South Korean Gas Imports

LNG IN KOREA
opportunities for growth
ABARE RESEARCH REPORT 03.4
ABARE
KEEI
Allison Ball Karen Schneider Jane Mlanie Robert Curtotti
Changwon Park Jaesung Kang Jaekyu Lim
proudly produced for:
Australian Government Department of Industry, Tourism and Resources
Commonwealth of Australia 2003 This work is copyright. The Copyright Act 1968 permits fair dealing for study, research, news reporting, criticism or review. Selected passages, tables or diagrams may be reproduced for such purposes provided acknowledgment of the source is included. Major extracts or the entire document may not be reproduced by any process without the written permission of the Executive Director, ABARE. ISSN 1037-8286 ISBN 0 642 76489 1 Ball, A., Schneider, K., Mlanie, J., Curtotti, R., Changwon Park, Jaesung Kang and Jaekyu Lim 2003, LNG in Korea: Opportunities for Growth, ABARE and KEEI, ABARE Research Report 03.4, Canberra. Australian Bureau of Agricultural and Resource Economics GPO Box 1563 Canberra 2601, Australia Telephone +61 2 6272 2000 Facsimile +61 2 6272 2001 Internet www.abareconomics.com ABARE is a professionally independent government economic research agency.
Korea Energy Economics Institute 665-1 Naeson-Dong, Euiwang-Si, Gyunggi-Do, 437-713, Korea Telephone +82 3 1420 2114 Internet www.keei.re.kr Facsimile +82 3 1422 4958
ABARE project 2835
foreword
Natural gas has played an increasingly important role in meeting Koreas rapidly growing energy demand since its introduction in the mid-1980s. This trend is likely to continue, with forecast strong growth in natural gas consumption over the next decade and beyond. With limited domestic reserves, Korea has relied exclusively on imports of liquefied natural gas (LNG) to meet its natural gas requirements. LNG will continue to meet the majority of Koreas projected demand although, over the longer term, pipeline natural gas imports could provide a complementary source of gas supply. A critical issue for Korea is that natural gas supply plans have not kept pace with projected demand and a significant gap between demand and supply could develop over the next decade. Failure to resolve the issues surrounding long term LNG procurement soon could leave Korea vulnerable to gas supply shortfalls in the coming years. The key objective in this report is to assess the potential growth in natural gas demand in Korea and, in particular, the role that LNG could play in that market. Koreas current and projected gas supply situation over the medium to longer term is also reviewed. To meet future Korean natural gas demand, potential sources of LNG supply in the Asia Pacic market are examined as is the feasibility of pipeline natural gas supply options. The study was undertaken jointly by ABARE and the Korea Energy Economics Institute.
BRIAN S. FISHER Executive Director ABARE August 2003
SANG-GON LEE President KEEI
LNG in Korea: opportunities for growth
iii
acknowledgments
The authors wish to thank several colleagues for their valuable contributions during the preparation of the report: in ABARE, Vivek Tulpul and Lindsay Fairhead; in the Department of Industry, Tourism and Resources, Paul Kay; and in the Australian Embassy, Seoul, H.E. Colin Heseltine, Australian Ambassador to the Republic of Korea, Anthony Aspden, Sian Ferguson, Kim Hye-Young and Bill Brummitt. Many organisations in Korea provided information and valuable comments on the study. In particular, the authors are grateful for contributions from the following: the Ministry of Commerce, Industry and Energy; the Korea Gas Corporation; the Korea Electric Power Corporation; POSCO; SK Corporation; the Korea South-East Power Company; the Korea Southern Power Company; LG-Caltex Oil Corporation; and LG International Corporation. In addition, the authors gratefully acknowledge the information and insights provided by Gavin Harper, ChevronTexaco, Seoul; Jeff Feltham, North West Shelf Australia LNG, Perth; Damian Deveney and Rob Mitchenall, Shell Pacic Enterprises Limited, Seoul; and Sean Rodrigues, Woodside Energy, Perth. ABARE and KEEI also gratefully acknowledge the support of ChevronTexaco, North West Shelf Australia LNG and Woodside Energy for the translation, publication and launch of the Korean language version of the study in Seoul on 28 August 2003. ABAREs contribution to the report was funded by the Australian Department of Industry, Tourism and Resources.
iv
ABARE research report 03.4
contents
Summary 1 Introduction
Objectives in the study
1
8 9 11 11 17 21 27 31 31 33 34 36 45 45 51 57 57 62 67 67 72 73 76 82
v
2 Energy and natural gas consumption in Korea

Energy consumption Natural gas consumption Natural gas supply Gas pricing
3 Factors affecting Koreas future natural gas demand

Environmental issues Security of energy supply New sources of demand Energy market reform
4 Projecting natural gas demand in Korea

Analytical framework Reference case projections
5 Alternative policy scenarios

Electricity and gas sector deregulation Impacts of a gas supply disruption
6 Natural gas supply considerations

Pipeline natural gas Can pipeline natural gas compete with LNG? Natural gas supply and demand balance Supplying LNG to Korea
7 Conclusions
Appendix
A Structure of the global trade and environment model (GTEM) 84 91 24 28 38 39 43 58 63 70 75 81 2 3 4 6 11 13 14 15 15 17 19 20 20 21
References boxes
1 2 3 Koreas LNG supply shortfall in winter 200203 Gas price setting procedures in Korea Economic reform under the Roh Moo-hyun administration 4 Assessing the costs of electricity generation 5 Entry of private LNG importers into the Korean gas market 6 Benets of deregulation in the electricity and gas sectors 7 LNG supply disruption to Korea in 2001 8 A gas-for-peace deal with North Korea implications for pipeline projects 9 Alternative natural gas supply and demand balance 10 Australian LNG supply
gures
A B C D 1 2 3 4 5 6 7 8 9 10
vi
LNG consumption, by sector Monthly LNG consumption, by sector Projected natural gas consumption, reference case Potential gas demand and supply balance Total primary energy consumption Fuel mix in primary energy consumption Final energy consumption, by sector Motor vehicle registrations Final energy consumption in key sectors, by fuel Energy imports, by fuel City gas demand, by sector LNG monthly consumption, by sector City gas monthly consumption patterns, by sector LNG imports
11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
LNG import terminals and pipeline network Average LNG and crude oil import prices Fuel mix in district heating systems, 2000 Electricity generation costs Indicative long run marginal costs for power generation Deviation from the reference case in a GTEM simulation Alternative projections for share of gas red power generation Residential consumption of coal, gas and electricity Annual growth in energy consumption, reference case, 200115 Primary energy consumption, by fuel, reference case Total primary energy consumption by fuel, reference case Annual growth in gas consumption, by sector, reference case, 200115 Gas consumption, by sector, reference case Projected unmet gas demand, reference case Change in energy prices following deregulation, 2015 Change in production and exports of energy intensive goods following deregulation, 2015 Change in energy consumption following deregulation, 2015 Gas consumption by sector following deregulation, 2015 Fuel mix in electricity generation following deregulation, 2015 Change in gas and electricity price following a gas supply disruption, 2005 Change in GNP following a gas supply disruption, 2005 Change in sectoral output following a gas supply disruption, 2005, Gas consumption following a gas supply disruption, 2005 Possible gas pipelines to Korea Potential natural gas demand and supply balance Alternative natural gas demand and supply balance
25 27 34 40 41 47 48 50 52 52 53 54 54 55 59 60 60 61 62 64 65 65 66 67 74 75
vii
37 Proved recoverable reserves in countries exporting LNG to the Asia Pacic market, 2002
77 2 3 5 12 12 13 16 16 17 18 19 22 23 26 26 26 27 29 29 35 39 40 46 49 51 53 56 61
tables
A B C 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Total primary energy consumption, 2002 LNG imports, by source, 2002 Projected natural gas demand and supply Major energy and economic indicators International comparison of major energy and economic indicators, 2000 Total primary energy consumption, 2002 Electricity generation, by fuel Electricity plants and capacity, 2001 Energy import indicators LNG consumption, by end use City gas consumption, by region LNG imports, by source Existing mid and long term LNG contracts LNG receiving terminals Planned expansion of LNG storage tanks Planned expansion of gas pipeline network Wholesale gas price for power plants, January 2003 Wholesale price for city gas, January 2003 Retail price for city gas, Seoul area, January 2003 Mid to long term projections for district heating supply Fuel costs for electricity generation, 2000 Cost estimates for new generating plants Regions and sectors in GTEM in this study Projected share of electricity generation, by fuel, reference case GDP and primary energy consumption, reference case Revision of special consumption taxes on fuel sources Contracted gas supply and projected shortfall, reference case Projected energy consumption following deregulation, 2015
viii
26 27 28 29 30 31
Sakhalin gas reserves Potential natural gas demand and supply balance Alternative natural gas demand and supply balance LNG trade in the Asia Pacic, 2002 Existing LNG plants, Asia Pacic market LNG plants under construction and planned, Asia Pacic market 32 Indicative LNG transport costs to Korea from various exporters, 2001
69 74 75 76 78 79 80
ix
summary
Since its introduction in 1986, natural gas has played an increasingly important role in meeting rapidly growing energy demand in the Republic of Korea (Korea). This trend is likely to continue, with forecast strong growth in natural gas consumption over the period to 2015. With limited domestic reserves, Korea has to date relied exclusively on imports of liqueed natural gas (LNG) to meet its natural gas requirements. LNG will continue to meet the majority of Koreas projected demand, although pipeline natural gas imports could provide a complementary source of gas supply over the medium to longer term. An important issue for Korea is that gas supply plans have not kept pace with projected demand and a signicant gap between demand and supply could develop over the next decade. Procurement of LNG supplies over the longer term remains uncertain in Korea as the government is delaying entering into new long term contracts until plans to liberalise Koreas domestic gas market are progressed. Failure to address this issue soon could leave Korea vulnerable to gas supply shortfalls over the medium term. The key objective in this report is to assess the potential growth in natural gas demand in Korea over the period to 2015 and, in particular, the role that LNG could play in that market. Koreas current and projected gas supply situation over the medium to longer term is also reviewed. In this context, potential sources of LNG supply in the Asia Pacic market are examined, as well as options for pipeline natural gas supply to Korea from the Russian Federation.
Energy overview
Energy consumption in Korea has increased by more than 7 per cent a year over the past two decades, driven by rapid growth in economic output and rising personal incomes. Total primary energy consumption in 2002 reached 209 million tonnes of oil equivalent, compared with 44 million tonnes of oil equivalent in 1980. Oil is the main source of energy in Korea, accounting for 49 per cent of primary energy consumption (table A), although its share has been declining in recent years.
LNG in Korea: opportunities for growth 1
Korea depends on imports for more than 97 per cent of its non-nuclear energy requirements. In conjunction with its reliance on oil, this has led to a strong emphasis on energy security and supply diversication policies. In this context, natural gas was introduced into the Korean market in 1986 in the form of imported LNG.
Total primary energy consumption, 2002 Korea

Mtoe % 23.5 49.1 11.3 14.2 1.9 100.0
Coal Oil LNG Nuclear Renewables Total

Source: KEEI (2003a).
49.1 102.7 23.6 29.8 3.9 209.1
Natural gas consumption in Korea

Natural gas use in Korea has grown at an average annual rate of 19 per cent since 1990, albeit from a small base, and represented more than 11 per cent of primary energy consumption in 2002. In 2002, natural gas consumption was 18.1 million tonnes (25.0 billion cubic metres). The rapid growth has been a result of active government policies to encourage natural gas use, expansion in gas infrastructure, including gas distribution networks and electricity generation plants, and rising personal incomes that have induced a shift in preferences to clean and efcient fuels. Rapid growth in city gas consumption in Korea over the past decade is the main source of the sharp rise in LNG demand (KEEI 2003a; gure A). The city gas sector accounted for 62 per cent of Korean LNG consumption in 2002, while electricity generation comprised 33 per cent. Within the city gas sector, the majority of demand is from the residential sector and is LNG consumption, by sector driven by strong demand for heatKorea ing and, increasingly, space cooling. This has led to strong seasonal uctuations in LNG consumption 15 Other in Korea (KEEI 2002a, 2003a; Electricity generation gure B). In the electricity sector, City gas LNG accounted for 11 per cent of 10 total power generation in 2001 and is used primarily as a peak load 5 fuel.
Currently all natural gas demand in Korea is met by imported LNG

2
Mt 1986 1990 1994 1998 2002
and Korea is the worlds second largest importer of LNG after Japan. The majority of LNG imports are on the basis of long term take or pay contracts from Indonesia, the Middle East, Malaysia and Brunei (table B). Korea also uses the spot market extensively to meet winter demand peaks and any shortfalls in contracted supply. From late 2003, domestic gas supply will begin from a small eld in the East Sea but supply from this project will meet only around 2 per cent of Koreas current gas demand.
B
2.0 1.5 1.0 0.5 Mt
Monthly LNG consumption, by sector Korea

Other Electricity generation City gas
2000
Dec
2001
Dec
2002
Dec
LNG imports, by source, 2002 Korea

Mt % 28.9 28.2 22.8 12.9 4.3 1.0 2.0
Factors affecting future natural gas demand
While natural gas demand is expected to continue to grow strongly in Korea, a range of issues will 17.8 100.0 affect the extent and profile of Total future demand, including environ- Sources: KOGAS (2003); BP (2003). mental considerations, energy security issues and new sources of gas demand. One of the most important factors will be the anticipated liberalisation of domestic electricity and gas markets. While the deregulation and privatisation plans for these sectors developed by the previous government have stalled under the current administration, some form of liberalisation is likely to occur over the medium term. Electricity market liberalisation is likely to increase competitive pressures on power generators and provide incentives for cost minimisation. Based on fuel costs alone, LNG is generally less competitive than other energy sources. However, gas fired electricity generation could compete more effectively when the total cost of generation is considered because of its lower capital and operating costs. This suggests a more robust future for gas use in power
Qatar Indonesia Oman Malaysia Brunei Australia Other
5.2 5.0 4.1 2.3 0.8 0.2 0.3
generation in a deregulated, competitive market, especially to meet peak demand. Similarly, the expected transition to a more efcient and competitive structure in the gas market has the potential to increase the relative competitiveness of natural gas and stimulate new demand. However, the delay in implementing gas market reform is having some serious implications for Koreas long term gas supply security. This is because the Korean government is postponing entering new long term LNG supply contracts until the issue of reform has been progressed.
Projecting natural gas demand in Korea

The analysis of the potential demand for natural gas in Korea over the period to 2015 presented in this report is based on results from ABAREs global trade and environment model (GTEM). The energy demand projections are based on an assumption that GDP growth in Korea will average 5 per cent a year between 2001 and 2015. The projections are also based on assumptions relating to the projected fuel mix in electricity generation. In Korea there is some uncertainty surrounding the role that natural gas may play in power generation over the outlook period. The assumptions used in this study are from the Korea Power Exchange (KPX 2002a). The share of gas in total electricity output is assumed to rise over the rst half of the outlook period but to fall between 2007 and 2010 as a result of strong expansion in nuclear and coal fired output. At 2015, the share of gas Projected natural gas consumption, reference case is 11 per cent.
Korea
On the basis of these assumptions, total primary energy consumption is projected to expand by 3.5 per cent a year to reach 319 million tonnes of oil equivalent in 2015. Natural gas is projected to remain one of the fastest growing fuels in Korea, averaging 5.0 per cent growth a year over the period 200115 to reach 33.3 million tonnes (45.9 billion cubic metres)
4
30 25 20 15 10 5 Mt
Electricity Residential Commercial Industry
2003
2006
2009
2012
2015
Projected natural gas demand and supply Korea

2005 Mt 2010 Mt 24.2 14.6 1.0 0.4 8.2 2015 Mt 33.3 11.9 1.0 0.4 20.0
Projected gas demand, reference case KOGAS LNG contracts POSCO/SK LNG contract Projected domestic supply Projected gas supply shortfall
23.9 19.4 1.0 0.4 3.1
or around 13 per cent of total primary energy consumption. The fall in overall natural gas use between 2007 and 2010 reects the assumed fall in gas red power generation over this period (gure C). The strongest growth in demand for natural gas is expected to be in the residential and industry sectors. Based on existing LNG import contracts, it is expected that there will be a gas supply shortfall of around 3 million tonnes in Korea in 2005 (table C). Taking into account the expiry of some existing contracts, supply in 2015 could be around 20 million tonnes lower than projected natural gas demand.
Natural gas supply considerations

In the absence of significant domestic reserves, there are two options for Korea to meet the anticipated gas supply shortfall to sign new LNG import contracts and to import pipeline natural gas. Additional short term solutions include increased LNG spot market purchases, cargo swaps with other countries such as Japan, and midterm LNG contracts. Two midterm (seven year) contracts were recently signed with Australia and Malaysia, with supply to begin in late 2003. Over the longer term, there is potential to develop pipeline natural gas supply to Korea. A pipeline from Irkutsk in eastern Siberia through northern China to Korea is currently the subject of a feasibility study, the results of which are expected by September 2003. The Korean government considers that supply from the Irkutsk pipeline could begin from 200810 and that it could deliver 7 million tonnes of natural gas a year for thirty years. However, construction of the 4100 kilometre, US$11 billion pipeline would have to begin rapidly to be operational within this timeframe. The commercial viability of the project also depends to a large extent on the commitment of China
to the pipeline without demand from China, there is unlikely to be sufcient gas to justify construction of the pipeline on commercial grounds. Koreas decision to use pipeline natural gas will depend signicantly on its competitiveness with imported LNG. Korea has sought pipeline prices that are believed to be competitive with LNG and that would enable the project to proceed on a commercially sound basis. However, some analysts have expressed doubts that pipeline natural gas could compete in Korea with LNG over such distances, especially in an environment of declining international LNG prices (Platts 2003a,b). Other recent trends, including greater exibility in the terms and conditions on which LNG is available, including an ability to meet seasonal demand patterns, can also be expected to increase the attractiveness of LNG. Economic factors aside, pipeline natural gas may still form a part of Koreas gas supply mix in the medium to longer term if noneconomic factors, including energy security and geopolitical concerns, are emphasised in the decision making process.
Indicative gas supply and demand balance

