natAmenrica and thez Carib bean Teclhnical ]Department'' Report No. 1 World Bank Strategy for the Natural Gas Sector in LAC" by Chakid Khelil, Luis Gutierrez, Tom Joyce Infrastructure and Energy Division March 1991 Papers in this series are not formal publications of the World Bank. They present preliminary and unpolished results of country analysis or research that is circulated to encourage discussion and comment; citation and the use of such a paper should take account of its provisional character. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank. to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. WORLD BANK STRATEGY FOR THE NATURAL GAS SECTOR IN LAC, Table of Contents EXECUTIVE SUMMARY CHAPTER I: INTRODUCTION................ ....... . . . . . 1 CHAPTER II: THE ENERGY SECTOR IN LATIN AMERICA. . ............ . . . . 3 Energy and the Economy ................... . 3 Sectoral Energy Demand........... ...... . . . 4 CHAPTER III: CHANGES IN THE ROLE OF NATURAL GAS 1970-1987 AND PROSPECTS FOR THE YEAR 2000 . . . . . . . . . . . . . . . . . . . . . . . . . 6 Natural Gas Reserves . . . . . . . . . . . . . . . . . . . . . 6 Growth of Natural Gas Demand . . . . . . . . . . . . . . . . . 6 Interfuel Substitution . . . . . . . . . . . . . . . . . . . . 6 Demand Outlook for Natural Gas to 2000 *.. . .. .. . .... . 7 Natural Gas Supply Prospects by the year 2000. ........ . 7 Natural Gas Potential for Development. .......... . . . 8 CHAPTER IV: ISSUES WHICH HAVE CONSTRAINED THE NATUPAL GAS SECTOR DEVELOPMENT . . . '.. .. .. . .. . . . . . . .. . . .*. .'. . 11 Government View of Natural Gas in Energy Sector Planning . . . 11 Legal and Contractual Constraints . . . . . . . . . . . . . . . 11 Regulatory Constraints . . . . . . . . . . . . . . . . . . . . 12 Institutional Constraints . . . . . . . .. . * .. . .. .'. . . 12 Public Sector Enterprise Lack of Autonomy........ . . . .13 Lack of an Effective Planning Structure for Natural Gas . . . . 13 Political Uncertainties. . ............ . . . . . . 14 Interregional Trade............. ....... . . 15 CHAPTER V: MACROECONOMIC BENEFITS OF NATURAL GAS USE........ . . . . . .17 Natural Gas Pricing Policies Affect Benefits. ...... . . .17 Macroeconomic Benefits of Increasing Natural Gas Use . . . . . 17 Argentina . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Colombia.................. ...... . . . 18 Uruguay.................. ....... . . . 19 CHAPTER VI: STRATEGIC OPTIONS FOR NATURAL GAS SECTOR DEVELOPMENT... . . . . .20 Elements of a Sound Policy. . .......... . . . . . . 20 GovernmeLt Role in Developing Energy Policies...... . . . . 20 1 This report has been prepared by: C. Khelil (Chief Energy Unit and Task Manager, LATIE), L Gutierrez (Sr. Energy Economist, LATIE) and T. Joyce (Gas Specialist, Consultant). Ms A. Mashayekhi (Chief, IENGU), Mr. G. Schramm (Chief, IENED) and Mr. T.A. Byer (Principal Evaluation Officer, OEDD2) were the Peer Reviewers. -2- Government Regulatory Role.................. 2. Government Role as a Shareholder of Gas Companies....... 21 Private Sector Role . . . . . . . . . . . . . . ........ 22 Options for Financing Sector Development........... 22 Convertibility of Local Currency Earnings........... 22 Payments in Crude or Fuel Oil or Barter............ 23 Joint-Ventures........................ 23 Advance Purchase Contracts............ 24 Public Debt Purchase by Private Investors........... 25 Sales of Shares of Gas Utilities to the Public........ 25 Limited and Non-recourse Financing.............. 25 End Users Participation . . .......... ... . . . . . 25 CHAPTER VII: A PROPOSED STRATEGY FOR THE BANK . . ...... ... . . . . . . . 27 Bank Activities in the LAC Natural Gas Sector... . . . . . . 27 Potential for Natural Gas Projects.......... . . . . . 27 A Proposed Bank Approach to the Natural Gas Sector . . . . . . 28 Bank Interactions with Host Governments..........................29 Priorities for Bank Operations in the Gas Sector in the 1990s.................... . . . .. . 29 Techniques and Instruments for Bank Assistance toLC Countriescipa.tio.n ........ . . . . . . . . . . . 2.30 BO0XES Box 1 mportance of Natural Gas in AC ............................... 3 Box 2 : Major Issues facing the Natural Gas Sector ..................... 10 Box 3 Importance of Gas Sector in Bank Country Strategy.............. 26 Box 4 : Proposed Bank Strategy in Natural Gas Sector ................... 31 &NNEXES Annex 1 Industrial Energy Prices ....................................... 33 Annex 2 : Status of the Natural Gas Sector in LAC Countries..............34 Annex 3 : Potential Natural Gas Sector Projects in LAC ................... 37 References ...............................................................38 Maps .....................................................................39 WORLD BANK STRATEGY FOR THE NATURAL GAS SECTOR IN LATIN AMERICA EXECUTIVE SUMMARY Introduction 1. The purpose of this paper is to propose a Natural Gas (NG) strategy in the Latin American region aimed at eliminating policy, legal and regulatory barriers that currently inhibit the use of this fuel, consistent with the policy objective of achieving a reliable and economic energy supply mix. In order to do this, it is necessary to examine the potential role of NG in the energy balance taking into account its availability and economic importance relative to other fuels; and to analyze the issues which have constcained the NG sector development in the past and evaluate the strategic options available to the countries in the region (maps) for overcoming the obstacles and developing the sector. Conclusions and Recommendations 2. There are large proved natural gas reserves in LAC and, even larger potential reserves to be found. Even though preliminary indications point out that the economic supply costs of NG are competitive with substitute fuels, the contribution of NG to energy requirements in LAC is below its economic potential. While natural gas is beginning to play an important role in satisfying the energy requirements in 9 countries (Argentina, Bolivia, Brazil, Chile, Colombia, Mexico, Peru, Trinidad and Tobago and Venezuela), its increased use would require the implementation of several new projects in field development, transmission and distribution not only in these countries but in other countries where NG plays a negligible role such as Ecuador, Uruguay and Paraguay. These investments required by these projects will provide opportunities for: (i) the private sector to participate; (ii) the public sector to reduce public investment and raise fiscal revenues; and (iii) the Bank with new lending opportunities. 3. The development of the natural gas subsector should be given the same emphasis as power and petroleum in the Bank energy strategy. This is the central conclusion of this study. This sector offers the Bank a wide ranging policy dialogue with Governments on some of the major issues which constrain economic development in Latin America in terms of a more efficient use of resources, promotion of private sector participation, improving the balance of trade, macroeconomic adjustment and environmental improvement. Natural gas can contribute in this direction because it : (i) is a potentially low cost energy source which can displace exportable fuels or generate import savings with a positive impact on public sector investments, deficit and debt; (ii) could be exported and is generally accompanied in its production by high value petroleum liquids; (iii) provides opportunities to promote trade liberalization; (iv) can help private sector involvement thus reducing the relative size of the public sector and fostering competition; and (v) is a clean and efficient fuel. (i 4. The proposed Bank strategy in the natural gas sector should be underpinned by a continuous policy dialogue on broad issues on trade, labor legislation and taxation, and by more focused energy sector issues dealing with least cost sector development, legislation, pricing policies, regulatory functions and organization, institutional development and the environment. In addition to energy sector studies, the Bank should provide assistance in specific areas : petroleum/natural gas legislation, investment legislation for promotion of private sector participation, sectoral interrelationships (i.e. gas use in power, industry, commerce, household, intersectoral pricing relationships), natural gas cost and tariff studies and sector regulations. Lending operations should be tailored to strengthen deregulation of the sector, promote the private sector, restructure public enterprises, and rationalize Government sector policies (regulatory, pricing, environmental, etc.). The proposed Bank strategy should be disseminated to all staff, regional organizations and borrowers. 5. The Governments in LAC play an important role in the gas sector, being the policy makers, regulators and in some cases the sole shareholder in natural gas public enterprises. The natural gas sector is dominated by public enterprises that manage -oduction, transmission and distribution. Except in three countries, the pivate sector is playing an important role in the exploration and production of natural gas and a minor role in transmission and distribution activities. In these countries, the Bank effort should be oriented to further private sector involvement and reduce Government intervention and public sector involvement through adequate legislation, contracts and regulations and appropriate energy pricing policies. In most other countries, where natural gas is under strong Government control, the Bank strategy should seek, on the one hand, a Government commitment to move towards private sector involvement in the sector and, on the other, the necessary legal and regulatory changes to implement the opening of the sector to private investors. 6. Regarding the Bank's resources, the LAC region in the Bank has been able to field missions in the past to carry out energy sector studies (Brazil and Argentina). The teams consisted of Bank staff who provided the intellectual leadership, complemented by local and international consultants. In both cases, an experienced gas consultant addressed the issues of costs, tariffs, regulations, and exploration/production contracts. Since the completion of this work, a Gas Unit in the Bank has been staffed with special experts, providing assistance supported with external consultants to carry out studies on gas regulations, tariffs, contractual issues and gas sector development. In the case of three ongoing lending operations, the required gas expertise came from outside consultants and Bank staff. Based on these experiences, the Bank's regional staff with support from outside consultants and the Gas Unit should be able to meet the work requirements foreseen for the near future in the gas subsector. Issues 7. The major issues facing the natural gas sector are : the poorly defined role of natural gas in energy and power sector policy and strategy, the lack of a clear legal and contractual status for natural gas, the unclear roles of the public and private sector companies, the lack of a rational and predictable intersectoral energy pricing policy, the weakness of public companies and the inadequate government institutional capacity to develop policies and regulate the sector. The objective of a country's energy strategy is to provide the economy with a least cost and reliable energy supply mix. The energy strategy in many LAC countries is usually not explicit about the role of natural gas in meeting this objective and consequently does not provide an adequate policy snvironment and proper economically efficient incentives to encourage investments in the sector. 8. While production and other upstream operations resemble the petroleum sector, transmission and distribution of natural gas are public activities that operate like power utilities. As a result the legal and contractual status of natural gas is poorly understood by the LAC countries. Risk petroleum contracts, for instance, do not include adequate provisions for natural gas pricing and marketing. 9. The main reason why natural gas penetration in the anergy markets has been slow is the government's control over pricing of petroleum products, coal and electricity. In Venezuela, the industrial consumer pays the equivalent of US$ 1.38/bbl for natural gas; in Brazil, 1.92; and in Colombia 3.84, far below the prices of competing fuels. But these low prices also are a strong disincentive to the private and public sector to develop or expand gas infrastructure. 10. The existing institutional structure is generally inadequate to encourage development of natural gas. In some cases, responsibility for the sector is divided among several agencies, some of which have conflicting interests. In addition to being the policy maker and regulator, the government may also be the sole shareholder in the gas company. As a result, companies operate with severe limits on their autonomy due to constraining labor laws, energy pricing policies and interference by other government agencies. 