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World Energy Source: The Future Is Gas? Article by Jeroen van der Veer, Chief Executive, Royal Dutch Shell Plc

World Energy Vol. 9 No. 2: September 2006

By Jeroen van der Veer
Chief Executive
Royal Dutch Shell plc

Natural gas – with its economic, efficiency and environmental advantages, relative abundance and expanding infrastructure – has the potential to play a vital role in meeting the world’s expanding energy needs while helping to cut greenhouse gas emissions. Global gas consumption is expected to grow strongly.

Most countries will become increasingly dependent on imports, and inter-regional gas flows could expand nearly threefold. But significant economic, technological, commercial and political challenges need to be overcome if this potential is to be realised. Success will depend on harnessing knowledge – technologies, organisational capabilities, and individual skills and qualities – and building relationships.

Strong partnerships have always been a feature of the gas industry because of the scale of the challenges and the need for global links. They work best when companies invest as partners. But this requires a transparent, predictable and secure framework that allows suppliers to invest and customers to make commitments.

Natural gas has been part of the fabric of the Dutch economy since the discovery of the massive Groningen field in 1959. By the early 1970s, almost all Dutch homes – as well as power stations and factories – were using gas from the Groningen field. Moreover, the Netherlands was exporting large amounts of gas from the field to its European neighbours.

Such exports drove the development of the European gas transmission network, which boosted prosperity and helped bind together the European community. But it is not just Groningen’s huge reserves that matter. Also of relevance is the way the field has been managed: as a balancing supplier, supporting the development of other supplies. Together with underground gas storage facilities, the Groningen system has the capacity to deliver nearly half a billion cubic metres of gas a day to meet peak demand.

A Û2 billion upgrade programme will enable Groningen to maintain its key role in providing flexibility and security to the northwestern European gas market. This will be even more important as the continent becomes increasingly dependent on more distant gas supplies.

The remarkable success of Groningen has rested on twin pillars. First, a strong and enduring public-private partnership is able to apply the skills, technology and investment necessary to develop and manage the complex system. Second, a clear, predictable and commercial policy has underpinned this investment while responding to market changes. I believe such conditions are of continuing and much wider relevance to the future of this industry.

The potential for gas is of great importance, as are the economic, technological, commercial and political challenges central to such using such a resource. Two key requirements for success – harnessing knowledge and building relationships – are also particularly relevant.

The Potential for Gas

Natural gas, with its environmental advantages, relative abundance and expanding infrastructure, should play a vital role in meeting the world’s growing energy needs. Global gas consumption could increase by more than 2 per cent a year during the next quarter century, and most of that consumption will be for power.

Natural gas will have to cross borders as most countries become increasingly dependent on imports. The European Union (EU) could be importing 80 per cent of gas by 2030. Inter-regional gas flows could grow nearly threefold. Most of the additional gas is likely to come from the Middle East, Russia, the Caspian and North Africa, but other suppliers will also achieve significant growth. Qatar, Nigeria and Australia will account for a major share of the expansion in liquefied natural gas (LNG) supplies.

The challenge for this industry is clear: to produce much more gas, and to deliver it to many more customers over much greater distances. We can do this, through bigger and longer pipelines, by delivering gas in the form of LNG or other liquid fuel. Long-distance pipeline supplies will become increasingly important, particularly for Europe.

When it is finished next year, the 1,200-kilometre Langeled pipeline will be able to carry 20 billion cubic metres (bcm) a year of gas from Ormen Lange to the United Kingdom and will be the world’s longest subsea pipeline. The North-East Gas pipeline is being designed to carry more than 27 bcm a year – in due course, perhaps twice that – from Russia to Europe under the Baltic Sea. And the proposed Nabucco pipeline could bring 25 bcm of gas a year from the Middle East and Caspian region.

The LNG business is growing and globalising quickly. At Shell, we believe that through 2020 LNG demand could increase by as much as 10 per cent a year. By that time supplies from more than 25 countries could be meeting one-fifth of the world’s gas needs. We are on track to meet our own target of 14 per cent average annual growth in our LNG production capacity from 2004 to 2009, with many opportunities for continued growth.

The expansion of LNG has been driven by its increasing cost competitiveness. For example, the recently completed Qalhat LNG train in Oman was finished at an engineering, procurement and construction cost of less than $150 per tonne of annual capacity, probably the lowest ever.