A potential natural gas supply and demand balance for Korea is provided in gure D based on the demand projections developed in the report and current and known planned gas supply. The balance assumes that 0.4 million tonnes a year of gas will be delivered from Koreas Donghae project and that the by POSCO/SK contract for around 1 million tonnes of LNG a year from 2005 will proceed. It also assumes that pipeline natural gas supply from Irkutsk will begin from 2010.
Potential gas demand and supply balance Korea
Gas supply shortfall/possible additional LNG Pipeline natural gas supply, Irkutsk Donghae gas field supply POSCO/SK LNG contract KOGAS LNG mid term contracts KOGAS LNG long term contracts 2006 2009 2012 2015
D
30 25 20 15 10 5 Mt
2003
On the basis of these assumptions, there is projected to be a natural gas supply shortfall of 13.0 million tonnes at 2015. The supply gap becomes more significant after 2010, when stronger growth in natural gas demand is forecast than in the earlier part of the outlook period. This shortfall is likely to be met by new LNG import contracts. The need for additional LNG contracts could be greater if the Irkutsk project is delayed beyond 2010 or is not able to supply 7 million tonnes of gas a year. In these circumstances, Korea would need to secure additional LNG contracts of around 3 million tonnes by 2005 and further term contracts to meet the projected shortfall in the remainder of the outlook period. Failure to contract additional medium to long term gas supplies is likely to leave Korea vulnerable to gas shortages and to exacerbate the difculties it has experienced in recent years. A key issue in this context is the governments preference to delay entering into new LNG supply contracts until decisions have been made regarding the reform of the gas market. However, waiting for gas reform plans to be implemented before committing to new LNG contracts is exacerbating the gas shortfall issue. Because gas market reform is complex and requires good planning to implement effectively, it is not necessarily in Koreas best interests to put pressure on the reform process to hasten the signing of new LNG contracts, or vice versa. By waiting, however, Korea is potentially missing the opportunity to secure favorable terms and conditions that are currently being offered under long term contracts in the international market. Further, there are currently a number of LNG supply projects in the Asia Pacific region existing and planned that have the capacity to meet Koreas long term gas requirements. Indeed, the size of Koreas long term gas requirements is sufcient to justify additional investment in production capacity by LNG suppliers. However, given the time required to bring new developments to the market, it will be important for Korea to commit to new supply contracts as soon as possible if it is not to face an increasingly difcult gas supply situation in the medium term. The current competitiveness of the LNG supply industry and its responsiveness to changing market conditions will also ensure that Koreas long term energy security objectives are met.
1
introduction
The Republic of Korea (Korea) has achieved remarkable economic progress over the past fty years, moving from a low income agrarian economy to an internationally competitive and highly industrialised economic system. This strong economic performance has been underpinned by large scale and often government-directed industrial development. The sustained shift from primary industries to more energy intensive sectors, including iron and steel production and ship building, along with rising incomes, limited natural resource endowments and climatic factors, has played a key role in shaping energy consumption patterns in Korea. In particular, Koreas strong economic growth and expansion of energy intensive industries has led to a rapid rise in energy consumption. Primary energy consumption has grown at more than 7 per cent a year since 1980, reaching 209 million tonnes of oil equivalent in 2002. Korea is the fourth largest energy consumer in Asia, with its fuel mix heavily biased toward oil. With limited indigenous energy resources, a key characteristic of the Korean economy is its dependence on imports for more than 97 per cent of its energy requirements, excluding nuclear power. From an energy policy perspective, this import dependence has led to a strong emphasis on energy security and strategies to diversify fuel supplies. With such high import dependence likely to continue, security of energy supply can be expected to remain one of the key pillars of energy policy in the foreseeable future. In this context, natural gas (in the form of imported liqueed natural gas or LNG) was introduced into the Korean market in 1986 and has since played an increasingly important role in the fuel mix. Natural gas represented 11 per cent of Koreas total primary energy consumption in 2002. LNG imports have increased in line with the rising consumption of gas, and Korea is now the worlds second largest importer of LNG after Japan. In 2002, Korea imported nearly 18 million tonnes of LNG, primarily under long term contracts with suppliers from Indonesia, Malaysia, Brunei and the Middle East. This is equivalent to around a quarter of Asia Pacic LNG trade.
8 ABARE research report 03.4
The role of natural gas in meeting Koreas energy demand is likely to continue to expand over the next decade, as gas offers a competitive and clean alternative fuel for a range of end uses. This trend is being reinforced by strong investment in new gas distribution networks. Also important will be proposed reforms in Koreas electricity and gas industries that are likely to introduce more efcient and competitive energy markets. Koreas limited domestic gas resources mean that any growth in gas consumption will need to be supplied either by increased LNG imports and/or the introduction of pipeline natural gas. While KOGAS, Koreas gas importing monopoly, has mid and long term LNG contracts for volumes of 19 million tonnes a year, Koreas first contract with Indonesia will expire in 2007. Further, a shortfall in contracted LNG supply is expected to expand over the period to 2015 as more long term contracts expire and Korean natural gas demand increases. This likely gas shortfall is emerging as a serious issue for Korea as KOGAS has delayed signing new long term LNG contracts until plans to reform the gas market are progressed. To date, KOGAS has addressed the anticipated supply shortfall by increasing its use of the spot market and by entering into midterm LNG contracts with Australia and Malaysia. However, to ensure that its gas requirements over the coming years can be met cost effectively and without risk it will be necessary for Korea to consider entering into further mid or long term LNG supply contracts in the near future. Over the longer term, pipeline natural gas could provide an additional and complementary source of gas supply to the Korean market. The feasibility of a long distance gas pipeline from the Irkutsk region in the Russian Federation is currently being considered by government and industry in Korea. In addition to cost effectiveness, a critical factor in the overall assessment of such projects will be their contribution to energy security and diversity of energy supply.
Objectives in the study

The key objective in this report is to assess the potential growth in natural gas demand in Korea and, in particular, the role that LNG could play in that market. The likely demand for natural gas is analysed on the basis of assumptions related to economic growth, the fuel mix in power generation and other factors that will influence energy sector outcomes. These include policies
associated with liberalisation of the electricity and gas markets, security of energy supply, nuclear power policies and environmental issues. The study also assesses the emerging natural gas supply gap faced by Korea and reviews the options available to meet this shortfall. Sources of LNG supply in the Asia Pacific market and their key characteristics, including resource availability, production capacity and security of supply are examined. Also analysed are options for pipeline natural gas supply to Korea, with a focus on the feasibility of long distance pipelines from the Russian Federation, and their potential competitiveness with LNG.
10
2
energy and natural gas consumption in Korea
Energy consumption
Primary energy consumption in Korea has grown rapidly over the past two decades, at an average rate of 7.4 per cent a year. In 2002, energy consumption was 209 million tonnes of oil equivalent, compared with 44 million tonnes of oil equivalent in 1980 (KEEI 2003a; figure 1). While the Asian nancial downturn in the late 1990s had a signicant impact on the Korean economy energy consumption fell by 8.1 per cent in 1998 it has since recovered rapidly (KEEI 2003a). Korea accounted for 8 per cent of Asia Pacic energy consumption in 2002 (BP 2003). Driving the rapid growth in energy consumption has been Koreas strong economic performance. The Korean economy has grown at an average annual rate of 7.1 per cent since 1980, with gross domestic product (GDP) valued at 596 trillion won (US$477 billion) in 2002 (table 1). Economic growth fell sharply in 1998 as a result of the Asian financial downturn but recovered quickly to reach 6.3 per cent in 2002, reecting robust domestic consumer spending and growth in export sectors. Economic growth in 2003 is expected to slow to around 3.5 per cent as a result of the sluggish world economy. Energy intensity, or energy consumption per unit of economic output, remains high in Korea, at 0.4 tonnes of oil equivalent per thousand won in 2002 (table 1). This reects the fact that economic growth has been led by expansion in energy intensive industries, including petrochemicals, steel and shipbuilding. While Koreas energy intensity has declined since 1997 as a result of industrial restructuring, it remains one of the highest among OECD countries (table 2).
1
200 150 100 50 Mtoe
Total primary energy consumption Korea

Renewables Nuclear LNG Oil Coal
1982 1986 1990 1994 1998 2002
11
Major energy and economic indicators Korea

Annual growth 1981 1991 103.6 327.4 43.3 0.4 2.4 2001 198.4 560.9 47.3 0.4 4.2 2002 209.1 596.4 47.6 0.4 4.4 1981 1991 2001 91 2001 02 % % % 8.5 8.9 1.1 -0.3 7.3 6.7 5.5 0.9 1.1 5.8 5.4 6.3 0.6 -0.9 4.7
Energy consumption Mtoe Real GDP a trillion won Population million Energy intensity toe/000 won Energy consumption per person toe
a in 2002 prices. Sources: KEEI (2003a); KNSO (2003).
45.7 139.2 38.7 0.4 1.2
Energy consumption per person in Korea has also grown rapidly, from 1.2 tonnes of oil equivalent in 1981 to 4.4 tonnes of oil equivalent in 2002 (table 1). Current levels are similar to those of Japan and Germany, although lower than in Australia and the United States (table 2).
Fuel mix in primary energy consumption

Total primary energy consumption is the total energy used by an economy. Primary fuels include coal, crude oil and net imports of petroleum products
International comparison of major energy and economic indicators, 2000

Primary energy consumption Mtoe Energy intensity a toe/000 US$ 0.30 0.17 0.20 0.24 0.26 0.18 0.23 0.22 0.32 Energy consumption b per person 4.10 4.13 3.74 0.91 8.35 4.13 5.75 4.74 0.64
Korea Japan Chinese Taipei China United States Germany Australia OECD average non-OECD average
193.6 524.7 11.5 1 142.4 2 299.7 339.6 110.2 5 316.9 c 6 251.5 c
a Tonnes of oil equivalent per thousand 1995 US$ PPP. b Tonnes of oil equivalent per person. c Total. Sources: IEA (2002a,b).
12
(hereafter referred to as oil), natural gas, nuclear power and renewables (hydropower and others such as wind and solar power).
Total primary energy consumption, 2002 Korea

Mtoe % 23.5 49.1 11.3 14.2 1.9
Oil constitutes the largest share of primary energy consumption in Korea, at 49 per cent in 2002 (table 209.1 100.0 3). While demand for oil has Total grown by more than 6 per cent a Source: KEEI (2003a). year on average over the past decade, its share of primary energy consumption has declined steadily since 1994 (KEEI 2003a; gure 2). High crude oil prices in recent years have contributed to the declining share of oil, as have government efforts to reduce Koreas dependence on imported oil supplies. Coal is also an important energy source in Korea, representing 23 per cent of primary energy consumption in 2002. While coal demand has been strong in recent decades, a signicant change in the composition of coal consumption has occurred over this period. Anthracite coal is the main domestic energy resource available in the Korean territory and was the major energy source before being replaced by oil in the 1970s. However, anthracite has to a large extent been replaced by imported bituminous coal the share of anthracite in total primary energy consumption was 2 per cent in 2002. Natural gas has led the growth in energy consumption in Korea since LNG was introduced into the market in 1986. LNG consumption has grown at an average annual rate of 18.7 per cent over the past decade, to reach 11 per cent of primary energy consumption in 2002, compared with 3 per cent in 1990. This rapid growth, albeit from a small base, is a result of active government policy initiatives encouraging LNG use and the expansion of gas infrastructure
Coal Oil LNG Nuclear Renewables
49.1 102.7 23.6 29.8 3.9
2
80 60 40 20 %
Fuel mix in primary energy consumption Korea
Renewables Nuclear LNG Oil Coal
1982 1986 1990 1994 1998 2002
13
throughout the country. LNG consumption is discussed in more detail later in this chapter. Use of nuclear power has also grown rapidly since the commissioning of Koreas rst nuclear power plant in 1977, to reach 14.2 per cent of primary energy consumption in 2002. This large expansion in the use of nuclear power reects government policy responses to Koreas growing reliance on imported energy. Renewable energy, including hydropower, constitutes a marginal share in primary energy consumption, at 2 per cent in 2002, although use of nonhydro renewables has been growing in recent years. Supportive government policies, including the New and Renewable Energy Development and Promotion Act, which encourages the installation of waste incineration facilities to generate heat and power and residential solar hot water systems, have been introduced as a means of reducing Koreas dependence on imported fossil fuels and to provide clean energy.
Final energy consumption

Total nal energy consumption is dened as the total amount of energy used by nal consumers. It includes energy used by industry, transport, residential and commercial services sectors but does not include the energy used in conversion (principally electricity generation and petroleum refining) and distribution activities. In 2002, nal energy consumption in Korea was 161 million tonnes of oil equivalent (KEEI 2003a; gure 3). The industry sector is the largest final energy user in Korea, at around 55 per cent in 2002. This sector has also been one of the fastest growing users of energy in recent years. Energy consumption in the residential and commercial sectors has grown more slowly and represented 22 per cent of final energy consumption in 2002. The transport sector has become more visible over the past decade as a
14
3
140 120 100 80 60 40 20 Mtoe
Final energy consumption, by sector Korea

Public/others Residential/commercial Transport Industry
1982 1986 1990 1994 1998 2002
result of the rapid expansion in vehicle ownership (KEEI 2003a; gure 4) and transport volumes in Korea, and now accounts for 21 per cent of nal energy consumption.
4
12 10 8
Motor vehicle registrations Korea

Trucks Buses Passenger cars
Within these sectors, there have 6 been notable changes in fuel choices. There has been substitu4 tion away from heavy fuel oil and 2 coal toward natural gas and electricity in the industry sector, million reecting the advantages of these 1982 1986 1990 1994 1998 2002 fuels in terms of environmental and inventory costs. In the residential and commercial sectors, rapid economic growth and rising incomes have led to a shift in consumer preferences away from coal to more convenient and clean fuels such as natural gas and electricity. The share of coal in the residential and commercial sectors, for example, fell from 23 per cent in 1992 to 2 per cent in 2002, while the share of gas rose from 8 per cent to 30 per cent over the same period (KEEI 2003a; gure 5).
Electricity generation
Electricity consumption in Korea has grown more rapidly than overall energy use over the past two decades, at 10.2 per cent a year, to reach 278 Final energy consumption in key terawatt hours in 2002. The largest sectors, by fuel Korea electricity consumers in Korea are the industry sector, accounting for more than half of electricity use in Other 80 2002, and the commercial sector Electricity (26 per cent) (KEEI 2003a). 60
City gas
Nuclear power constitutes the largest source of electricity generation in Korea, at 39 per cent in 2001 (table 4). Korea currently has sixteen nuclear units in operation at four sites, representing 27 per cent of total electricity generating
40 20 % 1982 1990 2002 Industry
Petroleum Coal
1982 1990 2002 Residential and commercial
15
Electricity generation, by fuel Korea

1981 TWh % 6.3 79.8 7.2 6.7 100.0 TWh 20.1 27.2 9.9 56.3 5.1 118.6 1991 % 17.0 22.9 8.4 47.5 4.3 100.0 TWh 110.3 28.2 30.5 112.1 4.2 285.2 2001 % 38.7 9.9 10.7 39.3 1.5 100.0
2.5 32.1 2.9 2.7 40.2
Sources: KEEI (2001); KPX (2002a).
capacity (table 5). Coal also accounts for approximately 39 per cent of power generation in Korea, while 30 per cent of capacity is coal red. LNG represented 11 per cent of electricity generation in 2001 but accounted for 25 per cent of capacity. This is because LNG is used primarily as a peak load fuel in Korea. There were 104 LNG red units in 2001, reecting their smaller size and peak load application. Oil red power generation in Korea has declined signicantly over the past two decades, to 10 per cent in 2001, as has hydropower, to 1.5 per cent in 2001.
Energy imports
Koreas dependence on energy imports has grown signicantly in the past two decades, from 74 per cent of energy requirements, excluding nuclear power, in 1980 to more than 97 per cent in 2002 (table 6). Energy imports were valued at US$31.5 billion in 2002 and represented 21 per cent of Koreas total import bill. Oil accounted for the majority of energy imports, at around 80 per cent in value terms, while LNG imports accounted for 13 per cent.
16
Electricity plants and capacity, 2001 Korea

Number of units Capacity GW Share % 30.5 8.8 25.5 27.0 8.1 100.0
38 21 104 16 200 379
15.5 4.5 13.0 13.7 4.2 50.9
Source: KPX (2002b).
Energy import indicators Korea

1980 1990 10.9 87.9 82.5 4.4 73.4 2000 37.6 97.2 83.6 10.1 76.8 2002 31.5 97.3 79.7 12.7 73.4
Energy imports Overseas energy dependence a Oil share in energy imports b LNG share in energy imports b Middle East share of crude oil imports b
US$b % % % %
6.5 73.5 92.3 98.8
a Excluding nuclear power. b Dollar value. Sources: KEEI (2002b, 2003a); MOCIE (2003).
Energy imports have grown rapidly in line with energy consumption, from 33 million tonnes of oil equivalent in 1980 to 215 million tonnes of oil equivalent in 2002 (KEEI 2003a; gure 6).
6
200 150
Energy imports, by fuel Korea

LNG Oil Coal
In addition, Korea remains highly 100 dependent on the Middle East for its supplies of crude oil, at 73 per 50 cent in 2002 (table 6). This is lower than in 1980, however, and reects Mtoe diversification away from Middle 1982 1986 1990 1994 1998 2002 Eastern oil following the oil price rises of the late 1970s and early 1980s. While LNG was introduced as a means of diversifying energy consumption away from oil, Korea has also depended entirely on imports for its natural gas supply. Such rapid growth in energy imports and import dependence has raised concerns in Korea over diversity and security of energy supply sources. This issue is discussed further in the following chapter.
Natural gas consumption

Natural gas consumption in Korea has grown rapidly since LNG was rst imported in 1986, at an average rate of 18.7 per cent a year over the past decade. In 2002, natural gas consumption was 18.1 million tonnes of LNG (25.0 billion cubic metres), compared with 2.3 million tonnes (3.2 billion cubic metres) in 1990 (KEEI 2003a).
Gas consumption, by sector

Rapid growth in city gas use or gas for nonpower generation is the main reason that LNG demand has increased so sharply (table 7). In the initial stage of the natural gas industry in Korea, most LNG was consumed in power generation. However, with the expansion of the pipeline distribution network and rising personal incomes, consumption of city gas has grown signicantly. Since 1990, LNG consumption by the city gas sector has grown at an average annual rate of 28 per cent. The city gas sector accounted for 62 per cent of total LNG consumption in 2002, followed by electricity generation (33 per cent), district heating (3 per cent) and other uses (2 per cent). This is in contrast with other countries, including Japan and Chinese Taipei, where electricity generation is the main user of LNG. Demand for LNG in electricity generation in recent years has remained steady, largely as a result of relatively high LNG prices. However, electricity sector demand for LNG spiked in late 2002 in response to increases in crude oil prices. While LNG prices are linked to international crude oil prices, the time lag in the adjustment to LNG prices meant that LNG became more competitive over this period and replaced oil red power generation. LNG demand for electricity generation in October and November 2002, for example, was 86 per cent and 68 per cent greater than their 2001 levels respectively (KEEI 2003a).
7
1986 1990 1995 1996 1997 1998 1999 2000 2001 2002
LNG consumption, by end use Korea

District heat kt 150 173 178 159 177 335 630 540
Electricity kt 45 1 741 3 412 4 448 5 197 4 029 4 591 4 353 4 653 5 969
City gas kt 575 3 417 4 561 5 770 6 232 7 886 9 528 10 299 11 194
Other kt 8 12 108 179 232 222 306 339 402 425
Total kt 53 2329 7 087 9 362 11 378 10 664 12 961 14 556 15 990 18 128
Sources: KEEI (2002c, 2003a).
18
City gas demand

LNG currently accounts for 99.5 per cent of city gas supply in Korea, hence trends in the city gas sector have a direct impact on LNG demand. Liqueed petroleum gas (LPG) accounts for the remaining 0.5 per cent of city gas supply.
7
12 10 8 6
City gas demand, by sector Korea

Industry Commercial Residential
Koreas consumption of city gas in 4 2002 was 14.1 billion cubic metres, 2 equivalent to 10.3 million tonnes of LNG. Increasing use of gas in billion m3 the residential sector has driven the 1986 1990 1994 1998 2002 expansion in city gas demand, with average annual growth of 27 per cent since 1990 (KEEI 2003a: gure 7). In 2002, the residential sector accounted for 55 per cent of total city gas demand. City gas is mainly used in this sector as a fuel for cooking, space heating and increasingly, space cooling. Industry use of city gas has grown at a similar rate over the past decade, to constitute 27 per cent of city gas consumption in 2002. This growth reects in part marketing efforts to boost gas sales in this sector. KOGAS, the state owned gas company, provides subsidies for industrial customers to build natural gas facilities or cogeneration units, and for commercial users to install gas cooling systems. The commercial sector is the smallest user of city gas,
City gas consumption, by region Korea

