sought pipeline prices that are believed to be competitive with LNG and that would enable the project

to proceed on a commercially sound basis. However, some analysts have

expressed doubts that pipeline natural gas could compete in Korea with LNG over such distances, especially in an environment of declining international LNG prices (Platts 2003a,b). Other recent trends, including greater flexibil- ity in the terms and conditions on which LNG is available, including an abil- ity to meet seasonal demand patterns, can also be expected to increase the attractiveness of LNG. Economic factors aside, pipeline natural gas may still form a part of Korea’s gas supply mix in the medium to longer term if noneco- nomic factors, including energy security and geopolitical concerns, are emphasised in the decision making process.

Indicative gas supply and demand balance

A potential natural gas supply and demand balance for Korea is provided in

figure D based on the demand projections developed in the report and current and known planned gas supply. The balance assumes that 0.4 million tonnes a year of gas will be delivered from Korea’s Donghae project and that the by POSCO/SK contract for around 1 million tonnes of LNG a year from 2005 will proceed. It also assumes that pipeline natural gas supply from Irkutsk will begin from 2010.

D Potential gas demand and supply balance Korea

30 25 20 15 10 5 Mt 2003 2006 2009 2012 2015
30
25
20
15
10
5
Mt
2003
2006
2009
2012
2015

Gas supply shortfall/possible additional LNG30 25 20 15 10 5 Mt 2003 2006 2009 2012 2015 Pipeline natural gas supply,

Pipeline natural gas supply, Irkutsk2012 2015 Gas supply shortfall/possible additional LNG Donghae gas field supply POSCO/SK LNG contract KOGAS LNG

Donghae gas field supplyadditional LNG Pipeline natural gas supply, Irkutsk POSCO/SK LNG contract KOGAS LNG mid term contracts KOGAS

POSCO/SK LNG contractnatural gas supply, Irkutsk Donghae gas field supply KOGAS LNG mid term contracts KOGAS LNG long

KOGAS LNG mid term contractssupply, Irkutsk Donghae gas field supply POSCO/SK LNG contract KOGAS LNG long term contracts 6 ABARE

KOGAS LNG long term contractssupply, Irkutsk Donghae gas field supply POSCO/SK LNG contract KOGAS LNG mid term contracts 6 ABARE

6

ABARE research report 03.4

On the basis of these assumptions, there is projected to be a natural gas supply shortfall of 13.0 million tonnes at 2015. The supply gap becomes more signif- icant after 2010, when stronger growth in natural gas demand is forecast than

in the earlier part of the outlook period. This shortfall is likely to be met by

new LNG import contracts. The need for additional LNG contracts could be greater if the Irkutsk project is delayed beyond 2010 or is not able to supply 7 million tonnes of gas a year.

In these circumstances, Korea would need to secure additional LNG contracts

of around 3 million tonnes by 2005 and further term contracts to meet the projected shortfall in the remainder of the outlook period. Failure to contract additional medium to long term gas supplies is likely to leave Korea vulner- able to gas shortages and to exacerbate the difficulties it has experienced in recent years.

A key issue in this context is the government’s preference to delay entering

into new LNG supply contracts until decisions have been made regarding the reform of the gas market. However, waiting for gas reform plans to be implemented before committing to new LNG contracts is exacerbating the gas shortfall issue. Because gas market reform is complex and requires good planning to implement effectively, it is not necessarily in Korea’s best inter- ests to put pressure on the reform process to hasten the signing of new LNG contracts, or vice versa. By waiting, however, Korea is potentially missing the opportunity to secure favorable terms and conditions that are currently being offered under long term contracts in the international market.

Further, there are currently a number of LNG supply projects in the Asia Pacific region –– existing and planned –– that have the capacity to meet Korea’s long term gas requirements. Indeed, the size of Korea’s long term gas requirements is sufficient to justify additional investment in production capacity by LNG suppliers. However, given the time required to bring new

developments to the market, it will be important for Korea to commit to new supply contracts as soon as possible if it is not to face an increasingly diffi- cult gas supply situation in the medium term. The current competitiveness

of the LNG supply industry and its responsiveness to changing market condi-

tions will also ensure that Korea’s long term energy security objectives are met.

LNG in Korea: opportunities for growth

7

1

introduction

The Republic of Korea (Korea) has achieved remarkable economic progress over the past fifty years, moving from a low income agrarian economy to an internationally competitive and highly industrialised economic system. This strong economic performance has been underpinned by large scale and often government-directed industrial development. The sustained shift from primary industries to more energy intensive sectors, including iron and steel produc- tion and ship building, along with rising incomes, limited natural resource endowments and climatic factors, has played a key role in shaping energy consumption patterns in Korea.

In particular, Korea’s strong economic growth and expansion of energy inten- sive industries has led to a rapid rise in energy consumption. Primary energy consumption has grown at more than 7 per cent a year since 1980, reaching 209 million tonnes of oil equivalent in 2002. Korea is the fourth largest energy consumer in Asia, with its fuel mix heavily biased toward oil.

With limited indigenous energy resources, a key characteristic of the Korean economy is its dependence on imports for more than 97 per cent of its energy requirements, excluding nuclear power. From an energy policy perspective, this import dependence has led to a strong emphasis on energy security and strategies to diversify fuel supplies. With such high import dependence likely to continue, security of energy supply can be expected to remain one of the key pillars of energy policy in the foreseeable future.

In this context, natural gas (in the form of imported liquefied natural gas or LNG) was introduced into the Korean market in 1986 and has since played an increasingly important role in the fuel mix. Natural gas represented 11 per cent of Korea’s total primary energy consumption in 2002.

LNG imports have increased in line with the rising consumption of gas, and Korea is now the world’s second largest importer of LNG after Japan. In 2002, Korea imported nearly 18 million tonnes of LNG, primarily under long term contracts with suppliers from Indonesia, Malaysia, Brunei and the Middle East. This is equivalent to around a quarter of Asia Pacific LNG trade.

8

ABARE research report 03.4

The role of natural gas in meeting Korea’s energy demand is likely to continue to expand over the next decade, as gas offers a competitive and clean alter- native fuel for a range of end uses. This trend is being reinforced by strong investment in new gas distribution networks. Also important will be proposed reforms in Korea’s electricity and gas industries that are likely to introduce more efficient and competitive energy markets.

Korea’s limited domestic gas resources mean that any growth in gas consump- tion will need to be supplied either by increased LNG imports and/or the introduction of pipeline natural gas. While KOGAS, Korea’s gas importing monopoly, has mid and long term LNG contracts for volumes of 19 million tonnes a year, Korea’s first contract with Indonesia will expire in 2007. Further, a shortfall in contracted LNG supply is expected to expand over the period to 2015 as more long term contracts expire and Korean natural gas demand increases.

This likely gas shortfall is emerging as a serious issue for Korea as KOGAS has delayed signing new long term LNG contracts until plans to reform the gas market are progressed. To date, KOGAS has addressed the anticipated supply shortfall by increasing its use of the spot market and by entering into midterm LNG contracts with Australia and Malaysia. However, to ensure that its gas requirements over the coming years can be met cost effectively and without risk it will be necessary for Korea to consider entering into further mid or long term LNG supply contracts in the near future.

Over the longer term, pipeline natural gas could provide an additional and complementary source of gas supply to the Korean market. The feasibility of a long distance gas pipeline from the Irkutsk region in the Russian Federation is currently being considered by government and industry in Korea. In addition to cost effectiveness, a critical factor in the overall assess- ment of such projects will be their contribution to energy security and diver- sity of energy supply.