LNG has become competitive with onshore pipelines in simple terrain covering as little as 1,800 kilometres, and it is always a better choice beyond 4,000 kilometres. LNG is competitive with offshore pipelines at a distance of at least 1,500 kilometres.

LNG also has a proven record of reliability. For example, since starting operations in the early 1970s, Brunei LNG has not missed a single cargo. And LNG is becoming increasingly flexible, with diverse suppliers, greater market access and increasing liquidity. China joined the growing list of importers this spring when the first cargo reached the Guangdong terminal from Australia.

The spot market now accounts for about 10 per cent of LNG sales. But most LNG will continue to be sold under long-term contracts, which are needed to underpin highly capital-intensive projects and provide security for customers. This shared need of suppliers and consumers for security – given that demand and supply are two sides of the same coin – is equally true for long-distance pipelines.

Gas-to-liquid (GTL) technology is now emerging as a commercial option. At Shell, we believe strongly in its potential and have been pursuing this for more than three decades. Our proprietary technology was developed in Amsterdam, at the Shell laboratory on the IJ River.

With a decade of operational experience at Bintulu in Malaysia, we hope to make a final investment decision on the major Pearl GTL plant in Qatar this year. It is designed to produce 140,000 barrels a day of GTL products, plus more than 100,000 barrels a day of natural gas liquids. Bintulu has also enabled us to develop markets. We are already selling GTL blends in seven countries.

GTL meets increasing demand for high-quality, clean transport fuels. GTL also has the great advantage that, unlike major gas supply projects, it serves a liquid and unconstrained market. According to the International Energy Agency, it could account for 2 per cent of the world’s oil supply by 2030.

The technology can also be used to produce similar high-quality fuels from coal and biomass.

Challenges

Economic. What are the economic challenges? Unlike oil in transport, natural gas does not have a monopoly of its key power market. It has to compete with coal, oil, nuclear and renewable energy.

The many advantages of gas – lower capital costs, efficiency, cleanliness and fewer carbon emissions – have driven rapid expansion in gas-fuelled generation. While the scope for fuel switching is limited, very high gas prices could prompt power investors to consider alternative fuels.

In Europe the link between oil and gas prices is sometimes questioned. But it provides essential security for investors in the very large infrastructure projects on which long-term supplies depend.

Open and transparent markets are the best way of ensuring that prices reflect the economic fundamentals. Storage and balancing suppliers like Groningen help to damp volatility.

With increasing flexibility in the LNG trade, along with the rapid growth of U.S. demand, the connection between prices in different regions is strengthening. But I do not expect to see a global gas price anytime soon.

Technological. Let me turn to the technological challenges of finding, developing and delivering the gas to meet this growing demand.

Gas resources may be relatively abundant, but that does not mean they are easy to develop – as the Sakhalin II development and the planned Shtokman project in Russia graphically illustrate.

We will increasingly have to find and develop supplies:

in harsher conditions, such as Arctic seas and ultra-deep water in more difficult geology, such as deeper, more complex and tighter formations from gas contaminated with hydrogen sulphide and carbon dioxide from unconventional sources such as coal and shale. This means applying better technologies in larger, more demanding, more integrated projects, often in remote and sensitive locations.

Recognising and responding to social and environmental concerns will be an essential capability. I know from my own experience that resolving these complex issues, which involve differing perspectives and interests, will never be easy. We learn from experience how to approach them better. The cost of equipment, contracting and materials for these projects is increasing rapidly. This reflects the very high activity rates in the industry, as well as more general inflation in areas of rapid economic development.

Developers will look hard for ways of reducing project costs, but they may also hold back some projects, as we have said we will probably do. At this time, gas has to be delivered competitively over much longer distances.

Bigger LNG trains and ships should continue cutting the cost of doing this. Qatar recently ordered six LNG tankers with a capacity of 265,000 cubic metres, 75 per cent bigger than the largest operating today. There are also technological advances in pipeline laying, although big pipelines are particularly affected by very high steel prices.

Gas-to-liquid plants are as complex as a major refinery, and we certainly don’t underestimate the challenge of progressing to a much larger scale. That is why we are taking our time with preparing Pearl GTL, to make sure we take into account all the lessons learned.

Commercial. Because of their scale and market impact, major gas projects face commercial challenges even when demand is growing rapidly. For example, when we gave the go-ahead for the Sakhalin LNG project, its capacity was nearly one-tenth of the demand in the Pacific basin.

The challenge for developers is to put together the complex chains from reservoir to customer – upstream, liquefaction, shipping, regasification and sales – in dynamic and competitive markets. This requires deep knowledge of the market, the trust of customers and the courage to invest early in strategic infrastructure.