Consumption 1990 million m3 2000 million m3 7 799 4 381 12 180 2001 million m3 8 148 4 709 12 858 Annual Connections growth Network as at 19902001 2001 Dec. 2001 % 24.9 30.3 26.6 km 89 927 41 099 131 027 000 6 019 2 671 8 691
Capital area a Province area Total
706 257 963
a Includes Seoul, Incheon and Gyeonggi. Source: Citygas Association (2002).
19
accounting for around 18 per cent of city gas consumption in 2002. The rapid expansion in city gas demand has been driven to a large extent by the development of gas distribution networks throughout the country. Koreas widespread gas distribution system has enabled natural gas to penetrate the market quickly, including in provincial areas (table 8). However, the Seoul region is by far the largest consumer of city gas, with more than 6 million users at the end of 2001.
8
2.0 1.6 1.2 0.8 0.4 Mt
LNG monthly consumption, by sector Korea

Total
City gas
Electricity generation 2000 Dec 2001 Dec 2002 Dec
Patterns of gas use

LNG consumption in Korea exhibits strong seasonal uctuations. LNG use in the peak winter months (DecemberFebruary) generally averages at least twice that in summer (KEEI 2002a, 2003a; gure 8). Most of this seasonal variation is explained by city gas use in the residential sector where about two-thirds of annual gas consumption occurs during the winter season (KEEI 2002a, 2003a; gure 9). The peak in winter is associated with high heating loads. Colder than average temperatures during winter months can further increase the peak demand. The turndown ratio, City gas monthly consumption, the difference between the highest by sector Korea and lowest demand months, for this Residential sector was 7.1 in 2002. That is, gas 1.2 consumption in the peak month was 7.1 times consumption in the 1.0 Industry month of lowest demand. 0.8 8
Although city gas consumption in the commercial sector is also affected by winter temperatures, the monthly consumption pattern is less severe than in the residential sector. The turndown ratio in 2002
20
0.6 0.4 0.2

billion m3
Commercial Dec 2001 Dec 2002 Dec
2000
was around 2.8 in the commercial sector. The industry sector exhibits the least monthly uctuations in demand, with a turndown ratio of around 1.6 in 2002. LNG demand in the electricity sector exhibits little seasonal fluctuation compared with that of city gas, although LNG demand for power generation can also peak in winter (gure 8). This partly reects maintenance schedules for base load coal and nuclear plants that increase demand for gas red plants at that time. The strong seasonal fluctuations in LNG demand evident in Korea have created supply and storage problems as contracted LNG deliveries have typically taken place throughout the year. This has necessitated signicant investment in gas storage capacity at LNG import terminals.
Natural gas supply

Domestic gas reserves
Koreas only known gas reserves are in the Donghae eld in the East Sea. Recoverable reserves in that field are estimated at around 6 billion cubic metres, equivalent to just over 4 million tonnes of LNG. The Korea National Oil Corporation (KNOC) plans to begin full commercial production of this eld from late 2003. The Donghae-1 project is expected to deliver 0.4 million tonnes of natural gas a year to KOGAS, or approximately 2 per cent of Koreas current gas demand (EIA 2002).
LNG imports
The government owned Korea Gas Corporation (KOGAS) was established in 1983 and currently controls LNG imports, LNG receiving terminals, the national gas distribution network, and wholesale LNG sales in Korea. KOGAS supplies LNG to city gas distribution companies and to electricity generators. Korea is currently entirely dependent on LNG imports for its natural
10
4 3 2 1 US$b 1986
LNG imports Korea

Volume 16 Value 12 8 4 Mt 1990 1994 1998 2002
21
gas supply. Korea is the second largest importer of LNG in the world after Japan, importing 17.8 million tonnes in 2002 (KEEI 2003a; figure 10). Indonesia has traditionally supplied the majority of Koreas LNG; however, in recent years Korea has diversied its supply sources. In 2002, Indonesia, Malaysia, Qatar and Oman supplied more than 90 per cent of Koreas LNG imports (table 9). Currently, Korea purchases most of its LNG requirements under seven long term take or pay contracts that account for 17 million tonnes of LNG (table 10). New procurement of LNG is based on The Basic Plan of Long Term LNG Supply and Demand issued by the Ministry of Commerce, Industry and Energy (MOCIE). Plans are revised every two years and the latest plan the sixth was released in November 2002 (MOCIE 2002a). Based on the demand and supply projections in the plan, the government permits KOGAS to directly negotiate an LNG procurement deal with the supplier. The government typically approves the new LNG contract, after KOGAS and the supplier set the price and other terms and conditions. However, KOGAS is postponing entering into new long term contracts until plans to restructure the gas sector are progressed. The issue of gas market reform is discussed further in chapter 3. Long term contractual supplies have typically not been adequate to meet the rapid rise in Koreas demand for LNG, particularly in the winter months.
LNG imports, by source Korea

Volume 1990 Mt 1995 Mt 5.26 1.04 0.71 0.06 0.03 7.09 2000 Mt 6.13 2.44 0.80 3.05 1.59 0.05 0.24 0.07 14.37 2002 Mt 5.02 2.30 0.77 5.15 4.06 0.18 0.23 0.12 17.83 1990 % 99.5 0.5 100.0 Shares 1995 % 74.2 14.7 10.0 0.8 0.4 100.0 2000 % 42.6 16.9 5.6 21.2 11.1 0.4 1.7 0.5 100.0 2002 % 28.2 12.9 4.3 28.9 22.8 1.0 1.3 0.7 100.0
Indonesia Malaysia Brunei Qatar Oman Australia United Arab Emirates Other a Total
2.29 0.01 2.30
a Includes cargo swaps with Japan and Chinese Taipei. Sources: KEEI; KOGAS (2003); BP (2003).
22
10
Source
Existing mid and long term LNG contracts Korea

Project name Amount Mt/yr Agreement period
Long term Indonesia Indonesia Indonesia Malaysia Brunei Qatar Oman Total Midterm Malaysia Australia Total
Arun III Korea II Bontang V MLNG II BLNG Ras Laffan OLNG
2.30 2.00 1.00 2.00 0.70 4.80 4.06 16.86
1986 2007 1994 2014 1998 2017 1995 2015 1997 2013 1999 2024 2000 2024
MLNG Tiga NWS Australia LNG
1.50 a 0.50 2.00
2003 2009 2003 2009
a The contract includes an option for an additional 0.5 million tonnes.
This has resulted in Korea also entering into short term contracts from the early 1990s. At their peak, between 1996 and 1999, short term contracts contributed almost 4 million tonnes a year to Koreas LNG supply. Korea is also an active buyer of spot product, to cope with winter peak demand and is one of the largest markets for LNG spot trade in the world. However, this reliance on the spot market has not always resulted in an optimal outcome for Korea. In winter 200203, for example, there was an unprecedented shortage of LNG in Korea and KOGAS had difculty sourcing additional spot cargoes (see box 1). This recent experience has highlighted the vulnerability of Koreas current gas supply situation and the importance of having adequate and secure long term LNG supplies. More recently Korea has entered into midterm contracts with Australia and Malaysia to supply 0.5 and 1.52.0 million tonnes of LNG a year respectively for seven years, beginning in late 2003. Delivery schedules in these contracts are heavily biased toward winter supply. Under the contract with North West Shelf Australia LNG, 100 per cent of the contracted volume will be delivered in the winter months.
23
Box 1: Koreas LNG supply shortfall in winter 200203 An unprecedented domestic shortage of LNG during winter 200203 required KOGAS to source additional supplies on international markets. KOGAS purchased a reported record 42 spot cargoes that winter, totaling around 2.5 million tonnes. This was equal to nearly 15 per cent of Koreas contracted LNG volumes at that time. Arrangements were also made with suppliers to redirect cargoes from other existing contracted customers, including some Japanese power companies, to Korea. In comparison, in the previous winter KOGAS purchased 22 spot cargoes.
The domestic supply shortage that necessitated such unprecedented access to the spot market was the result of a number of factors. There was a sharp and unexpected rise in LNG use by electricity generators during this period as LNG became relatively less expensive than oil. While LNG prices are linked to international crude oil prices, there is a time lag before rises in crude oil prices lter through. LNG was therefore cheaper over this period because of the lag in LNG price adjustment following the increase in crude prices. Increased LNG demand by electricity generators coincided with an early start to a cold Korean winter, which boosted city gas demand by the residential sector. The situation was exacerbated by limited spare international LNG shipping capacity. This was related in part to Japans increased demand for spot LNG cargoes over the same period as the Tokyo Electric Power Company (TEPCO) increased its use of LNG in response to the closure of its nuclear plants. Highlighting Koreas difculty in sourcing cargoes, KOGAS purchased three long haul LNG cargoes from Algeria, redirected from Gaz de France, and is understood to have exceeded the prevailing prices for these cargoes by more than 10 per cent. To help alleviate the tight gas supply situation, the Korean government required power plants running on LNG to switch to petroleum fuels. A nuclear plant undergoing maintenance and repairs was also brought back on line earlier than planned. Korea is likely to continue to require spot cargoes and short term contracts to make up further projected supply shortfalls as KOGAS is currently delaying entering into new long term contracts for LNG until plans to restructure the gas sector are progressed. In the interim, KOGAS has signed two midterm contracts with Australia and Malaysia to begin supplying in late 2003, which will alleviate the projected shortfall to some extent. It has also been reported that KOGAS has reached an agreement with Tohoku Electric Power Company in Japan to swap LNG cargoes when appropriate as a means of avoiding a repeat of last winters LNG shortage. Unlike Korea, Japan consumes more LNG in summer than in winter as a result of its relatively higher demand for air conditioning. This mismatch in seasonal demand has in the past lent itself to diverting LNG cargoes originally destined for Japan to Korea during the winter, subject to the consent of producers.
Sources: Reuters (2003a); Energy Argus (2002a,b; 2003a,b).
24
Gas supply infrastructure

Korea currently has three LNG receiving terminals at Pyeongtaek, Incheon and Tongyeong (gure 11). These terminals are all owned and operated by KOGAS. POSCO, Koreas largest steel producer, has commenced construction of an LNG receiving terminal at Kwangyang that is expected to be in operation in 2005. This will be the rst privately owned terminal in Korea.
11
LNG import terminals and pipeline network Korea
Seoul
Incheon LNG terminal Pyeongtaek LNG terminal
Donghae field
Tongyeong LNG terminal Kwangyang LNG terminal (under construction)
25
Twenty-six LNG storage tanks are LNG receiving terminals Korea located at the three existing terminals: fourteen in Incheon, ten in Supply Storage Storage Pyeongtaek and two in Tongyeong. capacity capacity tanks The total storage capacity at the three terminals is 3 billion litres, t/hr GL no. equivalent to 2.2 million tonnes of Pyeongtaek 2 016 1 000 10 gas (table 11). The Incheon termiIncheon 2 970 1 680 14 nal is being expanded to include Tongyeong 750 280 2 four additional storage tanks a year Total 2 960 26 between 2002 and 2004 to meet Source: KOGAS (2003). projected growth in LNG demand. According to the sixth Basic Plan of Long Term LNG Supply and Demand, Korea will have an LNG storage capacity of more than 7 billion litres (5.4 million tonnes) by 2015 (table 12).
11
In 2002, the operational length of the national gas pipeline network was 2442 kilometres. In the sixth Basic Plan of Long Term LNG Supply and Demand, it is planned that a total of 2597 kilometres of nationwide pipeline will be operational by 2010 (table 13). The network currently supplies natural gas to customers in around 60 cities, mainly through city gas companies.
12
Planned expansion of LNG storage tanks Korea

2001 200203 200405 200607 200810 201115 GL GL 1 500 3 780 GL 680 4 460 GL 700 5 160 GL 960 6 120 GL 1 260 7 380
New storage tanks Total storage tanks

Source: MOCIE (2002a).
280 2 280
13
Planned expansion of gas pipeline network
Korea
2001 km New pipeline Total pipeline 131 2 412
2002 km 30 2 442
200307 km 140 2 582
200810 km 15 2 597
201115 km 2 597
Source: MOCIE (2002a).
26
Gas pricing
LNG import prices
In 2002, the average LNG import price to Korea was US$223.80 a tonne, equivalent to around US$4.30/MBtu (million British thermal units). Prices since 2000 have been considerably higher than in previous years, as gas contract prices rose in line with movements in international oil prices (KEEI 2003a; figure 12). This reflects standard long term contract conditions in which up to 90 per cent of the LNG price is indexed to movements in international oil prices.
12
250 200
Average LNG and crude oil import prices Korea

Crude oil import price
right axis
25 20 15 10 5 US$/bbl
150 LNG import price 100 left axis 50 US$/t 1990 1994 1998
2002
Wholesale and retail gas prices

The KOGAS wholesale price for gas consists of a feedstock cost and a supply cost, the latter of which is differentiated by type of user and end use. This methodology is discussed in more detail in box 2. Gas supply costs for power plants are differentiated on a seasonal basis, reecting storage costs, hence supply costs in winter are higher than in summer. The average wholesale price of gas to electricity generators was between 325 and 327 won (US$0.28)
14
Wholesale gas price for power plants, January 2003 Korea

For POSCO won/m3 US$/m3 US$/MBtu For others won/m3 US$/m3 US$/MBtu 293.30 33.26 42.56 23.97 33.26 326.57 0.25 0.03 0.04 0.02 0.03 0.28 6.96 0.79 1.01 0.57 0.79 7.75
Feed stock cost Average supply cost for winter for summer for other seasons Average gas price
293.30 31.41 40.71 22.12 31.41 324.71
0.25 0.03 0.03 0.02 0.03 0.28
6.96 0.75 0.93 0.52 0.75 7.71
Average exchange rate, January 2003, US$1=1170.5 won. Source: KOGAS (2003).
27
per cubic metre at January 2003 (table 14). This is equivalent to between US$7.71 and US$7.75/MBtu. The wholesale price for city gas (table 15) is higher than for power plants and is different across end uses, including heating, industry and commercial use. The feed stock cost for city gas was 305 won (US$0.26) per cubic metre at January 2003, while the average supply cost was 74 won (US$0.06) per
Box 2: Gas price setting procedures in Korea The regulation of natural gas prices in Korea is based on the City Gas Business Law. The objectives of the regulations are to ensure that gas companies do not charge customers unreasonable supply costs and to enable gas companies to sustain their business on a sound basis.
Rates are subject to approval from the relevant regulatory institutions. Wholesale gas supply rates need to be approved by the Minister of Commerce, Industry and Energy, while the rates for retail gas supply must be approved by the provincial government in its jurisdictional area. For wholesale pricing, KOGAS adopts cost of service as the principle of its rate making system. This includes a predetermined reasonable return on investment. The KOGAS wholesale price consists of a feedstock cost and a supply cost. The feedstock cost is the sum of the LNG import price (cif) and additional domestic costs associated with LNG importing, including import tariffs and levies, handling charges, a special excise tax, and a safety management fund contribution. Supply costs are determined by type of demand (that is, city gas and power plants) and then by type of use. For power plants, use is based on season, while city gas uses include space heating, cooling, commercial, industry and cogeneration/community energy system use. These rates are then divided by an estimated supply volume to produce unit prices. To reect changes in import prices in the wholesale price, KOGAS adjusts the LNG feedstock cost for power plants on a monthly basis and for city gas customers every two months. The supply cost is subject to annual adjustment. Local city gas companies design city gas retail prices by adding locally specic supply costs to the wholesale price paid to KOGAS. That is, city gas retail rates are determined by the cost to recover the total expenditure by the local distribution company for supplying city gas to end users. The total cost of service includes a reasonable return on investment as well as reasonably estimated total operating costs.
Source: KEEI.
28
15
Wholesale price for city gas, January 2003 Korea

won/m3 US$/m3 0.26 0.06 0.09 0.04 0.03 0.06 0.03 0.32 US$/MBtu 7.24 1.76 2.47 0.98 0.70 1.59 0.70 9.00
Feed stock cost Average supply cost House heating Commercial Cooling Industry Cogeneration/CES winter summer other seasons Average city gas wholesale price
305.08 74.35 104.18 41.11 29.51 66.84 29.51 379.43
16
Retail price for city gas, Seoul area, January 2003

won/m3 US$/m3 0.04 0.36 0.38 0.38 0.38 0.39 0.38 0.34 0.20 0.30 0.32 0.27 0.29 0.35 0.29 0.31 US$/MBtu 1.02 10.03 10.56 10.69 10.69 10.97 10.51 9.47 5.52 8.30 9.01 7.42 8.12 9.61 8.03 8.73
Retail cost of service Average retail price Heating cooking heating (house) heating (apartment) heating (building) Commercial I Commercial II Cooling Industry Cogeneration/CES: district heating winter summer other seasons Cogeneration/CES: others winter summer other seasons
43.09 422.52 445.15 450.60 450.60 462.16 442.71 399.09 232.72 349.70 379.64 312.80 342.31 405.08 338.24 367.75
29
cubic metre. Combining these costs, the average city gas wholesale price was 379 won (US$0.32) per cubic metre at January 2003, equivalent to around US$9.00/MBtu. City gas for cooling is exempt from the supply cost charge, lowering its wholesale price, in order to encourage demand for gas cooling systems, while cogeneration/community energy systems are also exempt from the supply cost charge during summer. Table 16 shows city gas retail prices in the Seoul area in January 2003. The retail price is the sum of the wholesale price for city gas and the retail cost of service. The retail cost of service is the cost of supplying city gas to end users. In Seoul this is calculated to be 43 won (US$0.04) per cubic metre. The average retail price in Seoul at January 2003 was 423 won (US$0.36) per cubic metre, equivalent to US$10.03/MBtu, although the price varied across end uses.
30
3
factors affecting Koreas future natural gas demand
While natural gas demand is likely to grow strongly in Korea, a range of issues will affect the extent and prole of future demand. These include environmental factors, energy security concerns, the pace of investment in gas fueled district heating systems, growing demand for cooling systems by the expanding Korean middle class, and the implications of plans to deregulate Koreas electricity and gas markets.
Environmental issues
Until recently, environmental issues were generally given low priority in Korea in favor of economic expansion. As a result, most major cities and industrial areas have signicant environmental pollution problems. However, the environment and sustainable development, particularly in relation to energy use, are emerging as some of the most important issues facing the country. Major regulations and policies to address environmental issues have been introduced since the Korean Ministry of Environment was established in 1990.
Energy related environmental policies

Koreas energy related environmental policies focus principally on air quality control in the electricity, industry and transport sectors. The 1990 Air Quality Preservation Act, for example, bans the construction of thermal power plants that use fuels other than natural gas in the Seoul metropolitan area. This law also sets permissible emission standards for stationary and transport emission sources. One of the main goals of long term energy policy in Korea is to create a balance between economic growth and environmental protection. Many policies, at both the national and local government level, emphasise and encourage substitution away from conventional fossil fuels such as coal and petroleum, to relatively clean fuels, including natural gas. Mandatory air quality controls and stricter emission standards reinforce this trend.
31
In the industry sector, for example, recent trends indicate movement out of coal and oil into natural gas and electricity. In the iron and steel sector, natural gas accounts for around 12 per cent of energy consumption (IEA 2002a). Another relatively new source of demand for natural gas is the expansion of compressed natural gas (CNG) vehicles. More than 40 per cent of Koreas air pollution is from motor vehicle emissions and in the Seoul metropolitan area this source accounts for 85 per cent of total air pollutants. To reduce the emission of pollutants by motor vehicles the Korean government is promoting the use of CNG vehicles for public transport. The provisional operation of four CNG buses began in 1998 and has been gradually extended. According to government plans, 20 000 existing diesel buses will be replaced by CNG buses by 2007. If this replacement plan is carried out as scheduled, natural gas demand in the transport sector could account for a significant proportion of total gas demand. To implement the plan, the Korean government is providing bus companies with subsidies and tax incentives to purchase new CNG vehicles. In addition, a heavily discounted natural gas price is being offered and more natural gas stations will be provided.
Climate change response policies

