international gas union (igu) · • oil price escalation • bilateral monopoly • netback from...

WholesaleGasPriceFormation-Aglobalreviewofdriversandregionaltrends

International Gas Union (IGU)News, views and knowledge on gas – worldwide

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ForewordFollowingthesuccessful24thWorldGasConferenceinBuenosAiresinOctober2009,wehavedecidedtoconvertsomeofthestudyreportspresentedattheconferenceintoIGUpublications,includingthereport“GasPricing”writtenbyStudyGroupB2oftheIGUStrategyCommittee(PGCB).

TheIGUStrategyCommitteeisupdatingthereviewfortheWGCinJune2012.SomeinterimfindingshavebeenpublishedintheApril2011editionoftheIGUMagazineandareavailableonwww.igu.org.

Historically,gaspriceshavenotbeeninthenewstothesameextentasoilprices.Thisischanging.Theshareofgasinglobalenergyandfuelconsumptionhasincreasedandalsotheshareofinternationallytradedgasgloballyisgreaterthanbefore.LNGisprovidingintercontinentallinkagesthateventuallycouldconstituteaglobalgasmarket.

Naturalgasisanabundantresource,itiscleanandcost-competitive,andshouldthereforeplayanimportantroleinthemitigationofclimatechange.However,thepricingofthisvaluablecommodityiscriticaltoasustainablemarketgrowth.

Itisourhopethatthispublicationcanserveasoneexampleofhowvitalinformationrelatedtogaspricingcanbesharedacrossborderstothebenefitoftheglobalgasindustryandalsotoenablenewgasregionstolearnmoreaboutthedifferentpricingmodelsthatarebeingused.

June 2011

TorsteinIndrebøSecretaryGeneralofIGU

Table of contents1. ExecutiveSummary......................................................................................................................................42. Introduction...................................................................................................................................................7 Mandate.........................................................................................................................................................7 Whythisreport?............................................................................................................................................7 Outline of report............................................................................................................................................8 Termsandconcepts.......................................................................................................................................83. Gaspricedrivers..........................................................................................................................................10 Competitivemarkets....................................................................................................................................10 Shorttomediumtermsupplyanddemanddrivers..................................................................................10 Longtermsupplyanddemanddrivers.....................................................................................................11 Currentscenarios......................................................................................................................................13 Othermarketorganisation..........................................................................................................................13 OECDarea...............................................................................................................................................13 Non-OECDarea.......................................................................................................................................144. Keygaspricingmechanisms.......................................................................................................................155. Originsofindividualpricingmechanisms..................................................................................................18 Originsofgasoroilmarketbasedpricing..................................................................................................18 NorthAmerica..........................................................................................................................................18 TheUK.....................................................................................................................................................18 ContinentalEurope...................................................................................................................................19 AsiaPacific...............................................................................................................................................19 Originsofregulatedgaspricing..................................................................................................................206. Recentgaspricedevelopments...................................................................................................................23 OECDarea..................................................................................................................................................23 Restoftheworld.........................................................................................................................................247. Currentextensivenessofindividualpricingmechanisms...........................................................................28 Introduction.................................................................................................................................................28 PriceFormationMechanisms......................................................................................................................30 TypesofPriceFormationMechanism.....................................................................................................30 Results.........................................................................................................................................................30 FormatofResults.....................................................................................................................................30 WorldResults...........................................................................................................................................30 Regionalresults........................................................................................................................................34 WholesalePrices......................................................................................................................................38 Changesbetween2005and2007.............................................................................................................40 Conclusions..............................................................................................................................................418. Trendsintheextensivenessofindividualpricingmechanisms..................................................................42 Towardsaglobalisationofgaspricing?......................................................................................................45 Bumpsintheroadtowardglobalisedgaspricing....................................................................................479. Pricevolatility.............................................................................................................................................51 General........................................................................................................................................................51 Causesofvolatility......................................................................................................................................52 Volatilityassociatedwithgaspriceincreases...........................................................................................53 Volatilityassociatedwithgaspricedeclines............................................................................................53 Volatilityofoilindexedprices....................................................................................................................54 VolatilityandLNG......................................................................................................................................5410. Towardsfurtherchangesintheextensivenessofindividualpricingmechanisms?....................................55 Appendix1–PriceFormationMechanisms2005Survey..........................................................................58 FormatofResults.....................................................................................................................................58 WorldResults...........................................................................................................................................58 RegionalResults.......................................................................................................................................61 WholesalePrices......................................................................................................................................65 Conclusions..............................................................................................................................................66

June 2011 | International Gas Union 3

“Gas Pricing”; Study group B2 of IGU Programme Committee B (PGC B). The work was coordinated by Runar Tjærsland, Study Group leader with contributions of Meg Tsuda, Mike Fulwood, Ottar Skagen and Howard Rogers.

