A P R I L 2 0 0 4 Operational Guidance for World Bank Group Staff Public and Private Sector Roles in the Supply of Gas Services in Developing Countries THE WORLD BANK GROUP The Energy and Mining Sector Board A P R I L 2 0 0 4 Operational Guidance for World Bank Group Staff Public and Private Sector Roles in the Supply of Gas Services in Developing Countries The World Bank, Washington, DC THE WORLD BANK GROUP The Energy and Mining Sector Board ACKNOWLEDGEMENTS CONTACT INFORMATION This Note was prepared by Franz Gerner and Bent Svensson To order additional copies please call the Energy and Water of the Oil and Gas Policy Division of the World Bank, Help Desk 202-473-0652 energyhelpdesk@worldbank.org. under the supervision of Robert Bacon. This Note is available online www.worldbank.org/energy/ This Note has benefited from inputs from staff in the World Bank Group (IBRD/IDA, IFC and MIGA) and has been cleared by the Energy and Mining Sector Board. B ACRONYMS CDM Clean Development Mechanism E & P Exploration and Production EI Extractive Industries GGFR Global Gas Flaring Reduction Public Private Partnership LNG Liquefied Natural Gas PSC Production Sharing Contracts PCF Prototype Carbon Finance CONTENTS FOREWORD......................................................................................................................ii EXECUTIVE SUMMARY....................................................................................................1 CONTEXT AND BACKGROUND.....................................................................................2 MARKET STRUCTURE AND LEGAL AND REGULATORY FRAMEWORK.......................3 Gas Exploration and Production, LNG and Export-Oriented Pipelines ....................3 Transmission (including Storage & Regasification terminals) and Distribution.......4 PUBLIC AND PRIVATE PARTICIPATION ........................................................................6 Gas Exploration and Production, LNG and Export-Oriented Pipelines ....................6 The Downstream Transmission and Distribution Network.........................................7 STRATEGIES FOR EFFECTIVE BANK PARTICIPATION...................................................9 i Upstream .....................................................................................................................9 Downstream ..............................................................................................................10 MATRIX OF WORLD BANK GROUP GAS SECTOR INTERVENTIONS .......................12 FOREWORD Infrastructure services are critical to economic growth, poverty reduction and the achievement of the Bank's Millennium Development Goals (MDGs). The introduction of gas as an alternative source of energy in developing countries in the recent past is an important development since it often provides a cleaner and cheaper source of energy for industrial and domestic usage than alternative sources of fuels or technologies currently available. To fully benefit from the utilization of natural gas, developing countries will require private and public financing to develop infrastructure and to create domestic and regional gas markets. Developing countries will also require assistance to create efficient gas market structures and legal and regulatory frameworks that encourage private participation and the efficient utilization of gas. ii The private sector will have to account for a growing share of providing capital for upstream and downstream gas network development. At the same time, the public sector, public-private partnerships and international donor organizations, such as the World Bank Group, will continue to play an important investment role, mainly in those parts of the gas chain where international investors are less willing to provide capital, such as the development of downstream gas networks. This Note provides guidance to World Bank Group staff on assessing the suitability of available options for public-private roles in the financing and provision of natural gas, the potential role of the Bank in the various parts of the gas chain and the main steps which staff should take to analyze these options. It also links to appropriate World Bank Group instruments, relating them to the different public-private models and parts of the gas chain. As we accelerate the implementation of the Infrastructure Action Plan, the Note provides a framework within which staff can design operations in a way that will enable us to maintain the quality of our interventions. Rashad Kaldany Director Oil, Gas, Mining and Chemicals Department Jamal Saghir Director, Energy and Water Chairman, Energy and Mining Sector Board EXECUTIVE SUMMARY · The WBG should ensure that local communities benefit directly from EI projects (e.g. through 1. The discovery of large natural gas reserves in many supplying gas to communities in areas of production developing countries or the potential to import natural and transmission). gas in the domestic market provide a unique opportunity to stimulate economic growth and improve 4. The reports also highlight the need for an integrated the standard of living of millions of people in these strategy for World Bank Group activities in extractive countries and adjacent regions. To fully benefit from the industries; increased focus on governance by the utilization of natural gas a comprehensive upstream and World Bank Group ­ both in the context of projects and downstream gas network is required. To date, most in its dealings with resource rich countries generally; developing countries continue to lack relevant increased disclosure and transparency about revenues infrastructure, and this hinders the introduction of received by governments, about project outcomes and natural gas in the domestic market or the export of gas World Bank activities; environmental issues including to neighboring countries and international markets. concerns about particular processes and sensitive and biodiversity-rich areas; and greater use of World Bank 2. To create and further develop domestic gas markets Group convening power to advance the sustainability in developing countries and promote regional and agenda in the extractive industries international gas trade, substantial investment in 1 infrastructure will be needed. The public sector will continue 5. The World Bank can play a key role in achieving to play an important role in providing financing in all these objectives. First, by providing technical assistance segments of the gas market. At the same time local and (TA) and supporting governments in developing international investors will have to account for a growing countries to create efficient gas market structures, and share of total investment because the public sector, legal and regulatory frameworks. Secondly, by utilizing including state-owned energy companies in developing World Bank Group financial instruments (such as loans, countries, often has difficulties raising sufficient funds and guarantees, equity and others) to encourage participation providing technical know-how. To attract local and of domestic & international investors in the development international capital, developing countries will have to of gas production and downstream transmission and improve their investment climate. Gas market restructuring distribution networks to create and develop domestic and legal and regulatory reform, aiming to allow and and regional gas markets. promote private participation