Climate change has become one of the focal points of environment and energy related policies in Korea. Korea has had the fastest growth in carbon dioxide emissions from fuel combustion among OECD countries over the past decade: carbon dioxide emissions in Korea grew by 6.7 per cent a year between 1990 and 2000, while the OECD average over this period was 1.2 per cent a year (IEA 2002c). As a relatively low carbon intensive fuel, natural gas is likely to benet from increased emphasis on reducing the rate of growth in greenhouse gas emissions. Korea established an Inter-Ministerial Committee on the United Nations Framework Convention on Climate Change in April 1998 comprised of representatives of relevant government agencies, academia and industry under the chairmanship of the Prime Minister to coordinate overall activities related to climate change policy. In December 1998, Korea developed its first comprehensive action plan for climate change policy (19992001). One of the major achievements of the action plan was the introduction of voluntary agreements with the largest greenhouse gas emitting sectors including iron and steel, petrochemicals and cement to reduce carbon dioxide emis32 ABARE research report 03.4
sions and energy consumption. The government recently released the second comprehensive action plan (200204) in March 2002. This included a range of measures and expanded programs to stimulate efforts to ensure real greenhouse gas emission reductions and provisions for developing a national greenhouse gas emissions reduction target. In November 2002 the Korean government ratied the Kyoto Protocol. As a non-Annex B party to the protocol, Korea would not be bound by any emission reduction targets if the protocol enters into force but would be eligible to participate in projects under the clean development mechanism.
Security of energy supply

To enhance energy security, a key objective of Koreas energy policy has been to diversify both the types and sources of fuel supply. This policy led to the introduction of natural gas into the market in the mid-1980s and was behind the high level of government investment in natural gas infrastructure that facilitated its expansion. However, as discussed in chapter 2, oil remains the dominant source of energy in Korea, accounting for around half of primary energy consumption in 2002. In addition, around three quarters of crude oil imported by Korea is from the Middle East. The Korean government is likely to continue to attempt to reduce oil dependency by promoting the development and use of alternatives to oil, including natural gas and nuclear power.
Overseas investment
The government is further reducing the risks associated with imported energy supply through the promotion of equity participation in the exploration and production of overseas resources of oil, gas and coal. The governments Overseas Resource Development Program, funded by the Energy Special Account, encourages Korean companies to participate in overseas exploration and production business activities. Korea has equity investments, for example, in Oman LNG and RasGas, in addition to long term LNG supply contracts with these companies. According to the Korean governments second Basic National Energy Plan (200211), as much as 30 per cent of Koreas natural gas supply by 2010 could be sourced from projects or elds in which Korean companies have
invested (MOCIE 2002b). This target is likely to have implications for future sources of natural gas supply for Korea.
New sources of demand

District heating systems
The development of district heating systems throughout Korea is generating new demand for natural gas. A district heating system supplies large areas, including apartment complexes and ofce buildings, with heat produced by combined heat and power plants or other large scale heat production facilities using various fuels, including natural gas. District heating systems are generally part of larger community energy systems that provide the integrated supply of heating and electricity to communities. These systems are regarded as efcient, economical and environmentally friendly energy sources. Because many communities in Korea are placing more emphasis on environmental protection, clean energy sources, including natural gas, are in demand for district heating systems. This is despite LNG being relatively more expensive than other fossil fuels. Moreover, district heating systems are usually located in major cities such as Seoul and Busan, where the use of fuels other than natural gas is prohibited under the Air Quality Preservation Act. LNG accounted for around three-quarters of energy consumption in district heating systems in Korea in 2000 (KDHC 2002; gure 13). According to the Korean governments Basic Plan for Mid to Long term Supply of District Heating, it will spend about 1.4 trillion won by 2006 to provide district heating for 426 000 new households (MOCIE 2002c) (table 17). By 2006, about 1.6 million households will benet from district heating. This significant projected expansion of district heating is likely to contribute to future growth in natural gas demand in Korea.
34
13
Fuel mix in district heating systems, 2000 Korea
LNG 75.8% Oil 24.2%
17
Mid to long term projections for district heating supply Korea

2002 2003 79 1 245 468 779 2004 117 1 362 303 1 081 2005 152 1 514 232 1 313 2006 78 1 592 100 1 413
New residences Total residences New investment Total accumulated investment

Source: MOCIE (2002c).
000 000 bill won bill won
101 1 166 310 310
Cooling systems
Since the 1990s, rapid economic growth, rising personal incomes and more affluent lifestyles have stimulated greater demand for summer cooling in Korea. This trend is likely to continue as the penetration of cooling is not yet widespread throughout the country. The uptake of electricity based cooling systems has increased the summer peak level of electricity in recent years. As gas is a peak load fuel, the growing demand for summer cooling is in turn creating new demand for natural gas. In addition to growth in electric cooling systems, gas cooling systems are also likely to become more widespread in Korea, creating new direct demand for natural gas. The diffusion of gas cooling systems is expected to ease to some extent the seasonal imbalance of supply and demand in the natural gas industry as LNG demand in summer begins to rise. While gas cooling systems in Korea have been available for commercial use since the mid-1980s, recent demand for residential gas cooling systems has emerged as a result of the development of new small size cooling system technology. By 2010, it is anticipated that there will be 175 000 residential gas cooling systems across Korea, compared with 450 in 2002 (KOGAS 2003). The penetration of gas cooling systems will be assisted by government promotion policies, including a preferential low interest loan scheme for their installation. KOGAS is also encouraging new demand in this area with its own assistance program that provides subsidies to customers to install gas cooling systems.
Energy market reform

Korea is in the process of deregulating the electricity and gas industries in order to introduce competition and to enhance efciency in these key energy markets. This follows the deregulation of the petroleum industry that occurred in the late 1990s. In 1999, the then Korean government announced plans to restructure the electricity industry, including the privatisation of the state owned monopoly Korea Electric Power Corporation (KEPCO) (MOCIE 1999a). In the same year, the government announced a plan to restructure the gas industry and to privatise the Korea Gas Corporation (KOGAS) (MOCIE 1999b). The key objectives of the proposed reform programs were to introduce competition into these monopoly sectors, to enable long term, stable and cost effective energy supplies and to increase consumer benets through the expansion of consumer choice.
Electricity market reform

The fundamental elements of the former governments Basic Plan for Restructuring the Electricity Industry included:
I unbundling of the generation, transmission and distribution sectors of
KEPCO;
I restructuring of KEPCOs generation assets into six companies, includ-
ing one company to hold KEPCOs nuclear and hydro assets;

I separation of KEPCOs distribution assets into six companies; I privatisation of the non-nuclear and hydro generation companies and the
distribution companies; and

I phasing in of wholesale and retail competition, with full retail competi-
tion from 2009. In the rst phase, KEPCO was separated into a power generation business and a transmission/distribution business, and the generation assets were divided into the proposed six generating companies in April 2001. The six generators currently compete among themselves and independent power producers in a cost based pool market a transitional step to wholesale competition by bidding available capacity on a daily basis.
36
Other reforms undertaken to date include the establishment in April 2001 of the Korea Power Exchange (KPX), an independent nonprot organisation responsible for operation of the wholesale electricity market. The Korea Electricity Commission was also established at the same time to oversee KPX and the electricity market and to implement industry reforms. However, since the appointment of the new administration in early 2003, reforms in the electricity sector have stalled. This is a result of the new governments intention to review the privatisation plans of its predecessor. Key factors driving the review are concerns to ensure that efficiency increases are realised, concerns about privatising natural monopoly industries if sufciently strong regulatory frameworks are not in place, and a desire to build a consensus for privatisation with labor groups. This reects the generally more cautious approach to economic reform of the current government compared with its predecessor and has led to some uncertainty over the direction and timing of further reform (see box 3). In particular, the plan to privatise the ve non-nuclear and hydro generating companies has been delayed indefinitely. In March 2003 the government canceled the sale of Korea South-East Power Company (KOSEPCO) the first company nominated for sale after all potential investors indicated that they would not be submitting nal bids. This outcome was partly a result of the uncertainty surrounding the new administrations views on economic reform and the lack of clear market rules and a regulatory framework for the planned power pool market. Regional and international economic uncertainty is also a key reason for the lack of interest from buyers. KEPCO is now considering an initial public offering of a minority of the stock rather than the sale of a strategic stake through a tender process. However, this is likely to be delayed for some time, in order to ensure more favorable market conditions (Energy Argus 2003c,d). Also delayed is the planned division of KEPCOs power distribution assets, scheduled to be split into six companies in April 2004. At present it is uncertain when and if this stage of reform will be implemented (Korea Times 2003b). In the interim, KEPCO will continue to manage the transmission and distribution sectors. The introduction of the two way bidding pool system, scheduled for 2003, has also been delayed. It is understood that the earliest this operation could begin is April 2004. With the delay in the reform process, the timetable for
the introduction of full retail competition, planned from 2009, is now also uncertain. Given the uncertainties over the future of electricity sector reforms, it is difcult to predict the impact that reforms could have on natural gas demand. In
Box 3: Economic reform under the Roh Moo-hyun administration The new Korean government under President Roh Moo-hyun took ofce in late February 2003. It inherited from its predecessor a number of plans for reform throughout the economy, including privatisation plans for public entities in several sectors. These included the banks that had been nationalised during the Asian financial downturn of the late 1990s, as well as the railways, the electricity sector and the gas sector.
Since coming to ofce, the government has emphasised the need for ongoing and consistent structural reform in order to strengthen Koreas economic fundamentals and to enhance external credibility. To do so, in addition to reform in the above four major sectors, the government is focusing on further promoting market liberalisation, deregulation, privatisation and labor sector exibility. Privatising Koreas banks, which are still around 25 per cent state owned across the system as a whole, has been the key priority to date. The government recently sold the Chohung Bank to the Shinhan Financial Group, although there were strong labor protests over the issue. It is now targeting its stake in the Korea Exchange Bank. Apart from the banking sector, all other privatisation plans that the government inherited from its predecessor are being reviewed. This move has led to some uncertainty over the timing and direction of further reform throughout the Korean economy. More broadly, a priority of the Roh government is to increase transparency and accountability in the business sector. It has announced that it will continue to implement policies that enhance market transparency and corporate governance, improve supervisory regulations in the accounting sector, and limit large Korean conglomerates from controlling the financial sector. The government is also targeting improving labor relations, laws and institutions to global standards, by making the formal sector, particularly its unionised component, more exible, and by improving protection in the informal sector. Part of this policy will involve establishing socially cohesive labor management relations. The government is also aiming for Korea to become a north east Asian business hub and to strengthen its economic ties in the region. To do so, it is implementing measures to foster investment, including greater scal, nancial and tax support, as well as regulatory improvements.
Sources: MOFE (2003a,b); Korea Times (2003a); Economist Intelligence Unit (2003); Asia Pulse (2003).
38
a liberalised and privatised electricity sector, LNG demand for power generation will be determined on a commercial basis. Greater competitive pressures faced by generation companies will provide incentives for cost minimisation. This is likely to affect fuel procurement decisions as generators give more weight to the cost of alternative fuels, including LNG. Based on fuel costs alone, LNG in Korea is generally less competitive than other fuels. However, when the total cost of generation, or the long run marginal cost of electricity supply, is taken into account, there is evidence that gas fired generation can be competitive against other fuels, including coal (see box 4). This is because gas red plants typically have lower capital costs, consume less land, have shorter construction times and lower operating costs. Based on these comparative costs and higher fuel conversion efciency relative to coal red plants, private investors tend to favor gas red plants over coal (Poten and Partners 2002). The advantage of gas will be reduced, however, if investors, including public investors, are not required to meet private sector rates of return on their electricity generation assets. Nevertheless, the strong outlook for electricity consumption growth in Korea and the advantages of natural gas suggest that there could be a more robust future for gas use in power generation in a deregulated, competitive environment.
Box 4: Assessing the costs of electricity generation The total cost of electricity generation has several components, including capital expenditure for plant construction, operating and maintenance costs, and fuel costs. In Korea, as elsewhere, the cost of gas per kilowatt hour is higher on average than other energy sources, Fuel costs for electricity generation, 2000 Korea including coal, oil and nuclear (table 18). In particular, LNG prices have won/kWh USc/kWh increased in recent years in Korea, while those for coal have remained Nuclear 4.4 0.3 fairly stable. Imported coal 13.3 1.0
18
However, despite relatively high fuel costs, gas red power generation has a number of economic advantages over coal red plants. These include easier project nancing, lower capital requirements, less land, easier siting, shorter construction times, lower operating and
Domestic coal Gas Oil Hydro Pumped storage hydro Average

Source: IEA (2002d).
48.8 87.1 52.6 0.0 17.8 18.0
3.7 6.6 4.0 0.0 1.3 1.4
39
maintenance costs, including lower labor and water requirements, and greater thermal efficiency. As smaller plants, they also tend to be more flexible in supply. Environmental advantages of gas fired plants include lower noise, fewer pollutants emitted into the local environment, and a significantly lower carbon intensity than coal. Figure 14 (FACTS Inc. 2002) shows that capital requirements and operating costs for gas fired electricity generation can in fact be less than half those for coal, contributing to lower total costs at a range of gas prices.
14
4 3 2 1
Electricity generation costs

80% load factor, 10% discount rate Fuel Operating Capital
USc/kWh Gas at $3/MBtu
Gas at $3.5/MBtu
Gas at $4/MBtu
Coal
This conclusion is supported by data for the United States on electricity production costs for new plants for a variety of generation technologies, including pulverised coal, gas combustion turbine, gas combined cycle, nuclear, solar
19
Nuclear DOE Platts Coal DOE Platts Gas CC DOE Platts Gas CT DOE Platts Solar PV DOE Platts Wind DOE Platts
Cost estimates for new generating plants

In 2003 US dollars
Years to construct
Plant size MW
Capital $/kW 1 821 1 122 1 028 586 443 457 347 3 526 7 185 976 896
Fixed Variable O&M O&M $/kW 60.84 25.21 18.342 10.63 15.27 8.50 5.09 10.47 0.00 27.15 0.00 c/kWh 0.045 0.319 0.183 0.212 0.204 0.319 0.046 0.000 7.839 0.000 1.018
Base case Fuel total cost $/MBtu 0.43 1.27 0.81 3.40 3.31 3.40 3.31 0.00 0.00 0.00 0.00 c/kWh 5.0 4.0 3.7 3.8 3.8 6.1 10.3 22.3 61.8 6.6 5.9
5 4 3 3 2 2 1 2 1 3 1
600 400 400 400 400 120 120 5 5 50 50
Source: Drennen et al. (2003).
40
photovoltaic and wind (table 19). These costs incorporate a range of plant and economic assumptions, including capital, operating and maintenance costs, fuel costs, construction times, and interest and discount rates. The data indicate that gas combined cycle plants can be the least cost electricity generation alternative.
15
Indicative long run marginal costs for power generation Korea
$/MWh
Coal
The advantage of gas, especially CCGT over coal, is likely to be higher at (gas) low load factors as a result of the lower fixed costs of gas fired generation (figure 15). This reinforces the benets of gas as a fuel Load factor (%) for peak load electricity generation. As the load factor increases, fuel costs become a more important component of total costs and the advantage of coal increases. In addition, if the required rate of return on investment is lower, say in the case of public sector investment, the advantage moves more toward coal red generation.
Sources: Poten & Partners (2002); Platts (2003c); FACTS Inc. (2002); Drennen et al. (2003); IEA (2002d).
Gas market reform

The key components of the former governments Basic Restructuring Plan for the Natural Gas Industry were to:
I divide KOGAS into a gas import/wholesale business and a gas supply facil-
ity (receiving terminals, pipelines and storage infrastructure) business;

I separate the gas import/wholesale business of KOGAS into three inde-
pendent companies in 2001, with the existing long term LNG import contracts divided between the three;
I privatise two of these companies and retain KOGAS ownership of the
third;
I provide third party access to the facility sector; and I introduce competition in the retail sector, ending the regional monopoly
that city gas companies currently enjoy.
41
As in the electricity sector, gas market reform has not progressed significantly over this period. The previous government had difculty passing the required legislation for the implementation of the proposals. Under the new administration, the proposed reforms have been delayed further, with the government proposing that a review be conducted before any reforms take place. The government announced in March 2003 that the facility sector of KOGAS will maintain its present status as a state owned corporation that is, privatisation of the LNG receiving terminals, storage infrastructure and pipeline network will be excluded from any gas industry restructuring (Asia Pulse 2003). It is anticipated, however, that the LNG receiving terminals, storage and pipeline networks owned by KOGAS will be opened to third party access. In the import/wholesale sector of KOGAS, the government is considering two options: the original plan to split KOGAS into three companies, or allowing private companies to import LNG alongside KOGAS under a licensing system (MOCIE 2003; Reuters News 2003b). The previous governments option for reform to split KOGAS into three competing businesses is considered problematic because the existing contracts held by KOGAS are likely to be at higher average prices than future contracts. Hence, the new arrangements must involve a pooling of old and new contracts to ensure the disposal of volumes under the take or pay system (FACTS Inc. 2003a) and the establishment of some competitive equity between the companies. The complexities involved in the reassignment of contracts is one of the reasons why the gas market reform process has been delayed and why it is generally believed that the licensing system option is more likely to be adopted. Under the current industry structure, private parties can import LNG for their own use, subject to several requirements. This has not occurred in Korea to date. However, there are currently plans by POSCO and SK Corporation to begin importing LNG from 2005 through POSCOs planned LNG receiving terminal in Kwangyang for own use in electricity generation facilities and steel plants. If successful, this would represent the rst element of competition in Koreas LNG supply (see box 5). As with proposed reform in the electricity sector, the uncertainty surrounding the timing and nature of reforms in the gas industry makes it difcult to predict the impact that this issue will have on future natural gas demand.
However, any transition to a more efcient and competitive industry structure would have the potential to enhance the relative competitiveness of natural gas and therefore stimulate increased demand. It is important to note, however, that the delay in implementing gas market reform has some serious implications for Koreas long term gas supply
Box 5: Entry of private LNG importers into the Korean gas market While KOGAS has to date been the sole LNG importer in Korea, private companies are in principle permitted to import LNG, subject to several requirements. These include that the gas be for own use, that the importer have adequate storage capacity, and that it negotiates access from KOGAS to the gas pipeline network.
POSCO, Koreas largest steel producer, currently holds a licence to import LNG for its own consumption, which is around 0.5 million tonnes a year. In the past, the company has not imported LNG directly, relying instead on supplies from KOGAS. However, POSCO is planning to begin importing LNG directly from 2005. It is currently building an LNG receiving terminal in Kwangyang, with a planned capacity of around 1.7 million tonnes a year. It is understood that POSCO is still negotiating with KOGAS over access rights to the pipeline network. POSCOs decision to bypass KOGAS is reported to stem from the need to seek cheaper supplies of gas to boost competitiveness against other steel manufacturers, including those from China. New international LNG contract prices have tended to be lower than prices under KOGASs existing import contracts, the rst of which is not due to expire until 2007. The planned import terminal is larger than POSCOs own LNG needs and POSCO has announced that it intends to supply LNG from 2006 to a new 900 megawatt thermal power plant in Kwangyang planned by SK Corporation. In March 2003, POSCO and SK issued a tender for the supply of up to 1.1 million tonnes of LNG a year for twenty years from 2005. Of this, POSCO would use around 0.5 million tonnes and SK between 0.35 and 0.6 million tonnes. A shortlist of two potential suppliers, MLNG Tiga and Tangguh, was announced in May 2003. If the Korean government chooses to implement a gas import licencing system as a means of introducing competition into the gas market, POSCO, with likely spare capacity at its import terminal, could be in a strong position to win a license and increase its import volumes for the purpose of reselling. It may also be that the move by POSCO and SK to import LNG directly will create the impetus for other companies to seek their own LNG imports.
Sources: FACTS Inc. (2003a,b); Reuters (2003c); Energy Argus (2003e,f); Energy Intelligence Group (2003a).
43
security. KOGASs current delay in entering into new long term LNG contracts because of the uncertainties of reform means that the gap between contracted gas supply and projected demand is growing. Waiting for reform plans to be implemented before committing to new long term contracts is exacerbating this situation. As demonstrated in other countries, successful gas market reform is a highly complex process that requires good planning and time to implement. It is not necessarily in Koreas best interests to put pressure on the reform process in order to hasten the signing of new LNG contracts, or vice versa. Delinking new LNG procurement decisions from the implementation of reform is possible if appropriate assignment of contracts is part of the reform process. An important issue for Korea in this context is that the current LNG market is highly competitive in terms of price and other contract conditions. Reports of recent long term contracts signed by various suppliers with China, Japan and Chinese Taipei indicate that producers are able to meet buyers demands for lower prices and increased contract flexibility. By committing to new LNG contracts in this climate, Korea would also have the opportunity to benefit from similar conditions. However, these market dynamics could change relatively quickly if new sources of demand, such as China and the north American west coast, materialised over the next several years. By delaying its commitment to new LNG contracts, Korea could be putting its ability to secure equally favorable long term contract conditions at risk.
44
4
projecting natural gas demand in Korea
Analytical framework
The analysis of the potential demand for natural gas in Korea over the period to 2015 presented in this chapter is based on simulation results from ABAREs global trade and environment model (GTEM). GTEM is a multiregion, multisector, dynamic general equilibrium model of the world economy. It is derived from the MEGABARE model (ABARE 1996) and the GTAP model (Hertel 1997). GTEM is an appropriate framework for analysing energy markets because it takes into account the interaction between different sectors of the economy and between economies through trade linkages. The model includes a high level of commodity disaggregation, including a detailed treatment of energy and energy related sectors and a sophisticated representation of technological change and interfuel substitution possibilities in the energy sector. This enhances the capacity of GTEM to analyse the impacts of changes in energy policies and other external factors that could inuence the operation of energy markets. Further information on GTEM is provided in appendix A and on ABAREs web site (www.abareconomics.com).
Regional and sectoral aggregation