Objectives in the study

The key objective in this report is to assess the potential growth in natural gas demand in Korea and, in particular, the role that LNG could play in that market. The likely demand for natural gas is analysed on the basis of assump- tions related to economic growth, the fuel mix in power generation and other factors that will influence energy sector outcomes. These include policies

LNG in Korea: opportunities for growth

9

associated with liberalisation of the electricity and gas markets, security of energy supply, nuclear power policies and environmental issues.

The study also assesses the emerging natural gas supply gap faced by Korea and reviews the options available to meet this shortfall. Sources of LNG supply in the Asia Pacific market and their key characteristics, including resource availability, production capacity and security of supply are exam- ined. Also analysed are options for pipeline natural gas supply to Korea, with a focus on the feasibility of long distance pipelines from the Russian Federation, and their potential competitiveness with LNG.

10

ABARE research report 03.4

2

energy and natural gas consumption in Korea

Energy consumption

Primary energy consumption in Korea has grown rapidly over the past two decades, at an average rate of 7.4 per cent a year. In 2002, energy consump- tion was 209 million tonnes of oil equivalent, compared with 44 million tonnes of oil equivalent in 1980 (KEEI 2003a; figure 1). While the Asian financial downturn in the late 1990s had a significant impact on the Korean economy –– energy consumption fell by 8.1 per cent in 1998 –– it has since recovered rapidly (KEEI 2003a). Korea accounted for 8 per cent of Asia Pacific energy consumption in 2002 (BP 2003).

Driving the rapid growth in energy consumption has been Korea’s strong economic performance. The Korean economy has grown at an average annual rate of 7.1 per cent since 1980, with gross domestic product (GDP) valued at 596 trillion won (US$477 billion) in 2002 (table 1). Economic growth fell sharply in 1998 as a result of the Asian financial downturn but recovered quickly to reach 6.3 per cent in 2002, reflecting robust domestic consumer spending and growth in export sectors. Economic growth in 2003 is expected to slow to around 3.5 per cent as a result of the sluggish world economy.

Energy intensity, or energy consumption per unit of economic output, remains high in Korea, at 0.4 tonnes of oil equivalent per thousand won in 2002 (table 1). This reflects the fact that economic growth has been led by expansion in energy intensive industries, including petrochemicals, steel and shipbuilding. While Korea’s energy intensity has declined since 1997 as a result of industrial restructuring, it remains one of the highest among OECD countries (table 2).

1 Total primary energy consumption Korea

Renewables 200 Nuclear LNG 150 Oil Coal 100 50 Mtoe
Renewables
200 Nuclear
LNG
150 Oil
Coal
100
50
Mtoe

1982 1986 1990 1994 1998 2002

LNG in Korea: opportunities for growth

11

1 Major energy and economic indicators Korea

 

Annual growth

 

1981

1991

2001

2002

1981 1991 2001 –91 –2001 –02 %%%

Energy consumption Real GDP a Population Energy intensity Energy consumption per person

Mtoe

45.7

103.6

198.4

209.1

8.5

6.7

5.4

trillion won

139.2

327.4

560.9

596.4

8.9

5.5

6.3

million

38.7

43.3

47.3

47.6

1.1

0.9

0.6

toe/’000 won

0.4

0.4

0.4

0.4

-0.3

1.1

-0.9

toe

1.2

2.4

4.2

4.4

7.3

5.8

4.7

a in 2002 prices.

Sources: KEEI (2003a); KNSO (2003).

Energy consumption per person in Korea has also grown rapidly, from 1.2 tonnes of oil equivalent in 1981 to 4.4 tonnes of oil equivalent in 2002 (table 1). Current levels are similar to those of Japan and Germany, although lower than in Australia and the United States (table 2).

Fuel mix in primary energy consumption

Total primary energy consumption is the total energy used by an economy. Primary fuels include coal, crude oil and net imports of petroleum products

2

International comparison of major energy and economic indicators,

2000

 

Primary energy

Energy

Energy

consumption

intensity a

consumption b

Mtoe

toe/’000 US$

per person

Korea

193.6

0.30

4.10

Japan

524.7

0.17

4.13

Chinese Taipei

11.5

0.20

3.74

China

1 142.4

0.24

0.91

United States

2 299.7

0.26

8.35

Germany

339.6

0.18

4.13

Australia

110.2

0.23

5.75

OECD average

5 316.9

c

0.22

4.74

non-OECD average

6 251.5

c

0.32

0.64

a Tonnes of oil equivalent per thousand 1995 US$ PPP. b Tonnes of oil equivalent per person. c Total. Sources: IEA (2002a,b).

12

ABARE research report 03.4

(hereafter referred to as oil), natural gas, nuclear power and renewables (hydropower and others such as wind and solar power).

3 Total primary energy consumption, 2002 Korea

 

Mtoe

%

Coal

49.1

23.5

Oil

102.7

49.1

LNG

23.6

11.3

Nuclear

29.8

14.2

Renewables

3.9

1.9

Total

209.1

100.0

Source: KEEI (2003a).

Oil constitutes the largest share of primary energy consumption in Korea, at 49 per cent in 2002 (table 3). While demand for oil has grown by more than 6 per cent a

year on average over the past decade, its share of primary energy consumption has declined steadily since 1994 (KEEI 2003a; figure 2). High crude oil prices in recent years have contributed to the declining share of oil, as have government efforts to reduce Korea’s dependence on imported oil supplies.

Coal is also an important energy source in Korea, representing 23 per cent of primary energy consumption in 2002. While coal demand has been strong in recent decades, a significant change in the composition of coal consump- tion has occurred over this period. Anthracite coal is the main domestic energy resource available in the Korean territory and was the major energy source before being replaced by oil in the 1970s. However, anthracite has to a large extent been replaced by imported bituminous coal –– the share of anthracite in total primary energy consumption was 2 per cent in 2002.

Natural gas has led the growth in energy consumption in Korea since LNG was introduced into the market in 1986. LNG consumption has grown at an average annual rate of 18.7 per cent over the past decade, to reach 11 per cent of primary energy consumption in 2002, compared with 3 per cent in 1990. This rapid growth, albeit from a small base, is a result of active government policy initia- tives encouraging LNG use and the expansion of gas infrastructure

2 Fuel mix in primary energy consumption Korea 80 60 Renewables Nuclear LNG 40 Oil
2
Fuel mix in primary energy
consumption Korea
80
60
Renewables
Nuclear
LNG
40
Oil
Coal
20
%

1982 1986 1990 1994 1998 2002

LNG in Korea: opportunities for growth

13

throughout the country. LNG consumption is discussed in more detail later in this chapter.

Use of nuclear power has also grown rapidly since the commissioning of Korea’s first nuclear power plant in 1977, to reach 14.2 per cent of primary energy consumption in 2002. This large expansion in the use of nuclear power reflects government policy responses to Korea’s growing reliance on imported energy.

Renewable energy, including hydropower, constitutes a marginal share in primary energy consumption, at 2 per cent in 2002, although use of nonhy- dro renewables has been growing in recent years. Supportive government policies, including the New and Renewable Energy Development and Promotion Act, which encourages the installation of waste incineration facil- ities to generate heat and power and residential solar hot water systems, have been introduced as a means of reducing Korea’s dependence on imported fossil fuels and to provide clean energy.

