Gas/The LNG Export Debate: Lessons from Peru

The LNG Export Debate: Lessons from Peru

03/01/2014 | Javier Matos Flores-Guerra

What could a relatively small country in South America have to teach the U.S. about LNG exports?
Maybe a lot, as 2014 marks the 10th anniversary of its natural gas market.

Recent shale gas development, resulting in cheap natural gas in the U.S., has opened the debate about
whether or not to export some of that energy—mainly as liquefied natural gas (LNG). As the U.S.
considers the merits of LNG exports, it may be useful to look at how that debate played out in other
countries faced with a similar situation. Understanding how previous debates evolved, and the
consequences of the decisions, may prove to have lessons that the U.S. can learn from.

There are just two LNG export terminals in the Americas outside the U.S., in Trinidad & Tobago and
Peru. The Peruvian project, the first of its kind in South America, was the one that faced major
controversy over whether or not the nation should export natural gas.

The Peruvian Natural Gas Revolution

Peru is the third-largest country in South America, with a population of 30 million and a GDP per capita
of US$6,800. It is an emerging market that grew 7% a year on average in the past eight years. Unlike the
U.S., before 2004, Peru had never been a significant consumer of natural gas (see sidebar “Natural Gas
and Electricity in Peru”).

Natural Gas and Electricity in Peru. According to The World Factbook (published online by the U.S.
Central Intelligence Agency), in 2010, Peru had an estimated 8.613 GW of installed electric power
capacity. Fossil fuels accounted for roughly 60% of all generation, with the balance coming from
hydropower. Also for 2010, the International Energy Agency says that 12,226 GWh were generated by
natural gas, accounting for 34% of total generation.The U.S. Energy Information Administration reports
that domestic consumption of natural gas in Peru increased from 16 Bcf in 2002 to 202 Bcf in 2011,
“driven by government incentives, economic growth, and the growing number of gas-fired electricity
plants.” Overall, the role of natural gas in Peru’s energy sector and economy has increased dramatically
in recent years (Table 1).

—Gail Reitenbach, PhD, Editor

 Table 1. Natural gas ramp-up. Source: U.S. Energy Information Administration

The natural gas revolution in Peru had a name, and its name was Camisea.

Camisea hydrocarbon deposits are located 500 kilometers east of Lima, Peru’s capital city, in the Ucayali
Basin, in the Peruvian region of Cusco, in the southcentral jungle of the country. As early as 1981 the
Peruvian government signed an operation agreement with a subsidiary of Royal Dutch Shell (Shell) in
order to explore the deposit. From 1983 to 1987, Shell discovered and confirmed the Camisea deposit
was rich in natural gas and associated liquids reserves, with over 8 trillion cubic feet (Tcf) of reserves.
For many reasons—including political incompetency, the emergence of the leftist guerrillas known as
the Shining Path, and lack of capital and human resources—Camisea had to wait until the new
millennium to see the light.

In August 2004, Camisea started its commercial operation as an integrated project. The project’s entire
value chain included production, transportation—a 729-km pipeline from Malvinas to Lima and a 557-
km natural gas liquids (NGL) pipeline from Malvinas to Pisco—and distribution, including to the City of
Lima.

The Camisea project had two main phases, with the first involving resource exploration and
development and the second involving the LNG export components. When Camisea I was under
procurement and construction, between 2001 and 2003, Peruvian policymakers faced the dilemma that
American policymakers are facing now: There was too much gas for the country’s domestic
consumption—or at least that seemed to be the case.

From a global perspective, 8 to 10 Tcf is not much natural gas at all, but in the early stage of the
Peruvian natural gas industry, when nobody used natural gas because they did not even know about it,
it was reasonable, even indispensable, to evaluate all the alternatives available to obtain the highest
economic benefit from the natural gas.
Because gas reserves appeared to vastly exceed domestic needs, exportation initiatives started to make
sense. At the same time, questions started to arise. In an immature energy market like the Peruvian one,
how much natural gas was enough? How would internal consumption evolve? Would exports increase
the price for local consumers? Would exports deplete the resources too fast? Would it be against
Peruvian energy independence? Not surprisingly, we hear this group of questions nowadays a little
farther north.

Jaime Quijandría, who died in December 2013, was Peru’s minister of energy and mines and minister of
economics and finance between 2001 and 2004 and is recognized as a leader and a pioneer in the
Peruvian energy sector. Quijandría, a former president of Peru’s NOC Petroperu, was the main force
behind the Peruvian energy policymakers who were looking to make the most of Peruvian natural gas
resources for the nation. With that objective in mind, Quijandría and his team in the Ministry of Energy
found that the best way to accomplish that goal was to open and find new markets for Peruvian natural
gas through exportation. Quijandría was very aware of the dynamics of the oil and gas business and the
virtuous circle of open markets, exploration, and production and development of new reserves.

When Peru took the decision to allow exports of natural gas, it also looked to invigorate the exploration
and production business and to make it possible, through the right economic signals, that possible and
probable reserves become proven ones, making them commercially viable.