At its most disaggregated level, the version of GTEM used in this study consists of equations and data that describe the production, consumption, trade and investment behavior of representative producers and consumers in 45 regions across 55 sectors. The database used to simulate the potential demand for natural gas in Korea in this report has been aggregated to the fteen regions and fteen sectors presented in table 20. The sectoral aggregation was chosen to include the three fossil fuels coal, oil and gas and electricity, and the major energy intensive industries that are likely to inuence total energy consumption. The regional aggregation
45
20
Regions 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Regions and sectors in GTEM in this study

Sectors 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Coal Oil Gas Petroleum products Electricity Iron and steel Aluminium Nonferrous metals Chemicals, rubber and plastics Nonmetallic minerals products Other mineral products Other manufacturing Trade and transport Agriculture, sheries and forestry Services
Republic of Korea Australia Canada United States Japan Western Europe Eastern Europe and Russian Federation China a Chinese Taipei Indonesia Malaysia Rest of ASEAN b Rest of Asia Middle East Rest of World
a Comprises mainland China and Hong Kong. b Comprises the Philippines, Singapore, Thailand and Viet Nam.
identies major energy producing and trading regions, in particular existing and potential gas suppliers to Korea.
Developing a reference case

As a dynamic general equilibrium model, GTEM requires a reference case or a business as usual scenario against which the impacts of alternative policies can be measured. The reference case projects the growth in key variables in a region in the absence of any signicant policy changes or external shocks. In this study, for example, the reference case represents the likely outlook for economic activity and energy demand in Korea over the period to 2015 in the absence of any changes to key energy, environmental or economic policies. The reference case also provides a benchmark against which the impacts of policy initiatives, such as the deregulation of Koreas electricity and gas markets, can be measured. For example, the impact of deregulation can be isolated by comparing economic growth, sectoral output and investment, gas consumption and trade, and other variables in the policy simulation against those in the reference case scenario.
46
To provide a numerical example, suppose that reference case gas consumption at 2015 is projected to be 30 million tonnes of oil equivalent (distance ab in figure 16). Following deregulation of the electricity and gas sectors, gas consumption at 2015 is projected to be 33 million tonnes of oil equivalent (distance ac ). This corresponds to a 10 per cent increase in gas consumption from the reference case level (distance de). Hence the effect of deregulation in this example would be to increase gas consumption by 10 per cent relative to the reference case at 2015.
16
Mt 33 30
Deviation from the reference case in a GTEM simulation
c Policy simulation Reference case b
a 2001 Deviation from the reference case (%) 2015 Time
10 0
e d
Economic growth
In developing a reference case for 2001 2015 Time Korea, several key assumptions have been made. The rst of these relates to projected GDP growth rates in Korea and in other regions identied in the aggregation. The historical growth rates used in the study from 1995 to 2001 are from the International Monetary Fund. Long term projections to 2015 are from ABARE and are derived by fitting an ARIMA (autoregressive integrated moving average) forecasting model to the historical GDP data. GDP in Korea is assumed to grow at an average annual rate of 5 per cent between 2001 and 2015. While this projected growth rate is lower than the average achieved over the past fteen years it, nonetheless, reects a sustained recovery from the Asian nancial downturn that led to a sharp contraction in GDP in 1998. Growth prospects for Korea in the medium term will remain highly dependent on the strength of the world economy, particularly that of the United States. Given this uncertainty, a sensitivity analysis that assumes average annual GDP growth of 4 per cent over the outlook period is also conducted to examine the impacts that lower growth in Korea could have on energy and gas consumption.
Fuel mix in electricity generation

Also incorporated in the reference case are assumptions relating to the fuel shares in electricity generation. In GTEM, electricity production is modeled using a technology bundle approach. Under this approach, electricity is generated by a finite number of technologies, or fuels, with distinct fixed input requirements. The power generation technologies in the model are coal, oil, gas, nuclear, hydropower and other renewables. The share of each fuel in total electricity generation is determined exogenously (outside the model) in the reference case, using government and other projections. In a policy simulation, substitution between fuels occurs in response to changes in relative costs. In Korea there is some debate surrounding the projected fuel mix in electricity generation over the period to 2015. MOCIE published in 2002 a set of projections in its first Basic Plan of Long Term Electricity Supply and Demand that indicates a decline in the share of gas red power generation over the period 200712 (MOCIE 2002d). This is a result of planned expansions in nuclear and coal red capacity. MOCIE has indicated in subsequent discussions that its next set of projections is likely to incorporate higher shares of gas red electricity generation than those in the basic plan. An alternative set of projections is published by the Korea Power Exchange (KPX 2002a). The KPX most probable plan projections do not predict the same magnitude of decline in the share of gas red power generation over that period, although a decline also occurs between 2007 and 2010 (gure 17). Taking into consideration discussions with MOCIE and Alternative projections for share industry representatives in Korea, of gas fired power generation current uncertainty surrounding Korea future nuclear developments, enviMOCIE (2002d) ronmental concerns over coal red KPX (2002a) power generation, and the relative 12 competitiveness of gas red power generation over the long run when 8 total costs are taken into account, the KPX fuel share projections are 4 used in this study.
17
As indicated in table 21, signicant changes are expected to occur in the

48
% 2003 2006 2009 2012 2015
21
Projected share of electricity generation, by fuel, reference case Korea

2001 a % 2005 % 38.4 7.6 13.2 38.8 2.0 100.0 2010 % 44.2 4.8 6.7 42.1 2.1 100.0 2015 % 37.8 2.8 11.2 46.1 2.1 100.0
Coal Oil Gas Nuclear Renewables Total

a actual. Source: KPX (2002a).
38.7 9.8 10.7 39.3 1.5 100.0
fuel mix in electricity generation in Korea over the reference case. Based on KPX projections, nuclear power is likely to continue to be the main form of electricity generation over the outlook period, with its share increasing from 39 per cent in 2001 to 46 per cent in 2015. This expansion is underpinned by government policy responses to growing reliance on energy imports, as discussed in chapter 2. Five nuclear power plants are currently under construction and an additional eight units are planned for construction by 2015. However, the long term development of nuclear power in Korea will have to overcome growing public resistance to the siting of new nuclear plants and waste disposal. There are doubts among some analysts and industry representatives that these nuclear projections can be realised, given such concerns and previous delays in nuclear expansion in Korea. Experience in other countries, including Japan and Chinese Taipei, reinforce a less optimistic expansion in nuclear power for Korea. Coal is also expected to remain a major fuel for base load and midload electricity generation in Korea, maintaining its share of the fuel mix at around 38 per cent. The continued reliance on coal reects the competitiveness of imported bituminous coal in Korea relative to other fuels (table 18). Gas is assumed to account for 11 per cent of electricity generation in 2015, similar to its level in 2001. This is despite an expected increase in the share of gas red generation in the rst half of the outlook period. The projected growth in nuclear and coal red capacity is the main reason behind the limited growth in gas red electricity generation, as is the current high cost of LNG in Korea.
49
Conversely, the share of oil red electricity generation is expected to decline signicantly over the outlook period, from 10 per cent in 2001 to 3 per cent in 2015. This is driven principally by energy security concerns and the relatively high marginal cost of oil red power generation. The main risk in these assumptions is that Korea will not be able to realise its ambitious targets for nuclear power expansion or that planned additions to coal red capacity will be slower than expected. In these circumstances, it is likely that the share of gas red power generation would not decline over the intermediate period. This could occur, for example, if gas red capacity were used at higher load factors than currently assumed.
Other assumptions
In the reference case it is also assumed that:
I the switch away from oil toward natural gas in Koreas industry and
commercial sectors will continue over the projection period as access to gas improves in line with the expansion of gas distribution networks and ongoing policy efforts to increase gas consumption in these sectors.
I the income elasticity of demand for coal by households in Korea is nega-
tive. This means that as personal incomes rise in Korea, consumption of coal by households will fall. This reects recent experience in Korea indicating that the residential sector is moving rapidly away from coal and into cleaner and more efcient fuels, principally gas and electricity (KEEI 2003a: gure 18).
I the household income elasticity
for gas and electricity is strongly positive, implying that household demand for gas and electricity will grow more rapidly than GDP. This reflects the impacts of higher personal incomes on demand for clean and convenient fuels in the residential sector.
I the capacity for Korea to meet
18
10 8 6 4 2
Residential consumption of coal, gas and electricity Korea

City gas
Electricity
its gas requirements from domestic sources is limited by a lack of reserves. While there are
50
Coal Mtoe 1990 1994 1998 2002
plans for offshore gas production to commence in 2003, gas supplies from the Donghae eld are unlikely to meet more than 2 per cent of Koreas total gas requirements. As a result, Korea is unable to expand domestic production signicantly in response to increases in domestic gas demand.
I energy market reform in Korea, particularly in the electricity and gas
sectors, will not progress over the outlook period, with no further reforms than those already undertaken assumed to take place.
Reference case projections

The reference case projections presented here represent a possible outlook for energy demand, and in particular natural gas demand, in Korea over the period to 2015, in the absence of any major policy changes or external shocks. The results, however, are not forecasts of what will actually happen in the region. They are projections based on the set of assumptions outlined earlier that are considered plausible at the present time. If these assumptions are realised, the projections could provide a reasonable estimate of energy developments in Korea.
Energy consumption, by fuel

Underpinned by signicant increases in economic output, energy consumption in Korea is expected to grow strongly over the period to 2015. Total primary energy consumption is projected to grow at an average rate of 3.5 per cent a year, to reach 319 million tonnes of oil equivalent in 2015 (table 22). This implies a continuing decline in Koreas energy intensity over the outlook period, reecting efciency gains in energy use in many sectors and
22
GDP and primary energy consumption, reference case Korea

Total primary energy consumption Mtoe 196.1 319.0 % 3.5
Real GDP a US$b 2001 2015 Average annual growth 200115

a 2002 prices and exchange rates.
trillion won 560.9 1 117.9 % 5.0
423.0 843.0 % 5.0
51
continued restructuring of the economy toward less energy intensive sectors. When lower economic growth is assumed over the outlook period, growth in energy consumption is projected to slow to 3.3 per cent a year, to reach 310 million tonnes of oil equivalent in 2015.
19
5 4 3 2 1
Annual growth in energy consumption, reference case, 200115 Korea
Natural gas consumption is % projected to grow by 5.0 per cent a Coal Gas Renewables Oil Nuclear year between 2001 and 2015, from 16.7 to 33.3 million tonnes (23.1 to 45.9 billion cubic metres) (gure 19). Driving this growth will be the issues discussed in chapters 2 and 3, including increasing pressure for industry to use cleaner and more efcient fuels for environmental reasons and escalating demand for city gas by the residential and commercial sectors. However, the increase in overall demand for gas is moderated by continued improvements in the efciency of gas use in industry and electricity generation. The share of natural gas in Koreas primary energy mix is projected to increase to 13.0 per cent at 2015, from 10.6 per cent in 2001 (gure 20). Under the lower economic growth assumption, natural gas demand is projected to reach 32.2 million tonnes in 2015. Coal consumption in Korea is projected to grow more slowly than in previous years, at an annual rate of 2.0 per cent, to reach 60.4 million tonnes of oil equivalent in 2015 (gure 21). Lower growth is a result of the reorientation of the economy toward less fossil fuel intensive forms of production such as light industry and services, and an assumed substitution away from coal in the residential sector toward natural gas. Underpinning much of the growth in coal consumption will be growth in electricity gener52
20
Primary energy consumption, by fuel, reference case Korea 2001
Renewables Nuclear 0.6% Coal 14.3% 23.3% Gas 10.6%
2015
Renewables 0.8% Nuclear Coal 17.5% 18.9% Gas 13%
Oil 51.2%
Oil 49.8%
ation. As a result, coal will remain a major energy source over the outlook period, although its contribution to the primary energy mix is projected to fall from 23 per cent in 2001 to 19 per cent in 2015.
21
300 250 200
Total primary energy consumption, by fuel, reference case Korea

Renewables Nuclear Gas Oil Coal
Demand for oil is projected to grow 150 by 3.3 per cent a year over the 100 period to 2015. Oil is expected to 50 remain the dominant source of energy in Korea, with its contribu- Mtoe tion to total primary energy 2003 2006 2009 2012 2015 consumption falling only marginally to around 50 per cent in 2015. A signicant proportion of the growth in oil consumption is accounted for by the transport sector, which, in turn, reflects the impacts of high GDP growth and rising personal incomes on the demand for freight and passenger travel. Moderating the growth in oil consumption over the projection period is a signicant shift away from oil in the fuel mix for electricity generation and government policies to reduce Koreas reliance on oil. Also limiting oil demand growth are rising taxes on oil consumption, in line with an ongoing government program designed to rebalance the taxation burden across competing fuels. These changes can be expected to increase the relative cost of oil to industry and to enhance the competitiveness of natural gas for industrial applications (table 23). Nuclear energy is projected to be one of the fastest growing energy sources in Korea, driven by the increasing role it is assumed to play in electricity generation. Growth in nuclear power is projected to average 5.1 per cent a
23
Revision of special consumption taxes on fuel sources Korea Index of fuel prices after tax amendment (based on LNG at 100)
LNG m3 Heavy oil litre 84 85 87 Kerosene litre 175 189 205 Diesel litre 200 238 252 LPG litre 194 238 277
July 2002 July 2004 July 2006

Source: MOCIE (2002b).
100 100 100
53
year over the period 200115, to reach 55.9 million tonnes of oil equivalent at 2015, or around 18 per cent of primary energy consumption. Underpinning these projections is the assumption that there will be sufcient investment in nuclear power infrastructure to support the growth in consumption. However, as discussed earlier in this chapter, there remains signicant public opposition to the siting of proposed nuclear plants, making future projections of nuclear consumption somewhat uncertain. Demand for hydropower and other renewables is projected to grow by 5.5 per cent a year over the period to 2015, although from a relatively small base. Much of this growth will be derived from government programs that focus on research and development of alternative energy sources. For example, the government anAnnual growth in gas nounced the Alternative Energy consumption, reference case, R&D Basic Plan in February 2001, 200115 Korea which provides a framework within 6 which to develop alternative energy 5 sources, in particular, energy derived from wind and photovoltaic 4 power. Specific measures include 3 provision of financial support 2 through low interest loans and preferential tax treatments and incen1 tives, and by legislating that % KEPCO buy at least 1 per cent of Electricity Industry Commercial Residential electricity requirements from renewable sources (IEA 2002d).
22

Most of the growth in Koreas gas consumption will be driven by the residential sector. In this sector, gas consumption is projected to rise by 5.7 per cent a year over the period to 2015 (figure 22), to reach 14.4 million tonnes (figure 23). Underpinning this increase in demand is the continued switch from coal and oil to natural gas. This is reinforced
54
23
30 25 20 15 10 5 Mt
Gas consumption, by sector, reference case Korea
Residential Commercial Industry Electricity
2003 2006 2009
2012 2015
by growing demand for gas cooling systems as incomes rise and technologies for modular gas cooling units are further developed. Gas consumption in the industry and commercial sectors is projected to rise at 6.4 per cent and 4.3 per cent a year respectively over the period to 2015, to reach 6.8 million tonnes and 2.8 million tonnes respectively. This will be driven by continued government policies encouraging gas use, supported by investment in expanding the distribution network. Key factors behind the push for greater gas use include environmental considerations, associated in particular with the emission of sulfur dioxide particulates from consumption of heavy fuel oils, and continuing efforts to reduce oil dependence for energy security reasons. Consumption of natural gas in the electricity sector is expected to grow by around 3.6 per cent a year over the period 200115, which lowers its share in total gas consumption from 34 per cent in 2001 to 28 per cent in 2015. The assumed fall in gas fired electricity generation in the years 200710 accounts for the fall in overall natural gas consumption shown in gure 23 over this period.
Natural gas imports

In Korea, with all natural gas currently imported in the form of LNG, changes in natural gas demand to date have been reected in changes in LNG imports. As discussed previously, indigenous gas production in Korea is expected to begin from late 2003 and to supply around 0.4 million tonnes a year to 2015. Pipeline natural gas may also form part of the gas supply structure over Projected unmet gas demand, the longer term. reference case Korea
24
30 25 20 15 10 5 Mt
KOGAS currently has long term take or pay contacts of 16.9 million tonnes of LNG a year. It also recently negotiated two midterm contracts of 2.02.5 million tonnes a year. However, a number of Koreas contracts will mature prior to 2015, the first being the Indonesian Arun contract that expires in 2007. This will leave increasing shortfalls in natural gas
Projected unmet gas demand Domestic gas field supply Current LNG supply contracts
2003
2006
2009
2012
2015
55
24
Contracted gas supply and projected shortfall, reference case Korea