Final energy consumption

Total final energy consumption is defined as the total amount of energy used by final consumers. It includes energy used by industry, transport, residen- tial and commercial services sectors but does not include the energy used in conversion (principally electricity generation and petroleum refining) and distribution activities.

In 2002, final energy consumption in Korea was 161 million tonnes of oil equivalent (KEEI 2003a; figure 3). The industry sector is the largest final energy user in Korea, at around 55 per cent in 2002. This sector has also been one of the fastest growing users of energy in recent years. Energy consumption in the residential and commercial sectors has grown more slowly and represented 22 per cent of final energy consumption in 2002. The transport sector has become more visible over the past decade as a

3 Final energy consumption, by sector Korea

 

Public/others

140

Residential/commercial

120

Transport

100

Industry

80

60

40

20

 

Mtoe

 

1982 1986 1990 1994 1998 2002

14

ABARE research report 03.4

result of the rapid expansion in vehicle ownership (KEEI 2003a; figure 4) and transport volumes in Korea, and now accounts for 21 per cent of final energy consumption.

4 Motor vehicle registrations Korea

12 Trucks Buses 10 Passenger cars 8 6 4 2 million
12
Trucks
Buses
10
Passenger cars
8
6
4
2
million

Within these sectors, there have been notable changes in fuel choices. There has been substitu- tion away from heavy fuel oil and coal toward natural gas and elec- tricity in the industry sector, reflecting the advantages of these

fuels in terms of environmental and inventory costs. In the resi- dential and commercial sectors, rapid economic growth and rising incomes have led to a shift in consumer preferences away from coal to more conve-

1982 1986 1990 1994 1998 2002

nient and clean fuels such as natural gas and electricity. The share of coal in the residential and commercial sectors, for example, fell from 23 per cent in

1992 to 2 per cent in 2002, while the share of gas rose from 8 per cent to 30

per cent over the same period (KEEI 2003a; figure 5).

Electricity generation

Electricity consumption in Korea has grown more rapidly than overall energy use over the past two decades, at 10.2 per cent a year, to reach 278

terawatt hours in 2002. The largest electricity consumers in Korea are the industry sector, accounting for more than half of electricity use in 2002, and the commercial sector (26 per cent) (KEEI 2003a).

5 Final energy consumption in key sectors, by fuel Korea 80 Other Electricity 60 City
5
Final energy consumption in key
sectors, by fuel Korea
80
Other
Electricity
60
City gas
40
Petroleum
Coal
20
%
1982
1990
2002 1982
1990
2002
Industry
Residential and
commercial

Nuclear power constitutes the

largest source of electricity gener- ation in Korea, at 39 per cent in

2001 (table 4). Korea currently has

sixteen nuclear units in operation at four sites, representing 27 per cent of total electricity generating

LNG in Korea: opportunities for growth

15

4 Electricity generation, by fuel Korea

1981

1991

2001

 

TWh

%

TWh

%

TWh

%

Coal

2.5

6.3

20.1

17.0

110.3

38.7

Oil

32.1

79.8

27.2

22.9

28.2

9.9

LNG

9.9

8.4

30.5

10.7

Nuclear

2.9

7.2

56.3

47.5

112.1

39.3

Renewables

2.7

6.7

5.1

4.3

4.2

1.5

Total

40.2

100.0

118.6

100.0

285.2

100.0

Sources: KEEI (2001); KPX (2002a).

capacity (table 5). Coal also accounts for approximately 39 per cent of power generation in Korea, while 30 per cent of capacity is coal fired.

LNG represented 11 per cent of electricity generation in 2001 but accounted for 25 per cent of capacity. This is because LNG is used primarily as a peak load fuel in Korea. There were 104 LNG fired units in 2001, reflecting their smaller size and peak load application.

Oil fired power generation in Korea has declined significantly over the past two decades, to 10 per cent in 2001, as has hydropower, to 1.5 per cent in 2001.

Energy imports

Korea’s dependence on energy imports has grown significantly in the past two decades, from 74 per cent of energy requirements, excluding nuclear power, in 1980 to more than 97 per cent in 2002 (table 6). Energy imports were valued at US$31.5 billion in 2002 and represented 21 per cent of Korea’s total import bill. Oil accounted for the majority of energy imports, at around 80 per cent in value terms, while LNG imports accounted for 13 per cent.

5 Electricity plants and capacity, 2001 Korea

 

Number

of units

Capacity

Share

 

GW

%

Coal

38

15.5

30.5

Oil

21

4.5

8.8

LNG

104

13.0

25.5

Nuclear

16

13.7

27.0

Renewables

200

4.2

8.1

Total

379

50.9

100.0

Source: KPX (2002b).

16

ABARE research report 03.4

6 Energy import indicators Korea

 

1980

1990

2000

2002

Energy imports

US$b

6.5

10.9

37.6

31.5

Overseas energy dependence a

%

73.5

87.9

97.2

97.3

Oil share in energy imports b

%

92.3

82.5

83.6

79.7

LNG share in energy imports b Middle East share of crude

%

4.4

10.1

12.7

oil imports b

%

98.8

73.4

76.8

73.4

a Excluding nuclear power. b Dollar value. Sources: KEEI (2002b, 2003a); MOCIE (2003).

Energy imports have grown rapidly in line with energy consumption, from 33 million tonnes of oil equiv- alent in 1980 to 215 million tonnes of oil equivalent in 2002 (KEEI 2003a; figure 6).

6 Energy imports, by fuel Korea

 

LNG

200

 

Oil

 

Coal

150

100

50

Mtoe

In addition, Korea remains highly dependent on the Middle East for its supplies of crude oil, at 73 per cent in 2002 (table 6). This is lower than in 1980, however, and reflects diversification away from Middle

Eastern oil following the oil price rises of the late 1970s and early 1980s. While LNG was introduced as a means of diversifying energy consumption away from oil, Korea has also depended entirely on imports for its natural gas supply. Such rapid growth in energy imports and import dependence has raised concerns in Korea over diversity and security of energy supply sources. This issue is discussed further in the following chapter.

1982 1986 1990 1994 1998 2002

Natural gas consumption

Natural gas consumption in Korea has grown rapidly since LNG was first imported in 1986, at an average rate of 18.7 per cent a year over the past decade. In 2002, natural gas consumption was 18.1 million tonnes of LNG (25.0 billion cubic metres), compared with 2.3 million tonnes (3.2 billion cubic metres) in 1990 (KEEI 2003a).

LNG in Korea: opportunities for growth

17

Gas consumption, by sector

Rapid growth in city gas use –– or gas for nonpower generation –– is the main reason that LNG demand has increased so sharply (table 7). In the initial stage of the natural gas industry in Korea, most LNG was consumed in power generation. However, with the expansion of the pipeline distribu- tion network and rising personal incomes, consumption of city gas has grown significantly. Since 1990, LNG consumption by the city gas sector has grown at an average annual rate of 28 per cent. The city gas sector accounted for 62 per cent of total LNG consumption in 2002, followed by electricity gener- ation (33 per cent), district heating (3 per cent) and other uses (2 per cent). This is in contrast with other countries, including Japan and Chinese Taipei, where electricity generation is the main user of LNG.

Demand for LNG in electricity generation in recent years has remained steady, largely as a result of relatively high LNG prices. However, electric- ity sector demand for LNG spiked in late 2002 in response to increases in crude oil prices. While LNG prices are linked to international crude oil prices, the time lag in the adjustment to LNG prices meant that LNG became more competitive over this period and replaced oil fired power generation. LNG demand for electricity generation in October and November 2002, for exam- ple, was 86 per cent and 68 per cent greater than their 2001 levels respec- tively (KEEI 2003a).

