Philippines LNG: Developing New Import Markets Sarah Fairhurst 3rd Annual FSRU Conference, Singapore, November 26 2014

Prepared by:

Sarah Fairhurst

sfairhurst@lantaugroup.com

Agenda

Understanding Philippiness energy needs and government policy for LNG imports

Outlining possible terminal projects: Who might win the race to build the terminal?

Barriers to entry and possible options to manage them

1

Understanding the Philippines Energy Needs: Current Situation

Fuel mix is currently very diversified with a

high proportion of renewable and local

sources

Gas makes up 25% of the fuel for power

generation in the country higher if you just

look at Luzon

Practically all the gas comes from

Malampaya a single gas field offshore

Palawan via long (504km) undersea pipeline

The Malampaya concession expires in 2024

and while it may have enough gas for some

further expansion, this is not considered

sufficient for more than about 5 years at

current levels

2

After Malampaya what then?

Coal 43%

Oil 6%

Natural Gas 25%

Geo-thermal

13%

Hydro 13%

Wind 0.1%

Solar 0.002% Biomass

0.3%

2013 Generation Mix

Source: Philippine DOE (Power Statistics)

And although there is a lot of gas currently burnt, much of it is not economic

The three gas plants all currently run baseload

However, they ONLY run baseload because of the

take or pay (ToP) constraints of the contract for

the sale of gas

Without these ToP constraints, economically the

gas-fired plants would run less acting as peaking

or mid-merit plants

Between July 2007 and the end of 2013,

Meralco alone spent an extra US$300m on

its gas-fired IPPs compared to the cost

saving it could have got from its coal plants

3

3833

27

9

2012

without

ToP

48

2012

actual

42

80

60

40

20

0 Geothermal

Coal

Natural Gas

Oil-based

Hydro

Wind

Biomass

2017

est

without

ToP

74

2017

est

100

57

Luzon generation fuel mix

Percent

Source: TLG analysis

The Philippines has diverted a lot of money from electricity into other things since the

completion of Malampaya..

The Philippines has an event-driven electricity sector much uncertainty and

variability for both natural and technical reasons

Note: * Buying price (with 100% surplus)

Source: PEMC; TLG analysis

PhP/kWh

Average monthly WESM spot settlement price* (2007-14)

4

0

2

4

6

8

10

12

14

16

18

20

22

24

26

Jan-14 Jul-13 Jan-13 Jul-14 Jul-12 Jan-12 Jul-11 Jan-11 Jul-10 Jan-10 Jul-09 Jan-09 Jul-08 Jan-08 Jul-07 Jan-07 Jan-15

Low

hydro

Gas curtailments

and low hydro

Plant forced maintenance

outages and HVDC link

maintenance

Transformer breakdown and San

Jose substation congestion

Plant outages and

coal limitations

Plant outages

Gas curtailments

and plant outages

Gas scheduled outage

and plant outages

ERC-

regulated

price

reduction**

Weather effects vary widely each year the system must have the capability to

deal with strong swings between El Nino and La Nina

5

Deg. C

NOAA Oceanic Nio Index (ONI)

Source: NOAA

(2.5)

(2.0)

(1.5)

(1.0)

(0.5)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Jan-5

0

Oct-

51

Jul-5

3

Apr-

55

Jan-5

7

Oct-

58

Jul-6

0

Apr-

62

Jan-6

4

Oct-

65

Jul-6

7

Apr-

69

Jan-7

1

Oct-

72

Jul-7

4

Apr-

76

Jan-7

8

Oct-

79

Jul-8

1

Apr-

83

Jan-8

5

Oct-

86

Jul-8

8

Apr-

90

Jan-9

2

Oct-

93

Jul-9

5

Apr-

97

Jan-9

9

Oct-

00

Jul-0

2

Apr-

04

Jan-0

6

Oct-

07

Jul-0

9

Apr-

11

Jan-1

3

ONI measures average surface sea temperatures and it is used by the US

National Oceanic and Atmospheric Administration (NOAA) for their

operational definition of El Nino and La Nina

El-Nino

La Nina

And of course hydro is not the same each day, week, month, season, or year

6

13

2

1

0

5.2

12

5.3

11

5.5

08

4.4

10

4.0

09

5.5

05

4.3

04

4.3

03

5.4

07

4.6

06

4

3 2.9

2002

3.8

6

5

Source: DOE Power Statistics (2002-13); PEMC; TLG analysis; NOAA

Annual hydro generation in Luzon

(2002-13)

0

5

10

15

20

25

30

0

5

10

15

20

25

30

600

400

200

0

D N O S M F J A J J M A

800

Monthly hydro generation in Luzon and

2011 precipitation (2006-2012)