in upstream and downstream gas markets by reducing investment and regulatory risk, 6. The overall objective of this paper is to provide are paramount to attract capital into the sector. guidance to World Bank Group staff on the public and private sector roles in the supply of gas services in 3. The World Bank Group announced in 2000 that it developing countries and the main issues these countries would conduct a comprehensive review of its activities in have to address in order to develop gas markets. This the extractive industries (EI) sector, including natural gas, Note should also enable Bank staff to identify the in response to concerns expressed by a variety of technical and financial instruments available to assist stakeholders, primarily environmental and human rights governments in fashioning strategies to attract private organizations. The review was concluded in January participation in gas infrastructure. Bank staff should use 2004 and the WBG's final Management Response is the framework provided in the Note in conducting the provisionally expected around June, 2004. Of special dialogue with clients, and identifying and preparing new relevance to natural gas are the recommendations of projects. Bank staff should be aware that given the the reports that: variety and complexity of country circumstances, this Note cannot provide answers or detailed recommendations · IBRD and IDA should help countries remove subsidies to each individual situation that Bank staff will face. from carbon-based fuels, taking into account of the potential impact on the poor; · WBG lending should concentrate on aggressively promoting the transition to renewable energy and endorsing natural gas as a bridging fuel - building new pipelines and renovating leaking ones and funding fuel switching from coal to gas in power generation; CONTEXT AND BACKGROUND pipeline projects in North African and Nigeria over the next decade are estimated to require some 12 billion US 1. The natural gas chain comprises upstream and dollars.3 Regional network projects are also planned in downstream activities. In this Note, upstream activities the Middle East, Asia and Central and South America include exploration and production, Liquefied Natural Gas that require substantial investment. (LNG) and export-oriented gas pipelines. Downstream activities refer to transmission (including storage and 4. It is generally accepted that the public sector, including regasification terminals) and distribution activities to state-owned energy companies, in most developing domestic and industrial customers.1 countries and regions does not have the financial and technical capabilities to ensure exploration and production 2. Compared to other infrastructure industries such as of economically viable gas reserves and construction of electricity, transport, water and telecommunication, natural infrastructure either for gas export through LNG facilities gas markets in most developing countries have only and export-oriented pipelines or for domestic household recently evolved. The introduction of gas as an alternative and industrial consumption. International investors, both source of energy in developing countries is desirable as it private and public, will have to account for a growing provides a cleaner and often cheaper source of energy for share of upstream and downstream investment in the gas industrial and domestic usage, increases security of supply sector. At the same time, the public sector in developing 2 through energy diversification and gradually substitutes countries, public-private partnerships, and international more environmental harmful and unhealthy sources of energy donor organizations will continue to play an important (such as coal, oil and biomass) and provides a new source investment role mainly in those parts of the gas chain of revenue for governments if exported to international where international public and private investors are less markets. At the same time, many developing countries that willing to provide capital, notably in the development of have discovered economically viable gas reserves continue downstream transmission and distribution networks, to lack the network and demand required to supply industrial including for gas imports.4 and household customers in domestic markets or to export gas through export-oriented pipelines or LNG facilities. For 5. In principle, efficient private participation in the example in Africa, Equatorial Guinea and Nigeria have very development of gas markets is preferable not only because high reserve/production ratios that indicate limited it provides capital for upstream and downstream network development of gas markets and infrastructure. This hinders development, but also because it increases efficiency and the creation of domestic and regional gas markets that innovation which eventually benefits final consumers could potentially benefit millions of customers located in through lower tariffs and better services. However, financial gas rich regions - in particular in developing regions in constraints on the public and private sector in developing the Middle East, South and Central Asia, and West Africa. countries, monopolistic market structures and inadequate legal and regulatory regimes often prevent, hinder or 3. The creation and development of natural gas markets is discourage investment in upstream and downstream gas capital intensive, and future upstream and downstream network. To attract private investors, governments in investment requirements to create and develop domestic and developing countries must demonstrate political regional gas markets in developing countries and adjacent commitment and a clear policy that allows for efficient regions are enormous. The International Energy Agency (IEA) private participation and a level playing field in all parts has estimated that investment requirements in gas exploration of the gas chain, create market structures that provide and production and LNG and downstream transmission international companies access to the domestic market (including storage) and distribution network in developing and develop an efficient legal and regulatory regime countries over the next 30 years will amount to 790 and that reduces investment risks. 350 billion US dollars respectively.2 Export-oriented gas Distribution includes both low-pressure network and supply activities to final customers. 