7 LNG consumption, by end use Korea

 

District

 

Electricity

heat

City gas

Other

Total

kt

kt

kt

kt

kt

1986

45

8

53

1990

1 741

575

12

2329

1995

3 412

150

3 417

108

7 087

1996

4 448

173

4 561

179

9 362

1997

5 197

178

5 770

232

11 378

1998

4 029

159

6 232

222

10 664

1999

4 591

177

7 886

306

12 961

2000

4 353

335

9 528

339

14 556

2001

4 653

630

10 299

402

15 990

2002

5 969

540

11 194

425

18 128

Sources: KEEI (2002c, 2003a).

18

ABARE research report 03.4

City gas demand

LNG currently accounts for 99.5 per cent of city gas supply in Korea, hence trends in the city gas sector have a direct impact on LNG demand. Liquefied petroleum gas (LPG) accounts for the remain- ing 0.5 per cent of city gas supply.

7 City gas demand, by sector Korea

12 Industry Commercial 10 Residential 8 6 4 2 billion m 3 1986 1990 1994
12
Industry
Commercial
10
Residential
8
6
4
2
billion m 3
1986
1990
1994
1998
2002

Korea’s consumption of city gas in 2002 was 14.1 billion cubic metres, equivalent to 10.3 million tonnes of LNG. Increasing use of gas in the residential sector has driven the

expansion in city gas demand, with average annual growth of 27 per cent since 1990 (KEEI 2003a:

figure 7). In 2002, the residential sector accounted for 55 per cent of total city gas demand. City gas is mainly used in this sector as a fuel for cooking, space heating and increasingly, space cooling.

Industry use of city gas has grown at a similar rate over the past decade, to constitute 27 per cent of city gas consumption in 2002. This growth reflects in part marketing efforts to boost gas sales in this sector. KOGAS, the state owned gas company, provides subsidies for industrial customers to build natural gas facilities or cogeneration units, and for commercial users to install gas cooling systems. The commercial sector is the smallest user of city gas,

8 City gas consumption, by region Korea

 

Consumption

Annual

Connections

 

growth Network

as at

 

1990

2000

2001

1990–2001

2001

Dec. 2001

 

million

million

million

 

m 3

m 3

m 3

%

km

’000

Capital area a Province area

 

706

7 799

8 148

24.9

89 927

6 019

257

4 381

4 709

30.3

41 099

2 671

Total

963

12 180

12 858

26.6

131 027

8 691

a Includes Seoul, Incheon and Gyeonggi. Source: Citygas Association (2002).

LNG in Korea: opportunities for growth

19

accounting for around 18 per cent of city gas consumption in 2002.

The rapid expansion in city gas demand has been driven to a large extent by the development of gas distribution networks throughout the country. Korea’s widespread gas distribution system has enabled natural gas to penetrate the market quickly, including in provincial areas (table 8). However, the Seoul region is by far the largest con- sumer of city gas, with more than 6 million users at the end of 2001.

8 LNG monthly consumption, by sector Korea

Total 2.0 1.6 1.2 City 0.8 gas 0.4 Electricity generation Mt
Total
2.0
1.6
1.2
City
0.8
gas
0.4
Electricity generation
Mt
Dec Dec Dec 2000 2001 2002
Dec
Dec
Dec
2000
2001
2002

Patterns of gas use

LNG consumption in Korea exhibits strong seasonal fluctuations. LNG use in the peak winter months (December–February) generally averages at least twice that in summer (KEEI 2002a, 2003a; figure 8).

Most of this seasonal variation is explained by city gas use in the residential sector where about two-thirds of annual gas consumption occurs during the winter season (KEEI 2002a, 2003a; figure 9). The peak in winter is associ- ated with high heating loads. Colder than average temperatures during winter months can further increase the peak demand. The turndown ratio,

the difference between the highest and lowest demand months, for this sector was 7.1 in 2002. That is, gas consumption in the peak month was 7.1 times consumption in the month of lowest demand.

9

City gas monthly consumption, by sector Korea

Residential 1.2 1.0 Industry 0.8 0.6 0.4 0.2 Commercial billion m 3
Residential
1.2
1.0
Industry
0.8
0.6
0.4
0.2
Commercial
billion m 3
Dec Dec Dec 2000 2001 2002
Dec
Dec
Dec
2000
2001
2002

Although city gas consumption in the commercial sector is also affected by winter temperatures, the monthly consumption pattern is less severe than in the residential sector. The turndown ratio in 2002

20

ABARE research report 03.4

was around 2.8 in the commercial sector. The industry sector exhibits the least monthly fluctuations in demand, with a turndown ratio of around 1.6 in 2002.

LNG demand in the electricity sector exhibits little seasonal fluctuation compared with that of city gas, although LNG demand for power generation can also peak in winter (figure 8). This partly reflects maintenance sched- ules for base load coal and nuclear plants that increase demand for gas fired plants at that time.

The strong seasonal fluctuations in LNG demand evident in Korea have created supply and storage problems as contracted LNG deliveries have typi- cally taken place throughout the year. This has necessitated significant invest- ment in gas storage capacity at LNG import terminals.

Natural gas supply

Domestic gas reserves

Korea’s only known gas reserves are in the Donghae field in the East Sea. Recoverable reserves in that field are estimated at around 6 billion cubic metres, equivalent to just over 4 million tonnes of LNG. The Korea National Oil Corporation (KNOC) plans to begin full commercial production of this field from late 2003. The Donghae-1 project is expected to deliver 0.4 million tonnes of natural gas a year to KOGAS, or approximately 2 per cent of Korea’s current gas demand (EIA 2002).

LNG imports

The government owned Korea Gas Corporation (KOGAS) was estab- lished in 1983 and currently controls LNG imports, LNG receiving termi- nals, the national gas distribution network, and wholesale LNG sales in Korea. KOGAS supplies LNG to city gas distribution companies and to electricity generators.

Korea is currently entirely depen- dent on LNG imports for its natural

10 LNG imports Korea Volume 4 16 Value 3 12 2 8 1 4 US$b
10
LNG imports
Korea
Volume
4
16
Value
3
12
2
8
1
4
US$b
Mt
1986
1990
1994
1998
2002

LNG in Korea: opportunities for growth

21

gas supply. Korea is the second largest importer of LNG in the world after Japan, importing 17.8 million tonnes in 2002 (KEEI 2003a; figure 10). Indonesia has traditionally supplied the majority of Korea’s LNG; however, in recent years Korea has diversified its supply sources. In 2002, Indonesia, Malaysia, Qatar and Oman supplied more than 90 per cent of Korea’s LNG imports (table 9).

Currently, Korea purchases most of its LNG requirements under seven long term take or pay contracts that account for 17 million tonnes of LNG (table 10). New procurement of LNG is based on ‘The Basic Plan of Long Term LNG Supply and Demand’ issued by the Ministry of Commerce, Industry and Energy (MOCIE). Plans are revised every two years and the latest plan –– the sixth –– was released in November 2002 (MOCIE 2002a). Based on the demand and supply projections in the plan, the government permits KOGAS to directly negotiate an LNG procurement deal with the supplier. The government typically approves the new LNG contract, after KOGAS and the supplier set the price and other terms and conditions. However, KOGAS is postponing entering into new long term contracts until plans to restructure the gas sector are progressed. The issue of gas market reform is discussed further in chapter 3.