4 International Gas Union | June 2011

1. Executive Summary

Historicallygaspriceshavenotbeeninthenewstothesameextentasoilprices.Thisischanging.Theshareofgasinglobalenergyandfuelconsumptionhasincreased.Theshareofinternationallytradedgasinglobalgasconsumptionhasincreased.LNGisprovidingintercontinentallinkagesthateventuallycouldconstituteaglobalgasmarket.WithmostgasproducingOECDcountriesstrugglingtoreplacereservesandsustainproductiongrowth,thecentreofgravityofgasproductionandexportshasshiftedtowardsthesameregionsand–tosomeextent–countriesthatfor40yearshavedominatedoilproductionandexports.Finally,gaspriceshaveincreasedandbecomemorevolatile.

Gaspricesarenotdeterminedbutdefinitelyinfluencedbyindividualmarkets’choicesbetweenavailablepriceformationmechanisms.ThetwomaindebatesinthisrespectistheonethatgoesoninEuropeandtoanextentinAsiabetweenproponentsofcontinuedindexationofgaspricestooilpricesandproponentsofgas-on-gascompetitionbasedpricing,andtheonethatgoesoninsideanumberofNon-OECDcountries–andbetweenthesecountries’governmentsandentitiesliketheEUCommission,theIEAandthemultilateraldevelopmentbanks–onthesustainabilityofthemoreorlessheavyhandedpriceregulationthatprevailsinbigpartsoftheNon-OECDworld.

Arguablytheformerofthesedebatesistheleastimportant.EvidencefromNorthAmericawheregaspricesarenotcontractuallylinkedtooilpricessuggeststhatgaspricesnonethelesstendtotrackoilpricesinafairlystablelongtermrelationship.Gasandoilpricesarelinkedbyinterfuelcompetitionintheindustrialsector.Theyarealsoinfluencedinthesamemannerandtothesameextentbytheoilandgasindustry’scostcycles.Finallypricedeviationsmaybearrested,eventually,bychangesinoilandgasindustryinvestmentpriorities.

Inperiodsofamplegassupply,priceshavedelinkedwithgasbecomingsignificantlycheaperthanheavyfueloil,nottomentioncrudeoilorlightfueloil.Butinperiodsofgasmarkettightnessthelinkhasre-emergedwithoilproductpriceseventuallyputtinganendtogaspricerallies.

Forthemoment–bymid2009–theUSgasmarketisexceptionallywellsupplied.Asaresultpricesaresofterthanatanytimesince2002andwellbelowcrudeoilandrefinedproductpricesinenergyequivalenceterms.PossiblythissituationwilllastforawhileduetotheunexpectedlyrapidgrowthinUSunconventionalgasproduction.ButthatdoesnotneedtoapplytoEuropeorAsia.Consequentlyaradicalreplacementofoillinkedcontractswithgaslinkedcontractsinanyorbothoftheseregions–hadsuchathingbeenpoliticallyandpracticallypossible–wouldlikelyhaveincreasedgaspricevolatilitybutmightnothavemateriallychangedlongtermpricetrends.

Withrespecttothelatterdebate,Non-OECDcountriesalreadysupplyhighsharesoftheEuropeanandAsianOECDmember

countries’gasdemand,andthegasflowsfromRussia,theMiddleEastandAfricatotheOECDareexpectedtofurtherincrease.Severalgasexportingnon-OECDcountriesarehoweverstrugglingtosustain,letaloneincrease,theirexportsinthefaceofboomingdomesticgasdemand.Domesticdemandreflectsamongotherthingsdomesticprices.Consequentlytheoutlookfordomesticgaspricinginthesecountriesisnolongeroflocalinterestonlybutofglobalimportance.