1 International Energy Agency, World Energy Investment Outlook, 2003 Insights 2 Planned-export-oriented gas pipelines in Africa include GME expansion (Algeria to Spain via Morocco), Medgaz (Algeria to Spain), Galsi 3 (Algeria to Italy), Arab Mashreq (Egypt to Jordan), Green Stream (Libya to Italy), WAGP (Nigeria to Ghana) and Trans-Saharan (Nigeria to Algeria). For a detailed analysis of private participation in upstream and downstream gas markets around the world refer to the ESMAP Report on 4 Global Energy Sector Reform in Developing Countries: A Scorecard, ESM219, July 1999 by Robert Bacon and Charles McPherson and Private Participation in Infrastructure: Trends in Developing Countries in 1990-2001, World Bank, January 2003 6. This Note sets out the important role the World Bank become more competitive and gas buyers can Group (WBG) can play in (a) assisting governments in increasingly chose from alternative sources of gas developing countries to create and develop domestic gas supply. This has major implications on traditional long- markets, and fashion strategies that promote the creation term take-or-pay contracts. One can already observe of regional gas markets and international gas trade that gas producers offer more flexible take-or-pay through LNG and export-oriented pipelines, and (b) contracts with shorter durations and less restrictive applying WBG financial instruments (such as guarantees, contract terms (for example gas buyers are allowed to loans, equity) that reduce investment risks in gas network on-sell unused contracted gas to other markets). This projects and encourage international public and private would also have an impact on less mature gas markets investors to provide capital to developing countries. The where gas buyers depend on a single source of gas range of possible WBG technical assistance (TA) and given that LNG presents an alternative for expansion. financial instruments to support upstream and downstream gas network development is summarized in the matrix 9. Contractual arrangements are crucial to mitigate attached to this Note. investment risk, and governments in developing countries can play an important role in providing an investor- MARKET STRUCTURE AND LEGAL AND friendly environment, such as fiscal regimes that create REGULATORY FRAMEWORK financial incentives for international private and public investors to participate in upstream activities. Fiscal 3 7. Developing domestic and regional gas markets and instruments include royalty payments, taxes, government international gas trading facilities requires upstream and share (as defined in Production Sharing Contracts) and downstream network. Investments in gas networks are duties. These and other payments are often referred to as capital intensive, have very long economic lives and `total government take'.5 Reservoir and rights management, public and private investors look for assurance that they revenue management, access to LNG terminals, processing can make a reasonable rate of return on their investment plant and export-oriented pipelines, and emerging over the life of the asset. The legal and regulatory investments, such as carbon credits for reducing flaring of framework that governs the industry and the gas associated gas under the Clean Development Mechanism market has profound impacts on the willingness (CDM) can further affect investment in gas networks. of public and private investors to invest in upstream and downstream infrastructure. 10. There has been sufficient private and public-private funding available for upstream gas infrastructure projects Gas Exploration and Production, LNG and in developing countries that directly serve industrialized Export-Oriented Pipelines markets in Europe and the United States. In contrast, many developing countries with relatively smaller 8. Gas producers face substantial financial risks in the gas reserves and domestic markets, and unfavorable exploration and development of gas reserves and look investment conditions, struggle to raise sufficient capital to recover their investment costs by signing long-term to develop infrastructure due to political and economic take-or-pay contracts to sell natural gas in international risks. For example, the conflicts that have recently markets (through export-pipelines or LNG facilities) and affected some export-oriented gas pipeline projects in to anchor customers in domestic gas markets at prices South Asia and South America are of both a political that reflect economic costs. Long-term contracts will and economic nature. Many conflicts are based on continue to play an important role in financing capital economic issues, ranging from failure to agree on the intensive gas projects for the foreseeable future. At the terms of transit, and on profit and rent sharing among same time, with the introduction of new technologies, companies and governments in countries where the the cost of liquefaction and re-gasification has fallen state-owned national companies exercise several roles drastically over the last few years. As a result LNG is (see paragraph 25). increasingly competing with piped gas to supply markets in developing and industrialized markets. With the expansion of LNG, international gas markets have Many governments in developing countries have actively promoted gas development by providing larger fiscal incentives for gas compared 5 to oil production. These countries include China, Indonesia, Malaysia, Nigeria, Peru and Vietnam. 11. Governments in some developing countries will need practices, laws, and regulations, that prevent or to play a more proactive role in promoting investment discourage private investment. in certain high-risk, large-scale upstream gas projects such as export-oriented gas pipelines and LNG facilities. 14. To encourage efficient private and public This is best exemplified by the challenges the West participation in new and existing gas markets, Africa Gas Pipeline (WAGP) project has faced over the governments in developing countries have to last decade. Governments can also help to lower country ensure that new entrant companies have access risk by intensifying dialogue and developing relevant to downstream customers, unbundle vertically inter-governmental agreements to overcome overarching integrated monopolies, create fair competition legal jurisdictions to regulate activities and contracts. In and an efficient regulatory and legal framework. addition, a clear and transparent legal and regulatory A political commitment by government for reform framework for both upstream and downstream activities and restructuring, underlined by relevant laws and has to be established that provides a more stable regulations, will have profound impacts on investors' investment climate and confidence to investors. perception of investment risk and their willingness to provide capital for downstream gas market 12. The World Bank is in a good position to provide development in developing countries and regions. technical assistance on best practice fiscal regimes, 4 reservoir and right management, and access to LNG 15. Investment risks in transmission and distribution terminals, processing plants and export oriented pipelines, network projects in developing countries are including transit terms and profit and rent sharing methods. particularly large where the market being supplied In addition, the international investment community and is small and immature, future demand scenarios are donors increasingly look for prudent and transparent low and uncertain, and where there are doubts about revenue management frameworks in developing countries the creditworthiness of the major consumers ­ typically when committing private capital in the upstream sector to power stations and large industrial customers ­ on avoid mismanaged revenues from oil (and gas) which the financial viability of projects often rely. Private production. The Bank is actively involved in providing investors are only willing to participate in downstream advice to some developing countries on setting up projects if the regulatory and legal environment offers transparent and prudent revenue management regimes.6 tariffs that allow for cost recovery and access to Bank staff also have wide experience in establishing `anchor' customers such as power generators, investor friendly regimes through legal and regulatory reform. The World Bank, as part of the Global Gas Flaring Reduction Pubic Private Partnership (GGFR), is BOX 1 currently advising