11. Finally, interregional gas trade has been slow to develop mainly because of the conflicting policy objectives of fuel import substitution and of trade liberalizatior (required for gas imports). Presently, the energy strategy of Latin-American countries lacks a regional Zocus, but with the severe constraints on public investment foreseen, expansion of natural gas trade should be important within and outside the region. Economic Benefits 12. The macroeconomic benefits from increased use of low cost natural gas include the reduction in the cost of energy to the country; improvement in the balance of payments due to import savings and/or export revenue increases and reduction of public sector debt (when the private sector participates). An analysis made for Argentina shows that the cost of energy to the economy could be reduced by about US$ 700-900 million (1987 US$) over the period 1987-2000 due to the lower cost of locally produced natural gas as compared to the cost of the replaced fuels. The balance of trade would improve by US$ 130-530 million over the same period because of the exports of the released fuels replaced by natural gas. 13. The microeconomic benefits stem from the convenience and environmental benefits of natural gas and its lower economic cost than competitive fuels. As (iii) a result, one conclusion is that even if the economic cost of natural gas and the competing fuels were the same, the user benefits from expanding the energy supply with natural gas would be larger than expanding it without natural gas. The other conclusion is that, if tational energy pricing policies are in place, the lower economic cost of natural gas would translate into lower end-user prices for energy which would expand demand, providing the economy with additional benefits. Strategic Options 14. The energy strategy should aim at establisiing an environment of open competition and equal opportunities for public and private companies in all areas of exploration, production, transportation and marketing of natural gas, while ensuring the national interest is protected with a minimum of regulations and controls. Government policy decisions should be limited to : developing a national energy policy and strategy, setting the legal/contractual requirements for public and ,rivate enterprises an(' promoting investments in natural gas development. The regulatory agency ahould be responsible for approving tariffs for natural gas sale based on agreed and transparent criteria reflecting full economic costs, including incentive payments for risk taking and adequate returns on capital regulating access and transport tariffs of pipelines, ensuring public safety and monitoring performance by public sector entities. 15. While the publi sector enterprises should have full technical, administrative and financial autonomy, the role of the private sector in natural gas sector development should be well defined. In particular the private investor should have the right to sell gas to third parties and the right to build and own pipelines. There should be a .lear definition of the right by producers to expoLt gas and special terms that would encourage development of marginal fields. 16. Foreign private sector involvement in natural gas development can only be encouraged if a solution is found to the problem of securing payments in convertible currencies if natural gas is used for domescic consumption. There are many avenues which could be explor,d such as commodity payments (crude or fuel oil) or even barter deals. Innovative financing arrangements could also be found through joint ventures, public debt purchases by private investors, advance gas or gas liquids purchase contracts, sales of shares of gas utilities to the public, limited and non-recourse financing and end-users participation in infrastructure construction. Doc: EXSUM 12/19/90 (iv) WORLD BANK STRATEGY FOR THE NATURAL GAS SECTOR IN LATIN AMERICA I. INTRODUCTION 1.1 An adequate supply of reliable pricing structures which subsidize and low cost energy is essential if competing fuels, and lack of a proper the LAC countries' goals for economic institutional framework have all recovery and development are to be played a role in slowing sector realized in the 1990s. Most growth. If natural gas is to reach countries have had to import its full potential, these barriers petr.leum products to meet domestic must be eliminated. A sound natural and industrial energy needs and have gas sector policy must include an invested vast sums to develop adequate legal, fiscal, regulatory, hydroelectric and crude oil contractual and institutional resources. These expenditures have framework which will encourage strained public sector financial development, properly allocate resources, aggravated budget deficits resources, encourage private sector and increased the external debt participation and ensure the burden of most LAC countries. But financial integrity of the sector. natural gas (NG), which is available in commercial quantities in.ten LAC 1.3 Given its role in financing countries, has been effectively development projects and sector developed in only four. Natural gas, strengthening in Developing an environmentally clean fuel, can Countries, the World Bank could play replace most of the liquid fuels an important role in sector consumed in the residential/ development in Latin America but thus commercial, industrial and power far its involvement in the sector has sectors. It can replace electricity been limited. The Bank's guidelines for cooking and water heating and presently applied to natural gas consequently reduce liquid fuel sector lendingi (see references) imports, and/or release fuels for deal in great detail with the export. Should international energy exploration and development of prices remain high, the economic natural gas as well as the required burdens imposed by the present energy infrastructure for its transport and mix will become even more onerous, distribution. In most cases these making low cost natural gas an account for the larger portion of the increasingly important component in investment, and the economic and the energy balance. institutional issues involved are more similar to power sector issues 1.2 Several obstacles have impeded than those related to oil development natural gas development and market projects. The purpose of this paper penetration. Lack of an energy is to propose a natural gas strategy policy which do not discriminate aimed at eliminating policy, legal against natural gas; lack of and regulatory barriers that technical capability to develop the discourage the development and use of resource; lack of legal, contractual this fuel, consistent with the policy and commercial frameworks, which objective of achieving a reliable and would encourage investment; arbitrary economic energy supply mix. First it -2 - is necessary to determine the The maps (attached) show projected potential role of NG in the energy gas transmission lines to be built. balance, then the technical, economic Except for the Santa Cruz-Saa Paulo, and institutional factors which have Argentina/Chile, Cuzco-Lima and hindered the use of natural gas; to Buenos Aires/Montevideo transmission identify the strategic options the pipelines, the other projected lines LAC region- -and each country- -has for w-3uld only be justified if larger overcoming the obstacles and reserves are confirmed and markets developing the sector; and to expanded. This study does not focus recommend a natural gas strategy on liquid hydrocarbons such as LPG which the World Bank could adopt to and condensates which are extracted encourage appropriate sector from natural gas. development in LAC. 1.5 The study is presented in five 1.4 Commercial quantities of parts. First, the growth of the natural gas have been discovered from energy sector in LAC is reviewed and Mexico to Tierra del Fuego so there the impact of increased natural gas are both national and regional use on factors such as economic prospects for sector development. growth; foreign exchange balances; The countries with exploitable and public sector deficits is reserves include Argentina, Bolivia, examined. Second, bottlenecks which Brazil, Chile, Colombia, Ecuador, have slowed the use of natural gas Mexico, Peru, Trinidad and Tobago, are analyzed. Third, the costs and and Venezuela (Maps). Uruguay, benefits of using more natural gas Paraguay, as well as the Central are evaluated for selected countries American countries, have no known where natural gas could play a indigenous gas resources but they are significant role. Fourth, the strategically located to import strategic options for sector natural gas. Therefore, their roles development are reviewed. Finally, in regional developments is examined. based on these analyses a World Bank At present, the only international strategy to assist the LAC countries pipeline is between Bolivia and in developing the sector is proposed. Argentina but other regional pipelines have been proposed. There is significant development potential in the Southern Cone region (Argentina, Brazil, Chile and Bolivia) as well as other regions. -3- IMPORTANCE OF NA TURAL GAS IN LATIN AMERICA LARGE PROVED RESERVES: n6300 BILLION M3 REPRESENA S OF WORLD RSERVES HIGH PRESENT LEVEL OF SUPPLY EQUIVALENT TO 75 YEARS AT PRESENT RATE OF CONSUMPTION. YET SUPPLY LEVEL COULD BZ THREE TIMES THAT MUCH BECAUSE: INDUSTRY STANDARDS REQUIRE RESERVES TO ENSURE NLY 20-YEARS SUPPLY REI4TIVELYLTTLs FZPLORATION AND DEVELOPMENT ACTIVI1Y THE REGION HAS ONLY ONE EXPLORATORY WELL PER 1000 Iaf OF SEDIMENTARY BASIN VERSUS 80IN THE USA, 10 IN THE USSR AND C4NADA; AND 61N WESTERN EUROPE. RE8IAINING RESERVES ARE ES77MATED TO BE: - 17-20000 BILLION M3, I.E., TRIPLE THE PRESENT PROVED RESERVES LEVEL II. THE ENERGY SECTOR IN LATIN AMERICA Enerqy and the Economy 2.2 LLe relatively rapid growth of energy consumption conceals important 2.1 In LAC, energy consumption and differences in the demand for the economic growth have grown side by different fuels. Not all fuel uses side. When GDP grows energy grow at the same rate. Several consumption tends to grow as well. factors affect fuel demand in However, the energy curve is different manners: relative prices, generally above the GDP curve, convenience, ease of use in indicating that when incomes fall, consumption, availability, strategic energy consumption also declines but considerations, environmental less so, because of previous concerns, level of development, etc. investment by users in equipment and The most important reasons why appliances. On the other hand, when natural gas is favored above all GDP increases energy consumption other fuels, is its convenience and grows faster. The LAC economies price. Perhaps the reason why NG has generally grew faster during the not played a more important role in 1970s (5.0%) than during the 1980s the past is because policy. legal and (1.5%), and in both periods the pace regulatory deficiencies have not of energy consumption was faster, permitted the availability of NG to 6.3% and 2.8%, respectively. final users. -4- 2.3 The two oil price shocks of price of oil led to some important 1973 and 1979, and the precipitous indirect effects in other parts of price decline in 1986 lead to several the economy. The deterioration in changes in energy consumption the terms of trade, the plunge in patterns. The immediate effects on borrowing power, the decline in the oil importing countries of the public expenditure and the mounting price increases were inflationary social and political pressures lead pressures and balance of payment to a drive towards eff'ciency. problems. This led many of them to Although the decade of the 1980s was implement energy conservation and the lost decade (as commonly called), diversification policies dep'gned to where little, if any, per capita reduca domestic dependence o. foreign economic growth occurred in LAC, it oil. Several Governments delayed to was also a decade when the first pass on the oil price increases to steps were taken toward improving users, opting to subsidize energy policies. Several Governments consumption through deficit financing in the region began implementing and foreign borrowing. Other rational energy pricing policies, countries did pass on the price promoting sounder management increases while fostering development practices, searching for investment of domestic energy supplies, but did efficiency and encouraging private so with little regard to relative sector participation. prices and opportunity costs. The policies were based more on strategic Sectoral Energy Demand considerations. Thus, after many years of inefficient pricing and 2.6 Industry and transport are the diversifi-cation policies, many largest users of energy, each one countries in the region are now accounting for about 38% of facing the consequences in the form consumption in 1987, while the of higher inflation, lower residential/commercial sector consumption and investment levels, accounts for 23%. The rate of growth balance of payment problems and of industrial demand was 7.9% from inefficient energy use. 1971 to 1980, and 3.0% from 1980 to 1987. This meant that its share 2.4 The oil exporting countries increased from 35% in 1971 to 38% in (Venezuela, Mexico and Ecuador), on 1987. This sector, as one would the other hand, began huge public expect, is more sensitive to economic investment programs during the period conditions. Thus, the apparent of high oil prices, with little, if income elasticity of industrial any, regard to efficiency considera- consumption was 1.6 and 2, for both tions. During the succeeding period periods respectively, higher than of weak international orices and most of the other sectors. rising interest rates, while the Residential/commercial energy importing countries had a lower consumption grew at 6.7% per annum in import bill and lower inflationary the former period, and 3.6% during pressures, the exporting countries the later. The rate of growth in the had to meet rising domestic and transport sector, on the other hand, foreign expenditures with lower oil was the lowest, growing at 6.0% and export revenue. 2.1%, respectively. (See Table 1). 2.5 Given the commanding role of 2.7 During the 1980's power sector the energy sector in the economy, the nuclear generation grew at a fast drastic changes in the international pace in eAi (17.8% annually) because -5- Rates ofjGrowth mlastic,ties IM 1_8_ 1" IM'. 12L7'. Z 8IM 087 7-80 L0 :7. y..Els 12487. 167673 228120 250896 260084 272838 6.9% .2.6" 1.4 1.7 Coat S038 6150 8695 12544 I2304 13087 .6.3% <6.0% 1.3 4.0 oft 98463 129136 167002 167834 176131 181916 6.0% .1.2% 1.2 0.8 Natural Gas 9729 15882 26237 36181 35206 39494 11.7% 6.0% 2.3 4.0 Hydro/Other 11647 16505 26186 34337 36443 38341 9.4% 5.6% 1.9 3.7 By Segorst 120651 161856 219195 242352 251235 265553 6.9% 2.8% 1.4 1.8 Industry 42286 59136 84131 96775 97911 103491 7.9% 3.0% 1.6 2.0 Transport 51728 68848 8731? 90058 95294 100725 6.0% 2.1% 1.2 1.4 Res./Com. 26637 33872 47747 55519 58030 61337 6.7% 3.6%. 1.3 2.4 NG Msectors 14683 22804 36073 48631 48124. 47400 Industry. 7750 13261 22588 30372 28772 -26842 12.6% 2.b% 2.5 1.