Thisreportexaminestheextensivenessindifferentpartsoftheworldofthefollowinggaspricingmechanisms:

• Gasongascompetition• Oilpriceescalation• Bilateralmonopoly• Netbackfromfinalproduct• Regulationonacostofservicebasis• Regulationonasocialandpoliticalbasis• Regulationbelowcost• Nopricing

Chart 1.1: World gas price formation 2007 - total consumption

World gas price formation 2007 - total consumption

Regulation below cost

26 %

Oil price escalation

20 %No price

1 %

Netback from final product

1 %

Regulation social and

political9 %

Regulation cost of service

3 %

Bilateral monopoly

8 %

Gas-on-gas competition

32 %

Globally,in2007onethirdofallgassoldandpurchasedwaspricedaccordingtothegas-on-gascompetitionmechanism.Regionallytheshareofgastransactionsinthiscategoryvariedfrom99%inNorthAmericatozeroinmostofthedevelopingworld.

Thesecondbiggestcategoryin2007was“Regulationbelowcost“(seeChapter4fordefinitions)with26%oftheglobaltotal.Theshareofgassuppliedatpricescontractuallylinkedtooilproductorcrudeprices–thedominantmechanisminContinentalEuropeandtheAsiaPacificOECDcountries–was20%.

Acomparisonoftheresultsfor2007withthoseofasimilarstudycarriedouttwoyearsagoon2005datashowsanincreaseinthe“Regulationbelowcost”categoryinbothabsoluteandrelativeterms.85%ofthischangecanbeexplainedbyrobustgasconsumptiongrowthintheFormerSovietUnion,particularlyinRussia,wherethispricingmechanismremainsdominant.Only15%wasduetoshiftsfromotherpricingmechanismstoregulationbelowcost.


Theshareofgastransactionsatpricesreflecting“Regulationonasocialandpoliticalbasis”declinedfrom2005to2007duemainlytochangesinpricingmechanisminBrazilandArgentinaandalsotobelowaveragegrowthingasproductionforthedomesticmarketinUkraineandingasconsumptioninMalaysia,twocountrieswherethistypeofregulationiswidespread.

Gas-on-gascompetitionbasedpricinggainedsomeground,largelyattheexpenseofoilpriceescalation–between2005and2007largelybecauseofgrowthinJapan’s,Korea’s,Taiwan’sandSpain’sspotLNGimports,andinthetradingonContinentalEurope’semerginggashubs.AlsolessUKgaswassoldintotheUKmarketunderoillinkedcontracts.ThecombinedimpactofthesechangesdwarfedBrazil’sshifttowardsoilpriceescalation,andChina’sfirstLNGimportsatoillinkedprices,inthisperiod.

Astrikingaspectofrecentgaspricedevelopmentsisthatpricesseemtohavebecomemuchmorevolatile.Thisimpressionmaybeslightlymisleading.Inabsolutetermspricegyrationshavebecomestronger.Inrelativeterms–i.e.,ifonetakesintoaccountthatpricesinrecentyearshavefluctuatedaroundhigheraverages–volatilityappearstohavebeenroughlyconstantduringthe2000s.

Someshorttermpricevolatilityispartandparcelofgas-on-gascompetitionbasedpricing.AssuchitistypicalforNorthAmerica,theUKandtheshorttermtradingaroundContinentalEurope’semerginghubs–butnotforthebulkofContinentalEurope’sandAsia’sgastransactions.AtypicalContinentalEuropeangasimportcontractlinksthegaspricetoabasketofoilproductpricesinanaveragedandlaggedwaythatsignificantlydampenstheimpactofoilpricefluctuations.AtypicalAsianLNGimportcontractisstructuredthesameway,onlywiththegaspriceindexedtoabasketofcrudeoilprices.

However,ifsomepricevolatilityisinevitableundergas-on-gascompetition,strongvolatilityalsorequiresmarkettightness.Thelastcoupleofyears’biggaspricechangeswereduetosupplyanddemandintersectingwitheachotheratverysteepsegmentsofeitherthesupplycurveorthedemandcurveorboth.Forthemomentmarketsarelooseandvolatilityaswellaspricesaredown.

Anotheraspectofpricevolatilityisthatnoteverybodywouldagreethatitisabadthingthatshouldbeminimised.Whilesomeinvestorspursuinglowriskactivitieswithcorrespondinglylowreturnsneedstable,predictableprices,othersthriveonpriceinstabilitybecauseofthearbitrageopportunitiesassociatedwithadynamicenvironment.

