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Pakistan is a relatively new player in global LNG market, but has quickly become a major importer. Depleting indigenous gas reserves and a transition towards cleaner and cheaper power generation have been the major factors driving the country towards adding LNG to its energy mix. Over the past few years, the government has established the basic LNG infrastructure, which has helped bridge the gas supply-demand shortfall, and lately there has been some progress towards private sector participation in LNG import. However, multiple operational and structural bottlenecks in the current framework are causing import delays, price distortions, as well as lags and inefficiencies in the distribution of LNG. This section sheds light on some of the international best practices that the government may learn from, and emphasizes the need to introduce reforms to maximize the potential returns from deregulating the LNG market.

S1.1 Introduction

The objective of this section is to: (i) briefly explain the evolution of global LNG trade; (i) describe the existing structure of Pakistan's LNG sector; (iii) highlight the structural, contractual and pricing elements that cause delays at the import, transmission, and distribution stages and result in regulatory inefficiencies; (iv) provide an overview of the ongoing deregulation, onboarding of private sector participants, and capacity expansions underway in the domestic LNG sector; (v) evaluate the fundamental concerns associated with natural gas pricing and governance in distribution companies; and (vi) discuss the possible redressal measures to help the overall gas sector operate on a sustainable basis.

S1.2 Background

Natural gas is one of the most important sources fulfilling Pakistan's energy requirements (Figure S1.1), primarily because of the country's natural endowment of the fuel, and its inherent cost advantage over oil. Contributing nearly 35 percent of the country's primary energy supplies, local natural gas production currently stands at 29.3 million tons of equivalent (TOE) - placing Pakistan among the top-25 natural gas producing countries. In terms of final energy consumption, the share of natural gas has remained above 30 percent over the past two decades. Thermal power producers, households and general industries are major users of natural gas, while the fertilizer sector also uses it as a principal feedstock and fuel source.

However, despite a large and growing consumer base, indigenous gas supplies have stagnated since 2008. While security concerns in gas-rich areas led to fewer mining and exploration projects, consistently low well-head prices also adversely affected their commercial viability. In the meantime, gross underpricing of natural gas for the household sector resulted in excessive consumption and wastage of the fuel. These dynamics led to a burgeoning natural gas deficit in the country, which ultimately pushed the government to develop a medium-to-long-term gas import strategy. As a result, Pakistan signed two major pipeline trade agreements - the Turkmenistan-Afghanistan-Pakistan-India (TAPI) Gas Pipeline and the Iran-Pakistan (I- P) Gas Pipeline- in 2010. But these projects have been facing delays due to financing constraints and geo-political conditions in the region. To plug the gas deficit in the short term, Pakistan started importing natural gas (in liquefied form - LNG) in sizable quantities from FY15, and has since then quickly become a major buyer in the international market. At present, nearly 23 percent of the country's natural gas consumption is being met through imported LNG (Figure S1.2). The import of LNG has also helped reduce overall electricity generation cost in the country by around Rs 234 billion during FY17-20.

Going forward, the natural gas shortfall in the country is projected to increase substantially, stoking the demand for further LNG imports. Although variable renewable energy (VRE) sources - such as solar and wind - provide a better alternative to achieve the least-cost energy mix and attain broader energy security over the medium-to-long- term, a number of commercial and technical constraints hamper the short-term viability of these projects. Strong political commitment, massive investment in technical capacity and planning tools, support from global development partners, and most importantly, flexibility on the part of existing energy operators and investors, is required for a large-scale switch to VREs. The other low-cost alternative is coal, which has gained traction lately, especially under the coal- powered projects set up under CPEC. However, burning coal to meet domestic energy requirements is not a sustainable solution, given its heavy contribution to the greenhouse gas emissions. Leading IFIs have also lately advised against developing additional coal resources in Pakistan, except for the plants already committed.