* transport3 18 17 36.6% N1.A. Re/Cms. 1980 262 3649 5806 6416 5986 7.0% 7.3% 1.4 4.9 Power 4953 6922 9836 12450 12918 14555 7.9% 5.81 1.6 3.8 Total GDP 1986 ust 523759 665735 812234 845590 878544 901650 5.0, 1.5% Table 1: Energy Consumption in IAC, Millon tons of Oil Equivalent (MTOE) it started at a very low level (See in 1971 to 65% in 1987 due to a Table 2). Coal generation maintained higher growth rate in in 71-80 a rapid growth rate of 12.8% p.a. period. Oil, on the other hand, All of the electricity generation experienced a steady decline from 32% from other fuels was in the single of total electricity generation in digit range: hydroelectricity at 1971 to 24% in 1987. Natural gas 5.8%, natural gas at 4.7% and oil at stayed basically constant around 9% 3.8%. However, the hydro share of Rates of Growth Generatfon by Fuets 198 j 0. 1985 1 j j q- 80-8f Cost: 4949 4030 7023 13515. 17062 16321 4.01 17.8% . OfL 52398 66090 96430 96887 112130 124968 7.0% 3.8% Natural Gas 14616 19091 30146 37601 38284 41547 8,4. 4.7% Nuclear 2517 2340 8866 5835 7365 -1.4% 17.8% Hydro/other 88963 133496 222288 313452 323055 330091 10.7% 5.8% Total Generation 160926 221194 351204 456806 479304 503971 9.1%. 5.3% Table 2: Fuels Used in Electricity Generation (GWh) generation still increased from 55% of total electricity generation during the period. [II. CHANGES IN THE ROLE OF NATURAL GAS 1970-1987 AND PROSPECTS FOR THE YEAR 2000. Natural Gas Reserves residential/commercial sector energy use grew 5.2% per year while natural 3.1 The natural gas reserves of gas use increased 8.1% per year; Latin America have grown considerably industrial energy use increased 5.8% since 1970. Thanks to discoveries in annually and natural gas, 9.1%; Mexico, Argentina, Bolivia, Colombia, primary energy used for power Trinidad and Chile, and recent generation grew 6.9% annually and additional discoveries in Venezuela, natural gas, 7.6%. As a result, the Brazil and Peru, a number of major natural gas share of the combined gas regions are emerging in Latin markets grew from 18% in 1971 to 22% America. With more than 6300 billion in 1986. The status of the natural m3 of proved reserves, the region has gas sector in each of the producing 6.5% of the total world reserves but countries is described in Annex 2. markets only 4% of the world's production. The reserves of the Interfuel Subststution region in 1987 were sufficient to meet current production for 75 years 3.3 The overall growth of energy compared with the acceptable industry consumption conceals the very standard of 15 to 20 years. With important pattern of interfuel such high level reserves, the region substitution which occurred as a appears to have considerable scope result of the two oil price shocks for expanding gas use. Ultimate during the early 1970's and 1980's. remaining natural gas resources have As shown in Table 3, except for been estimated2 at about 17-20,000 alcohol which has a specialized billion m3, i.e. more than 3 times market in Brazil, in markets where the present level of proved reserves. the fuel is used directly, natural The large potential in the region has gas use increased more rapidly than not baen matched by exploratory either coal or electricity, drilling. Only one exploratory well indicating that when consumers make has been drilled per 1000 km2 of the energy selection decision they sedimentary basin, compared to 80 are increasingly selecting natural wells in the USA, 10 in the USSR and gas over coal and electricity. Canada, and 6 in Western Europe. 3.4 While country by country Growth of Natural Gas Demand experience may differ somewhat, natural gas has tended to displace 3.2 Based on IEA3 energy data LPG and kerosene in the statistics, natural gas use has residential/commercial sector, fuel outpaced overall energy consumption. oil and coal in the industrial While final energy consurption in the sector, and coal and fuel oil in the region grew at an average annual rate electric power sector. Given the of 5.0% over the 1971-1987 period, cost and convenience advantages of natural gas consumption grew at 8.5% natural gas, it is expected that this per year. The growth in each substitution process will continue to consuming sector mirrors this underpin the growth of natural gas pattern . In the demand in the region. -7- 197 L731975 1977 1991" 94 96.18 DIRECTLY CONSUMED. ELECTRICITY (ALL SOURCES) 100 119 137 159 191 204 219 244 268 281 NATURAL GAS* 100 131 137 159 207 219 251 276 291. 314 COAL* 100 106 124 143. 160 165 170 208 237 249 ALCOHOL 100 137 172 283 991 1237 638 2791 3650 M.A. CONSUMED FOR POWER GENERATION: HYDRO/NUCLEAR ELECTR. 100 125 153 187 230 253 283 334 374 386 NATURAL GAS (ELECTRICITY) 100 118 140 146 195 199 219 234 261 294 COAL (ELECTRICITY) 100 98 83 105 129 137 166 209 274 283 FUEL OIL (ELECTRICITY) 100 115 137 165 .185 205 202 212 200 N.A. DIESEL (ELECTRICITY) 100 114 174 182 233. 242 201 171 140 N.A. ALL PRIMARY ENERGY 100 120 132 148 . 172 180 187 193 206 217 * For- aLL uses including as fuet for electric power generation. Source: International Energy Statistics (1989) TABLE 3. Interfuel Substitution in IAC economic use of natural gas Demand Outlook for vis a vis other fuels and Natural Gas to 2000 electricity. 3.5 An estimate' of the potential Natural Gas Supply Prospects market for natural gas and the demand by the year 2000 by the year 2000 has been made for each country based on a simple model 3.7 All the countries considered in which correlates energy demand by this study have large natural gas market sector with economic growth. reserves relative to current World Bank GDP growth projections consumption rates. As shown by Table were used and it has been assumed the 5, the reserves life, based on 1987 countries would be able to continue consumption ranged between a low of gas sector development as in the 32 years for Colombia to a high of previous decade (Table 4). 121 years for Venezuela with an average of 75 years for all 3.6 Demand is projected to grow countries. However, adequate from 47.4 MTOE in 1986 to 130 MTOE by reserves do not necessarily guarantee the year 2000. Natural gas will that supplies will be economic to still only provide 19% of the ensure development of the sector. combined residential/commercial, The reserves must be developed when industrial and power sector markets, required and the natural gas must be actually a decrease from the 22% distributed to consumers at market penetration achieved in 1986. competitive prices. In some On the other hand, natural gas countries the reserves may not be consumption would be only 37 % of the well located to serve important potential market. Consequently, markets economically. A case in there appears to be a large scope for point is Chile's reserves in Tierra the countries to promote greater del Fuego which cannot be -8- NATURAL GAS DEMAND SY THE YEAR 2000 ANM POTENTIAL 4ARKET CONSUMPTICK (MTOE) AND SNARE (% Country Residenta 1idustriat Potat Pot.* De. Pot. Dem. % Pot. De. X. Pot. Dem. X Argentina 11.3 8.5 60 8.3 7.8 72 6.8 6.8 24 26.4 23.1 43 BoLivia 0.6 0.05 5 0.8 0.8 85 1.0 0.1 12 2.4 0.9 34 Brazit 19.5 0.4 1 46.0 6.7 9 15.1 - - 80.6 7.1 6 Chile 0.9 0.3 19 1.9 0.1 3 0.6 * - 3.4 0.4 8 Colombia 2.4 0.3 5 5.5 2.8 40 4.9 4.9 22 12.8 8.0 23 Mexico 27,4 2.4 7 77.8 42.7 49 60.4 4.6 6 165.6 49.7 25 Pert 1.6 0.05 2 .2.4 0.7 21 1.4 0.3 .5 5.6 1.05. 9 . 4 - 6.2 6.2 93 1.8 .1.8 98 8.0 8.0 94 Veneaneta 4.7 0.5 6 25.6 25.6 80 18.2. .6 11 48.5 32.1 35 Total 68.6 12.5 11 174.5 93.8 42 110.2 24.1 7 353.3 130.4 .19 * Market which could potentialLy be satisfied by natural gas. Note4 The percentage is the percent. of the sector market which is estimated to be met 4fth natural gas, not the potential market for natural gas. Source: Reference 4 TABLE 4. Natural Gas Demand by the Year 2000 and Potential Market Consumption and Share economically transported to the major Mexico, non-associated (higher cost), markets in the Santiago area. A more i.e., Bolivia and Colombia or a mix, detailed study of the reserves that i.e., Argentina and Venezuela. Given takes into account the distribution, the lower economic cost of associated size of reserves and geographical and non-associated natural gas as location with respect the major compared to the fuels it can replace, markets would be required to the prospects for developing establish the economic reserve. additional supplies are good, despite the uncertainty of oil prices. Natural Gas Potential for Development 3.9 The data on gas reserves were 3.8 The estimated economic cost5 obtained either from the official of natural gas delivered to agency in each country or from industrial consumers in 1990 is studies conducted by internationally $0.58/MMBtu in Venezuela; $1.13/MMBtu known consultants.' Estimates of in Argentina; and $1.34/MMBtu in additional reserves (Annual Additions Brazil, whereas the international in Table 5) yet to be discovered were price of heavy fuel oil is $2.00- based on historical correlations of $2.50/MMBtu (based on an oil price of reserve additions. The international $15-19/bbl). The cost of gas depends oil and gas companies will step up on whether it is associated with oil their exploration efforts and the (lower cost), i.e., Brazil and rate of reserve additions could be .9- NATURAL GAS SUPPLY REQUIREMENTS, RESERVES LEVEL (BCN)* AND LIFE (YEARS) Country S*ply Reserves Reserves/Supply (DotiM RatfooLife YgMrs 1987 2000 Annual :1987 2000 1987.. 2000 Additions ArgentinaCi) 20.7 31.2 15.2 682 542 33 17 Bolivia (2) 2.4 3.5 2.9 144 143 41 41 Bolivia(3) 2.4 5.9 2.9 144 128 41 22 Brazil 3.2 11.7 10.8 106 107 33 90) Chile 0.2 0.5 1.4 142 156 710 312(7) Colombia 3.4 10.7 3.0 109 56 32 5(4) Mexico 27.4 73.4 88.0 2166 2655 79 36 Peru 0.7 1.3 15.4 24 211 346). 162(6) T & T 4.9 1 .5 5.9 297 267 61 23 Venezuela 21.8 61.t 217.4 2646 4933 121 81 Tot6t $4.7 '215.6 360.0. 6316- 9266 75 43 Ofttlion cubic motersR of naturae gas. 1. .This case-essumes.imparts from-SoLivia would continue beyond 1992 but doer not incLude 2. possible exports to-either Brazil or-Chile. 2- This case-includes present-exports to-Argentfna but not to Brazil.- 3. This case.-assumes- equal volu.mes of exports to Argentina and Brazil. 4. This level of life of reserves is not consfdered adequate by industry standards. 5. Does-not include Camisea gas field. 6. RncLudesafCamisea-reserves.. 7. eincluded. TABLE 5. Natural Gas Supply Requirements, Reserves Level and Life much higher than is projected in this to do-velop natural gas and to paper if the incentives (see Section consider imports. However, in light IV) they receive are improved. The of the huge potential market in LAC projected supply includes gas which countries (Table 4), and the strong is flared, reinjected or used in likelihood that natural gas use will petroleum production and refineries, be expanded, all of the countries As shown in Table 5, in 2000 the should develop a strategy to expand average reserve life for all the their natural gas reserves to countries would be 43 years. The maintain a life of at least 20 years reserve life will still be very high by encouraging investment by the only in Chile, Peru,Venezuela and private sector. Mexico and these countries should, in Addition to maximizing internal use of gas, evaluate other options such as exports. On the other hand, Brazil and Colombia mey find their reserve life is very short. it will behoove them to increase incentives - 10 - MAJOR ISSUES FACING THE NATURAL GAS SECTOR 0 NATURAL GAS ROLE IN THE VARIOUS COUNTRY ENERGY POLICIES IS NOT CLEAR . PRODUCZ1ON AND OTHER UPSTREAMFOPERATIONS RESEMBLE TBE PETROLEUM SECTOR BUT TRANSMISSION AND DISTRIBUTION-ARE PUBLIC UTILITYACTIVITJES SO THE LEGAL STATUS IS POORLY DEFN WED; POTENTIAL ROLE IN METING COUNTRS ENERGY NEEDS NOT USUALLY WELL APPREClATED;: o NATURAL GAS ROLE IN INTERREGIONAL. TRADE NOT PROPERLY ASSESSED; o ROLE OF TZE PRIVATE SECTOR S NOr CLEARLY DEFINED; 0 PETROLEUM LAWAND CONTRACTS OFTEN DO NOT SPECIFY TERMS AND CONDITIONS FOR NATURAL GAS DEVELOPMENT, o PRICING OF NATURAL GAS IN RELATION TO COMPETING FUELS AND ELECTRICITY IS NOT PREDICTABLE; o REGULATORYAGENCIES LACK LEGAL FOUNDATION AND TECHNICAL CAPACITY TO MONITOR CONTRACTS AND PUBLIC SAFETY AND ENVIRONMENTAL STANDARDS. O PUBLIC"SECTOR ENTERPRISES LACI TECHNICAL, ADMINISTRATIVE AND FINANCILAUTONOMY; C ?UBLIC SECTOR ENTERPRISES LACK FLEXIBILITY TO ENTER JOINT VENTURES WITH PRIVATE SECTOR COMPANIES OR SELL SHARES TO THE PUBLIC. - 11 - IV. ISSUES WHICH HAVE CONSTRAINED THE NATURAL GAS SECTOR DEVELOPMENT Government View of Natural Gas In Eneray 4.3 The policy objective of a Sector Planninq rational energy strategy is to promote the provision of the least 4.1 In LAC the natural gas sector cost and reliable energy supply for has traditionally been treated as an the country. Given its low economic adjunct to the oil sector because cost in most LAC countries, natural natural gas is produced either in gas should play a well defined and association with oil (associated gas) important role in this strategy. The or separately as free (non- development of natural gas resources associated) gas. While upstream promotes diversification of the operations such as exploration, energy sources and reduces the production and processing are similar country's dependence on oil products. to oil operations and have a similar However, most countries have failed legal and contractual framework, to internalize all economic, social downstream operations such as and environmental costs of competing transportation and distribution to energy sources and have not taken consumers, are much more like utility into account the true cost of capital operations in the power sector. In required for competing projects. The particular, transportation and energy strategy is usually not distribution imply common carrier explicit about the role of natural utility-type regulations under terms gas in meeting the country's energy of a concession (franchise) to needs and does not incorporate the provide natural gas services to policies which will encourage private consumers in a geographically defined investment in the sector. area. Leqal and Contractual Constraints 4.2 In LAC natural gas is, except for the Bolivian exports to 4.4 Petroleum legislation and risk Argentina, a non-tradeable commodity contracts generally treat natural gas