Thesefindingsbegthequestionswheregaspricesandgaspricingmechanismswillgointhefuture.Thisstudywasneversupposedtoconcludewitheitheranothersetofgaspricescenariosorprecisepredictionsofthechangesintheextensivenessofindividualpricingmechanismsthatundoubtedlywilloccur1.Broaddevelopmentdirectionsmayneverthelessbeinferred

fromthetensionsthatcurrentpricingmechanismshavegivenriseto,andfromthedebatesongaspricingthatthesetensionshavetriggered.

Thebelowfigureishighlytentativeandintendedmerelytofacilitateadiscussion.

Chart 1.2: Hypotheses on future changes in the extensiveness of individual pricing mechanisms in individual regions



Bilateral monopoly


Regulation – cost of service

Regulation – social and political

Regulation – below cost

No price

North America, UK

Continental Europe, Developed Asia

Continental EuropeGas-on-gas competition


Bilateral monopoly





No price

Select Non-OECD

2008 2020

Russia

, Chin

a?Select market segments

Select Non-OECD

Select Non-OECD

Inthecountrieswheregas-on-gascompetitionbasedpricingprevails,theremaybeconcernsaboutpricevolatility,anddebatesonhowtodealwiththeharmfuleffectsofpricespikesandtroughs.Butthereislittletalkaboutareturntomoreregulationorashifttosomevariationonthemarketvaluepricingtheme.Assuch,gas-on-gasseemstobewidelyperceivedas“theendgame”withoutmoreefficientalternatives.

InContinentalEuropetheEUCommissionisseekingtopavethewayforashiftfromoilpriceindexationtogas-on-gascompetitionbasedpricing.TheCommission’sprioritiesarebeingsharedtovaryingdegreesbytheEUmemberstates’governmentsdependingontheirideologicalleaningsandprioritisationbetweenefficiency,environmentalandgassupplysecurityconcerns,andbytheregion’scommercialactorsdependingontheirstatusasincumbentsornewentrants.Theenthusiasmforthisorthatmechanismalsotendstovarywiththeoilpriceandwithoutlookfortheratiobetweenoillinkedgaspricesandhubgasprices.

Thoughoilpriceescalationisnotgoingtodisappearanytimesoon,gas-on-gascompetitionbasedpricingwilllikelygaingroundasmorehubsmature.

IntheAsiaPacificregion,themainLNGimportersarestickingtocrudeoilindexationasthedominantimportedgaspricingmechanism.GasmarketbasedpricingisnotyetanoptionsincetheAsiangasmarketsarecharacterisedbylimitedcompetitionandhavealmostnogashubs.ThiscouldchangewithmarketreformsaimedatintroducingthirdpartyaccesstoLNGterminalsandpipelinesandcompetitionatthewholesalelevel.

1 A more thorough examination of the scope for changes could instead be the subject for a follow-up study in the next WGC triennium.


InadditiontothepoliticalandregulatorypushforliberalisationtherehasbeenmuchtalkaboutHenryHubortheNBPpricebecomingbenchmarksalsoforAsiangasbuyers.In2007-08whenJapaneseandKoreanutilitieshadtodramaticallyincreasetheirimportsofAtlanticLNG,thispredictiongainedcredibility.By2009,however,withdemandindeclineduetothefinancialcrisisandwithastringofnewMiddleEasternandAsianLNGtrainsat–orapproaching–thecommissioningstage,theAtlantic-AsianLNGtradelookssetforanequallydramaticdecline,potentiallywithadampeningimpactonthepaceofpriceglobalisation.

Inthelongerterm,internalandexternalforcesmaywellcombinetoerodethepositionofoilpriceescalationalsointheAsiaPacificarea.Forthetimebeing,however,thisregionlookssettoremainwellbehindContinentalEuropeinintroducingalternativemechanisms.

BilateralmonopolypricingremainsimportantintheFormerSovietUnionandcharacterisesupto8-9%ofgastransactionsintheotherNon-OECDregions.Bilateralmonopolypricingmaybeexpectedtodeclineinimportance–probablytothebenefitofoilindexedpricing–asRussiaisnegotiatingnetbackpricesbasedonWesternEuropeanborderpriceswithitsnearneighbours.