developing countries on establishing an Experience from restructuring and liberalizing gas markets in transition economies in Eastern Europe, efficient regulatory framework that will encourage developing countries such as Argentina and China, and operators to utilize rather than flare and vent industrial gas markets in the US, Australia and the UK associated gas.7 suggests that gas market reform did encourage long- term investment in gas infrastructure. Transmission (including Storage and Regasification Terminals) and Distribution distributors and other large consumers. This is often 13. In many developing countries, the downstream lacking in developing countries and hence substantially gas sector tends to be dominated by vertically decreases the willingness of private investors to participate integrated, state-owned, oil and gas companies that and provide capital. focus on oil production, and that often lack the financial and technical capabilities to further develop domestic gas markets. International private and public participation in the creation and development of gas infrastructure often tends to be hindered by existing monopolistic market structures and institutional These countries include Nigeria, Chad, Equatorial Guinea, Palau, Timor-Leste and Sao Tome. 6 For further details refer to Regulation of Associated Gas Flaring and Venting ­ A Global Overview and Lessons from International 7 Experience, March 2004, A World Bank Report by Franz Gerner and Bent Svensson 16. The development of gas storage facilities in developing heating in cold climates as more efficient gas market (and transition) countries can play an important role to structures and pricing regimes are being implemented. provide increased security of supply, especially for economies that rely on a single source for piped natural 18. The risks and uncertainties associated with the gas to supply the domestic market. Gas storage can also creation and restructuring of gas markets point to a provide important operational functions allowing network need for governments in developing countries to clearly operators to balance seasonal gas demand and supply define the future envisaged gas market structure in (as well as imbalances over short time periods), to utilize order to ensure that the new rules and emerging market trading and contractual opportunities and thereby optimize structures do not impede or delay investments that are the utilization of the transportation system. The need for gas economically viable. The management of the transition storage facilities has to be analyzed on a case-by-case to a more competitive market structure in developing basis, and the costs of storage8 has to be assessed in a countries is especially critical to industry perceptions of wider context considering security of supply issues and uncertainty, the cost of capital and willingness to invest. availability of substitutes. For natural gas these include Establishing a long-term energy policy and introducing energy supply diversification in general and gas supply efficient and fair energy pricing would help to attract diversification (i.e. LNG) and fuel-switching capabilities for investment in gas supply infrastructure. gas with fuel and gas oil, in particular in the power and industrial sectors. In addition, in some countries and 19. Pricing of gas services is fundamental to maximize 5 regions the construction of storage facilities is not possible the contribution of the sector to economic growth. A for geological reasons. Countries lacking reservoir potential key element is to establish sound energy pricing policies or have a relatively small gas market could contract storage and methods that send correct signals to producers volume or facilities in a neighboring country, sometimes (what, when and how much energy to produce), and even operating the facility themselves. Bilateral agreements consumers (what, when and how much energy to of this kind already exist between Slovakia and Austria, consume). Correct price signals are fundamental for Poland and Ukraine and Switzerland and France. investment and consumption choices and prevent misallocation of scarce resources that reduce overall 17. Natural gas can always be replaced by other fuels, economic efficiency. In principle, the price of gas and and alternative fuel prices put a ceiling on the long-term tariffs for transmission and distribution should promote market price for gas. The availability of other sources of an efficient allocation of resources, achieve cost energy that are subsidized or cheaper, in particular recovery and avoid cross-subsidization. petroleum products and coal for power generation often constrain the development of domestic and regional gas markets in developing countries.9 Competing prices BOX 2 should reflect `economic' costs and these competing Most transition economies in Eastern Europe and some fuels are commonly less environmentally friendly and Central Asian countries have established, or are in the process of establishing, independent regulatory negative environmental externalities tend not to be frameworks. In contrast, only a few developing countries reflected in inter-fuel pricing structures.10 These implicit have passed relevant legislation for establishing an or explicit subsidies distort fuel prices and encourage to independent regulatory regime for downstream gas consumption of less environmental friendly sources of (including Argentina, Brazil, Pakistan, Indonesia and India). energy. To encourage the development of gas markets, governments will have to address the issue of cross- subsidies among consumer categories and ensure that 20. The intrinsic economic conditions of natural gas competing fuels are priced at market levels for networks, that are characterized by large economies of downstream gas projects to succeed. At the same time, scale, make competition in gas network construction experience from transition economies highlights the inefficient and undesirable. Consequently, natural importance of creating social safety nets to limit undue monopolies such as downstream gas transmission and hardship on poorer customers using gas for space distribution are generally subject to economic regulation. A study by the UN Economic Commission for Europe on Underground Gas Storage estimates that gas storage investment costs for 8 depleted fields and salt caverns in Europe are 0.35-0.6 US$/cm and 0.7-1US$/cm respectively. Press Release, ECE/ENE/00/1, Geneva, 15 February 2000. In some developing countries domestic sources of energy, most notably coal, can be produced and supplied much cheaper than natural gas. 9 In this context it is important to stress that the World Bank, in line with the Kyoto Protocol, does not consider global warming externalities 10 in developing countries as economic costs that should be reflected in final prices. 