Hydro generation is

low in Q2 when

demand is at its

peak

Low inflows in severe El-

Nino years reduce ability

of hydro plants to

generate

TWh (bars) GWh (lines) mm (bars)

2008

2007

2006

2011 precipitation

(RHS)

2012

2011

2010

2009

Generation peaks

when there is

plentiful inflows

As a consequence of all these things timely, flexible, capacity is needed

7

0

100

200

300

400

500

600

700

2/3/14 2/2/14 2/1/14 1/31/14 1/30/14 1/29/14 1/28/14 1/27/14

Sual G1

Mariveles G2

Pagbilao G1

Typical weekly generation schedule (w/c January 27, 2014)

MW

Source: PEMC (ex-post schedules)

COAL PLANTS

And most flexibility in the market is currently provided by coal which is not ideal

New power stations running LNG would meet this need but building power

stations in the Philippines is more complicated than many places in Asia

There is no national Government owned electricity utility in the Philippines

There are no Government backed long term PPAs on offer and no Government Guarantees

The electricity legislation (EPIRA) prevents the Government from building or contracting for power stations

(except in emergency situations)

There are two electricity markets the WESM (Luzon and Visayas) and the IMEM (Mindanao)

There is a degree of open access and retail competition meaning some loads are contestable

There remains extensive regulation of electricity contracts between generators and retailers

Not all of which is well designed or well implemented

So an investor in power in Philippines has to manage commercial and regulatory risks

through private sector investment and debt. Add to that the costs of building an LNG

terminal as well

8

Is it even possible?

So how much LNG could be economic in the power sector?

This is a question we answered recently as part of our work on the Gas Master Plan for the

Philippines

To answer the question, we modelled the electricity market using our electricity market simulation

tool (QUAFU) to identify:

What type of plant is is most economic to build in the future in the Philippines given the current plant mix,

future load projections and costs of different type of new build options

How would existing gas-fired plant operate after their existing gas contracts expire

Are there any other ways LNG could enhance the system, without adding to system costs?

9

We showed that there was a case for LNG in the least-cost capacity expansion

plan for the WESM and that this ran mid-merit

10

Least-cost capacity expansion plan for Luzon

under expected assumptions

0

200

400

600

800

1,000

1,200

29 27 25 23 21 19 17 15 2013

Net MW

Economic least-cost entry

Natural Gas

Biofuel

Wind

Geothermal

Hydro

Oil

Coal

Note: EWC plant assumed to not be committed

Source: DOE (committed plants as of Aug 2013); TLG analysis

Near-term need for more cost

effective mid-merit / peaking capacity

Conservatively, an LNG-fired CCGT

of about 600-800 MW and a LNG

import terminal appear to be the

least-cost option

They are able to recover reasonable

returns on their invested capital

(including for terminal)

The amount of LNG-fired capacity

required is relatively robust to near-

term committed capacity

However, at expected coal and LNG

prices, coal generation will continue

to be least-cost option for most of

future capacity requirement

Uncertainty over

how further supplies

from Malampaya

could be used?

In the longer term, existing plants would run mid-merit rather than as baseload

plant if take-or-pay constraints are eased

As we noted earlier, the Philippines already has 2700MW of gas-fired capacity which runs

baseload, out of merit

Between 2022 and 2024, the gas contracts forcing this plant to run baseload expire

When that happens, the existing plant will be able to operate economically in a mid-merit role

This means that no further gas-fired capacity is needed in the WESM

11

There is a current window of opportunity for some additional mid-merit plant, but LNG

fired power does not require investments in large amounts of plant

In addition to building new power stations, there is also an opportunity to import

LNG to back up the existing domestic gas

12

Start date Duration

Estimated additional system cost (mPhP)

Scheduled Malampaya maintenance outage

22 Nov 2006 25 days 2,500

27 Jun 2008 4 days 1,000

10 Feb 2010 30 days 1,300

20 Oct 2011 7 days 900

13 Jul 2012 8 days 600

11 Nov 2013 30 days 4,000

Subtotal: 10,300

Unscheduled Malampaya supply outages

Average curtailment of 1,700MW over about 287

hours since 2006 740

Total: 11,040

Imported LNG is more cost

effective than liquids, meaning

that having the option to back-

up Malampaya with LNG is a

valuable option

If LNG is used to replace liquid

fuels when Malampaya is on

outage, an opportunity to save

in the order of USD20-25

million per annum exists

Reduced availability also

means more expensive

generation is needed to

replace lost capacity

Note: * Used in scheduled maintenance outages

Source: DOE; TLG analysis

This is a conservative value if one took into account the impact on the market price