The‘netbackfromfinalproduct’mechanismwilllikelyprevailincertainmarketsegments.Forindustrialgasusersitrepresentsawaytoshiftproductmarketriskupstream.Forgassellersitrepresentsawaytosustainindustrialdemandintimesofpotentialmarketdestruction.Itishoweverdifficulttoseethismechanismmakingmajorinroadsintothemuchbiggersharesofgastransactionscharacterisedbygas-on-gaspricing,oilescalationorregulation.

OutsidetheOECDarea,gassubsidisationistakinganincreasinglyheavytoll.Onetrendseemstobeforcountriespracticingbelowcostregulationtomovetowardsadhocpriceadjustmentswiththepurposeofkeepingpriceslargelyinlinewithsupplycosts–i.e.whatwehavetermedregulationonasocialandpolitical

basis.Anothertrendseemstobeforgovernmentstoliberalisepricestoselect,presumablyrobust,customers,andincreasingremainingregulatedpricestotheextentpoliticallypossible.Typically,householdsandindustriesperceivedas“strategic”suchasthefertilizersectorcontinuetoenjoysomeprotection.

Russiahasembarkedonaprocessofaligningdomesticpriceswithopportunitycosts,i.e.,withthenetbacktotheproducersiftheyhadexportedthegasinstead,andthereiseveryreasontobelievethatthisprocesswillbecompleted,ifnotnecessarilyonschedule.SinceRussiaexportsgasonoillinkedcontracts,thismeansaneffectivegradualintroductionofoilpriceescalationinthedomesticmarket.

Russiaandothercountriesthathavepracticedgaspriceregulationarealsoexperimentingwithgas-on-gascompetition.Gasexchangesintendedtoserveassafetyvalvesforproducerswithsurplusgasandconsumerswithextraordinaryneedsarebeingestablished.Thevolumestradedonsuchexchangesandtheirpriceimpactwillhoweverbeminorunlessanduntilcompetitiontakeshold,andthatcouldtakesometime.

ChinaandIndiafacechallengesinincentivisingthepowersectortoshiftfromcheapindigenouscoaltogas,butthereissignificantindustrialandhouseholddemandatmuchhigherprices.Thefuturewilllikelyseepriceregulationwithaviewtobothconsumers’abilitytopay,supplycostsandthepricesofcompetingfuels.Butincreasinggasimportswillexposethesecountriestogas-on-gascompetitiontoo,andaffectthepricingenvironmentfortheconsumerswiththehighestwillingnesstopay.

MiddleEasterncountriesfacechallengesinprovidingfordevelopmentofnon-associatedgasreservesinthecontextofgaspricesthatreflecttheverylowcostsofassociatedgassupply.ButtheneedforcountrieslikeKuwait,AbuDhabi,DubaiandpossiblyBahraintostartimportinggaswillintroducenewbenchmarkstotheregionandmayeventuallydrivebroaderpricereforms.Tothesmallextentitstillexists,the‘noprice’categoryseemsdestinedforphase-out.


2. Introduction

Mandate

Thisreportisasnotednotanattempttoanalyseingreatdetailgaspricemovementsaroundtheworldingreatdetail,nortoprovideanothersetofgaspriceforecasts.ThemandategiventoIGUPGCB/SG2was:

• Tocarryoutacomprehensiveanalysisofgaspriceformationmodelsatregionallevel:pricedrivers,indexation,pricearbitrage,demandelasticity;

• Toinvestigatefuturetrendsandthefactorswhichcouldhelptominimizepriceanomaliesandcontributetoasustainablemarketgrowth

Theworkgrouphasonthebasisofthismandatesetitselfthefollowingtargets:

• Identifythemaingaspricedriversanddiscusshowtheyoperateintheshortandlongerterm;

• Offeracategorisationofhowgasispricedaroundtheworld;• Discusshowindividualpricingmethodsormodelshavearisen;

• Presenttheresultsofaglobalpricingmethodmappingexercise;

• Examineselecttrendsintheuseofindividualpricingmethods;• Discusstherootsandconsequencesofgaspricevolatility;• Offersomeviewsonhowthepopularityandprevalenceofindividualmethodsmaychangeintheyearsahead.

Why this report?