21. Economic regulation is different than just setting regulatory framework has encouraged many industrial technical and safety standards and guidelines for the and developing countries to set up a joint gas and gas industry. Economic regulation refers to ongoing electricity or multi sector regulator. price regulation of monopoly network businesses and aims to balance the interests of consumers, government and 25. The Bank can play a lead role in facilitating the companies in gas markets. Gas markets initially are often development of downstream transmission and distribution based on long-term contractual relationships between gas network in developing countries. Bank staff can upstream and downstream companies. To achieve balance provide technical assistance that supports governments between the various conflicting interests, an `independent' in developing sound energy sector policies and pricing regulatory framework has to be established that provides methodologies that allow for an efficient market structure confidence to all parties. A key requirement for establishing to evolve. Bank staff have also wide experience in advising such a framework is to clearly separate powers in the governments on reforming, corporatizing and unbundling gas industry between agencies and institutions dealing with state-owned energy companies. Developing an efficient matters of policy and regulation and the industry players legal and regulatory regime for downstream gas markets themselves. This requires that economic regulation must in developing countries requires political commitment be carried out independently to ensure that political and governments that endorse gas market reform, considerations do not influence the operation and restructuring and private participation. If that commitment 6 financial viability of the industry in the long-term. is communicated, Bank staff have access to a wide pool of resources to assist governments in building relevant 22. At the same time, an efficient regulatory system regulatory capacity and institutions and create an also protects the interests of consumers by preventing investment climate and a legal environment that promotes monopoly power abuses and excessive pricing, and private participation in both the upstream and ensuring quality of service and access to natural gas. In downstream sector. many developing countries vertically integrated state- owned entities and political institutions continue to carry PUBLIC AND PRIVATE PARTICIPATION out regulatory, policy and operational functions that affect private investment. Removal of all policy making Gas Exploration and Production, LNG and and regulatory functions from these parties is crucial in Export-Oriented Pipelines terms of avoiding potential conflicts of interests and allowing a level playing field for international investors. 26. Until 1990, private participation in the gas sector in developing countries was mostly limited to upstream gas 23. In establishing an efficient regulatory regime it is exploration and production and Liquefied Natural Gas also important to bear in mind the convergence of gas (LNG). Foreign direct investment by international oil and and electricity markets. The main driver for network gas companies played an important role in these areas in developments tend to be large `anchor' customers, the past and is likely to grow in importance, particularly mainly combined-cycle gas power generators (CCGT) for LNG facilities and export-oriented pipelines. that are supplied from the transmission network. Once a transmission network has been build to supply anchor customers it may become economically viable to BOX 3 develop a distribution network to supply smaller Export oriented pipelines included the Maghreb pipeline from Algeria to Morocco to Europe, the Bolivia-Brazil customers in developing countries. pipeline, section of the Yamal pipeline in Belarus and Poland, the Yadana pipeline from Myanmar to Thailand, 24. In most developing countries, policy, regulatory and Gasoducto Cruz del Sur from Argentina to Uruguay and institutional arrangements that govern the relationships Brazil, and four pipelines from Argentina to Chile between the power and gas sub-sectors are weak and (GasAndes, Gas Atacama, Gasoducto del Pacifico and underdeveloped. The absence of effective regulation, NorAndino). The last four projects, which launched the that covers both gas and electricity markets, potentially development of natural gas business in Chile, were hinders the efficient expansion of the gas and power developed by fully private consortia on a competitive basis. sectors. The convergence of gas and electricity markets and the costs associated with establishing an efficient 27. Exploration and development of gas fields in 30. International gas trade has grown rapidly in the past developing countries have traditionally been carried out by decade and will be a major source of revenue for many private or public-private partnerships where international oil developing countries in the decades to come. Future private and gas companies bring capital and know-how. investments in LNG facilities will be crucial and it can Production Sharing Contracts (PSC), which enable the be expected that this will be a major focus of investment public sector to transfer exploration and production risk for many international utilities. International electricity to the private sector, form the contractual basis for and gas companies are likely to increase investment in revenue sharing in many countries and have been export-oriented projects from developing (and transition successfully applied in Asia and elsewhere. economies) to be able to meet their gas supply commitments with customers in industrialized countries.12 28. Public-private partnerships have also played a key role in the LNG sector, and have developed LNG facilities 31. At the same time, there are countries and regions in Abu Dhabi, Brunei, Indonesia, Malaysia, Nigeria, with significant gas reserves that are less attractive for Oman, Qatar and Trinidad and Tobago among others, international public and private investors due to high mainly to supply industrial markets in the United States, political and economic risk or remoteness from any markets Western Europe and Japan. Different players are involved (stranded gas)13. Some developing countries have a resource in different parts of the LNG chain. In 2001, more than policy that requires a high gas reserves/production ratio 60 percent of the equity in global LNG liquefaction that prevents them from earning export revenues and 7 capacity was owned by state companies, in some cases discourages new exploration activities by international in a joint venture with a major oil and gas international investors. IDA and IBRD should provide technical company. Major international companies and utilities assistance to transfer international experience on the account for most of the rest of global LNG capacity. In upstream sector and IFC and MIGA may provide many cases, a significant proportion of the capital has financial assistance to mitigate risk and attract private been raised from commercial banks and export credit capital and public-private partnerships to kick-start gas agencies and international agencies. There are many production, LNG projects and the construction of projects for re-gasification plants in developing countries, export-oriented pipelines in these regions. and to date plants are already operational in India, the Dominican Republic and Turkey and are at an advanced The Downstream Transmission and planning stage in China. The involvement of export credit Distribution Network agencies and multilateral lending agencies will be essential to get more of those LNG facilities off the ground. 