as well it may be higher

And in the longer term, there are additional markets for gas

13

LNG would result in considerable

savings over LPG and diesel as a

heating fuel

And also as a transport fuel 05

10

15

20

25

30

35

US

D/m

mb

tu

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

US

D/m

mb

tu

Our base case scenario has growing demand from power, industry and

transport

In the short term, we believe it is more economic to

move LNG by truck to industry than by pipeline

There are a number of diesel fired power stations

in Visayas and Mindanao that could be converted

to run on LNG most of these are proximate to the

coast and could be serviced by small barges on a

milk run from the main Luzon terminal

Development of gas pipelines in the Philippines is

problematic due to access to land over time if

this is solved and after a base industrial demand

has grown, then additional pipelines into Manila

make sense

14

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

2017 2020 2025 2030

mtpa

Power

Industry

Transport

Forecast LNG consumption

So, there IS commercial potential for LNG in the Philippines, but not a huge

amount

Most of the potential LNG demand comes from the power sector:

To back up existing power stations now; or fuel existing power stations after 2024

Fuel for new power stations from 2017 onwards

Backing up existing power stations is worth about USD 20-25 million per annum until 2024

There is an economic case for about 600-800 MW of new power stations, running mid-merit

Highly variable gas demand due to variations in annual rainfall (hydro), outages, and weather (El Nino)

meaning quantities of LNG required are significantly less than 1mtpa in the near term

No economic case for new baseload gas fired power stations coal is always a cheaper option for

baseload, even after factoring in possible carbon credits

Small but potentially growing demand for gas in industry and transport

15

Unfortunately our findings do not sit well with recent policy developed

independently of this work

The Energy Secretary developed a Fuel Mix policy at the same time we were running this project,

which states that 30% of the electricity in the Philippines will come from gas.

It appears to roughly take the fuel mix in 2008 (the year the RE law was passed) and expands it

out into the future

However, appears to be a political desire with no economics nor analytics underpinning in.

Nor any active policy either (no mandatory actions required)

16

The recommendations of the Gas Master Plan are out of line with the new Fuel Mix

policy which is causing confusion in the DOE

So what will actually happen?

The Natural Gas Master Plan proposed a specific transaction structure to bring in a privately

owned FSRU to deliver back up LNG and supply for the economic amount of new power stations

It required only a small amount of Government assistance to get the process started but so far,

there are no indications that the DOE will act on any of the recommendations

DOE is understaffed and much focus is currently on the emergency power for next year

A number of internal movements within DOE mean that staff who were in charge of this project have now

moved elsewhere

However, all is not lost.

There are a number of initiatives from the private sector that may deliver very similar outcomes

17

A year ago a number of private sector proponents were active in this space.

At the start of our Master Plan study, we interviewed all the active proponents looking to build

LNG terminals in Philippines

Most were looking at land-based terminals

Most were looking at base load options for gas power plants and off-take

Few really understood the market

Our study recommended an FSRU instead of a land-based terminal

The amount of gas required is small, meaning expensive land-based terminals are unnecessary

Flexibility is important timing may change faster options are more appropriate

Building on land is problematic in Philippines land acquisition and approvals delay projects so a floating

solution has advantages

18

however now the credible suspects have been narrowed down

EWC is under construction at Pagbilao

Land-based terminal using marine-based technology to keep costs down

Significant progress has been made on the terminal and turbines have arrived on site for the power station

Construction started before the project was fully funded, making it hard to predict how it would outturn

Shell has been undertaking a FEED study for LNG import at Batangas

Their JV SPEX is currently the sole supplier of gas to the Philippines, with a depleting field, giving Shell a

clear economic incentive to find a way to continue supplying gas to the Philippines market

First Gen has also been looking at LNG options

First Gen owns two of the three gas-fired power stations currently operating and is building two more a

peaking plant and another mid-merit plant

Those plants will initially share gas from the existing gas supply, but this is only a short term solution so

First Gen have a clear economic driver to find alternative supplies

Meralco was previously looking at a terminal but now appears to be just looking at a gas-fired

power station

As the largest distribution utility in the Philippines, it makes a very credible and credit-worthy counter party

for any importer of LNG

19

Any of the options could supply the economic need for LNG-fired capacity in

the power sector

EWCs project is around 600MW and currently has no power contracts - meaning that it would

operate as required in the WESM exactly as our model predicted

First Gens projects take existing inflexible gas and remove the take-or-pay to allow much more

flexible and economic burn of the existing Malampaya gas but all these power stations will

need fuel in the future after Malampaya

Meralco has long argued that flexible, mid-merit power is what is needed in the Philippines

electricity market

20

All these projects are consistent with the economic requirement of the power sector

and all are private-sector driven

But barriers to entry still remain

There are no environmental incentives for gas-based generation in the Philippines

Regulation of power supply contracts continues to undermine efficient outcomes

Contract regulation is currently based on a cost-plus basis that does not take account of market prices

nor what alternative contracts might be available.