Peru is a country that has had many traumatic experiences of corruption in its highest levels of
government throughout its history. The worst thing about corruption is not just the economic losses
that inevitably result, but rather that it seeds mistrust among people. Peruvians mistrust their judiciary
system, their parliament, and their politicians. In that context, it’s easy for political, even technocratic,
opponents to point to different policy decisions as motivated by corruption.

Carlos Herrera, a well-known expert in energy matters, who had been Peru’s minister of energy and
mines twice (2000–2001 and in 2011) denounced export plans publicly and said that Peru did not have
enough natural gas reserves to justify developing an LNG export project. He suggested that it was
corruption in the administration that modified the Peruvian oil and gas regulations in order to make the
LNG project viable. However, parliamentary investigative commissions came and went and couldn’t find
any evidence of corruption or mismanagement.

Environmental concerns have also been an ongoing matter of debate, especially as a portion of the
natural gas reserves lie in the Amazon rainforest (see sidebar “Environmental Concerns”). Overall,
however, the resource development and export project has made remarkably fast progress.

Environmental Concerns. As in the U.S., any time a major new pipeline or resource development project
is discussed in South America, environmental questions are raised. For the Camisea project, which lies
partly in the Amazon rainforest, concerns included the displacement of indigenous people, clear-cutting
of forests, and pipeline spills.Typically, neither side in energy versus environment debates wins
everything it wants. One example from one phase of the Camisea project: In response to concerns about
adverse effects on the environment and indigenous people, the multinational development consortium
led by Argentina’s Pluspetrol agreed to not build roads but instead adopted a model used in offshore
exploration and production that uses boats and helicopters to move equipment, supplies, and workers
to and from the site.

The potential for pipeline ruptures has been cited by North American opponents to new pipelines and
LNG export projects, and the Peruvian project has experienced more than one episode of pipeline
breaks. In the first year and a half after the Camisea project went online in 2004, it experienced a series
of pipeline breaks that a San Diego, Calf.–based environmental consulting firm, E-Tech International,
determined were the result of shoddy work done by unqualified welders who used leftover corroded
pipes (though Peruvian regulatory audits could not confirm the use of leftover pipe). Presumably, with
better oversight and qualified workers, rupture risks could be minimized.

Though opposition to natural gas development on environmental grounds has not completely subsided,
some groups have recently pointed to successful efforts to mitigate negative environmental and cultural
consequences. In a March 2013 report titled “Peru LNG: A Focus on Continuous Improvement,” the
International Finance Corp. (which, along with other international lending agencies, provided $2.05
billion to the project) concluded that through “strong commitment to managing environmental and
social risks throughout all phases of the project, PLNG successfully managed and mitigated operational
and reputational risks related to their environmental and social performance.”

—Gail Reitenbach, PhD, Editor

Export Infrastructure

On June 22, 2010, Peru LNG—a multinational consortium created in 2003—dispatched its first shipment
of LNG from its state-of-the art liquefaction terminal located 170 km south of Lima at Pampa Melchorita
(Figure 1). The plant is a single-train facility with a capacity of 4.4 million metric tons per year.
1. Stored and ready to ship. South America’s first and only natural gas liquefaction terminal is located
170 kilometers south of Lima on the Pacific Ocean. Courtesy: Peru LNG

The project’s total cost (for the LNG plant, marine terminal, pipeline, plus development and financing
costs) was $3.8 billion, making it, at the time, the largest foreign investment in Peru’s history.

The nearly four-year development project also included a 408-km pipeline that crossed the Andes. The
engineering, procurement, and construction (EPC) contract for the liquefaction plant facilities (Figure 2)
was awarded to Chicago Bridge & Iron Co. (CB&I). The marine terminal EPC was awarded to a
consortium led by Brazilian contractor Odebrecht, and the pipeline contractor was Argentina’s Techint.
2. Under construction. The EPC contract for the liquefaction facility was awarded to Chicago Bridge &
Iron Co. (CB&I). The LNG export project was launched in January 2007, inaugurated on June 10, 2010,
and dispatched its first tanker on June 22, 2010. Courtesy: Peru LNG

Early Results

It’s too early to conclude whether or not the exportation decision was the best decision for Peru.
However, according to the “BP Statistical World Review of 2013,” at the end of 2012, Peru’s natural gas
proved reserves were up to 12.7 Tcf (up from 8.7 Tcf in 2006), and its reserves-to-production ratio
(R/P)—the length of time that the remaining reserves would last if production were to continue at the
current rate—was 27.9 years, the largest in the Americas (the U.S. R/P ratio is 12.5 years).

Since it began exports, Peru has shipped its LNG primarily to Spain, South Korea, Japan, and Mexico.
Additionally, Peru is currently considering new export projects (through LNG shipments or pipeline) to
Chile, a neighboring country with higher energy costs.

Industry sources estimate that Peru LNG will generate approximately $310 million annually of export
revenues.

Not bad at all for a small South American country. ■

— Javier Matos Flores-Guerra is an associate with the Peruvian law firm Hernández & Cia. and is a
specialist in the legal, regulatory, and project development aspects of the energy sector.