2005 Mt 2010 Mt 3.0 2.0 0.7 4.9 4.1 15.6 0.4 24.2 8.2 2015 Mt 1.0 2.0 4.9 4.1 12.9 0.4 33.3 20.0
Indonesia Malaysia a Brunei Qatar Oman Australia Total contracted LNG supply b Domestic gas supply Projected natural gas demand Projected unmet gas demand
5.3 4.0 0.7 4.9 4.1 0.5 20.4 0.4 23.9 3.1
a Assumes 0.5 million tonne option on MLNG Tiga contract is utilised. b Includes POSCO/SK 1 million tonne contract.
supply to meet projected demand over the outlook period (gure 24). Based on current contracts, the projected shortfall in gas supply could be as large as 20 million tonnes by 2015 (table 24). The projected gap between current contracted levels and projected demand over the outlook period is likely to provide a serious challenge for Korea in the coming years. It also suggests that new long term LNG contracts will be required to meet demand in the near future. As discussed earlier in the report, KOGAS is currently delaying entering any new long term LNG contracts until plans for gas market reform are progressed. This limits Koreas gas supply options, however, and increases the likelihood that gas supply shortages could occur in the coming years. Greater security of gas supply could be ensured by decoupling LNG procurement from plans for gas market reform. Until this issue is resolved, gas supply options include short and midterm LNG contracts and LNG spot cargoes. An additional option to meet natural gas demand over the medium to longer term currently being evaluated by Korea is the introduction of pipeline natural gas. This issue, and its potential to meet some of the projected gas supply shortfall over the period to 2015, is explored in chapter 6.
56
5
alternative policy scenarios
While the reference case presented in the previous chapter provides an outlook for energy and natural gas demand in Korea over the period to 2015 under a reasonable set of assumptions, there are a number of issues that may inuence these outcomes. The reference case, for example, assumes that no further progress is made to liberalise energy markets in Korea over the outlook period. However, as discussed in chapter 3, proposed reforms in Koreas electricity and gas sectors could make a signicant difference to market structure and the dynamics of fuel procurement decisions. Energy security concerns are also likely to remain a major focus of energy policies in Korea over the outlook period. Yet Koreas extreme dependence on imports to meet its fossil fuel requirements makes it vulnerable to external shocks or disruptions, including interruptions to supply in key energy exporting countries. Indeed, Korea was subject to this form of disruption in 2001 when LNG deliveries from Indonesias Arun plant were interrupted for a period of several months. These two issues and their possible impacts on energy and natural gas demand in Korea are explored in this chapter using GTEM. In the rst scenario, it is assumed that Koreas electricity and gas sectors are progressively liberalised over the period to 2010. The second scenario assumes that a proportion of Koreas LNG supplies is interrupted for a period of three months or six months in 2005. Results of these scenarios are reported as deviations from the reference case.
Electricity and gas sector deregulation

The key features of proposed deregulation in Koreas electricity and gas sectors were outlined in chapter 3. While there are many uncertainties about the structure and timing of reform under the new administration in Korea, the analysis in this chapter assumes that the key reforms outlined in the basic plans for the electricity and gas sectors are fully implemented. That is, complete deregulation of the wholesale and retail electricity sectors and of the import, wholesale and retail natural gas sector is assumed to occur by 2009.
Box 6: Benefits of deregulation in the electricity and gas sectors The broad principle underpinning reform of the electricity and gas sectors that has occurred in many economies is that there are signicant long term efciency benefits from allowing markets to play a greater role in determining what is produced, consumed or invested. Experience of regulatory reform in economies that have already implemented liberalisation policies in these sectors provides some evidence of the type of gains that may be generated in energy markets, including productivity improvements, lower prices, more efcient investment and wider consumer choice (Fairhead et al. 2002). Further, as energy is a fundamental input to economic activity, lower energy prices are likely to have economywide implications for the structure and level of economic output.
In general, it can be expected that economies, such as Korea, that have implemented only limited major reforms to date will benefit significantly from the implementation of further comprehensive liberalisation initiatives in electricity and gas sectors. In this study, ABARE has drawn on the available economic literature to estimate the potential productivity gains that could be derived from electricity and gas market liberalisation in Korea. In the case of electricity market reform, a study undertaken by the Korea Institute for Industrial Economics and Trade (1999) suggests that regulatory reform in the electricity industry in Korea could lead to total factor productivity improvements of around 1.3 per cent a year over the reform period. Productivity gains of this magnitude are estimated to lead to an 8 per cent reduction in electricity prices in Korea relative to the reference case over the period to 2010, as cost savings achieved through productivity gains are passed on to electricity users in terms of lower prices. These estimates of the potential price impacts of reform could be lower if, for example, current electricity prices are subsidised or if the rate of return on assets required by a private investor is higher than that received by the current government owner. Estimates of the potential efficiency gains from reform of the gas market in Korea are more difcult to obtain. Most of the measurement of the productivity impacts of gas market deregulation is conned to the United Kingdom, where British Gas, a publicly owned, vertically integrated enterprise, was privatised in 1986, and subsequent reforms adopted to allow competition to develop. In this context, the results of a study by Price and Weyman-Jones (1996) are used to estimate the maximum potential productivity impacts that could be derived from the implementation of comprehensive liberalisation programs in natural gas sectors characterised by extensive regulatory barriers, such as Koreas. Based on this analysis, it is assumed in this study that comprehensive liberalisation of Koreas gas sector could lead to an increase in total factor productivity of around 20 per cent relative to the reference case in 2010. This is because Koreas gas sector is highly regulated and that reforms are yet to be implemented. These productivity improvements are phased in through equal annual
58
increments over the period to 2010. The productivity gains are estimated to lead to a fall in the price of gas by 18 per cent relative to the reference case at 2010. Although there is a trend toward energy market liberalisation in many of Koreas trading partners, the analysis reported in this study assesses the impacts of energy market reform in Koreas electricity and gas sectors in isolation from energy sector reform programs being adopted in other countries. Because of its dependence on imports for natural gas supply, Korea stands to gain as much from liberalisation among its trading partners as from domestic reforms. While domestic reform will contribute to lower prices, efciency gains from reform among major suppliers of gas, such as Indonesia and Malaysia, are likely to result in even lower gas costs in Korea. These gains are demonstrated in ABAREs recent study, Deregulating Energy Markets in APEC: Economic and Sectoral Impacts (Fairhead et al. 2002). Because extra-national gas market reforms can enhance the gains in Korea from domestic reforms, the modeling results for Korea in this study will differ from those in Fairhead et al. (2002).
This scenario represents the adoption in Korea of a comprehensive liberalisation package involving greater reliance on market forces in electricity generation and retailing and gas imports and retailing areas where competition is feasible and the design of an effective regulatory framework where there is a need for government intervention to address issues associated with natural monopolies and externalities. Liberalisation of this nature in electricity and gas markets is projected to have both direct and indirect impacts on the Korean economy, including on energy prices, consumption and trade (see box 6). Because the results presented in this study are based on assumptions, they should be viewed Change in energy prices as illustrative only of the general following deregulation, 2015 impacts and direction of change that relative to the reference case Korea can be expected from regulatory Electricity Gas % reform in Koreas energy markets.
25
5 10
Economic impacts
As a result of enhanced productivity and lower electricity and gas prices following deregulation (gure 25), total demand for goods and services in Korea expands relative to the reference case. This
15
20
59
effect is reinforced by the resource allocation benets of liberalisation that is, the efciency gains that are realised when resources are employed in their most productive end use as energy consumers and producers respond to price signals. As a result of these effects, Koreas GDP at 2015 is 0.3 per cent higher than its reference case level. This is equal to an increase in GDP at 2015 of around US$2.1 billion (2.8 trillion won) relative to the reference case.
Structural impacts
Underlying the rise in GDP in Korea is an improvement in the competitiveness of industrial and commercial output resulting from higher productivity in the electricity and gas industries Change in production and exports and lower energy prices. In particof energy intensive goods ular, lower electricity and gas prices following deregulation, 2015 have a favorable impact on the cost relative to the reference case structures of energy intensive indusKorea tries such as iron and steel, chemi- 1.0 Iron and steel Chemicals, rubber cals and plastics, nonmetallic and plastics minerals and other manufacturing. 0.8 Nonmetallic minerals This leads to an increase in the Other manufactures competitiveness of Koreas energy 0.6 intensive sectors relative to other 0.4 sectors of the economy and relative to energy intensive production in 0.2 other economies. Consequently, % demand for, and exports of, energy Production Exports intensive goods rise relative to the reference case, together with the Change in energy consumption following deregulation, 2015 share of energy intensive industries relative to the reference case in total economic output (gure 26).
26
27
3.0 2.5 2.0 1.5 1.0 0.5 %
Korea
Energy consumption impacts

Reecting the fall in electricity and gas prices and increased economic output, electricity and gas consumption in Korea rise by 1.4 per cent and 3.1 per cent respectively relative to the reference case at 2015 (gure 27). In the case of electricity, this is equivalent to an increase
60
Coal
Oil
Gas
Electricity
in consumption of 6 terawatt hours in 2015, to around 467 terawatt hours. The increase in electricity use is driven by higher demand by the industry, commercial and residential sectors. Greater demand for electricity also increases the relative demand for other fuels, including coal. Total primary energy consumption is projected to rise to 321 million tonnes of oil equivalent at 2015 (table 25).
25
Projected energy consumption following deregulation, 2015 Korea

Reference case Deregulation Mtoe Mtoe 61.5 158.9 42.6 55.9 2.6 321.5 40.1 b
Coal Oil Gas Nuclear Renewables
60.4 158.8 41.4 55.9 2.6
Total primary energy consumption 319.0 Electricity 39.6 a
The projected rise in natural gas a Equivalent to 460 terawatt hours. b Equivalent consumption relative to the refer- to 467 terawatt hours. ence case at 2015 is equal to around 1 million tonnes and total gas consumption reaches 34.3 million tonnes (47.4 billion cubic metres). The relative increase in gas consumption following deregulation is driven primarily by the enhanced competitiveness of gas as a fuel for electricity and residential applications.

The largest growth in natural gas consumption following deregulation is in the electricity sector (gure 28). Along with the rise in electricity consumption, there is an increase in the share of natural gas in the fuel mix for Gas consumption by sector electricity generation in Korea, as following deregulation, 2015 gas becomes more competitive relaKorea tive to other fuels. The share of gas 12 Reference case in electricity generation rises from Deregulation 11.2 per cent at 2015 in the refer- 10 ence case to 11.8 per cent following 8 deregulation (gure 29).
28
6 4 2
The overall increase in gas consumption is moderated by the increased use of electricity in some sectors relative to the reference case, particularly in industry. The switch
Mt Electricity Industry Commercial Residential
61
toward gas following deregulation would be expected to be larger if gas market reform was undertaken independently from electricity market reform, as the relative competitiveness of gas would be enhanced.
29
40 30 20
Fuel mix in electricity generation following deregulation, 2015 Korea

Reference case Deregulation
Impacts of a gas supply disruption
10
% As discussed in previous chapters, Coal Gas Renewables Korea currently depends entirely on Oil Nuclear LNG imports for its natural gas supply. While sources of supply have expanded over the past few years, four countries Indonesia, Malaysia, Qatar and Oman account for more than 90 per cent of Koreas gas imports. In addition, three of Koreas current seven long term LNG contracts are with Indonesia. As demonstrated by the events of 2001, this could leave Korea vulnerable to international shocks, including disruptions to LNG supply (see box 7). As gas is an important input to economic activity, any interruption to LNG supplies could be costly for the Korean economy.
In this scenario it is assumed that there is a gas supply disruption in 2005 that decreases LNG deliveries to Korea and other countries in the north east Asian region for a period of three months and six months. The disruption to Korea is equivalent to around 2 per cent and 4 per cent of its total LNG demand respectively in that year. In the scenario it is assumed that Korea continues to import the majority of its LNG supplies under long term contracts, at contracted prices. As all other contracted LNG supply to Korea continues as usual in the year of the disruption, it is expected that these prices will not be affected. To maintain LNG supply, Korea and other affected countries are required to source additional cargoes from alternative suppliers, including the spot market. It is assumed that spot supplies and transport are available in this situation, subject to shipping capacity constraints. However, it would be difcult for suppliers to increase LNG production in the short term in response to a sudden increase in demand.
Box 7: LNG supply disruption to Korea in 2001 In March 2001, security concerns in Indonesia led Exxon-Mobil to shut its Arun LNG complex in North Aceh for several months. The closure of the Indonesian gas plant had a direct impact on the supply of natural gas to Korea as Indonesia was the largest single LNG supplier to Korea at that time. In 2001, KOGAS held a contract to import 3.4 million tonnes of LNG a year from Arun and Arun was contracted to supply KOGAS with 20 per cent of Koreas total annual gas requirements in that year.
As a result of the disruption to contracted deliveries, involving several cargoes a month for the period of the disruption, Korea was required to seek alternative LNG supplies to make up the shortfall. Indonesia was able to switch supply to the Bontang LNG facility to cover some of the cargoes, while Korea was able to cover its remaining requirements with spot cargoes from Malaysia and Brunei. An LNG swap deal was also arranged with Chinese Taipei and import schedules from other LNG suppliers were advanced. While in this case Korea was able to source adequate additional LNG supplies to meet its requirements, it was fortunate that the interruption to supply did not occur in the peak winter months. Considering Koreas seasonal gas demand patterns, if the LNG supply disruption had occurred during that season, the impacts on the gas sector and the broader economy could have been severe.
Sources: Doh (2001); Reuters (2001a,b).
Given the likely increased demand and competition for spot cargoes, it is expected that spot prices could rise significantly in the short term. As discussed in box 1, with a tight international supply situation, Korea had difculty sourcing additional cargoes in early 2003 and in one case paid up to 10 per cent more than prevailing prices to secure a cargo. Assuming that Korea has not signed any new term contracts for the period 200305, it would already be meeting a significant shortfall of LNG around 3 million tonnes on the spot market or through short term contracts. The gas supply disruption would intensify the pressure to source additional spot cargoes in that year, with a greater proportion of overall LNG demand met by spot purchases. During the period of disruption it is assumed that there is limited interfuel substitution in Korea. This is designed to reect the short run nature of the analysis as well as specic industry conditions that preclude the procurement of alternative energy supplies over that timeframe. Some substitution of nongas red technologies coal, oil, hydro and nuclear in the electricity generation sector is permitted, to represent excess capacity in those systems.
The scenario demonstrates that a disruption in gas supply has impacts on the broader economy, including on energy prices, energy consumption, sectoral output and national income. While this scenario involves an interruption to a relatively small proportion of Koreas total gas supply, the effects of a disruption could be more severe than modeled here if it occurred during Koreas winter, when gas demand peaks, or if international LNG supply capacity was tighter.
Energy price impacts

The impacts of a disruption to LNG supply are felt primarily on energy prices. Following a three and six month disruption, gas prices in Korea are projected to rise by 2.6 per cent and 3.9 per cent respectively relative to the Change in gas and electricity price reference case at 2005 (gure 30). following a gas supply disruption, This reflects the fact that a larger 2005 relative to the reference case Korea proportion of Koreas total gas imports is now accounted for by 3 month 3 higher priced spot LNG cargoes. As 6 month gas is a key fuel for electricity generation, electricity prices also 2 rise, by around 0.20.3 per cent relative to the reference case at 2005.
30
Economic impacts
Higher energy prices and input Electricity Natural gas costs that follow the supply disruption have a negative impact on Koreas economy. Gross national income, for example, is lower than reference case levels. It is projected that a three month gas supply disruption in 2005 could result in GNP that is around US$96.5 million (74.7 billion won) lower than in the reference case in the same year. As the length of the disruption period increases, the economic effects deepen. Following a six month disruption in gas supply, GNP is around US$142.6 million (110.5 billion won) lower than in the reference case at 2005 (gure 31).
Sectoral impacts
Underlying the macroeconomic impacts in Korea are changes at the sectoral level. As the gas supply disruption has an impact on gas and electricity prices
in Korea, the cost structures of Change in GNP following a gas supply disruption, 2005 energy intensive industries are negarelative to the reference case tively affected in the short term Korea because there is limited interfuel US$m substitution. Higher energy costs 25 reduce the competitiveness of 50 energy intensive industries, leading to a contraction in demand for their 75 output. The most affected sectors in this scenario are the nonmetallic 100 minerals and iron and steel indus- 125 tries (gure 32). Industries that are less energy intensive are also 150 3 month disruption 6 month disruption affected, though to a lesser degree, depending on the contribution of electricity and gas use to their total cost of production.
31
Because industries that use electricity reduce their output relative to the reference case, the electricity industry also contracts. Electricity production is between 152 and 222 gigawatt hours lower than in the reference case at 2005.
Gas consumption impacts

As expected, natural gas consumption in Korea is projected to decline relative to the reference case at 2005 following the rise in gas prices that result from the supply disruption. The fall in gas use is moderated by the limited ability of some users to substitute Change in sectoral output into alternative fuels. Under the following a gas supply disruption, three month supply disruption 2005 relative to the reference case scenario, gas consumption falls by Korea Services 2.1 per cent relative to the reference case at 2005, or by around 0.5 Manufacturing million tonnes (figure 33). When 3 month disruption Chemicals, 6 month disruption supply is interrupted for six months, rubber and plastics gas consumption is projected to fall Iron and steel by around 3.1 per cent relative to the reference case, or by 0.8 million Nonmetallic minerals tonnes in that year.
32
Electricity
The results of this scenario highlight the potential cost to Koreas econLNG in Korea: opportunities for growth
0.06
0.04
0.02
65
omy if reliable, secure supplies of natural gas are not ensured. Failure to resolve the issue of LNG procurement policy and the projected gap between supply and demand as soon as possible could leave Korea vulnerable to gas supply shortfalls over the medium term and the subsequent adverse economic effects discussed in this scenario. However, Korea could reduce the likelihood of supply interruptions if it reduced its reliance on a small number of suppliers by further diversifying its LNG supply portfolio.
33
20 15 10 5 Mt
Gas consumption following a gas supply disruption, 2005 Korea
Reference case
3 month disruption
6 month disruption
66
6
natural gas supply considerations
Because Korea has limited indigenous gas resources, with the Donghae project expected to supply only 0.4 million tonnes a year, meeting the potential increase in demand for natural gas will require signicant increases in gas imports. This could be met either by expanding LNG imports or by constructing natural gas pipelines to international sources of supply. Each of these options has different cost proles and other characteristics that will affect its competitiveness and penetration in the Korean market.
Pipeline natural gas