much like electricity, and sector as crude oil. But, as there often is development is principally driven by no developed market for the gas, the local consumers' demand. However, terms and conditions under which natural gas competes with practically natural gas would be developed and all other forms of energy, including produced are not specifically electricity. Even in the transport defined. As a result, risk petroleum sector compressed natural gas (CNG) contracts do not include provisions competes with gasoline and diesel. for natural gas pricing and Because of these complex marketing. They are usually left to interrelationships with other energy be negotiated after gas is discovered sources, the natural gas sector does but in the meantime the local natural not appear to have a well defined gas market is not being developed status in most Latin American because the reserves have not been countries. It is generally dealt developed. In addition the risk with as a subsector of the petroleum exploration/production contracts do sector and is not integrated into the not include provisions for the national energy plans as a separate downstream activities including sector, such as electricity. transport, export and marketing of natural gas. - 12 - 4.5 On the other hand, even if the remain below international prices and contract does specify a natural gas the price structure is highly price at the wellhead or the city distorted. Electricity tariffs also gate, it may not provide the are often set well below the long run investors a return on investments marginal cost. Long term price commensurate with the risks they have stability is essential to attract taken. Finally, and equally private investment to the public importantly, since natural gas is a utility sector but investors cannot non-tradeable commodity, predict, with any degree of international private investors may certainty, what prices and tariffs not have an incentive to develop gas the Government may put in place. As reserves for the local market if the a result they cannot plan their long legislation does not allow for some term investments in the natural gas direct or indirect convertibility of sector. Bureaucratic delays and "red revenues into foreign exchange. In tape" often delay government approval some countries (Brazil, Mexico and of price increases. This "regulatory Venezuela), the private sector is lag", particularly in an inflationary restricted from having any role in economies, erodes the financial natural gas development. viability of regulated public utilities thus creating another Requlatory Constraints disincentive for private investment. 4.6 The Government's control over 4.8 In those countries where the pricing policy for petroleum natural gas transmission pipelines products, coal and electricity has exist, common carrier regulations had the greatest impact in slowing setting rules for access, conditions natural gas penetration in the energy of service and transportation charges markets. The prices for these fuels have not been established. In which are competitive with natural addition, the regulating agency does gas, are usually subsidized and as a not properly monitor the investors' result the netback value of NG at the performance in meeting public service wellhead may be well below its obligations and adhering to design economic cost. This is also and construction standards, public generally true for consumers' natural safety rules and environmental gas prices which may be below both guidelines. the opportunity value of competing fuels in a gas short country and the Intiutional Constraints long run marginal cost of natural gas in a gas surplus country. In 4.9 The existing institutional Venezuela, the industrial consumer structure is generally inadequate to paid the equivalent of $1.38/BBL for encourage development of natural gas natural gas; in Brazil, $1.92/BBL; or to allocate properly the limited and in Colombia, $3.84/BBL, far below institutional resources which are world prices in January 1990. available for that purpose. In some Industrial fuel prices are listed in cases responsibility for the natural Annex 1. gas sector may be divided among several agencies so the same agency 4.7 Some countries have partially is not responsible for both policy deregulated natural gas and petroleum making and regulation. In this case product prices in order to stimulate the role of each must be clearly competition. However, in several LAC defined and adequate resources countries petroleum product prices provided for both functions. In - 13 - addition to being the policy maker financial autonomy. There is no and regulator, the Government may guarantee that the enterprise would also be the sole shareholder in the receive a rate of return which would public gas company. This raises the allow it to internally finance a potential for conflicts of interest large share of its investments, thus and the need for an independent increasing the power of the treasury regulatory body is heightened. In to control growth. This lack of addition to the lack of defined autonomy, with all the risks inherent responsibilities, Government in political control of an institutions also suffer from a lack enterprise, when coupled with the of an appropriate organization to normal business risks and uncertainty deal with the sector and a shortage of oil prices leads to capital of qualified staff to carry out the premiums and, ultimately to higher policy planning and regulatory consumer prices. functions. The roles the Government could play are discussed in Section 4.12 A number of other legal or VI. policy requirements may impinge on the public enterprise's autonomy. It 4.10 In addition to the inadequate may be required to subsidize local institutional structure, there is industries or provide natural gas to overlapping of responsibilities since other state agencies at less than the the public sector enterprise may also opportunity cost. There are no perform duties which should be performance targets by which the handled by the Government. For principal shareholder (the example the public enterprises may be government) can judge the performance promoting exploration to the private of the public enterprise. The public sector; negotiating risk contracts; entity may not be able to enter into and monitoring private contractor's joint ventures with private sector performance contracts. They may also companies or sell shares to the regulate design and construction of public. gas processing installations, pipelines and distribution networks. Lack of an Effective Planning Structure for Natural Gas Public Sector Enterprise Lack of Autonomy and Accountability 4.13 The institutional structure of the energy sector in most LAC 4.11 If the Government acts as countries has evolved to meet policy maker, regulator and national needs. The government shareholder of a publicly owned gas involvement in each sub-sector has enterprise, the latter operates with developed independently because severe limits on its autonomy. The interactions between them were very labor laws deny the gas enterprise limited. As a result, the the administrative autonomy to fix electricity and petroleum sectors salaries or to hire and fire have received most of the attention employees. Energy pricing policies but few countries have established a which set consumer prices below the clear-cut assignment of economic value of natural gas erodes responsibility for natural gas the financial viability of the development and utilization. company. Financing plans, dividend Historically natural gas has been policies and capital structure must treated as a by-product of crude oil be approved by other government production and governments have been agencies so the enterprise lacks willing to delegate all -14 responsibilities for its development and technical underpinning for an to the national oil company. effective system. Unfortunately, the national oil company policies are usually o Legislation. The hydrocarbon established by petroleum-oriented laws which were adopted by many managers who consider natural gas of the LAC countries in the only as a means of maximizing oil 1970s gave little, if any, production and once their needs are attention to natural gas. met, natural gas development becomes Specific natural gas a drain on their limited capital legislation is required to which could generate a higher rate of define the legal basis for crude oil produ-cdon, though at lower regulation of production and rates of return. Many national pricing; the scope of petroleum companies in LAC countries responsibilities of government -- and other parts of the world -- agencies; and the have not always been as diligent as interrelationship with other they might in optimizing economically energy and commercial laws. natural gas use, and massive volumes have been flared and wasted. o Regulation. The legislation must be implemented in a set of 4.14 Planning for crude oil is regulations which will be used relatively simple: produce as much as by the responsible government possible and sell at world market authorities to establish rules prices. Because of oil's impact on for production and the national economy responsibility transportation; for price and for sector development was tariff regulation; and rules centralized at the highest government for quality of service and level. On the other hand it is more protection of the public health difficult to plan natural gas and safety. development. If gas and its derived products, could be exported, natural o Operating standards. Opc -ating gas would be commercially equivalent companies must establish to crude oil, except there is no engineering standards for world market price and no OPEC building and operating production quotas. So long as the pipelines and other facilities. market is assured and the project is economically viable, the gas should Political Uncertainties be produced and exported. On the other hand, if the gas is to be sold 4.16 Price stability is a keystone in the internal market, an integrated for the healthy development of public supply and demand program, often utilities such as electric power and involving several Government natural gas distribution companies. ministries as well as provincial and The highly leveraged debt/equity local governments, must be developed. ratios and low financing costs which are characteristic of public 4.15 The institutional structure of utilities can be maintained only if the natural gas sub-sector must be investors can have reasonable geared to deal with all aspects of assurance that debt service ratios production, transportation and will be met and financial integrity marketing. This entails a three will be sustained. But prices are pronged approach to provide the legal more often set on the basis of political, rather than economic, - 15 - considerations. This results in track record in exporting natural gas misallocation of resources, cross- to Argentina for the last 13 years subsidization and abrupt price with another 12 years before contract changes when government policies -- expiration and is also finalizing an or governments -- change. arrangement to export gas based electricity to Brazil in 1992. 4.17 High inflation coupled with Interregional natural gas trade has inadequate pricing policies has been slow to materialize in the most severely eroded utility earnings and promising southern cone area investor confidence. Price indexing, (Table 4) represented by the most asset revaluation and other impoitant natural gas market in techniques which are intended to Brazil and to a smaller extent by offset inflation have been considered Uruguay and Chile (Santiago) and but none has been completely large reserves in Bolivia and effective in maintaining investor Argentina which could be delivered confidence. economically to those markets. In addition to the major issues facing 4.18 The pricing structure can be the development of natural gas in somewhat insulated from the political each LAC country discussed above, the arena by placing responsibility for major obstacle to a rapid expansion tariffs with an independent of natural gas trade in the region regulatory agency which sets tariffs has been the basic conflict between on the basis of economic principles. fuel import substitution policies Wellhead gas prices may conceivably followed until recently by all be vulnerable to political influences countries in the region and trade but the downstream investor could be liberalization policies that would protected by "purchased gas promote a more regional oriented adjustment clauses" or other energy policy approach by the various provisions to pass-on higher wellhead countries. In addition transmission prices to the end user. of gas over long distances requires large volumes and rapid build-up, Interregional Trade calling for integrated demand and supply planning. The Bank has a very 4.19 In terms of the development of important role to play as a catalyst a natural gas market, Latin America for interregional gas trade projects. is about the stage Europe was 30 Already the Bank has been involved in years ago: very large potential the Bolivia-Argentina natural gas markets for natural gas in Argentina, pipeline and the pipeline/power Brazil, Venezuela and Mexico, and project between Bolivia and Brazil. strategically well located natural The following table lists one gas reserves in countries such as probable scenario for interregional Argentina, Bolivia, Peru, Venezuela gas trade (Million m3/year) in the and Colombia. In addition, the USA southern cone countries by the year will remain well into the twenty 2000: first century a large potential market' for natural gas. LAC are becoming more and more conscious of the need to think "more regionally" in terms of their energy needs. Already several binational projects exist in petroleum and electricity production. Bolivia has a proven 16 - Importers ExporterS market and exports to Colombia but Argentina Bolivia Intal also justify an LNG export project oriented to the US market. Already Argentina --- 2200 2200 Venezuela is searching for private Brazil 1100 1100 2200 partners for this scheme despite that Chile 