Long term contractual supplies have typically not been adequate to meet the rapid rise in Korea’s demand for LNG, particularly in the winter months.

9 LNG imports, by source Korea

 

Volume

 

Shares

 
 

1990

1995

2000

2002

1990

1995

2000

2002

Mt

Mt

Mt

Mt

%

%

%

%

Indonesia

2.29

5.26

6.13

5.02

99.5

74.2

42.6

28.2

Malaysia

1.04

2.44

2.30

14.7

16.9

12.9

Brunei

0.71

0.80

0.77

10.0

5.6

4.3

Qatar

3.05

5.15

21.2

28.9

Oman

1.59

4.06

11.1

22.8

Australia

0.06

0.05

0.18

0.8

0.4

1.0

United Arab

Emirates

0.24

0.23

1.7

1.3

Other a

0.01

0.03

0.07

0.12

0.5

0.4

0.5

0.7

Total

2.30

7.09

14.37

17.83

100.0

100.0

100.0

100.0

a Includes cargo swaps with Japan and Chinese Taipei. Sources: KEEI; KOGAS (2003); BP (2003).

22

ABARE research report 03.4

10 Existing mid and long term LNG contracts Korea

Source

Project name

Amount

Agreement period

 

Mt/yr

Long term

Indonesia

Arun III

2.30

1986 – 2007

Indonesia

Korea II

2.00

1994 – 2014

Indonesia

Bontang V

1.00

1998 – 2017

Malaysia

MLNG II

2.00

1995 – 2015

Brunei

BLNG

0.70

1997 – 2013

Qatar

Ras Laffan

4.80

1999 – 2024

Oman

OLNG

4.06

2000 – 2024

Total

16.86

Midterm

Malaysia

MLNG Tiga

1.50 a

2003 – 2009

Australia

NWS Australia LNG

0.50

2003 – 2009

Total

2.00

a The contract includes an option for an additional 0.5 million tonnes.

This has resulted in Korea also entering into short term contracts from the early 1990s. At their peak, between 1996 and 1999, short term contracts contributed almost 4 million tonnes a year to Korea’s LNG supply. Korea is also an active buyer of spot product, to cope with winter peak demand and is one of the largest markets for LNG spot trade in the world.

However, this reliance on the spot market has not always resulted in an opti- mal outcome for Korea. In winter 2002–03, for example, there was an unprecedented shortage of LNG in Korea and KOGAS had difficulty sourc- ing additional spot cargoes (see box 1). This recent experience has high- lighted the vulnerability of Korea’s current gas supply situation and the importance of having adequate and secure long term LNG supplies.

More recently Korea has entered into midterm contracts with Australia and Malaysia to supply 0.5 and 1.5–2.0 million tonnes of LNG a year respec- tively for seven years, beginning in late 2003. Delivery schedules in these contracts are heavily biased toward winter supply. Under the contract with North West Shelf Australia LNG, 100 per cent of the contracted volume will be delivered in the winter months.

LNG in Korea: opportunities for growth

23

Box 1: Korea’s LNG supply shortfall in winter 2002–03

An unprecedented domestic shortage of LNG during winter 2002–03 required KOGAS to source additional supplies on international markets. KOGAS purchased a reported record 42 spot cargoes that winter, totaling around 2.5 million tonnes. This was equal to nearly 15 per cent of Korea’s contracted LNG volumes at that time. Arrangements were also made with suppliers to redirect cargoes from other existing contracted customers, including some Japanese power companies, to Korea. In comparison, in the previous winter KOGAS purchased 22 spot cargoes.

The domestic supply shortage that necessitated such unprecedented access to the spot market was the result of a number of factors. There was a sharp and unexpected rise in LNG use by electricity generators during this period as LNG became relatively less expensive than oil. While LNG prices are linked to inter- national crude oil prices, there is a time lag before rises in crude oil prices filter through. LNG was therefore cheaper over this period because of the lag in LNG price adjustment following the increase in crude prices.

Increased LNG demand by electricity generators coincided with an early start to

a cold Korean winter, which boosted city gas demand by the residential sector.

The situation was exacerbated by limited spare international LNG shipping capacity. This was related in part to Japan’s increased demand for spot LNG cargoes over the same period as the Tokyo Electric Power Company (TEPCO) increased its use of LNG in response to the closure of its nuclear plants.

Highlighting Korea’s difficulty in sourcing cargoes, KOGAS purchased three long haul LNG cargoes from Algeria, redirected from Gaz de France, and is understood to have exceeded the prevailing prices for these cargoes by more than 10 per cent.

To help alleviate the tight gas supply situation, the Korean government required power plants running on LNG to switch to petroleum fuels. A nuclear plant under- going maintenance and repairs was also brought back on line earlier than planned.

Korea is likely to continue to require spot cargoes and short term contracts to make up further projected supply shortfalls as KOGAS is currently delaying entering into new long term contracts for LNG until plans to restructure the gas sector are progressed. In the interim, KOGAS has signed two midterm contracts with Australia and Malaysia to begin supplying in late 2003, which will allevi- ate the projected shortfall to some extent.

It has also been reported that KOGAS has reached an agreement with Tohoku

Electric Power Company in Japan to swap LNG cargoes when appropriate as a means of avoiding a repeat of last winter’s LNG shortage. Unlike Korea, Japan consumes more LNG in summer than in winter as a result of its relatively higher demand for air conditioning. This mismatch in seasonal demand has in the past lent itself to diverting LNG cargoes originally destined for Japan to Korea during the winter, subject to the consent of producers.

Sources: Reuters (2003a); Energy Argus (2002a,b; 2003a,b).

24

ABARE research report 03.4

Gas supply infrastructure

Korea currently has three LNG receiving terminals at Pyeongtaek, Incheon and Tongyeong (figure 11). These terminals are all owned and operated by KOGAS. POSCO, Korea’s largest steel producer, has commenced construc- tion of an LNG receiving terminal at Kwangyang that is expected to be in operation in 2005. This will be the first privately owned terminal in Korea.

11 LNG import terminals and pipeline network Korea

Seoul Incheon LNG terminal Pyeongtaek LNG terminal Donghae field Tongyeong LNG terminal Kwangyang LNG terminal
Seoul
Incheon LNG terminal
Pyeongtaek LNG
terminal
Donghae
field
Tongyeong
LNG terminal
Kwangyang
LNG terminal (under construction)

LNG in Korea: opportunities for growth

25

Twenty-six LNG storage tanks are located at the three existing termi- nals: fourteen in Incheon, ten in Pyeongtaek and two in Tongyeong. The total storage capacity at the three terminals is 3 billion litres, equivalent to 2.2 million tonnes of gas (table 11). The Incheon termi- nal is being expanded to include four additional storage tanks a year between 2002 and 2004 to meet

projected growth in LNG demand. According to the sixth Basic Plan of Long Term LNG Supply and Demand, Korea will have an LNG storage capacity of more than 7 billion litres (5.4 million tonnes) by 2015 (table 12).

11 LNG receiving terminals Korea

 

Supply

Storage

Storage

capacity

capacity

tanks

t/hr

GL

no.

Pyeongtaek

2 016

1 000

10

Incheon

2 970

1 680

14

Tongyeong

750

280

2

Total

2 960

26

Source: KOGAS (2003).

