Pressed by suppliers to pay more for the liquefied natural gas they use, buyers in Japan are beginning to consider Papua New Guinea as a new source, attracted by its geographic proximity and the possibilities of acquiring equity stakes.

Although PNG's discovered gas reserves are much smaller than major suppliers of gas such as Malaysia, Indonesia and Qatar, the gas could probably be brought to market quicker and more cheaply than fields in other countries, and there is less risk of the type of resource nationalism seen in Russia or Venezuela.

Already, one Japanese company has invested in a PNG block, and a delegation of energy and trading companies led by the Japan Bank for International Cooperation visited the country in October last year to assess the opportunities.

A senior Japanese government official confirmed that several companies are in discussions with PNG, but he declined to give any specifics because the talks were continuing.

No More Cheap LNG

Japan is the world's largest LNG importer, and has so far been buying the gas according to a price formula called S-curve. The formula links LNG prices to crude, but the relationship becomes weaker as crude prices rise to the levels they have recently, making LNG relatively cheap compared with oil.

LNG producers have been fighting back, pressuring Japanese buyers in the past few months to abandon the formula as global supplies tighten. As a result, many Japanese LNG buyers have been forced to revise prices higher.

Tokyo Electric Power Co. - Japan's single largest LNG buyer - said in January that rising LNG prices were partly to blame for its wider full-year loss forecast. It plans to buy 19.6 million metric tons of LNG in the fiscal year ending March 31, about 30% of Japan's annual demand for LNG.

"They've been really tough," Masaru Takei, the company's managing director, said of talks with LNG suppliers. "Of course we don't want big price hikes, and we are still in talks. But we have to prepare ourselves for realistic scenarios."

Many analysts expect LNG supplies will ease after several projects come online in the first half of the next decade. However, many of these are suffering significant delays and upward revisions in costs because of insufficient human resources and equipment, as well as rising raw material prices.

Japanese companies hope, therefore, that Papua New Guinea can provide a short-term fix.

Dependent On Resources

Papua New Guinea relies heavily on revenues from its natural resources, such as crude oil and gold. But its crude oil reserves have been drying up, and the government now aims to develop its natural gas reserves.

In his State of the Nation address in September last year, Prime Minister Michael Somare said he hopes that "commercialization of gas reserves is accomplished by year 2011."

The following month, officials from Itochu Corp., Mitsubishi Gas Chemical Co., Mitsubishi Heavy Industries Ltd., JGC Corp. and Cosmo Oil Co. visited the country.

The delegation, led by state-owned Japan Bank for International Cooperation, was seeking LNG and other investment opportunities, and also included LNG Japan Corp. - a joint venture held by a few trading companies, and Sumitomo Mitsui Banking Corp.

Nippon Oil Exploration Ltd., a unit of refiner Nippon Oil Corp., already has a stake in a block in the country's northwestern mountain area. And there are opportunities for Japanese companies to partner with other groups exploring the possibilities there.

"At the moment, we have three groups conducting feasibility studies of LNG projects," said Michael Maue, Papua New Guinea's ambassador to Japan.

The three groups are led by U.S. energy giant Exxon Mobil Corp., local energy company Oil Search Ltd. and Canada's InterOil Corp., according to Maue.

The country has 7 trillion cubic feet of proven gas reserves, and this is sufficient volume for at least one LNG project, Maue said.

Maue said he understands not all of the Japanese companies that visited PNG last year are necessarily interested in LNG projects there.

An LNG project needs large investment in liquefaction and regasification plants and tanks. To cover such high costs, both producers and buyers invest in a typical LNG project with commitments of 20 years or more for delivery and purchasing.

Even if Japanese companies don't want to get involved with the nitty-gritty of exploring for gas reserves, they can still ensures supplies by buying into a project at a later stage, as they have done elsewhere.

The government by law takes about a 22.5% stake when an energy project moves on to the development phase, Maue said, but it can sell any or part of its stake, which Japanese companies would be able to buy.

Not Just Money

Maue said Papua New Guinea would welcome Japan not just for the funds but also for the technology it could provide. "We have a few major LNG plant makers like Chiyoda Corp. and JGC," said Ippei Nagatomo, loan officer of JBIC's Energy and Natural Resources Finance Department's No.2 Division. "In that sense, we can say Japan has strength in this technology."

He said that Japan and PNG could make a good fit in the LNG market.

"The geographic proximity certainly gives Papua New Guinea an advantage, for example over African countries, in attracting Japanese buyers," Nagatomo said, adding, "Currently, Japan buys about 40% of LNG traded globally."

Copyright (c) 2008 Dow Jones & Company, Inc.