365 --- 365 it would require an amendment of the Uruguay 365 --- 365 present legislation to allow involvement of foreign partners (Maps). Finally, Central American Total 1830 3300 5130 countries could be supplied by both an LNG based scheme (possibly The southern cone countries will thus connected with that planned by constitute the most dynamic natural Venezuela) but also through a gas market in the next 20 years; but pipeline system connecting Mexico to in the long term, the giant Peruvian the north and Colombia with Venezuela natural gas reserves would be tapped to the south. The Central American to supplement the Brazilian natural LNG supply scheme would not be gas market requirements as well as unrealistic in light of similar exports in the form of LNG to the schemes already in place between USA. The Venezuelan enormous gas Algeria (LNG exporter) and countries reserves would underpin a major with no gas infrastructure such as development of the local natural gas Greece, Turkey and Portugal. - 17 - V. MACROECONOMIC BENEFITS OF NATURAL GAS USE Macroeconomic Benefits of Increasing Natural Gas Use Argentina 5.1 The macroeconomic impact of 5.2 Two different pricing scenarios increasing natural gas supplies is were considered in the analysis. very important. First, there is the Under the first, the subsidized price improvement in the balance of trade scenario, it was assumed that the for an oil importing country from price structure of 1987 for different substituting higher-cost fuel imports energy forms would be retained. That by cheaper domestic natural gas, and is, the prices would be kept at for an oil exporting country from levels lower than international. releasing for exports high priced oil Under the second scenario, the products from the subsitution by efficient prices scenario, prices cheaper natural gas. Second, would gradually be adjusted to distribution of natural gas increases international levels. Under the the potential for private sector subsidized prices scenario the participation, increasing the overall overall cost of energy to the economy investment level and reduces strains during the 1987-2000 period would be on public finances. The investment reduced by approximately $900 million needed to build the delivery (1987 $) and $680 million under the facilities would increase public efficient price scenario compared debt, unless private capital is with a baseline scenario assuming no attracted. Third, natural gas investments are made in gas increases public sector revenue, development during the period. The because the long run marginal cost of savings would derive from the lower natural gas is lower than the cost of locally produced natural gas opportunity costs of the substitute as compared to the cost of the fuels fuels. Fourth, natural gas it replaced. Gas infrastructure contributes to the diversification of development would require investing the energy economy, reducing the $1.6 billion under the efficient dependency risk of a sudden price scenario during the 1987-2000 curtailment of supplies and of sudden period. Assuming that US$1.4 billion international price changes. The would be public sector expenditures, macroeconomic effects of increased taxes could be increased and the natural gas use on two natural gas public sector budget could be producing countries, Colombia and improved by about $450 million. Argentina, and one country which Assuming that 15% of the investments could import natural gas, Uruguay, wotild be externally financed, have been assessed in detail under Argentina's external debt would the following Bank crude oil price increase from US$ 238 million under (US$ 1987 per BBL) scenario: 13.1 the efficient price scenario to US$ (1988), 14.7 (1989), 16.0 (1990), 382 million under the subsidized 16.4 (1991), 16.8 (1992), 17.1 price scenario during the period. The (1993), 17.3 (1994), 17.5 (1995), and impact on the balance of trade would 21.0 (2000) be positive under either scenario because the petroleum products which would be replaced by natural gas would be exported. Under the - 18 - subsidized scenario the balance of with cheaper natural gas. The trade would improve by $130 million macroeconomic effects under the same but under the efficient price two scenarios were estimated. Under scenario it would improve by $530 the first, "High" scenario, imported million over the period. natural gas would replace both fuel oil and biomass (largely firewood) as Colombia an industrial fuel. Under the second (Low) scenario it would replace only 5.3 In view of the more limited fuel oil. Under the High scenario potential for natural gas the natural gas imported over the development, unless additional gas 1992 - 2000 period would cost $155 reserves are proved up, the million while the fuels it replaced macroeconomic 1-.nefits are limited. would have cost $215 million i.e., The benefits were evaluated for a cost savings of US$ 60 million. limited development strategy which Under the Low scenario natural gas would provide for limited additional imports would be lower and the cost irvestment in the sector. The cost savings would be about US$ 20 of energy for the economy for the million. It was assumed the project 1987-2000 period would be reduced by could be externally financed to the about $135 million compared to a level of 70%, so there would be a baseline scenario assuming no further public sector debt increase of $80 investments in gas development, due million under the High scenario and to the lower cost of natural gas as $70 million under the Low scenario. compared to the cost of the fuels it replaced. The sector investment was Natural Gas Pricing Policies estimated to be $980 million. Affect Benefis Assuming that US$ 830 million would be public, the budget deficit would 5.5 As previously discussed increase significantly given the (para. 4.4), private investors are limited margin for increasing taxes. reluctant to invest in gas On the other hand, external debt exploration or development because in would increase by US$ 150 million most LAC countries neither the risk under the assumption that 15% of contracts nor the hydrocarbon investment would be externally legislation specify how the wellhead financed. However, since private price for natural gas will be investors already participate in the determined. Therefore the producer sector, a portion of the capital may has no basis to assess the potential be provided by them, substituting for economic return. Even in countries public capital. The trade balance where pricing formulas have been would be favorably impacted by the tried they have often proved increased export of petroleum counterproductive and actually been a products which natural gas would disincentive for drilling. For replace generating an additional $280 example, in Colombia the field price million over the period. is indexed to the export price of fuel oil but without reflecting the Uruguay real economic value of gas. When fuel oil prices were high in the early 5.4 Uruguay is a potential natural 1980s private companies were eager to gas importer. The macroeconomic invest in exploration in gas prone benefits would accrue from replacing provinces. However, prices now more expensive imported petroleum (before the Gulf crisis) do not products or indigenous biomass fuels reflect the economic value of gas, - 19 - have not attracted new investors and the residential market, continue to the gas provinces are not being be subsidized on the grounds that developed. A similar problem they provide a social benefit to low occurred in Argentina where. at one income consumers. This leads to the time, the price of gas was set as low economically absurd situation of a as 14% of the crude oil price. The country paying hard currency for negotiated price approach has been imported LPG which it sells at less used in Brazil to set a reasonable than the CIF price. It is difficult price for gas after it was discovered for natural gas to compete with in the search for oil. subsidized fuels unless it also is subsidized. The economic cost of 5.6 Subsidization of alternative distributing natural gas exceeds the fuels has also been a strong delivered price of subsidized LPG and deterrent to natural gas development. consumers have no incentive to switch In the early 1980s retail energy to natural gas, particularly if they prices were heavily subsidized in must pay an initial connection charge most countries. Declining oil prices for the service. in the mid 1980's mitigated subsidies to some extent but they still exist in several countries. The prices of electricity and LPG, fuels which compete directly with natural gas in - 20 - VI. STRATEGIC OPTIONS FOR NATURAL GAS SECTOR DEVELOPMENT Elements of a Sound Policy to setti.*, the general parameters for the rational development of the 6.1 The key components of a sound sector and regulating its operation. national energy policy have been Some state enterprises would yield to presented in many Bank papers and the Government the current regulatory other publications but few have duties they now perform. The addressed the role that natural gas Government should retain its role as could play and the manner in which policy maker and regulator and the policy should integrate the strengthen the Government agency natural gas sector. As previously responsible for the sector by discussed, natural gas has generally establishing a strong legal been treated as a petroleum by- foundation and providing adequate product. However, natural gas is to human, financial and logistical be developed to maximize national resources. benefits, the Government agencies responsibilities must be clearly 6.4 The Government policy decisions defined. The specific functions of should be limited to the Government are discussed below. o Develnping a national energy 6.2 Development policies for natural strategy which fully considers gas must be founded on sound the economic, social and technical and economic criteria. The environmental benefits of policies should be supported by natural gas, and the advantages adequate information and statistical of competition and private services to monitor the effect of sector participation. policies on the sector and the national economy. The policies o Setting the legal regulatory should recognize the need for an requirements f r public economic regulatory structure. The enterprises based on commercial regulatory agency must have a solid criteria. legal foundation and a. clearly stated mission with the scope of its o Promoting exploration/ responsibilities defined within the production, transmission and legislation. distribution activities by private concerns, and Government Role in Developing EneMy negotiating risk contracts with Policies these entities. 6.3 The Government's energy plan o Establishing reasonable ad- should aim at establishing an valorem taxes on petroleum environment of open competition and products and natural gas to equal opportunity in all a:spects of capture a share of the economic exploration, production, rent and encourage energy transportation and marketing of conservation, while maintaining natural gas, while ensuring that the incentives. national interest is protected with a minimum of regulations and controls. 6.5 The Government should recognize The Government shoule limit its role the significant differences between - 21 - oil and gas activities which require o Regulating access to trans- it to include specific and detailed mission pipelines and provisions for natural gas transportation tariffs; development in the petroleum risk contracts with private companies. o Monitoring compliance of all The contracts should provide: companies, including public sector enterprises, with their o Private companies to freely risk contracts commitments; dispose of a share of gas production for export; o Reach an agreement with the state enterprise on performance o Adequate guidelines for pricing targets which would reflect exports of natural gas; profitability andproductivity, i.e. measure the real o The basis for pricing natural performance on the basis of the gas delivered at the city gate, parameters under the state considering prices of enterprise's control; and substitute fuels in areas with periodically evaluate and established gas markets; reward/penalize performance of the state enterprise based on o Concrete criteria for market- the meeting of agreed price determination in areas performance targets; and with no previous gas markets and a potential demand, to o Issuing and enforcing standards offer attractive return for for the design and construction developing domestic reserves. of oil and gas installations and pipelines to ensure safety 6.6 Finally the Government should and environmental protection use the fiscal system to collect part from hydrocarbon related of the economic rent as income tax activities. since this approach provides more incentives to the private company to Government Role as a Shareholder of Gas invest than high royalties which are Companles skimmed off the top of the private companies gross revenues. 