There is considerable support among government and industry in Korea for the development of pipeline natural gas supplies, for both economic and
34
Possible gas pipelines to Korea
Russian Federation
Lake Baikal
Okka
Irkutsk Ulan-Ude Mongolia
Chita Manzhouli
Khabarovsk Harbin
Sakhalin
Shenyang Beijing Dalian Pyeongtaek China
Vladivostok North Korea Pyongyang Nigata Seoul
Japan
South Korea
Tokyo
67
strategic reasons. While there are many pipeline projects that have been proposed in the north east Asian region, only two projects are considered to have realistic commercial potential as sources of supply into Korea over the medium term. These are pipelines from the Irkutsk region in eastern Siberia and from Sakhalin Island in the Russian far east (gure 34).
Irkutsk
The Russian Federation, China and Korea are conducting a joint feasibility study into the supply of pipeline natural gas from the Kovykta eld, in the Russian province of Irkutsk, to China and Korea. The results of the feasibility study are expected to be released in September 2003. Natural gas deposits in the Irkutsk region are estimated at around 840 million tonnes. The volume of gas supplied to Korea could reach 7 million tonnes (10 billion cubic metres) a year for thirty years. China has sought at least 15 million tonnes (20 billion cubic metres) a year over the same period. There are two proposed pipeline routes considered in the feasibility study. The rst is overland from the Kovykta eld through north eastern China and North Korea to Pyeongtaek, south of Seoul. The second route is overland from Kovykta through north eastern China, then via a subsea pipeline from Dalian to Pyeongtaek, bypassing North Korea. Both the proposed pipeline routes are around 4100 kilometres in length. The Korean Ministry of Finance and Economy recently estimated the total cost of the project to be US$11 billion (Reuters 2003d). It has been agreed by the Russian Federation, China and Korea that each party will construct the relevant portion of pipeline in its own territory. However, it is understood that there has been some difculty in reaching an agreement between the parties on gas prices. China has reportedly sought gas prices that are linked at least partly with coal prices rather than oil as in traditional LNG contracts. In contrast, the Russian Federation has advocated that the price should reect gas prices for Chinas west to east pipeline (Dow Jones 2003). Korea is believed to have sought gas prices that are 2030 per cent lower than current LNG contract prices. The Korean government is optimistic that the Irkutsk pipeline could begin delivering natural gas to Korea by 200810. However, for a number of reasons this view is not shared by all. First, construction of the pipeline would take
a number of years to complete and would therefore need to begin quickly to be operational within this timeframe. Second, for Korea, at the end of the pipeline supply chain, the viability of the project depends to a large extent on China, including both its potential natural gas demand and infrastructure priorities. Chinas potential demand for natural gas is vast, generating some concern that China could absorb all potential supply from Irkutsk for its own needs. Alternatively, China is currently investing large amounts of capital in building the west to east gas pipeline, and some commentators have questioned Chinas willingness to commit to two large pipeline projects in the same time period. There are also reports that China prefers to use domestic gas supplies and imported LNG and will be unlikely to commit to Russian pipeline gas before 2015 (Platts 2003a,b). In addition, there are potential security risks for Korea if the proposed pipeline transits North Korea. However, such an option could also provide strategic advantages as it could better integrate the North into the region and provide the country with both much needed energy and an alternative to nuclear power (see box 8). Given the uncertainties associated with the project, some reports have suggested that the earliest the Irkutsk pipeline could deliver gas to Korea is around 201213 and that a possible startup date could be after 2015 (Platts 2003a,b,d; Wybrew-Bond and Stern 2002). Many of the uncertainties surrounding the pipeline project could be clarified when the results of the feasibility study are announced.
Sakhalin 1
Another potential source of pipeline natural gas to Korea over the period to 2015 is Sakhalin Island, although no feasibility studies for a route to Korea have been undertaken. The Sakhalin 1 development is dedicated to pipeline natural gas for export. Reserves for this development are estimated to be around 354 million tonnes (485 billion cubic metres) (table 26).
26
Field
Sakhalin gas reserves

Application Reserves billion m3
Sakhalin 1 Sakhalin 2 Sakhalin 3 Sakhalin 4 Sakhalin 5 Sakhalin 6
Pipeline LNG Unassigned Unassigned Unassigned Unassigned
485 500 970 540 600 na 3 095
Preliminary total
na Not available. Source: Platts (2003a).
69
Box 8: A gas-for-peace deal with North Korea implications for pipeline projects It has been suggested, including by some in South Korea, that a gas for peace plan could form part of a possible solution to the current North Korean nuclear standoff. Under such a plan, gas could be delivered to the North through the proposed Irkutsk pipeline, or alternatively from the Sakhalin 1 project, in return for the North dismantling its nuclear arms program. The proposed pipeline would pass through North Korea to supply customers in the South but could allow the North to access an agreed volume of gas per year as a transit payment.
Any such arrangement would effectively replace a 1994 accord with the United States that provided monthly shipments of fuel oil in return for North Koreas guarantee that it would not pursue its nuclear ambitions. The 1994 accord stalled in late 2002 and oil shipments were halted after North Korea revealed that it has a uranium enrichment program and later reopened its Yongbyon nuclear power plant and withdrew from the nuclear nonproliferation treaty. North Korea has since announced it is in possession of nuclear weapons and tensions have heightened between North Korea, the United States and several other countries in north east Asia. North Korea is suffering a critical shortage of energy and its economy is close to collapse. It recently announced that it will proceed with its plan to construct two new nuclear reactors with a combined generating capacity of at least 200 megawatts. Under a gas for peace deal, North Korea could be provided with sufcient natural gas to generate an equivalent volume of electricity. There have been reports that the Russian Federation is likely to favor the proposal, not only because of the geopolitical and security implications but because it would provide its gas elds with access to the South Korean market. However, the Russian Federation would be unlikely to provide natural gas to North Korea free of cost, hence any supplies to the North could have to be built into the cost of the gas supplied to the South. This could make pipeline natural gas less competitive in South Korea against its established sources of imported LNG. Alternatively, the proposal could form part of a multilateral aid program to North Korea. Such a proposal is still in the early stages of discussion and the North Korean stance toward this and other such projects on regional energy cooperation remains uncertain. Other problems include uncertainty surrounding any large scale projects in the North, the lack of gas infrastructure in the country, and issues relating to sovereign risk. In addition, neither of the proposed gas pipelines is scheduled to be constructed until at least the end of the decade. Nevertheless, the North Korean issue is likely to remain a key point for consideration in the development of any natural gas pipeline for the South.
Sources: KEEI (2003b); World Markets Research Centre Limited (2003); Energy Intelligence Group (2003b).
70
The distance from Sakhalin to Seoul is shorter than that from Irkutsk and would imply lower pipeline construction costs. However, recent announcements suggest that any pipeline from Sakhalin 1 would target Japan as its principal market. A US$15 billion scheme has been proposed to build a 19002200 kilometre subsea pipeline that would supply around 6 million tonnes (8 billion cubic metres) a year of Sakhalin gas to the Niigata or Tokyo area in Japan from 2008 (Platts 2003b; Energy Argus 2003g). It is unlikely, however, that Japans gas market, with its emphasis on LNG, will absorb the minimum volume of pipeline gas required for the project to be viable in the medium term particularly in the light of recent LNG import commitments by Japanese companies from the Sakhalin 2 project (Platts 2003e). These market factors could reduce the likelihood of the Sakhalin 1 pipeline project proceeding, or at least postpone its development until there is sufcient market growth (Energy Intelligence Group 2003c). While it has been suggested that pipeline gas from Sakhalin 1 could be redirected or extended to Korea to enhance its viability, possibly via the North, there are no well developed plans at this stage (FACTS Inc. 2003a; Platts 2003b).
Issues relating to pipeline natural gas

Natural gas pipelines are characterised by high capital costs, long construction times and often complex international transit issues. These and other factors are important in assessing the overall viability of pipeline projects into Korea and their competitiveness with alternative gas supplies. In the rst instance, the size and quality of natural gas reserves that provide pipeline gas supplies will be a critical determinant of the viability of both the Irkutsk and the Sakhalin 1 projects. These projects will be viable only if the gas reserve is large enough to recover the costs incurred in constructing the pipeline and in bringing the gas to end markets. If clusters of reserves are located near the original development, this may increase the lifespan and viability of the project. The gas base must also be dependable, as continuity of supply is an essential issue not only for producers and consumers but also for nanciers and other parties involved in the project. Because of the high capital costs of nancing either of the proposed pipeline options, access to nance will be an important determinant of their viability. This is likely to involve both domestic and foreign capital. Well dened legal, taxation and foreign exchange systems will be important in terms of
encouraging the appropriate ow of foreign funds. While it has been estimated that the Irkutsk pipeline project would cost around US$11 billion, there has been little discussion of how this will be nanced. The existence of a viable market will also be a prerequisite to the development of natural gas pipeline projects in Korea. As discussed above, there is signicant potential for future gas demand growth in Korea. However, existing pipeline proposals have not targeted Korea as a priority market rather they have been extensions of planned pipeline to other markets, principally China and Japan. Hence the dynamics of these markets will be as important for the viability of the pipeline projects in Korea as the Korean market itself. The viability issue will be compounded by factors associated with the transit of gas pipelines through third countries. Transit fees, either nancial or in kind through physical deliveries of gas, can add substantially to gas pipeline transit costs, particularly if the pipeline must traverse more than one country. In the case of the Irkutsk and Sakhalin pipelines to Korea, the transit issue is compounded by the geopolitical situation surrounding the relationship with North Korea. Transit of either pipeline project through North Korea could present considerable risk for the security of South Koreas gas supplies, However, as discussed in box 8, there could also be strategic advantages associated with such an option, including increased economic and energy security for North Korea and access to non-nuclear energy, and the easing of the current political tensions on the peninsula. Further information on issues related to developing natural gas projects in Korea and the north east Asian region can be found in Park et al. (2002) and Park, Lee and Lee (2002).
Can pipeline natural gas compete with LNG?

An important question regarding the implementation of any pipeline project in Korea is whether pipeline natural gas can compete on a price basis with imported LNG. If pipeline natural gas is not price competitive with LNG then there is little economic argument for pursuing a pipeline development to provide additional gas supply. In these circumstances, agreement to supply gas by pipeline would rely heavily on noneconomic factors such as enhancing energy security through fuel diversication or increasing political stability and economic security on the Korean peninsula.
There is much speculation about whether pipeline natural gas can compete on a price basis with LNG imports into Korea. Given the absence of pipeline natural gas in the north east Asian region, a direct comparison with LNG import prices cannot be made. As discussed earlier, Korea has reportedly sought gas prices from the Irkutsk pipeline project that are 2030 per cent lower than current LNG contract prices. Such prices could enable pipeline gas to compete with LNG and allow for some fall in LNG prices over time. However, some analysts believe that pipeline natural gas cannot be delivered to Korea at such a discount to LNG prices. For example, at distances greater than 4000 kilometres, LNG is generally considered to be a more cost effective form of gas transport than pipeline. At around 4100 kilometres, the Irkutsk pipeline is therefore unlikely to have a transport cost advantage over imported LNG (Energy Argus 2002c; Platts 2003a,b). Further, average LNG contract prices to Korea are likely to fall over the period to 2015 as existing contracts expire, making it more difficult for pipeline natural gas to compete with LNG. The downward trend in prices will be the result of new technology and production methods, lower shipping costs and greater competition. The terms and conditions on which LNG is available are also likely to become more exible (Platts 2003a). Economic factors aside, pipeline natural gas may still form an important part of Koreas gas supply mix in the medium to longer term. This could occur if noneconomic factors, including security and geopolitical concerns, are emphasised in the decision making process.
Natural gas supply and demand balance

An indicative natural gas demand and supply balance for Korea is provided in gure 35 that sees new pipeline gas supply complementing existing LNG supply toward the end of the outlook period. The balance is based on the set of demand projections for Korea that were developed in chapter 4, in which gas demand is forecast to reach 33.3 million tonnes at 2015, and existing mid and long term LNG supply contracts. The balance assumes that 0.4 million tonnes of natural gas a year is provided from Koreas Donghae gas field. It also assumes that POSCO and SK Corporation import 1 million tonnes of LNG a year from 2005, as currently planned. In addition, pipeline
35
30 25 20 15 10 5 Mt 2003
Potential natural gas demand and supply balance Korea

natural gas supply from Irkutsk is assumed to commence from 2010 and is ramped up to 7 million tonnes of gas a year by 2013. On the basis of these assumptions, there is projected to be a natural gas supply shortfall of 13.0 million tonnes at 2015 (table 27). The supply gap becomes more signicant after 2010, when stronger growth in natural gas demand is forecast than in the earlier part of the outlook period. This shortfall is likely to be met by new LNG import contracts. The need for additional LNG contracts could be greater if the Irkutsk project (or other pipeline options) are delayed beyond 2010 or are not able to supply 7 million tonnes of gas a year (see box 9).
27
Potential natural gas demand and supply balance Korea

2005 Mt 2010 Mt 24.2 20.4 14.6 1.0 0.4 4.4 3.8 2015 Mt 33.3 20.3 11.9 1.0 0.4 7.0 13.0
Projected gas demand Assumed total gas supply KOGAS LNG long term contracts KOGAS LNG midterm contracts a POSCO/SK LNG contract Donghae gas eld Pipeline natural gas, Irkutsk Supply shortfall/market for additional LNG
23.9 20.8 16.9 2.5 1.0 0.4 3.1
a Assumes 0.5 million tonne option on MLNG Tiga contract is utilised.
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Box 9: Alternative natural gas supply and demand balance As discussed in this chapter, some analysts express doubts that the Irkutsk pipeline from eastern Siberia could begin supplying natural gas to Korea by 200810. Such a delay could occur for a number of reasons, including uncertainties over the projects economic viability, difculty in resolving transit issues, a postponement by China in committing to the project, and delays in the construction process.
Given this possibility, a less optimistic view of the Irkutsk pipeline project is presented in the following alternative supply and demand balance (gure 36). This balance assumes that pipeline gas supply to Korea does not commence until 2014. The volume of gas supplied in 2014 is assumed to be around 5 million tonnes, ramping up to 7 million tonnes the following year
36
30 25 20 15 10 5 Mt 2003
Alternative natural gas demand and supply balance Korea

28
Alternative natural gas demand and supply balance Korea

2005 Mt 2010 Mt 24.2 16.0 14.6 1.0 0.4 8.2 2015 Mt 33.3 20.3 11.9 1.0 0.4 7.0 13.0
Projected gas demand Assumed total gas supply KOGAS LNG long term contracts KOGAS LNG midterm contracts POSCO/SK LNG contract Donghae gas eld Pipeline natural gas, Irkutsk Supply shortfall/market for additional LNG
23.9 20.8 16.9 2.5 1.0 0.4 3.1
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A delay in the delivery of pipeline gas of this magnitude would increase Koreas potential gas supply shortfall over the outlook period and would put further pressure on the demand for additional LNG contracts. Under the less optimistic scenario, Koreas potential supply shortfall at 2010 could be around 8.2 million tonnes, rising to 13.0 million tonnes in 2015. If the pipeline is delayed further, say beyond 2015, then Koreas gas supply shortfall in 2015 could be as high as 20 million tonnes.
In these circumstances, Korea would need to secure additional LNG contracts of around 3 million tonnes by 2005 and further term contracts to meet the projected shortfall in the remainder of the outlook period. Failure to contract additional medium to long term gas supplies is likely to leave Korea vulnerable to gas shortages and to exacerbate the difculties it has experienced in recent years.
Supplying LNG to Korea

An additional 13 million tonnes of LNG a year or greater in the Korean market would add significantly to Asia Pacific LNG trade. It would also provide a strong incentive for LNG producers to invest in new production capacity to ensure reliable supply to an expanding market.
29
LNG trade in the Asia Pacific, 2002

Importer Japan Korea 4.95 2.26 5.07 0.18 0.76 4.00 0.23 b 17.56 Chinese Taipei 3.03 2.08 5.11 Total 25.06 14.93 11.21 7.27 6.56 4.80 4.56 1.24 75.77
Exporter Indonesia Malaysia Qatar Australia Brunei Oman Unites Arab Emirates United States Total
Mt Mt Mt Mt Mt Mt Mt Mt Mt
17.08 10.59 6.13 7.10 5.80 0.80 4.33 1.24 a 53.10
a Includes a cargo swap from Korea to Japan of 0.04 million tonnes. b Includes a cargo swap from Japan to Korea of 0.11 million tonnes. Source: BP (2003)
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The objective in this section is to assess LNG supply capacity to meet Koreas potential demand and to examine some of the factors that could affect the competitiveness of alternative LNG suppliers in the Korean market. Issues relevant to this assessment are the size and distribution of gas reserves, existing and planned LNG export capacities, transport and other cost considerations, and the reliability and security of potential suppliers. Geographical separation and transport costs mean that LNG pricing, demand and supply in the Asia Pacic market are relatively distinct from and unaffected by the Atlantic basin market although there can be some spillover between markets, especially in spot trades. Because Korea falls rmly within the Asia Pacic region, this section focuses on the dynamics of that market. The Asia Pacic market dominates world LNG trade. In 2002, total world LNG trade was 110 million tonnes, of which Japan, Korea and Chinese Taipei accounted for almost 70 per cent. Of the eight LNG exporters to the Asia Pacific market, Indonesia is the largest followed by Malaysia, Qatar and Australia (table 29).
Natural gas reserves

Proved recoverable reserves of natural gas dened as the volumes in place that geological and engineering information indicates with reasonable certainty can be recovered in the future from known reserves under existing economic and operating conditions held by the group of eight existing LNG exporters to the Asia Pacific market are considerable (gure 37). The most significant gas reserves are in Qatar. Together with those of the remaining Asia Pacic LNG exporting countries, the group collectively accounts for 22 per cent of total world proved recoverable reserves. The Russian Federation and Iran have the worlds largest reserves (48 and 23 trillion cubic metres respectively, equivalent to 35 and 17 billion tonnes), and while they do not currently export LNG, both have
37
Proved recoverable reserves in countries exporting LNG to the Asia Pacific market, 2002
Qatar United Arab Emirates United States Indonesia Australia Malaysia Oman Brunei 0 2 4 6 8 10 12 14 trillion m3
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plans to do so in the future. It should be noted, however, that not all the gas reserves identied in any country will be available for liquefaction.
LNG production capacity

There are currently twelve LNG plants in the eight countries that supply the Asia Pacic market (table 30). Indonesia has the largest operating capacity followed by Malaysia, Qatar and Australia. Collectively, the total capacity of all existing plants in the market is about 90 million tonnes a year. Approximately 80 million tonnes a year or 89 per cent of this capacity is tied up in medium or long term contract commitments to established buyers. The remaining 10 million tonnes a year capacity is sold through short term arrangements, on the spot market or remains unused. This modest production overcapacity has, in part, been the product of contract cancellations and weaker than expected demand among Asia Pacic buyers, particularly in Japan and Korea, as a result of the effects of lower economic growth. Market demand is, however, expected to be robust over the coming decades as the energy sectors of established buying countries resume stronger
30
Country
Existing LNG plants, Asia Pacific market

Number of Operating Current trains capacity contracts Mt/yr Mt/yr 7.3 6.7 6.8 19.5 8.3 6.9 3.4 4.7 6.0 4.8 4.7 1.2 80.3
Project
Customers
Australia Brunei Indonesia
North West Shelf Lumut Arun I-III Bontang A-H Bintulu MLNG I Bintulu MLNG II Bintulu MLNG III OLNG Qatargas Rasgas Das Island Alaska
Malaysia
Oman Qatar United Arab Emirates United States Total 78
Japan Japan, Korea Japan, Korea Japan, Korea, Chinese Taipei Japan Japan, Korea, Chinese Taipei Japan, Korea Japan, Korea Japan Korea Japan Japan
3 5 4 8 3 3 1 2 3 2 3 1
7.5 7.2 6.8 22.1 7.6 7.8 3.4 6.6 7.7 6.6 5.5 1.5 90.3
growth. New LNG buyers, including China, India and the United States west coast, could also provide a major demand stimulus. Compared with these strong demand projections, there are limited new gas supply projects under construction in the region. Projects under construction include Australias North West Shelf Train 4 and the Bayu Undan project in the Timor sea and Malaysias MLNG Tiga Train 2 (table 31). Together with projects in the Middle East, these projects could deliver an additional 18.6 million tonnes a year, with start dates from 2003 to 2006. Other projects in the region are at various stages of planning and approval. These include Australias North West Shelf Train 5, Sunrise and Gorgon projects, and others in Indonesia, Brunei, the Middle East and the Russian Federation. If these greenelds projects are to proceed, however, they will need to be underpinned by secure long term contracts that ensure their economic viability and access to nance. The potential demand from Korea if converted to contracts could provide the necessary incentive for producers to proceed with some of these developments.
31
Country
LNG plants under construction and planned, Asia Pacific market

Operating capacity Mt/yr Number of trains Startup date
Project
Projects under construction Australia North West Shelf Train 4 Bayu-Undan Malaysia Bintulu MLNG III Train 2 Oman OLNG T3 Qatar Ras Laffan Total Projects planned or proposed Australia North West Shelf Train 5 Gorgon LNG Sunrise Brunei Lumut II Indonesia Bontang I Tangguh Qatar Ras Laffan Russian Federation Sakhalin 2 LNG in Korea: opportunities for growth
4.2 3.0 3.4 3.3 4.7 18.6 4.2 5.0 7.5 4.0 3.0 7.0 4.7 9.6
1 1 1 1 1 5 1 1 2 1 1 2 1 2
2004 2006 2004 2005 2004
2007 2008+ 2007+ 2008+ 2005+ 2007 2005 2007 79
Competitiveness of alternative LNG suppliers