In 2002, the operational length of the national gas pipeline network was 2442 kilometres. In the sixth Basic Plan of Long Term LNG Supply and Demand, it is planned that a total of 2597 kilometres of nationwide pipeline will be operational by 2010 (table 13). The network currently supplies natural gas to customers in around 60 cities, mainly through city gas companies.

12 Planned expansion of LNG storage tanks Korea

 

2001

2002–03

2004–05

2006–07

2008–10

2011–15

GL

GL

GL

GL

GL

GL

New storage tanks Total storage tanks

 

280

1 500

680

700

960

1 260

2 280

3 780

4 460

5 160

6 120

7 380

Source: MOCIE (2002a).

 

13

Planned expansion of gas pipeline network

Korea

 
 

2001

2002

2003–07

2008–10

2011–15

km

km

km

km

km

New pipeline

131

30

140

15

Total pipeline

2 412

2 442

2 582

2 597

2 597

Source: MOCIE (2002a).

26

ABARE research report 03.4

Gas pricing

LNG import prices

In 2002, the average LNG import price to Korea was US$223.80 a tonne, equivalent to around US$4.30/MBtu (million British thermal units). Prices since 2000 have been considerably higher than in previous years, as gas contract prices rose in line with movements in international oil prices (KEEI 2003a; figure 12). This reflects standard long term contract condi- tions in which up to 90 per cent of the LNG price is indexed to move- ments in international oil prices.

12 Average LNG and crude oil import prices Korea

Crude oil 250 import price 25 right axis 200 20 150 LNG 15 import price
Crude oil
250
import price
25
right axis
200
20
150
LNG
15
import price
left axis
100
10
50
5
US$/t
US$/bbl
1990
1994
1998
2002

Wholesale and retail gas prices

The KOGAS wholesale price for gas consists of a feedstock cost and a supply cost, the latter of which is differentiated by type of user and end use. This methodology is discussed in more detail in box 2. Gas supply costs for power plants are differentiated on a seasonal basis, reflecting storage costs, hence supply costs in winter are higher than in summer. The average wholesale price of gas to electricity generators was between 325 and 327 won (US$0.28)

14 Wholesale gas price for power plants, January 2003 Korea

For POSCO

For others

 

won/m 3 US$/m 3

US$/MBtu

won/m 3 US$/m 3

US$/MBtu

Feed stock cost

293.30

0.25

6.96

293.30

0.25

6.96

Average supply cost – for winter – for summer – for other seasons

31.41

0.03

0.75

33.26

0.03

0.79

40.71

0.03

0.93

42.56

0.04

1.01

22.12

0.02

0.52

23.97

0.02

0.57

31.41

0.03

0.75

33.26

0.03

0.79

Average gas price

324.71

0.28

7.71

326.57

0.28

7.75

Average exchange rate, January 2003, US$1=1170.5 won. Source: KOGAS (2003).

LNG in Korea: opportunities for growth

27

per cubic metre at January 2003 (table 14). This is equivalent to between US$7.71 and US$7.75/MBtu.

The wholesale price for city gas (table 15) is higher than for power plants and is different across end uses, including heating, industry and commercial use. The feed stock cost for city gas was 305 won (US$0.26) per cubic metre at January 2003, while the average supply cost was 74 won (US$0.06) per

Box 2: Gas price setting procedures in Korea

The regulation of natural gas prices in Korea is based on the City Gas Business Law. The objectives of the regulations are to ensure that gas companies do not charge customers unreasonable supply costs and to enable gas companies to sustain their business on a sound basis.

Rates are subject to approval from the relevant regulatory institutions. Wholesale gas supply rates need to be approved by the Minister of Commerce, Industry and Energy, while the rates for retail gas supply must be approved by the provin- cial government in its jurisdictional area.

For wholesale pricing, KOGAS adopts ‘cost of service’ as the principle of its rate making system. This includes a predetermined reasonable return on invest- ment. The KOGAS wholesale price consists of a feedstock cost and a supply cost.

The feedstock cost is the sum of the LNG import price (cif) and additional domestic costs associated with LNG importing, including import tariffs and levies, handling charges, a special excise tax, and a safety management fund contribution.

Supply costs are determined by type of demand (that is, city gas and power plants) and then by type of use. For power plants, use is based on season, while city gas uses include space heating, cooling, commercial, industry and cogen- eration/community energy system use. These rates are then divided by an esti- mated supply volume to produce unit prices.

To reflect changes in import prices in the wholesale price, KOGAS adjusts the LNG feedstock cost for power plants on a monthly basis and for city gas customers every two months. The supply cost is subject to annual adjustment.

Local city gas companies design city gas retail prices by adding locally specific supply costs to the wholesale price paid to KOGAS. That is, city gas retail rates are determined by the cost to recover the total expenditure by the local distrib- ution company for supplying city gas to end users. The total cost of service includes a reasonable return on investment as well as reasonably estimated total operating costs.

Source: KEEI.

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ABARE research report 03.4

15 Wholesale price for city gas, January 2003 Korea

 

won/m 3

US$/m 3

US$/MBtu

Feed stock cost

305.08

0.26

7.24

Average supply cost

74.35

0.06

1.76

House heating

104.18

0.09

2.47

Commercial

41.11

0.04

0.98

Cooling

Industry Cogeneration/CES

29.51

0.03

0.70

– winter

66.84

0.06

1.59

– summer

– other seasons

29.51

0.03

0.70

Average city gas wholesale price

379.43

0.32

9.00

Average exchange rate, January 2003, US$1=1170.5 won. Source: KOGAS (2003).

16 Retail price for city gas, Seoul area, January 2003

won/m 3

US$/m 3

US$/MBtu

Retail cost of service

43.09

0.04

1.02

Average retail price

heating (house)

422.52

445.15

450.60

0.36

10.03

Heating – cooking

0.38

10.56

0.38

10.69

heating (apartment)

450.60

462.16

0.38

10.69

– heating (building)

0.39

10.97

Commercial I

442.71

0.38

10.51

Commercial II

399.09

0.34

9.47

Cooling

232.72

0.20

5.52

Industry

349.70

0.30

8.30

Cogeneration/CES: district heating – winter

379.64

312.80

342.31

405.08

338.24

367.75

0.32

9.01

– summer

0.27

7.42

– other seasons Cogeneration/CES: others

0.29

8.12

– winter

0.35

9.61

– summer

0.29

8.03

– other seasons

0.31

8.73

Average exchange rate, January 2003, US$1=1170.5 won. Source: KOGAS (2003).

LNG in Korea: opportunities for growth

29

cubic metre. Combining these costs, the average city gas wholesale price was 379 won (US$0.32) per cubic metre at January 2003, equivalent to around US$9.00/MBtu. City gas for cooling is exempt from the supply cost charge, lowering its wholesale price, in order to encourage demand for gas cooling systems, while cogeneration/community energy systems are also exempt from the supply cost charge during summer.

Table 16 shows city gas retail prices in the Seoul area in January 2003. The retail price is the sum of the wholesale price for city gas and the retail cost of service. The retail cost of service is the cost of supplying city gas to end users. In Seoul this is calculated to be 43 won (US$0.04) per cubic metre. The average retail price in Seoul at January 2003 was 423 won (US$0.36) per cubic metre, equivalent to US$10.03/MBtu, although the price varied across end uses.

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ABARE research report 03.4

3

factors affecting Korea’s future natural gas demand

While natural gas demand is likely to grow strongly in Korea, a range of issues will affect the extent and profile of future demand. These include envi- ronmental factors, energy security concerns, the pace of investment in gas fueled district heating systems, growing demand for cooling systems by the expanding Korean middle class, and the implications of plans to deregulate Korea’s electricity and gas markets.