6.8 The public sector enterprises should have full technical, Government RequlatoEy Role administrative and financial autonomy, thus limiting the role of 6.7 The Government regulatory role the Government to that of a in the natural gas sector would shareholder ensuring accountability. consist of: In this capacity, the Government would: o Monitoring implementation of natural gas regulations relat- o Appoint qualified public and ing to conditions of service; private representatives to a board of directors which would o Approving tariffs for the sale include members with the of natural gas to residential, experience and stature needed commercial, industrial, trans- for the job. portation and electric power generation consumers; 6.9 State sector enterprises should be encouraged to enter into joint - 22 - ventures with private companies, sell 6.13 In the past much of the sector stock to private shareholders in the financing was obtained from stock market, and act only as a last government souices. Restrictions on resource, when no acceptable private oil and gas development contracts sector options exist. discouraged private investors and there was no incentive for private investors to put money into Private Sector Role downstream operations. There are some indications this may be changing 6.10 Production agreements with to some extent. The new policies in private companies to develop and Argentina and Colombia are designed market natural gas should provide the to expand private participation in private investor: upstream activities. However, the downstream activities are still o The right to sell gas to third largely financed by the public parties; sector. o The right to build pipelines 6.14 If government-owned companies under conditions specified in continue to own and operate the the production agreement; downstream pipelines and distribution networks, the investment funds will o A clear definition of what have to come from public sector constitutes gas reserves for financing. The company can generate domestic requirements and gas investment funds internally only if reserves for exports. its tariffs are properly structured. It must avoid the pitfalls of the o Guidelines on free disposal of electric utility industry which has gas production and pricing been forced to sell electricity at (para.6.5). less than cost and then rely on government funds for expansion 6.11 A clear definition of what (sometimes even for operations). constitutes a commercial gas discovery should be provided to the 6.15 The private sector may be private company. It should also be encouraged to invest in gas if the allowed sufficient time to appraise incentive framework, particularly the discovery and the markets and prices, is adequate and the time to construct the transportation appropriate investment tools are and distribution facilities. The available. However, a number of time before reversion should be problems must be recognized by the longer than for an oil discovery in government when establishing rules order to make it possible to earn a for private investment. These are reasonable return on investment. discussed below and some specific proposals to promote private sector 6.12 The private company should be participation as a partner and as a able to negotiate the inclusion of cofinancier of natural gas special contractual terms that development and distribution projects encourage development of marginal but are presented in this section. economically attractive gas fields. Convertibility of Local Currency Earnings Options for Financing Sector Development 6.16 With few exceptions around the world, when natural gas is discovered - 23 - by a privately owned international which they delivered to the oil and gas company it is destined Government. These materials were in for the local market. If the local turn exported by the private market is well established -- the companies who were paid in hard only established markets in the LAC currency. Similar innovative barter countries are in Argentina, Colombia, deals involving exportable Venezuela and Mexico--the company commodities could be found on a case- will be paid for the gas in local by-case basis. These are however currency. If the company cannot qualitatively inferior to hard repatriate its profits as hard currency and oil products payments. currency it has little incentive to make further hard currency 6.18 Payment for the gas with investments. The Government could natural gas liquids (NGLs) extracted agree to pay for the gas at the from the gas is also feasible. Most wellhead in hard currency at a price of the natural gas produced in LAC equal to the netback value, that is contains economically recoverable the opportunity value minus delivery quantities of hydrocarbon liquids, costs, of the fuels the gas would mainly LPG and condensates. The displace. This is the case in Brazil Government could authorize the where Petrobras pays Shell Pecten the investor to export some or all of equivalent of fuel oil prices based those liquids as a form of payment on Rotterdam prices. There are for the gas delivered to the local similar pricing arrangement in market. International oil and gas Colombia and Argentina where prices companies have mele such proposals to have been negotiated but not the governments of Bolivia and necessarily based on the price of Argentina. As an added incentive substitutable fuels. they also offered the option of financing gas-fueled electric Payments In Crude or Fuel Oil or Barter generating stations which would be amortized through the export and sale 6.17 When foreign exchange markets of natural gas liquids. are not freed, a possibl, solution to the hard currency shortages would be Joint-Ventures for the producer to receive payment for the gas in the form of crude oil 6.19 Private international companies or fuel oil which is displaced by the have expressed some interest in use of gas and which could be participating in downstream exported at world prices. Of course, activities such as trunk gas pipeline this would be feasible only in transmission and urban distribution countries which are net petroleum networks. In Colombia a consortium exporters. Even in exporting of local private companies, including countries this approach should be the gas producer, has suggested used with caution. There is always joining with the government-owned oil the risk that a country could become company to finance and build the an importer within the contract north-south gas pipeline. In period. Barter arrangements might be Argentina a foreign company built and useful, but certainly not as operated a major gas transmission attractive to investors. In Bolivia, pipeline for a number of years. international oil companies have However, foreign investment is often accepted oil field materials and tied to use of goods manufactured in equipment produced in a neighboring the country which provides the country as payment for oil and gas financing. Many of the gas user - 24 - countries can manufacture high- sector involvement. It is important pressure transmission line pipe as to note that there is an opportunity well as pipe suitable for urban to develop many types of networks, and some local Government/private partner manufacturers have shown an interest arrangements. Given the nature of in participating in the construction regional projects to be considered, and operations of the gas specific arrangements could be transmission and distribution system. developed taking into account the On the other hand, compressors which needs for financing; the extent of constitute the second largest cost Government participation; the impact component, are usually imported. of the project on the country's Consequently, the tendency in LAC is macroeconomy; the expected rate of to have local companies involved in return; and foreign investors' the construction and operation of requirements. transmission and dist:ibution systems, sometimes in a joint venture 6.21 Liquefied natural gas (LNC) arrangement with international projects provide opportunities for groups. private sector participation. Their main benefit is the generation of 6.20 The joint venture concept hard currency. LNG projects, offers many advantages to both the however, require multi-billion dollar Government and the foreign companies. investments in field development, The Government partner would bring processing, transmission and the know-how in the local conditions liquefaction plus the cost of LNG for construction, operation and the tankers. LNG projects are finance of its share of the project. technically complex and require the This would streamline project experience and know-how of the management and speed project international oil companies as well completion. Ultimately it would lead as their capital. They are not to more efficient operations. The generally highly profitable. These private partner would bring outside projects would require financing from expertise and private capital thereby bilateral and multilateral agencies improving efficiency and reducing the as well as commercial banks. In public sector investment and debt. certain cases when requested by the The primary question in this type of project partners, the Bank could play venture is whether the share of the an important role as a facilitator economic rent the Government allows and cofinancier in these projects: the private partner to retain will In some LAC countries; e.g. in provide a sufficient incentive to Venezuela and Trinidad and Tobago in participate. Equally importantly, is the short term and Peru in the longer the economic rent sufficient to term. provide both the Government and the partner a reasonable return on their Advance Purchase Contracts investment? In these types of ventures, the private participant 6.22 Advance purchase contract probably will require a guaranteed financing is well suited to natural gas purchase price for part or all of gas field development. Investors the contract period. The World Bank guarantee long term sales of natural could play an important role not only gas and/or natural gas liquids to by providing cofinancing and consumers in return for a future attracting others to cofinance but payments. A down-payment is included also as a catalyst for the private to help finance the drilling and - 25 - field development costs. This type Limfted and Non-recourse Financing of arrangement was proposed in 1983 by a group of French banks against 6.25 Non-recourse financing can be oil to be recovered from a secondary effective in financing a well-defined oil recovery project in Peru. The project such as an LNG export scheme. French oil company, Total, would have As described in OHS 3.82, the provided the technical guarantee by potential for non-recourse financing managing directly the operations on depends on whether the project can be behalf of the Petroperu, -,he national structured to protect its cash flow Peruvian oil company. adequately, e.g., through the use of sales contracts, throughput Public Debt Purchase by Private Investors agreements and/or trust accounts; to minimize the risk of non-performance 6.23 This method of attracting through the presence of an private investment would be available experienced and reliable operator and in countries where natural gas contractor; and whether an activities are mainly controlled by environment exists or can be created the government-owned companies. in which political and convertibility Private investors would purchase the risks are deemed acceptable. public debt and gain an equity posi- Financing natural gas projects "off tion through a debt for equity swap. balance sheet" with exportable liquid products can make them attractive to Sales of Shares of Gas Utilities investors and governments which to the PublIc cannot mobilize private financial resources on the basis of their own 6.24 Since transportation and credit standing, but may be able to distribution of natural gas are do so for enclave projects. Such an public service activities closely arrangement has been proposed to akin to activities of electric finance the Bolivia-Brazil gas utilities there is a large scope for pipeline/power project. The Bank is equity ownership of the gas companies considering financing a portion of by the general public. The the cost. Government should foster a climate of investor confidence. First, if a End Users PartICIRation Government-owned company has a monopoly on gas supply, it should 6.26 End users such as power open-up the sector for private sector generation companies, petrochemical participation, while securing the manufacturers, industry or long term availability of natural gas residential users cooperatives could at commercial prices. If the gas purchase natural gas at the wellhead supply is not monopolized by the and build, or partially finance, the government, the government should transmission pipeline required. encourage further development by the While this possibility has been private sector. Investors must be considered in Argentina, it raises assured of an opportunity to earn a legal questions about its feasibility reasonable rate of return on its when a Government-owned entity has a fixed assets if the public is to have monopoly on gas transport. This type confidence in the financial viability of arrangement also raises policy of these companies. questions about guaranteeing gas reserves to fulfill the long term contract. - 26 - IMPORTANCE OF GAS SECTOR IN BANK COUNTRY STRATEGY BANK INVOLVEMENT IN THE NATURAL GAS SECTOR SHOULD SUPPORT THE MAJOR POLICY OBJECTIVES IN THE REGION; EMICIENT USE OF RESOURCES: NATURAL'GAS IS GENERALLY A LOW ECONOMIC COST ENERGY SOURCE WHICH CAN DISPLACE EXPORTABLE FUELS OR GENERATE IMPORT SAVINGS WrI A POSITIVE IMPACT ON PUBLIC SECTOR INVESTMENTS, DEFICIT AND DEBT; REDUCES INVESTMENT REQUIREMENTS OF POWER SECTOR WHEN USED AS A PRIMARY ENERGY SOURCE. (II) PROMOTION OF EXPORTS: NATURAL GAS COULD BE DIRECTLY EXPORTED AS LIQUEFIED NATURAL GAS (LNG) OR AS A GAS AND ALSO INDIRECTLY EXPORTED IN THE FORM OF FERTILIZERS AND PETROCHEMICALS' DEPENDING ON ITS COMPOSITION, IN SOME COUNTRIES PRODUCTION OF NATURAL GAS IS ACCOMPANIED BY HIGH VALUE EXPORTABLE PETROLEUM LIQUIDS SUCH AS CONDENSATE AND LPG; (III) MACROECONOMIC ADJUSTMENT: THE NATURAL GAS SECTOR PROVIDES OPPORTUNITIES TO PROMOTE TRADE LIBERALIZATION THROUGH EXPORTS OF GAS AND DERIVED PRODUCTS BY BOTH PRIVATE AND PUBLIC ENTITIES AND ENCOURAGES THE COUNTRIES TO ELIMINATE TRADE BARRIERS AND PROTECTION OF LOCAL INDUSTRIES SUPPLYING EQUIPMENTS, MATERIALS AND SERVICES; AND (IV) ENVIRONMENTAL IMPROVEMENT: NATURAL GAS IS A CLEAN BURNING FUEL WHICH IS HIGHLY CONVENIENT AND ECONOMIC FOR RESIDENTIAL COMMERCIAL AND INDUSTRIAL USERS DISPLACING MORE POLLUTING FUELS SUCH AS HIGH-SULPHUR OIL AND COAL IT IS A VERY EFFICIENT FUEL FOR POWER GENERATION. - 27 - VII. A PROPOSED STRATEGY FOR THE BANK Bank Activities In the LAC Sao Paulo, Brazil and is preparing Natural Gas Sector two major projects: one, a major Gas Pipeline and Power Generation Project 7.1 The Bank has only recently in Bolivia and the other, an Energy become involved in lending to the Transportation Project in Brazil. natural gas sector in LAC but it has These projects involve investments participated in a number of energy upstream (gathering and processing studies. In the