32. The 1990s has seen a significant increase in private participation in the downstream gas network in developing 29. The private sector and public-private partnerships countries. The increasing participation has resulted mainly also played an important role in the construction of from a growing demand for new gas transport facilities export-oriented pipelines.11 Developing countries with in domestic markets, public sector budget constraints, gas reserves and lack of domestic gas network seek to and coincides with a growing consensus in favor of private export gas to industrial markets to earn revenue. Export- participation in infrastructure industries. However, private oriented gas pipelines from developing countries such participation in downstream transmission networks, and as Algeria and transition economies such as Russia, to in particular in distribution networks, in many developing industrial countries in Western Europe were mainly countries remains relatively small and there is a potential financed by the public sector (that is government-owned for growth. utilities). Some of the transmission pipeline network between Mexico and the United States was financed by public-private partnerships. Cross-Border Oil and Gas Pipelines: Problems and Prospects, UNDP/ESMAP, June 2003, Paul Stevens and Robert Bacon. 11 Investment in new LNG facilities in Africa and the Middle East and export-oriented pipelines is expected to increase over the coming decades, 12 mainly driven by cost reductions of liquefying and re-gasification plants, and increasing demand for gas in Europe and the United States. The Africa Gas Initiative investigated options for utilizing stranded and flared gas, including for Gas-to-Power, LPG extraction and other industry 13 usage and Gas-to-Liquids (GTL). Africa Gas Initiative, Main Report, Volume 1, February 2001, Mourad Belguedj and Henri Beaussant. 33. The distribution of natural gas is in its infancy in many 36. The vast majority of private participation in the developing countries. In contrast, in many transition downstream gas sector is in greenfield projects and economies (most notably in Eastern Europe) the distribution divestures. Divestures dominate in countries with well- sector is highly developed (mostly based on public funding). developed pipeline network. Private participation in In both cases there are substantial obstacles to private greenfield projects occurs mainly in countries with little sector participation as the main vehicle for investment. or no transportation network and often in combination with broader reforms aimed at liberalizing gas markets. 34. Most infrastructure projects with private participation fit Management and lease contracts and concessions are in one of the following four categories ­ divesture, rare in the natural gas downstream sector.16 greenfield projects, management and lease contracts, and concessions14. The type of private sector involvement varies 37. Private participation in the downstream transmission with the characteristics and peculiarities of a country's and distribution of natural gas has increased significantly gas industry and network. over the last decade in developing countries, and international experience shows that the private sector can 35. In a divesture (that is full or partial) a private investor play a leading role in developing or expanding the natural buys an equity stake in a state-owned enterprise through gas industry.17 However, some developing countries are an asset sale, public offering or mass privatization unable to attract enough private investment due to country 8 program. Under a greenfield project a private entity (or risk, governance and payment issues. Governments in a public-private venture) builds and operates a new these countries must take policy actions to address these facility for the period specified in the project contract15. shortcomings, and in some cases public involvement In case of management and lease contracts a private will be necessary to mitigate these risks and provide entity takes over the management of a state-owned reasonable rate of returns for investors. Public sector enterprise or elements of it, such as exploration and participation is particularly required for distribution. production, for a given period. The facility remains in Capital costs for gas distribution construction are high the ownership of the public sector, and investment and depend on a number of factors: household density decisions and financial responsibilities also remain with in the city, geographical distribution of customers, and the public sector. Contracts, where a private entity takes the mix of commercial/industrial and residential customers over the management of a state-owned enterprise for a in the area (and their disposable income). given period during which it also assumes significant investment risk, are often referred to as concessions. 38. Demand plays an important role in the economics of gas distribution network. The consumption volumes for residential customers depends on the heat load during the BOX 4 winter months and other residential gas consumption such Divesture takes different forms across regions. In Latin as water heating and cooking. The tropical and subtropical America (such as Argentina) and some countries in climate conditions of many developing countries do not Eastern Europe and Central Asia (such as Hungary and require space heating of residential and commercial Kazakhstan) divestures were usually structured as the sale of controlling stakes to strategic operators, which took premises and restrict the potential usage of natural gas control of the privatized companies. In other countries in to cooking and water heating that tends to make the Europe and Central Asia (such as the Czech Republic) development of distribution network to residential divestures took the form of voucher privatizations, with customers uneconomic. In addition, customer control of the privatized companies remaining with the connection charges tend to be high in many developing government. In East Asia and Pacific (China, the Republic countries and this reduces access of natural gas to poorer of Korea, Malaysia, and Thailand) natural gas transport income groups. Uncertain demand forecasts, long pay facilities were divested through public offerings of back and build-up periods, and payment risk from minority stakes on local and regional stock exchanges, customers (both domestic and commercial) make private with the government retaining control of the companies. financing of distribution networks challenging. Gas pricing, Boundaries among these four categories are not always clear, and some projects have features of more than one category. 14 When ownership is transferred to the Government at the end of the project period they are referred to as BOT or BOOT contracts. 