A range of factors will inuence the competitiveness of alternative potential LNG suppliers into the Korean market. Transport costs will be one such factor and these will be affected to a large extent by distance. A summary of relevant transport data for existing LNG suppliers to the Korean market is provided in table 32. Suppliers to Korea fall into three groups. The first comprises those from Brunei, Malaysia and Indonesia, from where transport costs account for around 1015 per cent of delivered LNG costs. Transport costs for the second group, consisting of Australia and the United States (Alaska), are higher at around 20 per cent of landed LNG prices. Middle Eastern suppliers make up the third group. These are furthest from the Korean market, with shipping costs representing 30 per cent of delivered LNG costs. While price will be a key factor inuencing the competitiveness of potential suppliers into Korea, nonprice issues will also be important. These include the capacity of a supplier to negotiate flexible contracts in areas such as seasonal delivery patterns, realistic take or pay provisions and make good and resale provisions. The ability to offer exibility in such matters will often depend on a suppliers overall contract commitments and the capacity to balance supply commitments in different markets. Given the seasonal nature of Koreas gas consumption, with strong demand peaks in the winter, exibility and timing of delivery are also likely to inuIndicative LNG transport costs to Korea from various exporters, 2001
Distance, one way nautical miles Australia Indonesia Malaysia Brunei Oman Qatar United Arab Emirates US Alaska 80 3 633 2 493 2 124 2 082 5 694 6 156 6 093 4 027 Time, round voyage days 19 14 12 12 28 31 30 21 Shipping cost, share of delivered price % 20 15 15 10 30 30 30 20
32
ence the relative attractiveness of one source of LNG over another. Koreas recent midterm LNG contract with North West Shelf Australia LNG, for example, will deliver all the contracted volume in the winter period. Less tangible factors that are likely to be important determinants of competitiveness in the Korean market are the reliability and security of supply, and the capacity to contribute to overall energy security through the diversication of energy supply sources (see box 10). This issue has formed a key part of Koreas energy policies and fuel procurement decisions. These factors will tend to favor politically stable economies, including Australia, and tend to discriminate against regions where instability could increase the risks associated with investing in LNG infrastructure and hence Koreas overall gas security position. The disruption of part of Koreas gas supply in 2001 demonstrated the potentially high costs if reliability and security of supply are not met.
Box 10: Australian LNG supply To reduce its risk profile, Korea has in recent years contracted LNG supplies from a more diverse portfolio of suppliers. More than 90 per cent of Koreas LNG supply in 2002 was from four sources Indonesia, Malaysia, Qatar and Oman. However, there are other gas producers in the Asia Pacic region, including in Australia, with the capacity, or planned capacity, to export LNG.
To date, Australia has had a limited role in supplying LNG to Korea, with trade restricted to several spot cargoes from the North West Shelf project, operated by Woodside Energy. Recently, the gas links between Australia and Korea were expanded when a 7 year contract to supply 0.5 million tonnes of LNG a year from late 2003 was awarded to NWS Australia LNG. Australia has abundant reserves of natural gas, a reputation for reliable delivery, is politically stable and has supportive government policies toward the export of its natural gas resources. In addition, the North West Shelf joint venture has demonstrated an ability to offer flexible supply conditions, as evident in the midterm contract with KOGAS in which all cargoes will be supplied during the winter period. The North West Shelfs 4.2 million tonne fourth train is expected to be online in 2004. A fth train is planned, but would require long term commitment from a buyer such as Korea to underpin its development. There are several other projects in Australia either under construction or planned that could potentially supply Koreas LNG market. These include Sunrise in the Timor Sea and Gorgon LNG on the North West Shelf.
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7
conclusions
Natural gas has played an increasingly important role in meeting Koreas rapidly growing energy demand in all sectors of the economy since imports of LNG commenced in 1986. Government policy to diversify energy supplies away from oil has been a key driver of growth in natural gas consumption, while strong investment in nationwide gas distribution networks has facilitated its expansion. Analysis in this study indicates that natural gas demand in Korea is likely to continue to grow strongly over the period to 2015, although at a slower rate than in the recent past. Given current policy settings and assumptions about economic growth and the fuel mix in electricity generation, natural gas demand in 2015 could reach 33 million tonnes. This will be underpinned by the increasing use of gas in households and by industry as well as in the electricity sector. Increased use of gas would assist Korea to meet a number of its key energy policy objectives. These include addressing the environmental implications of energy consumption and ensuring a secure, reliable and diversied energy supply base. However, one of the major issues faced by Korea in the short and long term is how to establish effective gas procurement policies that will help to realise the benets of gas consumption throughout the economy. Korea is the worlds second largest importer of LNG after Japan and has in place medium and long term contracts to import 19 million tonnes of LNG a year. This is insufcient, however, to cover Koreas gas requirements over the medium to longer term. In addition, KOGAS has made extensive use of the spot market and short term contracts to meet its current demands. The costs of this policy, as demonstrated by Koreas experience in the winter of 200203, are lack of certainty about access to gas supplies and prices higher than under long term contracts. Given the strong projected growth in LNG demand in Korea it is imperative that cost effective, reliable and secure supplies of gas are available to electricity generators and city gas companies. This is emerging as a serious concern for Korea, as gas supply plans have not kept pace with projected
demand and a signicant gap between demand and supply is likely to arise over the next decade. The issue is complicated by the fact that KOGAS is delaying entering into new long term LNG supply contracts until plans to liberalise the gas market have progressed. However, waiting for gas reform plans to be implemented before committing to new LNG contracts is exacerbating the potential gap between demand and supply. Because gas market reform is complex and requires good planning to implement effectively, it is not necessarily in Koreas best interests to link the process to new gas supply contracts. By doing so, Korea is potentially missing the opportunity to secure favorable terms and conditions that are currently being offered under long term contracts in the international market. An alternative form of natural gas supply that is currently being investigated by the Korean government is the delivery of gas by pipeline from reserves in Siberia or Russias far east. The Irkutsk pipeline proposal is currently the subject of a feasibility study by a consortium of Russian, Chinese and Korean government and industry representatives. While the results of the feasibility study are not yet known, many observers believe that it is unlikely that the pipeline will deliver gas to Korea before 2010. Even if the project proceeds within this timeframe, the analysis in this study indicates that Korea will need signicantly more natural gas to satisfy its requirements over the period to 2015. This could amount to around an additional 13 million tonnes a year at 2015 and will be met almost certainly by increased imports of LNG. If the pipeline is not developed by 2015 then the demand for additional LNG could be as high as 20 million tonnes. There is currently a number of LNG supply projects in the Asia Pacic region, backed by large gas reserves and extensive existing and planned production facilities, that have the capacity to meet Koreas long term gas requirements. Indeed, the size of Koreas projected gas demand over the period to 2015 is sufficient to justify additional investment in production capacity by LNG suppliers. However, given the time required to bring new greeneld or browneld gas developments to the market, it will be important for Korea to commit to new supply contracts as soon as possible if it is not to face an increasingly difcult gas supply situation in the medium term. The current competitiveness of the LNG supply industry and its responsiveness to changing market conditions will ensure in these circumstances that Koreas long term energy security objectives are met.
appendix
structure of the global trade and environment model (GTEM)

GTEM is a multiregion, multisector, dynamic general equilibrium model of the world economy with a database that has a detailed representation of production sectors and regions in the global economy. A nontechnical description of the major assumptions and features of GTEM is presented below. A detailed description of the model can be found on ABAREs website (www.abareconomics.com).
Dynamics
GTEM is a dynamic model that includes relationships between variables at different points in time. This is in contrast to comparative static models, which compare two equilibriums, one before a policy change and one following. As a dynamic model, GTEM requires a reference case against which the results of policy simulations can be compared. The reference case provides projections of growth in labor and capital in each economy or region, and the associated growth throughout the rest of the economy in the absence of any policy measures. The results of policy simulations are then interpreted as deviations from the reference case.
Factors of production
The four primary factors of production in GTEM are capital, land, labor and natural resources. The capital stock in each region accumulates by investment less depreciation in each period. Both capital and labor are mobile between industries and, to a lesser extent, across regions through international capital ows and labor migration. Land is used only in agriculture and is xed in each region. GTEM explicitly models natural resource inputs as a factor of production in resource based sectors (coal mining, oil and gas extraction, other minerals, forestry and shing). For example, the natural gas extraction industry uses three factors of production labor, capital and a natural resource (reserves of natural gas). The natural resource is a factor used solely in the production of resource based commodities and is not mobile between sectors or regions.
Returns to the natural resource adjust to maintain its full employment. If, for example, the demand for natural gas declines, returns to the natural resource (its price) fall, leading to a reduction in the supply price of natural gas. Population and labor supply for each region are determined endogenously (within the model) over time. GTEM contains an elaborate description of population dynamics, which captures the idea that as economies move along the economic development path, increasing per person incomes lead to well dened changes in fertility and mortality rates. The model uses estimates of the dependence of fertility and mortality rates on income and an exogenously imposed migratory pattern to predict age and gender specific population changes.
Natural rate of unemployment

It is assumed that the imposition of any policy change does not raise unemployment above the so-called natural rate of unemployment for any economy. Any downward shifts in the demand for labor are assumed to be offset by reductions in real wages growth sufficient to prevent the emergence of unemployment above the natural levels. This assumption is often known as the full employment assumption and its use is justied in cases where policy changes are introduced progressively, allowing time for wages to adjust to new market conditions. In practice, however, it could be expected that changes in patterns of production caused by a policy shock such as the implementation of trade and investment liberalisation or the imposition of greenhouse gas emission constraints could lead to the emergence of some unemployment, especially if liberalisation has negative impacts in sectors where the skills of the labor force are not easily transferable
Prices
For each commodity and primary factor in the model, taxes on production, sales, exports and imports are accounted for separately. As a result, the supply price, market price, domestic user prices and the export price (including export taxes) for a commodity in the producing region and the import price (including international freight), duty paid market price and user prices in the importing region of a given commodity are clearly distinguished. In the standard model closure, prices adjust fully to equate the supplies of and demands for all factors and commodities in each region in each period.
Producer behavior
Producers in GTEM are assumed to operate in perfectly competitive markets using constant returns to scale technologies. Under these assumptions, prices will be set to cover costs and GTEM industries earn zero prots at all times, with all returns paid to primary factors of production, including any returns paid to owners of natural resource assets. Thus, changes in output prices are determined by changes in input prices of materials and returns to primary factors.
National income, savings and consumption

In GTEM, a representative household in each region owns all factors of production and receives all payments made to the factors, all tax revenues and all net interregional income transfers. The representative household allocates its net income across private and public consumption and savings. National savings are assumed to move in line with national income. Total consumption expenditure is calculated as the difference between current household income and savings, with the ratio of private consumption to government consumption assumed to be constant. Given total private consumption, the representative consumer maximises current period utility by choosing consumption levels for each of the commodities in the database, from both domestic and imported sources.
Trade
A key feature of GTEM is that it models bilateral trade ows of all commodities between all regions. In GTEM an Armington preference structure is adopted. This implies that a good produced in one region is an imperfect substitute for goods produced by the same industry in other regions (Armington 1969a,b). In other words, the same commodity from different sources can trade at different prices. Consumers in a region can substitute goods produced in that region with the same goods produced in other regions. For any given consumption activity, demand for a commodity is allocated between a domestic product and a composite imported product according to a constant elasticity of substitution (CES) function. The demand by a region for each composite imported commodity is then allocated between sources of imports according to a further CES function. Substitution between domestic and imported commodities
and between imported commodities from different sources will depend on movements in relative prices and the specied elasticity of substitution the Armington elasticity. The Armington elasticities in GTEM vary between commodities and are derived from current literature and from empirical work undertaken by Jomini et al. (1991) in the construction of the SALTER world trade model. As with all parameters in a global computable general equilibrium model, there is uncertainty about the appropriate size and relativities of the Armington elasticities for various commodities. These elasticities are important determinants of the model results as they affect the estimated trade impacts on commodities resulting from policy shocks. In equilibrium, the exports of a good from one region to the rest of the world are equal to the import demand for that good in the remaining regions. Goods are transported between regions by an international transport industry. The cost of international transport is added to the cost of imports to each region. GTEM does not require the current account to be in balance every year. It allows the capital account to move in a compensatory direction to maintain the balance of payments.
International capital mobility

Global investment equals global savings in GTEM. It is assumed that regional borrowers (investors) issue bonds to global savers at a risk free, global average rate of return. At the regional level, however, rates of return may differ to reect country specic differences in the risk premium required by global savers. For example, global savers tend to place a higher risk premium on investing in developing countries in GTEM to reect greater uncertainty of investing in these regions. The equilibrium rates of return in developing countries are therefore higher than in developed countries. Investment demands, in turn, are determined by changes in regional GDP and regional expected rates of return relative to expected global rates of return. Thus, changes in investment ows represent changes in demand from expansionary or contractionary effects (changes in real GDP) and expectation effects. Any excess of investment over domestic savings for a given region causes an increase in net debt for the region. Borrowers service the debt at the global rate of return (interest rate).
Exchange rates
The exchange rate in GTEM is the price of converting local currency into global currency. It is the price that adjusts to keep the balance of payments in equilibrium. For example, if trade liberalisation leads to a significant decline in export earnings from a particular region this will, other things being equal, result in an exchange rate depreciation for that region. The depreciation in the exchange rate will improve the competitiveness of exporters and import competing producers in that region. Exports will increase and imports decline, restoring balance of payments equilibrium. A change in the exchange rate will also inuence international transfers associated with foreign debt or lending. For example, a region that has borrowed from international capital markets in GTEM that experiences an exchange rate depreciation will have a greater level of debt denominated in foreign currency. The debt servicing requirement (interest paid) will increase in domestic currency terms. On the other hand, a region holding foreign assets through international lending will earn more interest income in domestic currency if its exchange rate depreciates.
Technology bundle
In the standard general equilibrium modeling approach, industries produce a commodity by combining primary factors and intermediate inputs in xed proportions. Substitution is only possible between primary factors. In GTEM, electricity generation and iron and steel production are modeled using the technology bundle approach. With this approach, different production techniques are used to generate a homogeneous output from each industry. Electricity can be generated from coal, petroleum, gas, nuclear, hydro or renewable based technologies, while iron and steel can be produced using blast furnace or electric arc technologies. Industries are able to substitute between technologies in response to changes in their relative costs. By modeling energy intensive industries in this way, GTEM restricts substitution to known technologies, thereby preventing technically infeasible combinations of inputs being chosen as model solutions.
Production and interfuel substitution

For industries other than those characterised by the technology bundle, production in each region is assumed to use only one technology. This tech88 ABARE research report 03.4
nology requires xed proportions of intermediate inputs, with the exception of energy inputs and primary factors. Non technology bundle industries obtain a least cost combination of four energy commodities (coal, gas, petroleum products, and electricity) to produce an energy composite and a least cost combination of the three primary factors to produce a primary factor composite. The industry then forms a least cost combination of these two composites to obtain an energyfactor composite. Allowing for interfuel substitution and substitution between fuel and primary factors in this way means that industries can alter their production input structure in response to price changes by substituting between energy and primary factors or by changing the energy mix.
Database
The starting point for the GTEM database is the GTAP-4E database that contains 50 commodities and 45 regions, which is expanded by ABARE to include 55 commodities by expanding the coal producing sector to three distinct industries (brown, black steaming and coking coal) and explicitly identifying bauxite, alumina and primary aluminium producing sectors. The GTAP-4E database is based on 1995 production and trade data (expressed in United States dollars). The GTAP database required substantial alteration to form the GTEM database, particularly in the energy sector, and additional data (principally energy sector, greenhouse gas emissions and population data) were collected. For example, the data underpinning the representation of two major fossil fuel using industries (electricity and iron and steel) were enhanced to reect inputoutput relationships in the range of known technologies. In addition, the contribution of each technology to total electricity and iron and steel production has been derived to reect external data (IEA 1998; International Iron and Steel Institute 1996). Also, signicant demographic detail is required in GTEM to model population and labor force growth over time. Underpinning the demographic module are historical data showing the age and gender composition of the population in each region in one year cohorts from age 0 to 100. These are sourced from United Nations (1998).
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Greenhouse gas emissions accounting

GTEM models emissions of three greenhouse gases carbon dioxide, methane and nitrous oxide. Emissions of methane and nitrous oxide are represented in GTEM in carbon dioxide equivalents. The carbon dioxide equivalent is derived by multiplying the emissions by the appropriate global warming potential, a measure of the relative radiative forcing of different greenhouse gases. The global warming potential values are 1, 21 and 310 for carbon dioxide, methane and nitrous oxide respectively over a one hundred year time horizon (IPCC 1996). At current atmospheric concentrations, an additional tonne of nitrous oxide in the atmosphere, for example, is considered to be 310 times more potent in terms of radiative forcing than an additional tonne of carbon dioxide, over a one hundred year time horizon.
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references
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South Korean Gas Imports

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LNG IN KOREA

opportunities for growth

ABARE RESEARCH REPORT 03.4

Allison Ball Karen Schneider Jane Mlanie Robert Curtotti

Changwon Park Jaesung Kang Jaekyu Lim

proudly produced for:

Australian Government Department of Industry, Tourism and Resources

ABARE project 2835

BRIAN S. FISHER Executive Director ABARE August 2003

SANG-GON LEE President KEEI

LNG in Korea: opportunities for growth

ABARE research report 03.4

2 Energy and natural gas consumption in Korea

3 Factors affecting Koreas future natural gas demand

4 Projecting natural gas demand in Korea

5 Alternative policy scenarios

6 Natural gas supply considerations

ABARE research report 03.4

LNG in Korea: opportunities for growth

ABARE research report 03.4

LNG in Korea: opportunities for growth

Total primary energy consumption, 2002 Korea

Coal Oil LNG Nuclear Renewables Total

49.1 102.7 23.6 29.8 3.9 209.1

Natural gas consumption in Korea

Currently all natural gas demand in Korea is met by imported LNG

Mt 1986 1990 1994 1998 2002

ABARE research report 03.4

Monthly LNG consumption, by sector Korea

LNG imports, by source, 2002 Korea

Factors affecting future natural gas demand

Qatar Indonesia Oman Malaysia Brunei Australia Other

5.2 5.0 4.1 2.3 0.8 0.2 0.3

Projecting natural gas demand in Korea

Electricity Residential Commercial Industry

ABARE research report 03.4

Projected natural gas demand and supply Korea

23.9 19.4 1.0 0.4 3.1

Natural gas supply considerations

Indicative gas supply and demand balance

ABARE research report 03.4

LNG in Korea: opportunities for growth

Objectives in the study

ABARE research report 03.4

Total primary energy consumption Korea

1982 1986 1990 1994 1998 2002

Major energy and economic indicators Korea

45.7 139.2 38.7 0.4 1.2

Fuel mix in primary energy consumption

International comparison of major energy and economic indicators, 2000

193.6 524.7 11.5 1 142.4 2 299.7 339.6 110.2 5 316.9 c 6 251.5 c

ABARE research report 03.4

Total primary energy consumption, 2002 Korea

Coal Oil LNG Nuclear Renewables

49.1 102.7 23.6 29.8 3.9

Fuel mix in primary energy consumption Korea

Renewables Nuclear LNG Oil Coal

1982 1986 1990 1994 1998 2002

Final energy consumption

Final energy consumption, by sector Korea

1982 1986 1990 1994 1998 2002

ABARE research report 03.4

Motor vehicle registrations Korea

40 20 % 1982 1990 2002 Industry