early 1980's the facilities) as well as downstream Bank, in cooperation with UNDP, (transmission pipelines and carried out many energy assessment distribution networks). These studies under the ESMAP program. In projects promote the expansion of Latin America, the energy sectors in natural gas supply; foster the Bolivia, Chile, Colombia, Costa Rica, implementation of an efficient Ecuador, Haiti, Honduras, Jamaica, pricing policy for petroleum fuels Paraguay, Peru, Saint Lucia, Saint and natural gas; and promote an Vincent and the Grenadines, Trinidad action program for the efficient use and Tobago and more recently the of energy. The projects also aim to Dominican Republic were analyzed. An improve the efficiency of the public energy strategy study in Guatemala is sector energy enterpriser by to be completed by ESMAP soon. In restructuring them and promoting addition to the above studies, the private sector involvement. LAC region will soon issue two important energy sector studies on Potential for Natural Gas Prolects Argentina and Brazil. Finally a trust fund financed gas market study 7.3 There is a large potential was carried out in Peru. No energy market for natural gas in Latin sector reviews are currently America, principally in: Argentina, available for Mexico, Venezuela and Bolivia, Brazil, Chile, Colombia, Uruguay. Unfortunately, except for Ecuador, Mexico, Peru, Trinidad and the Argentina and Brazil studies, Tobago, Uruguay and Venezuela. if none analyzed natural gas markets these potential markets are to be potential, reserves , production, developed, a large number of projects transportation and distribution in will have to be undertaken to develop any depth. The very important issues the gas and provide the delivery of sector investment programs, the infrastructure. Potential projects long run marginal cost of gas and its include projects in exploration netback value for different uses, the promotion to attract investments by institutional and regulatory the private sector, gas field framework, pricing policies, the need development, gas pipeline for restructuring of public transportation and distribution, gas- enterprises and private sector fueled electric power generation, involvement in the sector received compressed natural gas use as a fuel scant attention. for road transportation, regional exports of natural gas and LNG 7.2 As part of its ongoing lending exports. These projects offer awide operations, the Bank is financing a scope for policy dialogue with the Gas Utilization and Technical above mentioned countries and a good Assistance project in Argentina; a base for a lending program in the gas Gas Recycling Project (Vuelta Grande) sector. in Bolivia; a Natural Gas Distribution Project in the State of - 28 - A Proposed Bank Approach to Promote gas substitute for gasoline and Natural Gas In LAC diesel in the transport sector, tailpipe emissions are greatly 7.4 In all energy sector studies reduced. In crowded urban centers carried out by the Bank natural gas such as Mexico City and Sao Paulo should be treated in a similar manner natural gas-powered transit buses to power, petroleum products and could significantly cut pollution. other sources of energy, receiving the same in-depth analyses, even in Bank Interactions w1th those countries which would have to Host Governments import natural gas. The analyses should consider the resource base of 7.7 In several LAC countries, the natural gas and whether it is planning ministries and other associated or non-associated gas. government agencies are not fully Non-associated gas can be developed aware of the potential benefits of and produced as long as it is natural gas development. An initial economically feasible but the rate of step should be to make them aware of development of associated gas is the role of natural gas and the closely linked to the oil production importance of attracting the private rate. A special effort should be sctor, through dissemination of made to ascertain the potential information and promotion of dialogue resource base in light of the with potential private investors. investment plans to explore and develop hydrocarbons. 7.8 Government agencies should be encouraged to utilize the analytical 7.5 Since natural gas competes with tools and methods developed by the other energy sources in a wide Bank and other organizations for the variety of uses, market studies and analyses of natural gas resources, demand forecast require specialized markets and costs. The Gas analytical methods and an iterative Utilization Study methodology9 is a procedure. The long-term demand sound basis for initiating sector should be based on income and price reviews. Based on these studies the variables, as well as the cross- government should establish a sector elasticities with other fuels. development program which determines Forecasts of substitute fuel prices provisions for private sector should consider their relative long participation, identifies specific run marginal costs of supply. As projects for exploration, previously pointed out, the cost of development, transportation and natural gas is usually less than the marketing of natural gas. cost of the substitute fuels in the residential, commercial, industrial, 7.9 The Bank could provide power and transportation markets. technical assistance to government agencies in organizing and 7.6 In assessing projects, the implementing the appropriate environmental benefits of natural gas institutional structure. The first should be explicitly evaluated. requirement is to establish the legal While it is difficult to quantify the foundation for regulation of the air quality improvements in terms of sector. As discussed in Section 4.4, health benefits and other social the existing hydrocarbon law may not gains, they should not be neglected. adequately address natural gas Natural gas is clean-burning and development, particularly the power plant emissions can be downstream activities and the laws significantly reduced. When natural governing issuance of franchises to - 29 - distribute gas in local regions may Natural gas could be directly be required. A set of regulations exported as LNG or natural gas, and for implementing the legislation will indirectly exported in the form of be needed. The staffing requirements fertilizers and petrochemicals, if and training needs for the staff these prospects are economically responsible for sector planning and viable. Increased natural gas regulation must be defined. production could also increase the production of exportable high value liquids such as condensate and LPG. Priorities for Bank Operatlons In the Gas Sector In the 1990s 7.13 The macroeconomics of the country would be improved. Trade 7.10 Bank involvement in the natural relations would be liberalized gas sector should support its major through exports of natural gas and policy objectives in the region. It derived products; trade barriers could lead to more efficient use of would be reduced through development resources, promotion of exports, of regional projects; and special improvement of trade balances, rules which protect inefficient local reduction of public debt and industries which supply equipment, improvement of the environment. materials and services to the natural gas industry would be eliminated. 7.11 The Bank can promote the rationalization of the energy market 7.14 Consequently, natural gas in in LAC. Indigenous energy resources the energy strategy in IAC is a could be used more efficiently if the resource to be seriously considered. Bank promotes the provision of lower The first step should be to pursue a cost supplies of NG. Natural gas is wide ranging dialogue with the LAC a high quality fuel, along with Governments on the major issues which electricity and LPG. It is clean and constrain its development. easy to use and is a fuel of choice for users. This means that the willingness to pay by users for Technlgues and instruments for Bank natural gas should normally be higher Assistance to LAC Countries than for petroleum fuels. Thus, even if the costs of natural gas and the 7.15 Energy sector studies can serve competing fuels were the same, the as the first step in establishing benefits from expanding energy supply communications between the Bank and with natural gas would be greater countries which have a potential to than expanding it with alternative develop economically their natural fuels (higher consumer surplus). If gas sector The energy sector work the lower economic costs of natural should follow the pattern set for the gas is considered the expansion of studies recently carried out in supply with natural gas would lead to Argentina and Brazil which provided savings. Furthermore, if rational an in-depth analysis of issues in the energy pricing policies are in place, gas sector and provided a broad range the lower economic cost of natural of recommendations. Issues to be gas would be reflected in a lower considered should include the end-user price for energy which would government policy involving trade, inter alia expand demand and provide labor and taxation as well as the the economy with larger consumer energy sector issues discussed in benefits. Section IV. 7.12 Exports should be promoted when 7.16 Energy sector studies in Mexico it is economically viable to do so. and Venezuela should be given - 30 - PROPOSED BANK STRATEGY ZN NATURAL GAS SECTOR POlJCYDIALOGUE THROUGH SECTOR WORK o ISSUES THAT SUOULD BE DISCUSSED WITH THE GOVERNMENT INCLUDE POIJCY ON TRAD LABOR LEGISLATION AND TAXATION. o ISSUES THAT SHOULD BE DISCUSSED WITHIN THE FRAMEWORK'OFENERGY SECTOR STUDIES INCLUDE POWER NATURAL GAS, PETROLEUM AND OTHER FUELS LEGISLATION, PRICING POLICY, REGULATORY FUNCTIONS AND ORGANIZATION, INSTITUTIONAL SET VP AND ENVIRONMENT. 4 ENERGY SECTOR STUDIES IN MEXICO AND VENEZUELA MAYBE NEEDED. - ENERGY SECTOR STUDIES IN BOLIVIA, COLOMBIA, ECfADO PERU, TRINIDAD AND URUGUAYSHOULDB9 UPDATED. o THE STUDIES SHOULD FOCUS ON SPECIFIC AREAS WHERE THE GOVERNMENTS NEED HELP. NATURAL GAS COST AND TARIFF STUDIES, COMMON CARRIER REGULATIONS, AMENDMENT TO PETROLEUM LEGISLATION, AMENDMENT TO INVESTMENT LEGISLA TION FOR PROMOTION OF PRIVATE SECTOR, ORGANIZATION AND MANAGEMENT OF REGULATORYAGENCY. POLICYIMPLEMENTATION THROUGH BANK LOANS e GAS SECTOR LOANS SHOULD INCLUDE CONDITIONS FOR DEREGULATION, LEGISLATION CHANGES FOR PROMOTING PRIVATE SECTOR INESTMENT, RESTRUCTURING OF PUBLIC ENTERPRISES, STRENGTHENING OF GOVERNMENT POLICYAND REGULA TORY ROLE AND ENV1RONMENTAL POLICY. o PUBLIC SECTOR ENTERPRISE RESTRUCTURING OR ADJUSTMENT LOANS WOULD ALSO BE OTHER VEHICLES TO EFFECT THE ABOVE POLICY CHANGES. o NATURAL GAS SECTOR INVESTMENT LOANS SHOULD ENCOURAGE4PARTICIPATION OF THE PRIVATE COMPANIES. BANK LOANS THROUGH INNOVA TIVE MECHIANISMS TO SUPPORT EIPANSION OF PRIVATE SECTOR INESTMENTS AND PERMANENCE OF GOVERNMENT POLICY REFORMS. POLICY SUPPORT THROUGH INFORMATION DISSEMMATION " EXCHANGE IDEAS ON PROPOSED STRATEGY WITH STAFF OF THE DIFFERENT REGIONS OF THE BANK AND PRE. o EXCHANGE EXPERIENCE WITH REGIONAL ORGANIZTIONS (ARPEL, OLADE) THROUGH CONFERENCES. o DISSEMINATE INFORMATION ON THE NATURAL GAS SECTOR TO BORROWERS. a COOPERATE WIT REGIONAL ORGANIZATIONS ON NATURAL GAS STUDIES. - 31 - priority since the Bank has recently 7.20 Public sector restructuring reestablished lending programs with loans would also be an appropriate Mexico in the power sector and has vehicle for initiating a dialogue on opened a dialogue with Venezuela all of these issues. Since the Bank relating to power sector development. cannot undertake all issues under one operation, an appropriate strategy, 7.17 The Bank should also consider which takes into account the updating energy sector studies in comparative advantage of Bank countries where energy assessment financing vehicles, must be devised studies have been carried out such as for each country. Bolivia, Chile, Colombia, Ecuador, Peru, Trinidad & Tobago and Uruguay. 7.21 There are numerous projects in Particular attention should be given Latin America which would need to natural gas. financing in the future. Given the credit situation of most of the 7.18 The Bank should be prepared to Bank's borrowers in Latin America, assist the Governments in carrying natural gas projects could be out the specific studies which will conceptualized as enclave projects have been identified and recommended with limited or full recourse by the energy sector studies. These financing or any other type of may include natural gas marginal cost arrangement so that the Bank would and tariff studies; preparation of truly be the source of last resort common carrier regulations for gas financing. Investment and adjustment transmission pipelines; development loans in the natural gas sector of organizational and staffing plans should be conditioned to ensure that for the Government agency responsible the policy changes to foster private for the natural gas sector. sector participation and a reduction of public sector control are 7.19 The Bank lending program can be permanent. There is a lag time an appropriate mechanism to follow up between the implementation .f policy the recommendations of the energy changes and the realization of the sector studies. Gas sector benefits. The borrower may need investment loans should be considered financing to bridge this gap and for certain countries to achieve compensate for distortions created by policy changes in: (i) deregulation past policies. A good example is the of the oil/gas sector including problem of disposing of the fuel oil elimination of price controls on which is substituted by natural gas. natural gas and competitive fuels, Bank loans would also encourage the establishing a competitive market for private sector to participate in crude oil and petroleum products, joint ventures or negotiate special liberalizing trade and eliminating financing arrangements. After the barriers to entry in the sector; (ii) Government has agreed to a petroleum legislation which would significant involvement of private provide incentives to the private companies in the NG sector, Bank sector to invest in both upstream and should continue its support to ensure downstream activities in the natural that the new policies become gas sector; (iii) legal framewark permanent. The Bank could either under which the public enterprises in support the private sector (credit the oil/gas sector operate; (iv) the lines) or provide adjustment loans to Government management of the oil/gas the Government to stay the course sector to strengthen its capacity as over the long term. a policy maker and regulator; and (v) environment policy guidelines for oil 7.22 Dissemination and exchange of and gas operations. information with other regional - 32 - groups within the Bank can play a key for the oil and gas industry. These role in encouraging sector usually include the engineering and development. The Bank strategy in industrial lobbies as well as the the natural gas sector in Latin local private and internati3nal America would be disseminated to the private oil and gas companies. other regions and the experiences of the other groups could be reviewed. 