15 Management contracts exist in the upstream gas sector where Mexico and Venezuela, whose constitution prohibits foreign ownership of oil and 16 gas reserves, are currently developing contracts with international investors. Bulgaria's State Energy Regulation Commission (SERC) recently published a tender that will allow private investors to bid for a 35-year license to 17 develop and run a gas distribution network in a region of Bulgaria. the cost of metering and payment collection are also · IBRD and IDA should help countries remove often a deterrent for private investors to enter the market. subsidies from carbon-based fuels, taking into account the potential impact on the poor; 39. A number of multilateral and regional institutions · WBG lending should concentrate on aggressively provide financial and technical assistance to downstream promoting the transition to renewable energy and gas infrastructure projects, including the World Bank. endorsing natural gas as a bridging fuel - building new Development agencies, as well as national and multilateral pipelines and renovating leaking ones and funding expert credit agencies, will continue to play an important fuel switching from coal to gas in power generation; role in backing transmission and distribution pipeline · The WBG should ensure that local communities projects in the future and it is important that there is a benefit directly from EI projects (e.g. through close dialogue between the Bank and other donor supplying gas to communities situated close to organizations to ensure financing is provided for the most production areas or transmission pipelines). viable projects in a systematic manner with the overall objective to minimize competitive distortions and promote The reports also highlight the need for: the efficient operation of the industry. · an integrated strategy for World Bank Group STRATEGIES FOR EFFECTIVE BANK activities in extractive industries18; PARTICIPATION · increased focus on governance by the World Bank 9 Group ­ both in the context of projects and in its 40. The World Bank Group's lending, investment and dealings with resource rich countries generally; advisory services are designed to promote public and · increased disclosure and transparency about private gas infrastructure projects in developing countries revenues received by governments, about project by providing policy advice to help governments build outcomes and World Bank activities; credible, stable policy and legal and regulatory frameworks · environmental issues including concerns about that support infrastructure projects generally and by particular processes and sensitive and biodiversity- offering different types of finance for specific projects, rich areas; and including loans, guarantees, equity investments, · greater use of World Bank Group convening structural lending and political risk insurance. power to advance the sustainability agenda in the extractive industries. 41. The various organizations of the World Bank Group ­ IBRD, IDA, IFC and MIGA ­ increasingly work together in Upstream providing financial support to the same projects, combining their comparative advantage to catalyze private investment. 43. In natural gas production and LNG facilities, the private sector or private-public partnerships have taken 42. The World Bank Group announced in 2000 that it the lead role in most developing countries. Where the would conduct a comprehensive review of its activities private sector is reluctant to invest in upstream gas in the extractive industries (EI) ­ oil, gas, and mining facilities, the World Bank may have a role to facilitate production ­ in response to concerns expressed by a investment, including addressing institutional, regulatory variety of stakeholders, primarily environmental and and policy shortcomings for upstream development. The human rights organizations. The review, which included current IBRD and IDA policy is not to get directly an independent evaluation of WBG activities in EI involved in financing exploration activities while MIGA (OED/OEG/OEU), a CAO report, and a separate and IFC provides financial products to encourage independent stakeholder consultation process headed by private participation in gas production and in LNG. Dr. Emil Salim, concluded in January 2004. The WBG's final Management Response is provisionally expected around June, 2004. Of special relevance to natural gas are the recommendations of the reports that: The internal evaluations recommended that such an integrated strategy should be designed to transform resource endowments into sustainable 18 development. The strategies should incorporate governance issues, and the use of EI revenues to support development priorities. They will require closer cooperation between the WBG and other stakeholders. 44. The World Bank can provide technical assistance on an efficient legal and regulatory regime for downstream international best practice fiscal regimes, international gas markets in client countries to attract private gas contracting, right management, access to LNG investments. Partial Credit Guarantees and Partial Risk terminals and processing plants, rent sharing methods Guarantees in combination with IFC and MIGA financial and transparent revenue management frameworks to products should be considered for such projects. Direct facilitate private capital in the upstream sector. Bank lending to state-owned transmission companies has had low priority in recent years. This may change in some 45. Regional and international gas trade is rapidly countries with well performing state-owned companies, growing. An increasing part of international gas trade takes if the share of gas in the energy balance is to increase. place through LNG and many projects for exporting LNG from developing countries to Europe and in particular to 48. Creating or extending gas distribution networks in some North America are at a planning stage. In addition, re- developing countries with large demand (commercial and gasification plants are planned in several developing smaller industries or residential heating consumption in countries, including China and India. cold climates) may be economically feasible and the Bank has a major role in encouraging and supporting 46. The WBG can play an important financing role in such initiatives. those markets to get projects off the ground. For export- 10 oriented gas pipelines, public and private partnerships may 49. The main issues in the sector are related to the creation be needed to bring political and legal stability to the of viable distribution networks, economic regulations that venture. In this case there may be a role for a combination allow private investors to recover the cost of providing of Bank Group products, including IBRD/IDA and pipeline networks, and the treatment of connection costs IFC/MIGA working in tandem. Export projects are typically and payment collection. Partial Credit Guarantees, MIGA very large, and the World Bank Group's role tends to and IFC support can be considered for private sector ensure the overall quality of the investment as well as projects. The Bank can play an important role in developing providing funding. In the case of export-oriented gas financial schemes for connecting poorer customers to pipeline projects, where pipelines transit more than one the network. Good performing public distribution border, Bank staff should seek to assist governments in companies should be considered for new Bank lending. developing relevant inter-governmental agreements to lower country risk. These would include agreements on 50. Transmission and distribution management contracts principles for transit fees and how to overcome overarching or leases are unlikely to be a suitable long-term solution legal jurisdictions in regards to taxes and other financial and should be considered selectively, and only if continued matter that would impact the economics of the projects, public sector management and private sector investment and how to regulate the activities. Bank staff should also in the short- and medium-term are both not possible. ensure that the Bank's environmental and social policies, procedures and guidelines are applied to the project within 51. Small scale and rural gas use is a newly emerging the country that benefits directly from Bank support through area of interest. The