Keeping these limitations in mind, it appears that the magnitude of future LNG requirements (if natural gas exploration levels and the pricing policy remain unchanged) would remain high over the short- to-medium-term. Estimates by the Ministry of Energy and Ogra suggest that Pakistan's indigenous supplies would only fulfil 22.3 percent of the estimated demand by 2030. If the long-delayed I-P and TAPI gas pipeline projects do not become operational, the average annual net gas shortfall during 2021-2030 is projected to be 2,593 mmcfd (Figure S1.3). To put this deficit in context, it is 2.7 times the volume of LNG the country imported in 2020. Thus, it has become crucial to develop an efficient LNG market, characterized by a robust regulatory and operational infrastructure, to help run the domestic gas sector on a sustainable basis and strengthen Pakistan's energy security.

Within this context, this section intends to evaluate the existing regulatory and operational infrastructure of the LNG market (including imports and domestic sales) in the country, and discuss what is required to operate this sector efficiently and in a cost- effective manner. Since the global LNG trade is relatively new compared to oil, and is still evolving, the section initially takes stock of developments in the major markets and closely tracks the recent policy transitions in terms of nature of contracts, pricing benchmarks, and the role of governments. Similar transitions are either underway or being contemplated in Pakistan's LNG market as well.

Following that, the section provides a detailed account of major stakeholders in domestic LNG market, and identifies specific procedural bottlenecks causing delays at the import, transmission, and distribution stages. These challenges not only lead to recurring supply shortages, but also result in cost escalation, which ultimately feeds into consumer tariffs or accumulation of arrears. There is also a perception among various stakeholders in the country about the cost of imported LNG, and there are frequent debates over the quality and duration of the long-term sovereign LNG contracts and the timeliness and benefits of spot procurements. These dynamics make a strong case for greater involvement of domestic private sector in LNG import and local sales, which is expected to introduce efficient practices in LNG supply chain, as experienced by other countries in the region.

While the government has recently allowed the private sector to import LNG, and has also issued licenses to interested parties, the remaining duration of the long-term sovereign contracts implies that the private sector would be operating in parallel with the public sector for some time. But it is important to understand that private participation alone will not solve the sector's broad operational and financial problems.

Specifically, without addressing the fundamental issues associated with natural gas pricing, governance in distribution companies, and uncertainties at the end of the gas supply-chain, the domestic LNG market and the overall gas sector would continue to operate sub-optimally.

In particular, while addressing bottlenecks in the existing import, regasification, and pipeline infrastructure is necessary, it is equally important to expand the LNG user- base in the country; this is especially to reduce the per unit terminal capacity charges, which the private sector would also be paying for. However, this expansion appears challenging, given the prevailing mindset of cheap/subsidized access to natural gas, which has seen users (especially industries) vying for a greater share in the indigenous natural gas pie instead of shifting to LNG. Subsidy rationalization is also important in the context of managing fiscal and quasi-fiscal costs of the government, especially when imported LNG is provided to already heavily subsidized sectors, such as households and fertilizer. The situation could become more challenging for the gas distribution companies when their high- revenue sectors (such as transport and power) start shifting their gas demand to the private sector. In this context, political consensus and strong provincial coordination is needed to get a policy buy-in for the rationalization of subsidies.

Finally, cross-sector linkages need to be carefully evaluated. In particular, the robustness of demand projections that ultimately feed into timely procurement decisions, crucially hinges on the adoption of more structured and regulatory-compliant practices in the power sector, which is consuming 60 percent of total LNG.

S1.3 Why is LNG gaining traction worldwide

Natural gas was historically traded via networks of extensively laid inter- and intra-country pipelines, as its low density made it costlier to store and trade via shipping channels as compared to oil.

Over time, however, the industry saw rapid advancements in purification, liquefication and regasification technologies. These not only made it cost-effective to transport gas in liquefied form via specialized vessels, but also increased the commodity's trade potential by reducing the need for highly capital-intensive long-distance pipelines. As a result, this mode of transportation became increasingly popular.

(To be continued)

(Excerpts from "The State of Pakistan's Economy 2020-21: Second Quarterly Report of the Board of Directors of State Bank of Pakistan")

Copyright Business Recorder, 2021

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