Eversincenaturalgasbecameamarketablegoodwithaneconomicvalue,gaspricingprinciplesandpricelevelshaveattractedproducer,consumer,governmentandgeneralinterest.Gaspriceshavehowevernotbeeninthenewstothesameextentasoilprices.Thisisbecause:

• Historicallygashasbeenlessimportantthanoilinmostcountries’fuelmix;

• Onbalancegasborderorhubpriceshasbeenlower,inenergyequivalenceterms,thancrudeoilborderorhubprices;

• Unlikeoil,gashassubstitutesinitsmainapplications,afactthathasservedtocheckgaspricefluctuations;alsothewaygasisindexedtooilinEuropeanandAsiancontractshassmoothenedthegaspricecurve:

• Gashasbeenaregionalfuelandhencenotinthesamewayasoilamatterofglobalimportance;

• GasreserveshavebeenmorewidelydistributedthanoilreserveswithOECDcountriesholdingamajorportionoftheresourcebase;thusthedividebetweenproducingandconsumingcountrieshasbeenlessclear-cutandgaspriceslessgeo-politicised.

Thesedifferencesbetweengasandoilarebecominglesspronounced:

• Thegasshareofthefuelmixhasincreasedworldwide;• Gaspriceshaveincreased;• Gaspriceshavebecomemorevolatile;• LNGisprovidingintercontinentalgaspricelinkagesthateventuallycouldconstituteaglobalgasmarket;

• WithmostgasproducingOECDcountriesstrugglingtoreplacereservesandsustainproductiongrowth,thecentreofgravityofgasproductionandexportshasshiftedtowardsthesameregionsandtosomeextentthesamecountriesthatfor40yearshavedominatedoilproductionandexports.

GaspricesinNorthAmerica,EuropeanddevelopedAsiaarebeingmorecloselymonitoredthanpricesintherestoftheworld.Thishasseveralreasons:

• HistoricallytheOECDareahasaccountedforthebulkofworldgasconsumption,

• Theworld’sleadingenergyresearchinstitutionsarelocatedintheOECDareaandsponsoredbyOECDareagovernmentsandcompanies,

• WhilepricesintheOECDareaaremarketdrivenandthereforeamenabletostandardeconomictheoryandmodels,pricesintherestoftheworldarewithafewnotableexceptionspoliticallydeterminedandthereforeessentiallybeyondforecasting.

Thevalidityofthefirstreasoniswearingthin.2007worldgasusewassplitevenlybetweentheOECDcountriesandtherestoftheworld,andsinceOECDareaconsumptionisgrowingataslowerpacethannon-OECDconsumption,thelatterareawillsoonhavealeadontheformer.Moreover,severalnon-OECDcountriesarealreadyplayingkeyrolesindeterminingthesupplyofgastoworldmarkets,andwillonlybecomemoreimportantinthisrespectinthefuture.TheirdomesticgaspricingdecisionscouldthereforebestronglyfeltintheOECDarea.

Russiaisacaseinpoint.EurasiangasbalancestudiestypicallyconcludethatthecallonRussiangaswillincreasesignificantlyandthatGazprom,theRussianoilcompaniesandRussia’sindependentgasproducersneedtoinvestmassivelyintheupstreamandmidstreamtostaveoffshortages.Thisfromtimetotimepromptsdiscussionsontheadequacyofbudgetedinvestments.However,ifagapexistsitmaybeclosedbydampeningfuturedemandaswellasbyboostingfuturesupply.ThebulkofRussiangas–currentlyalmost70%–isconsumedathome.ThusifthepaceofgrowthofRussiandomesticgasusecanbecontainedthroughforinstancepriceincreases,budgetedinvestmentsinsupplymaybemorethanadequate.

TheMiddleEastisanothercaseinpoint.Forecasterstendtovesthighsharesoftheresponsibilityforsupplyingworldgasdemandinthedecadesahead,withthisregion.ButtheMiddleEast’scurrentandpotentialgasexportersarecurrentlystrugglingtosustainorstartexportsinthefaceofstagnantproductionandboomingdomesticdemand.Thelatteraspectoftheregion’s


fuelsituationiscloselylinkedtoitstraditionallyverylowenduserprices.

