John McBeth, Jakarta – Indonesia's 25-year reign as the world's largest liquefied-natural-gas (LNG) exporter is under threat, though it's taken a distracted government years to wake up to the fact.

Three factors jeopardize Indonesia's primacy: customers' concern over security of supply, the entry of competitive new suppliers and the way China's emergence as a major buyer has upended LNG pricing structures.

These challenges are starkly illustrated in Anglo-American oil-giant BP's trouble finding buyers for much of the planned output from its new Tangguh gas field in Papua, Indonesia's easternmost province (formerly known as Irian Jaya).

With construction of the first phase of the $2.8 billion project due to begin early next year, there's a lot of nail-biting at BP's headquarters in Jakarta. Says one industry analyst: "It's a project that's all dressed up with nowhere to go."

BP's basic problem is that Tangguh is in a remote and sometimes volatile corner of the world, which makes customers counting on reliable delivery schedules nervous about locking in long-term contracts.

The company had hoped to line up deals for Tangguh's first two 3.5-million-tonne production trains – the facilities that convert natural gas into transportable, liquefied form – but things haven't gone as planned. BP had counted on winning the 3-million-tonne contract for China's first LNG terminal in Guangdong province, due to be completed in 2005. However that contract went to the consortium controlling Australia's Northwest Shelf gas field, leaving Tangguh's developers with the consolation prize – a 2.6-million-tonne contract to supply the province of Fujian.

Now, they and Indonesian government salesmen are scrambling to nail down contracts with other buyers to underwrite the cost of developing the field. "It is almost inconceivable that it won't go ahead," says Gerald Peereboom, president of Tangguh LNG. "Is it 100% [bound to proceed]? We can't really say. But Tangguh is all part of BP's future outlook; it is one of the key growth areas we have."

Peereboom says the Tangguh consortium – comprising BP, Mitsubishi, the China National Overseas Oil Corporation (CNOOC), Nippon Oil, British Gas and four other Japanese partners – plans to make what he calls "a final investment decision" on whether to go ahead with the project by the end of this year. By then, he says, "we expect to have sufficient commitments from the markets" – an indication that a lot is riding on finding more buyers.

Tangguh's proven gas reserves stand at 14 trillion cubic feet, but BP is confident the field could hold as much as 24 trillion cubic feet. Eventually BP, which holds a 37% stake in the project and a 30-year concession to exploit the reserves, hopes to be operating six production trains, and will have land available for two more.

But changing market conditions are complicating things. China's awarding of its first two contracts has turned LNG pricing on its head. That's because both supplier groups agreed to prices considerably lower than what has prevailed for North Asian contracts over the past 20 years. Indeed, Tangguh's price is just half of the $4.25-4.30 per million British Thermal Units (BTUs) currently being paid by utility companies in Japan and South Korea. Japanese and Korean buyers are already making it clear they will drive a hard bargain over future renewals of Indonesian contracts. Industry sources say disgruntled Taiwanese utilities are on the verge of shifting to new suppliers.

Meanwhile, in addition to the Northwest Shelf, Indonesia has to contend with new competition from Malaysia's planned 23-million-tonnes-a-year Sarawak LNG complex, which went into partial production in March, and from Qatar, which expects to be producing 45 million tonnes a year by 2010.

Industry analysts believe that with ExxonMobil's Arun gas reserves in Aceh province being gradually depleted, Indonesia waited too long to promote Tangguh as a new companion to Bontang, the country's other established LNG centre in East Kalimantan. They also point out that when separatist rebel activity closed Arun temporarily two years ago, it ended the premium Indonesia had enjoyed in the market for security of supply.

It now remains to be seen whether Japanese and Korean buyers have been sufficiently frightened by Arun's temporary closure to move their business away from Indonesia as the time approaches to renegotiate contracts, many of which will expire between 2009 and 2011. They'll be aware that Papua could become a security problem as well, though the low-level separatist insurgency there has never touched the area around Tangguh.

BP's failure to win the LNG contract in Guangdong meant a major adjustment in planning. The company slashed $100 million from its 2003 budget for Indonesia , laid off staff and put construction plans back by a year. Peereboom calls the delay "breathing space" – space that is now needed to find buyers. "Obviously we want at least one train's worth [of buyers] by the start of construction to make the lenders feel comfortable," he says.

Under BP's financing plan, the company will cover its equity stake from internal sources and raise the rest through bank loans. Many of the questions about Tangguh's fate begin with Fujian, BP's anchor contract. Industry analysts point to a lack of any real planning, either for CNOOC's proposed LNG receiving terminal or for the two 650-megawatt power stations and home-supply networks that will use the gas.

The company can take some comfort from the fact that under the take-or-pay provision of the contract, Fujian must begin paying for the gas from 2007, whether its facilities are ready or not. Peereboom says that CNOOC, which paid $275 million for a 12.5% stake gin the Tangguh project, has "every incentive" to see it go ahead.

Unlike Guangdong, resource-scarce Fujian badly needs alternative sources of energy for its future development. Even if Fujian comes through, BP is finding it tough to attract other customers for Tangguh. Perhaps its best hope rests on the Indonesian government persuading Japanese and Korean buyers to transfer two existing contracts, for 3.3 million tonnes of gas a year, from Arun to Tangguh when they expire in 2009-10. Both are expected to be renegotiated this year.

Another potential customer for Tangguh's gas is GNPower, a private Philippine company which signed a letter of intent in 2001 to take 1.3 million tonnes a year for a planned 1,200-megawatt power station in Bataan, northwest of Manila. But the key to nailing down that contract is a power-purchase agreement between GNPower and the Manila Electric Company that has been held up by deregulation issues.

BP is also bidding to supply 1.1 million tonnes of LNG a year to SK Corp., South Korea's top oil refiner, and Pohang Iron and Steel Corp., plus another 1.7 million tonnes to Taiwan Power's planned 4,000-megawatt Tatan complex in northern Taiwan.

Peereboom says that shipping LNG from Tangguh to Java is another option, particularly with demand for power rapidly overtaking supply on Indonesia's most densely populated island. BP executives are even considering the possibility of sales to the American West Coast or Mexico's Baja California, where six LNG terminals are on the drawing board. Says BP Vice-President for Marketing Jimmy Straughan: "It could be a factor in the first two trains, or it could be part of the longer-term market."

Finally taking action to maintain its LNG markets and find new ones, the Indonesian government has sent a sales team to Mexico, and Mines and Energy Minister Purnomo Yusgiantoro recently led a team to Japan to secure commitments to renew contracts due to expire at the end of the decade. As befits the changing market conditions, however, price and terms have still to be negotiated.