Environmental issues

Until recently, environmental issues were generally given low priority in Korea in favor of economic expansion. As a result, most major cities and industrial areas have significant environmental pollution problems. However, the environment and sustainable development, particularly in relation to energy use, are emerging as some of the most important issues facing the country. Major regulations and policies to address environmental issues have been introduced since the Korean Ministry of Environment was established in 1990.

Energy related environmental policies

Korea’s energy related environmental policies focus principally on air qual- ity control in the electricity, industry and transport sectors. The 1990 Air Quality Preservation Act, for example, bans the construction of thermal power plants that use fuels other than natural gas in the Seoul metropolitan area. This law also sets permissible emission standards for stationary and trans- port emission sources.

One of the main goals of long term energy policy in Korea is to create a balance between economic growth and environmental protection. Many poli- cies, at both the national and local government level, emphasise and encour- age substitution away from conventional fossil fuels such as coal and petroleum, to relatively clean fuels, including natural gas. Mandatory air quality controls and stricter emission standards reinforce this trend.

LNG in Korea: opportunities for growth

31

In the industry sector, for example, recent trends indicate movement out of coal and oil into natural gas and electricity. In the iron and steel sector, natural gas accounts for around 12 per cent of energy consumption (IEA 2002a).

Another relatively new source of demand for natural gas is the expansion of compressed natural gas (CNG) vehicles. More than 40 per cent of Korea’s air pollution is from motor vehicle emissions and in the Seoul metropolitan area this source accounts for 85 per cent of total air pollutants. To reduce the emission of pollutants by motor vehicles the Korean government is promot- ing the use of CNG vehicles for public transport. The provisional operation of four CNG buses began in 1998 and has been gradually extended. According to government plans, 20 000 existing diesel buses will be replaced by CNG buses by 2007.

If this replacement plan is carried out as scheduled, natural gas demand in the transport sector could account for a significant proportion of total gas demand. To implement the plan, the Korean government is providing bus companies with subsidies and tax incentives to purchase new CNG vehicles. In addition, a heavily discounted natural gas price is being offered and more natural gas stations will be provided.

Climate change response policies

Climate change has become one of the focal points of environment and energy related policies in Korea. Korea has had the fastest growth in carbon diox- ide emissions from fuel combustion among OECD countries over the past decade: carbon dioxide emissions in Korea grew by 6.7 per cent a year between 1990 and 2000, while the OECD average over this period was 1.2 per cent a year (IEA 2002c). As a relatively low carbon intensive fuel, natural gas is likely to benefit from increased emphasis on reducing the rate of growth in greenhouse gas emissions.

Korea established an Inter-Ministerial Committee on the United Nations Framework Convention on Climate Change in April 1998 comprised of repre- sentatives of relevant government agencies, academia and industry under the chairmanship of the Prime Minister to coordinate overall activities related to climate change policy. In December 1998, Korea developed its first comprehensive action plan for climate change policy (1999–2001). One of the major achievements of the action plan was the introduction of voluntary agreements with the largest greenhouse gas emitting sectors –– including iron and steel, petrochemicals and cement –– to reduce carbon dioxide emis-

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sions and energy consumption. The government recently released the second comprehensive action plan (2002–04) in March 2002. This included a range of measures and expanded programs to stimulate efforts to ensure real green- house gas emission reductions and provisions for developing a national green- house gas emissions reduction target.

In November 2002 the Korean government ratified the Kyoto Protocol. As a non-Annex B party to the protocol, Korea would not be bound by any emis- sion reduction targets if the protocol enters into force but would be eligible to participate in projects under the clean development mechanism.

Security of energy supply

To enhance energy security, a key objective of Korea’s energy policy has been to diversify both the types and sources of fuel supply. This policy led to the introduction of natural gas into the market in the mid-1980s and was behind the high level of government investment in natural gas infrastructure that facilitated its expansion.

However, as discussed in chapter 2, oil remains the dominant source of energy in Korea, accounting for around half of primary energy consumption in 2002. In addition, around three quarters of crude oil imported by Korea is from the Middle East. The Korean government is likely to continue to attempt to reduce oil dependency by promoting the development and use of alterna- tives to oil, including natural gas and nuclear power.

Overseas investment

The government is further reducing the risks associated with imported energy supply through the promotion of equity participation in the exploration and production of overseas resources of oil, gas and coal. The government’s Overseas Resource Development Program, funded by the Energy Special Account, encourages Korean companies to participate in overseas explo- ration and production business activities. Korea has equity investments, for example, in Oman LNG and RasGas, in addition to long term LNG supply contracts with these companies.

According to the Korean government’s second Basic National Energy Plan (2002–11), as much as 30 per cent of Korea’s natural gas supply by 2010 could be sourced from projects or fields in which Korean companies have

LNG in Korea: opportunities for growth

33

invested (MOCIE 2002b). This target is likely to have implications for future sources of natural gas supply for Korea.

New sources of demand

District heating systems

The development of district heating systems throughout Korea is generating new demand for natural gas. A district heating system supplies large areas, including apartment complexes and office buildings, with heat produced by combined heat and power plants or other large scale heat production facili- ties using various fuels, including natural gas.

District heating systems are generally part of larger community energy systems that provide the integrated supply of heating and electricity to communities. These systems are regarded as efficient, economical and envi- ronmentally friendly energy sources.

Because many communities in Korea are placing more emphasis on envi- ronmental protection, clean energy sources, including natural gas, are in demand for district heating systems. This is despite LNG being relatively more expensive than other fossil fuels. Moreover, district heating systems are usually located in major cities such as Seoul and Busan, where the use of fuels other than natural gas is prohibited under the Air Quality Preservation Act. LNG accounted for around three-quarters of energy consumption in district heating systems in Korea in 2000 (KDHC 2002; figure 13).

According to the Korean govern- ment’s Basic Plan for Mid to Long term Supply of District Heating, it will spend about 1.4 trillion won by 2006 to provide district heating for 426 000 new households (MOCIE 2002c) (table 17). By 2006, about 1.6 million households will benefit from district heating. This signifi- cant projected expansion of district heating is likely to contribute to future growth in natural gas demand in Korea.

Fuel mix in district heating 13 systems, 2000 Korea LNG 75.8% Oil 24.2%
Fuel mix in district heating
13 systems, 2000 Korea
LNG 75.8%
Oil 24.2%

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ABARE research report 03.4

17 Mid to long term projections for district heating supply Korea

 

2002

2003

2004

2005

2006

New residences

’000

101

79

117

152

78

Total residences

’000

1 166

1 245

1 362

1 514

1 592

New investment

bill won

310

468

303

232

100

Total accumulated

investment

bill won

310

779

1 081

1 313

1 413

Source: MOCIE (2002c).

Cooling systems

Since the 1990s, rapid economic growth, rising personal incomes and more affluent lifestyles have stimulated greater demand for summer cooling in Korea. This trend is likely to continue as the penetration of cooling is not yet widespread throughout the country.

The uptake of electricity based cooling systems has increased the summer peak level of electricity in recent years. As gas is a peak load fuel, the grow- ing demand for summer cooling is in turn creating new demand for natural gas.

In addition to growth in electric cooling systems, gas cooling systems are also likely to become more widespread in Korea, creating new direct demand for natural gas. The diffusion of gas cooling systems is expected to ease to some extent the seasonal imbalance of supply and demand in the natural gas industry as LNG demand in summer begins to rise.