There are no incentives for distribution utilities to procure an overall least cost portfolio

As such, it makes it harder to highlight how mid-merit and peaking generation options fit into the mix

compared to cheaper baseload coal.

Government policy and intervention in the electricity market is undermining private sector

incentives

Interference in the market to lower market prices after the fact has caused some generators to lose

money

Lowering the cap on the market price and adding a new secondary price cap at a level lower than a

peaking plant needs to recover its costs has serious implications for new investment

There remains no clarity of rules on NG use and infrastructure

21

Lack of regulatory incentives for retailers to contract are possible one of the

biggest barriers to entry of new flexible plant

Retailers are the companies who buy from the wholesale market and sell to end use customers

In the Philippines these are distribution utilities and co-operatives servicing franchise consumers

(as well as a small number of retailers servicing the contestable market)

The purchases of these retailers are regulated by the ERC, but this regulation is unlike that found

in most markets

The regulation is focussed solely on individual contracts

It does no analysis of whether the contract is actually NEEDED, only the cost of the contract

It does not take account overall purchases by the retailer

It does not take into account alternatives available

And nobody regulates what is not contracted (that is, purchases from the spot market)

Once approved, all the costs of these contracts are passed directly through to the consumer,

even if they later change, even if the contract is not needed

22

The impact means that retailers focus on what is easy to get approved, not on what is

actually needed. They have no incentives to contract efficiently

In any market, or to meet any load shape of electricity demand, there is a mix

of plants that is cheapest

23

Oil Gas Coal Oil Gas Coal

0

50

100

150

200

250

300

Fixed costs - $/kW per year Variable costs - $/MWh

0

20

40

60

80

100

120

140

160

180

Capital

Fixed O&M

Fuel

Variable O&M

ITS BECAUSE

YOU WANT TO RUN IT A LOT

IF YOU SPEND ALL THIS

MONEY TO BUILD IT

No single technology is inherently better than the other it is the way they are mixed

that makes the optimal solution

In a market like the Philippines, we would expect retailers to purchase a mix of

peak, baseload and mid-merit capacity to meet their needs

24

Peaking plant such as diesel or hydro

Mid-merit (flexible) plant such as CCGT or recips

Baseload (always on) plant such as coal, geothermal

This is important because it is the incentives on retailers to contract that drives the

contract underpinning new entry into a merchant market

LO

AD

Hours in the year

If you look at the data, retailers in the Philippines are not contracting according to

an optimal mix

25

Average power cost vs. load factor for Luzon grid ECs (2012)

The evidence is consistent with our hypothesis, that the structure of regulation does not

incentivise contracting for anything other than baseload plant

In addition, normal merchant markets put risks on retailers to encourage them

to contract (and to contract efficiently)

Since WESM purchases are not subject to regulation, all WESM costs are passed through to

consumers

In other markets, customers have fixed tariffs, and if spot prices are high, it is RETAILERS, not

the customers, who bear this risk

In Philippines this is backwards.

Since customers bear the risk, the regulator and the DOE worry about high WESM prices and

have capped the price

26

This band-aid solution merely tackles the symptom, not the disease and in the long

term will make the problem worse

The market cap price much lower than other markets

27

Comparison of the Market Price Caps

0

100

200

300

400

500

600

Singapore

NEMS

159

US

ERCOT

226

32

Australian

NEM

WESM

(2013)

538

62

PhP/kWh

Due to increase

in 2015

With a higher price cap:

More attention would be paid to effective

contracting

strategies especially contracts to cover

disruptions

outages and peak demand

Flexible and responsive capacity (such as that

provided by LNG) would become

more commercially attractive, leading to

earlier

replacement of older, expensive, and less

responsive

capacity

However risk to retailers would increase, as

they would be more exposed to uncovered

(spot) price risk

And changes to the regulatory environment

are required to support this outcome

WESM

(2014)

The market woes and regulatory short-comings may yet hinder efficient development of

LNG in the Philippines

In summary

There is an economic case for LNG to enter the Philippines

The market is driven by the private sector and the private sector is responding to the needs

Government policy is lagging private sector needs and recent decisions are actively deterring

new investment

And regulation continues to undermine the incentives for efficient contracting which would assist

in underpinning new entry

28

We continue to watch, wait and push for improvements

Sarah Fairhurst

sfairhurst@lantaugroup.com

The Lantau Group

4602-4606 Tower 1, Metroplaza

223 Hing Fong Road

Kwai Fong, Hong Kong