Long-term purchase contacts have now been sold for virtually all the Sakhalin output. As well as deals with traditional Asian customers, we have invested in developing market access to North America.

An important change in the LNG business has been the increasing market role of major companies, with the capabilities to commit to long-term gas purchases for delivery to their own customers. This supports the development of new liquefaction capacity and helps to optimise global trade for the benefit of both customers and producers.

Political. Finally, the rapid growth in the international gas trade presents great political challenges.

There is much concern for security of supply. This is understandable as import dependency increases and energy prices become more volatile. But it should always be seen in the contexts of investment and security of demand.

Resource holders – and those who invest large sums and effort to develop gas projects – need to be as sure about their access to markets as customers must be about the security of their supplies.

The gas business, with its very high capital requirements and limited flexibility, depends on shared interests and mutual trust. This has worked very well. Russia, for example, has been a very reliable gas supplier to Western Europe for more than 40 years, despite the political divide for many years.

Governments have a vital role in ensuring that there exists a transparent, predictable and secure framework that allows suppliers to invest and customers to make commitments. As our experience in the Netherlands shows, this does not in any way prevent governments from ensuring that natural resources are developed, and markets are operated, for the benefit of their people.

Knowledge and Relationships

While the role of natural gas is poised to grow very strongly, we face significant challenges in bringing this about:

Finding and developing the required gas – from more difficult resources than those tackled previously – will be a continuing technological challenge.

Executing larger-scale, more complex and increasingly demanding projects will take great financial, technological and managerial strengths.

Delivering competitive supplies to customers over longer distances, and in volatile and unpredictable global markets, will require superior commercial capabilities.

I believe the two key requirements for success will be harnessing knowledge and building relationships.

By knowledge I mean the technologies, organisational capabilities, and individual skills and qualities necessary to undertake such challenging work.

There are many sources of technological advance: academia, small companies, other industries and the major energy companies. But it takes a deep understanding of the operational and business context to recognise and realise their possibilities.

The capabilities to apply these advances effectively, integrated with many other technologies, are best developed by wide experience. All this depends on attracting, developing, motivating and deploying people with the expertise and judgement to face up to the challenges. Last year, Shell recruited over 2,700 new, high-quality graduates and experienced professionals from around the world. We need them to seize the opportunities we have ahead of us.

I believe international companies have a particular role in harnessing the knowledge to meet those challenges because of our technological depth, our worldwide experience and the fact that we live or die as businesses by our ability to do so.

Of course, we are not the only ones who can do this. For example, no company has more knowledge of developing and operating long-distance gas pipelines than Gazprom. That is why we need to pool our knowledge in strong partnerships, which have always been a feature of this industry – because of the scale of the challenges and because a global trade requires strong links.

That is why building relationships is so important. I believe these relationships work best when companies invest as partners and have a shared interest in harnessing their knowledge to achieve success.

That is why openness to foreign investment is so important, and arbitrary barriers so damaging.

I know that our business in Shell depends on the many strong relationships, with partners and customers, we have built up around the world. We work constantly to build and sustain such relationships by demonstrating that we add real value in overcoming challenges and expanding possibilities.

I believe open trade remains vital both for the world’s continued economic development and for binding us together. Nowhere is this more important than in the gas trade, which can play such a vital role in meeting the world’s energy needs while helping to reduce carbon emissions.

Despite all the challenges, I have no doubt that the future is gas.

Jeroen van der Veer is chief executive of Royal Dutch Shell plc. He was a managing director of Royal Dutch Petroleum from 1997 until the unification under Royal Dutch Shell in July 2005. He joined Shell Nederland in 1971 and worked in the manufacturing and marketing units based in the Netherlands, as well as Cura�ao and the United Kingdom. In 1984 he returned to Shell Nederland as manager of Corporate Planning, and then of the Pernis refinery. After an assignment with Shell International, looking after Africa and Canada, he became a managing director of Shell Nederland in 1992. Four years later he was appointed president and chief executive of the Shell Chemical Company in the United States.

Mr. van der Veer was born in Utrecht, the Netherlands, and is married and has three daughters. He has a degree in mechanical engineering from Delft University and another in economics from Rotterdam University. In 2005 he was awarded an honorary doctorate from the University of Port Harcourt in Nigeria. He is a non-executive director of Unilever and serves as a member of the organization’s nomination and remuneration committees.

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