Estimatesofthelongtermimpactofgaspricechangesongasdemandvaryacrosscountriesandtimeperiods.AndifitisdifficulttoreachconsensusonpriceelasticitiesforOECDcountries,itisevenharderforregionsliketheFSUandtheMiddleEast.However,althoughgasconsumptionpercapitamaybeloweroutsidethaninsidetheOECDarea,gasconsumptionperunitofGDPproducedinthesectorsusinggasinthefirstplace,istypicallyhigher.Hencethefuelswitchingandsavingspotentialthatcouldbereleasedbygaspriceincreasesshouldnotbeunderestimated.

Outline of report

Chapter3ofthisreportidentifiesthegaspricedriversatworkindifferentmarketsandofferssomeviewsonhowtheymaydevelopintheyearsahead.

Chapter4presentsandbrieflyexplainseightgaspricingmechanismsthattogethercapturenearlyallgasproducedandconsumedintheworld.

Chapter5discussestheoriginsandhistoryofeachofthesemechanisms,withanemphasisonthoseinuseintheOECDcountries.

Thecurrentinterestingaspricingmodelshasacontext,andthiscontextisthegaspriceturbulenceexperiencedsince2000inbigpartsoftheworld.Forthisreasonchapter6offersabriefoverviewofrecentpricedevelopmentsinsideandoutsidetheOECDarea.

Chapter7isthecoreofthereportinthatitpresentstheresultofanempiricalinvestigationoftheprevalenceofindividualpricingmodelsinindividualmarketsin2007,andalsoacomparisonofthesituationin2007tothatin2005.AsampleofIGUmemberorganisationswereaskedtoestimatethesharesofgassalesintheirhomecountriesthatbelongedtoeachoftheeightpricingcategories.Thememberorganisationswereselectedsoastoensurethatallregionsandpreferablyallkeycountrieswerecovered.ThereplieswerethenanalysedbySGB2.

Chapter8addressesthetensionsinherentinindividualpricingmechanisms,theconsequentchallengesofsustainingthecurrentpatternofmethods,andtheattemptsbeingmadebymarketplayers,politiciansandregulatorstointroducenewmethods,typicallywithaviewtoshiftingpricestomoreefficientlevels.

Chapter9addressesthisissueofgaspricevolatility.Sincetheturnofthedecade,gaspriceshavenotonlyfluctuatedaround(untilrecently)risingtrends,theyhavealsogyratedmoreviolentlythantypicalforthe1980sand1990s.Thereasonsforandnatureofthepost2000gaspriceinstability,andwhetherthefuturewillbringevenmore,orless,volatility,arequestionsoneverygasmarketplayer’smind.

Thischapteralsoaddressestheissueofgaspriceglobalisation.Asnoted,gaspriceshavehistoricallybeenregional.Priceformationinoneregionhaslargelyreflectedcircumstanceswithinthatregiononly,andhasinturnnotimpactedonpriceformationinotherregions.Thisischanging,drivenbythegrowthinflexibleLNG,andatamoregenerallevelbythecommoditizationofgas,thebetteravailabilityofglobalgaspriceinformationandahigherawarenessineverycorneroftheworldofthevalueofgas.

Chapter10offersaviewonthesustainabilityofindividualpricingmodels,andaviewonwherewewillmostlikelyseechangesandwhereweprobablywillnotseemuchdeviationfromtoday’spricinghabits.

Finally,Appendix1presentsthefullresultsofthe2005mappingexerciseinthesamewayasChapter7presentsthe2007exercise.

Terms and concepts

TherearemanypricesalongpipelinegasorLNGvaluechains.Thefocusinthisstudyisonwholesaleprices,thatis,hubpricesor–intheabsenceofhubsprovidingreliablepricesignals–borderprices.

Study object is wholesale –border or hub – price formation

Hub price

Border or DES (LNG) price Wellhead prices may be

unrepresentative for pricing conditions further down the chain

End user prices reflect, in addition to wholesale prices, taxes, downstream margins and local factors – noise in the big picture

Also, border/hub prices are better documented

Citygateprice

Small end user

prices

Wellhead price

Large end user prices

FOB price (LNG)

Itisatthelevelofwholesalepricesthatbattlesoverpricingprinciplesarefought.Itisthislevelthatissubjecttonationalorsupranationalregulation.