7.25 The LAC region in the Bank has been able to field missions in the 7.23 The program for dissemination past to carry out energy sector and exchange of information with studies (Brazil and Argentina). The regional agencies in LAC should be teams consisted of Bank staff who expanded. The Bank shoulo promote provided the intellectual leadership, closer cooperation with regional complemented by local and organizations such as ARPEL and OLADE international consultants. In both to: (i) exchange information on cases, an experienced gas consultant experience in the natural gas sector; addressed the issues of costs, (ii) promote joint projects such as tariffs, regulations, and the natural gas study financed with exploration/production contracts. Italian government funds or the soon Since the completion of this work, a to be initiated study on the Gas Unit in the Bank has been staffed environmental impact of oil/gas with special experts, providing operations; and (iii) organize assistance supported with external regional conferences to address consultants to carry out studies on decision makers in the oil/gas sector gas regulations, tariffs, contractual in Latin America on the major issues issues and gas sector development. in the sector. ARPEL and OLADE could In the case of three ongoing lending provide an excellent forum for member operations, the required gas countries and companies to exchange expertise came from outside regional experiences on policy issues consultants and Bank staff. Based on and the need to harmonize them in these experiences, we estimate the order to expand regional gas trade. Bank's regional staff with support from outside consultants and the Gas 7.24 The Bank should also address Unit should be able to meet the the concerns of the private sector requirements foreseen for the near trade and p:ofessional associations future. in each country which provide technical and commercial leadership - 33 - ANNEX 1 INDUSTRIAL ENERGY PRICES January 1990 NATURAL RESIDUAL FUEL OIL ELECTRICITY GAS ------.---.---.....-- ------..-..-. USSMMBTU US$/BBL UIMM USSM US$MBTU Argentina 1.66 10.08 1.76 0.008 2.38 Bolivia 1.82 34.38 6.00 0.056 15.25 Bre-il 0.32 3.78 0.66 0.010 2.97 Colombia 0.64 14.78 2.58 0.051 14.85 Chile 0.57 17.88 3.12 0.051 14.85 Mexico 2.55 9.34 1.63 0.041 11.88 Venezuela 0.23 1.43 0.25 0.010 2.97 Source: OADE AN34 - STATUS OF THE NATURAL GAS SECTOR IN IAC COUNTRIES Introduction 1. Although commercially investors. Natural gas is imported exploitable natural gas reserves have from Bolivia and projects to export been discovered in ten IAC countries, gas to Chile and Brazil are under the extent of sector development consideration. varies greatly, primarily because of the availability of other energy Brazil resources or failure to recognize its benefits. Some countries which have 3. Brazil's natural gas sector is abundant resources, such as newer and somewhat less developed Argentina, have a well developed than Argentina's. Proved reserves infrastructure and are now entering currently provide a reserve to the market expansion phase. Others, production ratio (R/P) ratio of 33 like Brazil have made little effort years. About half the gas is to uate but plan to accelerate sector associated with oil but recent development. The availability of discoveries off-shore and in the gas, the existing infrastructure and Amazon Basin have greatly boosted the commercial structure of the non-associated reserves. PETROBRAS, sector in each country are provided the national oil company which has below. The larger existing pipelines the monopoly to transport natural and those which are under gas, operates five unconnected consideration are shown in Maps 1 and pipeline systems along the Atlantic 2. coast which deliver gas from the fields to local industrial users. Arqentina The existing urban distribution networks in Sao Paulo and Rio de 2. Argentina's gas industry has a Janeiro, which are operated by public history of more than 30 years and is sector enterprises, are being one of the most extensively developed expanded and new networks are planned gas industries outside North America for Belo Horizonte and other cities. and Europe. The proved reserves are Negotiations are ongoing to import more than adequate to meet current electric power, fertilizer and other needs and at present consumption products derived from natural gas levels the R/P ratio is 33 years. from Bolivia and gas from Argentina. Buenos Aires, the principal market center, is connected to the largest Chile producing fields in the Andean foothills and Tierra del Fuego by a 4. Chile's known gas resources network of transmission pipelines. are relatively small and are confined More than 3 million customers are to associated gas produced from oil served by a 50,000 km network of fields in Tierra del Fuego. The gas transmission and distribution is used locally for residential fuel pipeliner. Two government owned and as feedstock to produce methanol companies, YPF and Gas del Estado, for export. Gas has been discovered have controlled gas production and offshore several hundred kilometers marketing but recently efforts have south of Santiago but the reserves been made to shift distribution to are not considered commercially municipal governments or private exploitable at this time. There are - 35 - ongoing discussions to import natural Colombia gas to Santiago from Argentina's Western gas $ields. 7. Colombia's gas reserves could meet present requirements for 32 Peru years. Non-associated gas from the Guajira fields off the north coast 5. Natural gas resources in Peru near Barranquilla comprise about increased dramatically with the three-quarters of the total. A high discovery in the mid-1980s of the pressure pipeline delivers the very large deposits in the Camisea Guajira gas to consumers along the region in southeast Peru. The coast including distribution reserves may exceed 300 billion cubic companies in Barranquilla, Cartagena meters (BCM) which is equals almost and other cities. Deliveries from two-thirds of Argentina's proved nearby fields to Bogota started in reserves. Several plans have been late 1989 and a distribution network proposed to build a pipeline to Lima is being built to serve initially the where the gas could be used locally low income consumers in the south of for power generation and industrial the city. ECOPETROL, the national applications or exported as liquefied oil company, is a shareholder in natural gas (LNG). numerous mixed public/private ownership companies which transport Bolivia and distribute natural gas. Texaco, which operates the Guajira field, is 6. A large portion of Bolivia's the largest gas producer. The gas is proved natural gas reserves of bought in the field by ECOPETROL; approximately 125 BCM contain a high transported by PROMIGAS, a Lixed petcentage of natural gas liquids company; and resold to industrial (LPG and condensate) which have a consumers or to distribution high market value. The liquids are companies at the city gate. A plan extracted before the gas is used for to build the 500 km Gasoducto Central power generation in the Santa Cruz from the north coast to Bogota has region and as industrial fuel in been postponed pending proof of other regions. YPFB, the government- additional reserves in Guajira. owned oil company is responsible for most of the gas production but a Venezuela private compeny operates the field which supplies the gas exported to 8. Venezuela has reserves to Argentina. A YPFB affiliate, YABOG, provide an R/P ratio of over 100 operates the pipeline and the urban years, but most of the gas is distribution network in Santa Cruz. associated with oil so, at present, The 1200 km Altiplano pipeline, gas production is affected by OPEC extending from Santa Cruz to La Paz quotas. Large non-associated gas now connects the largest producing reserves have been discovered fields in the south with the offshore recently. The transmission principal cities. The urban infrastructure is well developed but distribution network in Santa Cruz is may require expansion in the next being expanded and others are being three years. Gas produced in the established in La Paz, Cochabamba and Anaco region is shipped south to the the other large cities. Bolivia has industrial complex at Puerto Ordaz; exported gas to Argentina since the north to Puerto La Cruz; and wpst to mid-1970s and negotiations continue the Caracas region. The gas produced to extend the contract beyond the in the Lake Maracaibo region is used April 1991 expiration date. locally or shipped to north to the power plants and refineries near the - 36 - coast. The pipeline networks connect Trinidad and Tobago most of the large consuming centers but the east and west systems are not 10. Although the country has large interconnected. CORPOVEN, a proved and potential gas reserves, subsidiary of PdVSA, the government- and export projects were proposed in owned oil company, produces and the mid-1970s, the pace of transports 70% of the gas. Other development has been limited by the PdVSA subsidiaries produce and market ability to use natural gas locally. some gas and small quantities are The total proved reserves are 490 sold at retail by private companies. billion CM, equivalent to more than LAGOVEN, a PdVSA subsidiary is 60 years consumption. More than 60% discussing a project to export LNG of the reserves are non-associated which would utilize the non- but the larger portion of the 8 associated offshore gas and probably billion CM produced annually is would be jointly financed by private associated gas. Natural gas companies. development policy is set by the Ministry of Energy which also Mexico regulates conservation, safety and environmental practices. Associated 9. Mexico's natural gas reserves, gas is produced by TRINTOC, AMOCO and which are largely associated with other oil producers and is delivered crude oil, total approximately 2,000 to the petrochemical complex at Port BCM, second only to Venezuela in Lisas via a pipeline. Some gas is Latin America. Production has used for power generation and steel declined in the recent past as oil production but the principal use is production dropped, but at present to convert it to exportable products production rates the R/P ratio is 61 such as fertilizer and methanol. The years. PEMEX, the national oil government-owned National Gas Company company which produces and markets is developing a project to recover all of the natural gas has natural gas liquids for export and constructed an extensive pipeline TRINTOC is evaluating a 2200 ton per network from thL producing fields to day methanol project at Point Fortin. the principal markets. A decade ago The offshore non-associated gas Mexico built a large capacity reserves could be a source of pipeline to the U.S. border and liquified natural gas exports to the exported gas to U.S. markets for a United States. short time. However, no gas has been exported since 1984 and although it has been suggested from time-to-time, it is not likely exports will be resumed in the near future. - 37 - REFERENCES 1. Guidelines for Petroleum Lending, The World Bank Operational Manual Statement, November, 1984. 2. Natural Gas in the World: Outlook to 2000. Association Technique de l'Industrie du Gas en France- Edition Technip-1989. 3. International Energy Agency Statistics (1989). 4. Natural Gas in Latin America: Market Structure and Future Outlook. C. Khelil. Presented at ARPEL Meeting, La Paz, Bolivia. May 23, 1990. 5. Various Bank Internal Reports as follows: Argentina Energy Sector Study (1990); Brazil Energy Sector Study (1990); Venezuela Public Sector Investment Review (1990). 6. International Petroleum Statistics, 1070 - 1988, Degolyer and MacNaughton, Dallas, Texas. 7. North American Natural Gas Markets: Summary of an Energy Department Paper No.3. H.G. Huntington and G.E. Schuler Jr. The Energy Journal. Vol.II, No.2, July 90. 8. Study of the Economic Role of Natural Gas in Latin America, SNAM SpA, 1989. 9. Gas Utilization Study Methodology. World Bank Energy Department Paper No.3. November 1985. IBRQ 2245? UNITED STATES OF AMERICA a " Ciudad Juarez Lrmosio - Colulos w Chihuahua Nueva Rositc, OLaredo NATURAL GAS PIPELINES MonclovaPROPOSED EXISTIN - Principal Natural Gas Pipelines 0 Selected Cities Monterrey Rio Bravo - - nternational Boundaries Solfillo oDurango Matehuala Mazatl6n San Luis Potosi San Blas Merida Leon Tialchinol Mrd 20* Guadalajara 2o, Campeche MEXICO CITY b i6o 20o ad0 MILES Monzanillo Veraeruz 0 190 00 3qo 4 O 50 KILOETrRSMinalitloniBLZ 160 60 00 ALESSalina Cruz GUATEMALA HONDURAS 110* 10. 9v 'COSTA RICA la- PANAMA ENE oSURNAME FRENCN 5f11JÅN oApioy C O 1 O M B l A t· Y 0Quito E C U A D O R manaus Portalezo oRecife Maomio, B R A Z Cuzco BOLIVIA .,Brasilia Santa Cruz Sucre Belo Horizonte Potosi Rio de Janeiro Y XSoo Paulo As..uncion43°"' orto Alegre Cordobo 30\ U RUGUA I .Santiago1 Buenos Aires Montevideo z SOUTH AMERI CA 40- NATURAL GAS PIPELINES O 2?0 400 600 ROA KILOMETERS .0 0 .11E -1 OTENTIAL PKOJOSED X_ISTING S00 200 300 400 500 - . Principol Natural Gas Pipelines Marine LNG Tonker Exports (Potentioi only) Methanol Tonker Exports 0 Selecred Cities - -- International Boundories Rivers 80. 10* 60- 50. 10N