technology for small scale distribution direct lending or other means of credit support. For is still evolving. Investments are typically small and spread adjacent countries that include contiguous project over a wide area. Issues of management and ability to pay infrastructure but where the Bank may not be providing are important. Community, municipal and small and direct financial support, Bank staff should ascertain that medium sized enterprises are the key players under this the procedures are reasonably equivalent to the Bank's scheme and the public sector and international donors own policies and procedures. play a key part in providing financing. Small and medium sized enterprise credit lines offer one means of funding, Downstream as does the Bank Group's municipal lending program. IDA/IBRD provides support but due to the small scale of 47. The majority of investment in the downstream sector in the interventions, potentially high transaction costs and developing countries is required for the construction of gas the difficulty of centralized management by government transmission pipelines to supply anchor customers such there are only a few countries that have experienced as power plants. Bank staff should provide advice in the some success with developing small scale local gas areas of gas market structure and reform and development projects, most notably Mozambique. 11 Matrix of World Bank Group Gas Sector Interventions SUB- KEY ISSUES PRIVATE SECTOR GOVERNMENT WORLD BANK GROUP SECTOR INTEREST APPROACH INSTRUMENTS UPSTREAM Exploration · Design of HIGH but. . . . HIGHLY RECEPTIVE Technical and contract terms Assistance on Production in PSCs Policy, contractual Most governments key issues · Revenue and fiscal aim for substantial management environment has to private sector No financing of · Fiscal be right investment in E & P gas exploration incentives which is high risk activities by WBG · Reservoir and Transparent, capital rights competitive bid IBRD guarantees management processes for E & P By using PSCs · Access to rights seen as governments can IDA credits 12 processing desirable by private shift E & P risks to plant sector E & P companies IFC loans, equity · Carbon credits financing · Ownership of Transparent Public investment associated gas revenue role often in joint MIGA political risk · Access to management ventures private insurance domestic and processes investors international increasingly PCF for carbon gas markets important credits · Associated gas flaring Direct access to reduction downstream anchor · Transparent customers legal and increasingly regulatory important framework Liquefied · Design of HIGH but. . . . HIGHLY RECEPTIVE Technical Natural long term Assistance on Gas (LNG) supply Policy, contractual, Most governments key issues contracts fiscal and regulatory aim for substantial · Fiscal environment has to private sector IFC loans, equity incentives be right investment in LNG financing · Ownership of facilities associated gas MIGA political risk insurance Matrix of World Bank Group Gas Sector Interventions SUB- KEY ISSUES PRIVATE SECTOR GOVERNMENT WORLD BANK GROUP SECTOR INTEREST APPROACH INSTRUMENTS Liquefied · Access to Public investment Natural international role will tend to be Gas (LNG) markets in a joint venture (cont.) with private parties Export- · Contract HIGH MODERATELY Technical oriented design RECEPTIVE "Assistance on Pipelines · Political risk Private investment key issues · Divergence of favors large Most governments energy sector regional export assume continued IBRD guarantees reform in schemes, to state ownership various solvent markets and operational IDA credits countries role but 13 · WB International gas increasingly open IFC loans, equity environmental and electricity to private financing and social utilities invest in investment in policies export-oriented export-oriented MIGA political risk · Ownership pipelines to supply pipelines insurance and operation customers in of pipeline industrial Most governments · Profit and countries like the idea of rent sharing interconnection, · Inter- LOW but absence of Governmental functioning internal Agreements Many developing or regional markets and political countries around makes it difficult dialogue the globe do not · Transit fees have geographic Projects are unlikely · Legal and access to customers to produce regulatory in industrial expected benefits framework countries and only unless country-level that governs are able to export reform is successful pipeline to neighboring or · Third-Party regional markets Access that are less liquid and developed Matrix of World Bank Group Gas Sector Interventions SUB- KEY ISSUES PRIVATE SECTOR GOVERNMENT WORLD BANK GROUP SECTOR INTEREST APPROACH INSTRUMENTS DOWNSTREAM Trans- · Network MODERATE MODERATELY Technical mission expansion and RECEPTIVE Assistance on (including rehabilitation Fair, predictable, key issues Storage · Capacity rights and transparent Most governments and · Third-Party regulatory assume continued IBRD guarantees Regasi- Access framework is state ownership and fication · Tariff critical for operational role but IDA credits terminals) methodology attraction of some developing · Anchor private investors countries are gradually IFC loans, equity customers receptive for private financing Private investors investment in new lines 14 · Long-term contracts seek long term MIGA political risk · Unbundling of contracts with Political commitment insurance transportation solvent anchor required to allow for activity from customers to private participation commodity mitigate risk · Economic Legal and regulatory regulation changes crucial Distribution· Network LOW MODERATELY Technical investment RECEPTIVE Assistance on · Economic Fair, predictable, key issues regulation and transparent Many governments · Unbundling of regulatory recognize that private IBRD guarantees distribution framework is sector participation is network critical for highly desirable but IDA credits business from attraction of many also are reluctant supply activities private sector to push pricing reform IFC loans, equity · Cost-covering participation too fast or cede control financing tariffs of a strategic sector · Subsidies for Investment needs MIGA political risk poor customers are high in Important to deal up- insurance · Social safety particular in front with social, labor nets distribution to small issues (such as subsidies) customers, in new markets an immature business may have long cost-recovery times Matrix of World Bank Group Gas Sector Interventions SUB- KEY ISSUES PRIVATE SECTOR GOVERNMENT WORLD BANK GROUP SECTOR INTEREST APPROACH INSTRUMENTS Distribution· Payment Key challenge is Avoiding tariff shock IFC municipal (cont.) collection how to package is key political funds for small · Connection Government reform concern scale gas costs and policyinitiatives and Bank · Metering Group products to Some governments requirements increase private show reluctance · Wholesale or sector interest regarding retail regulatory competition Emerging local and independence · Rural and regional players can small scale play an important Political economy of gas use role as operators or pricing puts · Collection minority partners regulatory agencies 15 policy in difficult position Regulatory and policy linkages between power and gas are crucial 16 THE WORLD BANK GROUP The Energy and Mining Sector Board The World Bank 1818 H Street N.W. Washington, D.C. 20433 USA