While gas cooling systems in Korea have been available for commercial use since the mid-1980s, recent demand for residential gas cooling systems has emerged as a result of the development of new small size cooling system technology. By 2010, it is anticipated that there will be 175 000 residential gas cooling systems across Korea, compared with 450 in 2002 (KOGAS

2003).

The penetration of gas cooling systems will be assisted by government promo- tion policies, including a preferential low interest loan scheme for their instal- lation. KOGAS is also encouraging new demand in this area with its own assistance program that provides subsidies to customers to install gas cool- ing systems.

LNG in Korea: opportunities for growth

35

Energy market reform

Korea is in the process of deregulating the electricity and gas industries in order to introduce competition and to enhance efficiency in these key energy markets. This follows the deregulation of the petroleum industry that occurred in the late 1990s.

In 1999, the then Korean government announced plans to restructure the electricity industry, including the privatisation of the state owned monopoly Korea Electric Power Corporation (KEPCO) (MOCIE 1999a). In the same year, the government announced a plan to restructure the gas industry and to privatise the Korea Gas Corporation (KOGAS) (MOCIE 1999b). The key objectives of the proposed reform programs were to introduce competition into these monopoly sectors, to enable long term, stable and cost effective energy supplies and to increase consumer benefits through the expansion of consumer choice.

Electricity market reform

The fundamental elements of the former government’s Basic Plan for Restructuring the Electricity Industry included:

unbundling of the generation, transmission and distribution sectors of KEPCO;

restructuring of KEPCO’s generation assets into six companies, includ- ing one company to hold KEPCO’s nuclear and hydro assets;

separation of KEPCO’s distribution assets into six companies;

privatisation of the non-nuclear and hydro generation companies and the distribution companies; and

phasing in of wholesale and retail competition, with full retail competi- tion from 2009.

In the first phase, KEPCO was separated into a power generation business and a transmission/distribution business, and the generation assets were divided into the proposed six generating companies in April 2001. The six generators currently compete among themselves and independent power producers in a cost based pool market –– a transitional step to wholesale competition –– by bidding available capacity on a daily basis.

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ABARE research report 03.4

Other reforms undertaken to date include the establishment in April 2001 of the Korea Power Exchange (KPX), an independent nonprofit organisation responsible for operation of the wholesale electricity market. The Korea Electricity Commission was also established at the same time to oversee KPX and the electricity market and to implement industry reforms.

However, since the appointment of the new administration in early 2003, reforms in the electricity sector have stalled. This is a result of the new govern- ment’s intention to review the privatisation plans of its predecessor. Key factors driving the review are concerns to ensure that efficiency increases are realised, concerns about privatising natural monopoly industries if suffi- ciently strong regulatory frameworks are not in place, and a desire to build a consensus for privatisation with labor groups. This reflects the generally more cautious approach to economic reform of the current government compared with its predecessor and has led to some uncertainty over the direc- tion and timing of further reform (see box 3).

In particular, the plan to privatise the five non-nuclear and hydro generating companies has been delayed indefinitely. In March 2003 the government canceled the sale of Korea South-East Power Company (KOSEPCO) –– the first company nominated for sale –– after all potential investors indicated that they would not be submitting final bids. This outcome was partly a result of the uncertainty surrounding the new administration’s views on economic reform and the lack of clear market rules and a regulatory framework for the planned power pool market. Regional and international economic uncer- tainty is also a key reason for the lack of interest from buyers. KEPCO is now considering an initial public offering of a minority of the stock rather than the sale of a strategic stake through a tender process. However, this is likely to be delayed for some time, in order to ensure more favorable market conditions (Energy Argus 2003c,d).

Also delayed is the planned division of KEPCO’s power distribution assets, scheduled to be split into six companies in April 2004. At present it is uncer- tain when and if this stage of reform will be implemented (Korea Times 2003b). In the interim, KEPCO will continue to manage the transmission and distribution sectors.

The introduction of the two way bidding pool system, scheduled for 2003, has also been delayed. It is understood that the earliest this operation could begin is April 2004. With the delay in the reform process, the timetable for

LNG in Korea: opportunities for growth

37

the introduction of full retail competition, planned from 2009, is now also uncertain.

Given the uncertainties over the future of electricity sector reforms, it is diffi- cult to predict the impact that reforms could have on natural gas demand. In

Box 3: Economic reform under the Roh Moo-hyun administration

The new Korean government under President Roh Moo-hyun took office in late February 2003. It inherited from its predecessor a number of plans for reform throughout the economy, including privatisation plans for public entities in several sectors. These included the banks that had been nationalised during the Asian financial downturn of the late 1990s, as well as the railways, the elec- tricity sector and the gas sector.

Since coming to office, the government has emphasised the need for ongoing and consistent structural reform in order to strengthen Korea’s economic funda- mentals and to enhance external credibility. To do so, in addition to reform in the above four major sectors, the government is focusing on further promoting market liberalisation, deregulation, privatisation and labor sector flexibility.

Privatising Korea’s banks, which are still around 25 per cent state owned across the system as a whole, has been the key priority to date. The government recently sold the Chohung Bank to the Shinhan Financial Group, although there were strong labor protests over the issue. It is now targeting its stake in the Korea Exchange Bank.

Apart from the banking sector, all other privatisation plans that the government inherited from its predecessor are being reviewed. This move has led to some uncertainty over the timing and direction of further reform throughout the Korean economy.

More broadly, a priority of the Roh government is to increase transparency and accountability in the business sector. It has announced that it will continue to implement policies that enhance market transparency and corporate governance, improve supervisory regulations in the accounting sector, and limit large Korean conglomerates from controlling the financial sector. The government is also targeting improving labor relations, laws and institutions to global standards, by making the formal sector, particularly its unionised component, more flexi- ble, and by improving protection in the informal sector. Part of this policy will involve establishing socially cohesive labor management relations.

The government is also aiming for Korea to become a north east Asian busi- ness hub and to strengthen its economic ties in the region. To do so, it is imple- menting measures to foster investment, including greater fiscal, financial and tax support, as well as regulatory improvements.

Sources: MOFE (2003a,b); Korea Times (2003a); Economist Intelligence Unit (2003); Asia Pulse (2003).

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ABARE research report 03.4

a liberalised and privatised electricity sector, LNG demand for power gener- ation will be determined on a commercial basis. Greater competitive pres- sures faced by generation companies will provide incentives for cost minimisation. This is likely to affect fuel procurement decisions as genera- tors give more weight to the cost of alternative fuels, including LNG.

Based on fuel costs alone, LNG in Korea is generally less competitive than other fuels. However, when the total cost of generation, or the long run marginal cost of electricity supply, is taken into account, there is evidence that gas fired generation can be competitive against other fuels, including coal (see box 4). This is because gas fired plants typically have lower capi- tal costs, consume less land, have shorter construction times and lower oper- ating costs. Based on these comparative costs and higher fuel conversion efficiency relative to coal fired plants, private investors tend to favor gas fired plants over coal (Poten and Partners 2002).

The advantage of gas will be reduced, however, if investors, including public investors, are not required to meet private sector rates of return on their elec- tricity generation assets. Nevertheless, the strong outlook for electricity consumption growth in Korea and the advantages of natural gas suggest that there could be a more robust future for gas use in power generation in a dereg- ulated, competitive environment.

Box 4: Assessing the costs of electricity generation