Moreover,wholesalepricingprincipleslargelydetermineenduserpricingprinciples.Onecannothave,e.g.,gas-on-gascompetitionbasedhuborborderpricesandatthesametimecompetingfuellinkedcitygateorenduserprices.

Athirdreasonforfocusingonwholesalepricesisthatcitygateandenduserpricesareinfluencedbytaxesandbylocalsupplyanddemandconditionsreflectinginturnlocalweatherpatterns,localinfrastructuralbottlenecks,thelevelofcompetitionforlocaldistributionrights,localregulators’abilitytocounteractattemptsatmonopolypricing,etc.

Afourth,relatedreasonistheinherentcomplexityofenduserprices.Maturemarketstypicallyhaveextensiveenduserpricematriceswithpricesvaryingbygeography,endusersegment,customersizeandinterruptibilityofsupply.Thus,enduserpricesstudiesrequireadegreeofaccountingforthelocalcontextthatisbeyondthescopeofthisstudy.


Finally,inmanyareaswholesalepricesareasarulebetterdocumentedthanotherprices.

Therearehoweverexceptionsfromthelatterrule.Therearecountrieswithimmaturegasmarkets,nohubs,noexportsorimportsandwithstatecompaniesthatdonotpublishmuchfinancialinformationinchargeofgassupply–butwhereonecanstillfindsomeanecdotalevidenceofprices,typicallyatenduserlevel.Insuchcasesitisnecessarytocombinewhatlittleinformationexistsintoguesstimatesofwholesaleprices.

Thefollowingisanattempttofurtherdefineandexplainthepricingtermstobeusedinthisreport.

Wellhead price

• Thevalueofgasatthemouthofthegaswell• Ingeneralthewellheadpriceisconsideredtobethesalespriceobtainablefromathirdpartyinanarm’slengthtransaction

• WellheadpricesarewelldocumentedfortheUS,lesssoforothercountrieswithlesstransparencyintheupstream

Border/beach price

• Thepriceofgasatabordercrossingorlandingpoint• USandEuropeannaturalgasandLNGimportpricesare

welldocumentedbytheUSDepartmentofEnergy’sEnergyInformationAdministration(DOE/EIA)andEurostat,andbytheInternationalEnergyAgency(IEA)initsquarterlyEnergy

Prices and Taxes report

• ThereportingonEuropeanimportpricesisincompleteasthelongtermexport-importcontractsthatdeterminethesepricesareasarulenotinthepublicdomain

• NonOECD/IEAcountryborderorbeachpricesarenotsystematicallycompiledandpublished,butagreatdealofinformationonindividualagreementsexists

• Sincesofewcountrieshavehubsprovidingreliablepriceinformation,border/beachpriceswilloftenbethebestwholesalepriceproxiesavailable

FOB and DES LNG prices

• FOB(FreeOnBoard)price–ThepriceofLNGatthepointofloadingontothevessel.–TheFOBbreakevenpriceneedstocoverupstreamcosts(i.e., E&D,gasprocessingandfieldtoplanttransportationcosts) andliquefactioncosts,butnotshippingandregasification costs.

• DES(DeliveredEx-Ship)price– ThepriceofLNGatthepointofunloadingoffthevessel.– TheDESbreakevenpriceneedstopayforthesamecost componentsastheFOBpriceplusshippingcosts

Hub price

• Thepriceofgasatahub,typicallyapipelinejunctionwhereasignificantamountofgassalesandpurchasestakesplaceandwheresellersandbuyerscanalsopurchasestorageservices

• Ahubdoesnotneedtobephysical,itcanbevirtualliketheUK’sNationalBalancingPoint

• Servingasmarketplaces,hubsareaprerequisiteforgaspricingthroughgas-to-gascompetition

• Hubpricesarewelldocumentedastheyunderpintheworld’sgasfuturesmarkets

• TheUS’HenryHubistheclosestthingthereistoaworldgaspricingpoint

• Hubpricesareoptimalwholesalepriceindicators• However,hubsliquidenoughtoconveyreliablepricesignalsexistforthemomentonlyintheUS,intheUKandtoanextentintheBeneluxarea

Citygate price

• Thepriceofgasatacitygate,typicallyattheinlettoalowpressurepipelinegridownedandoperatedbyalocaldistributioncompany

• UScitygatepricesonamonthlystate-by-stateandweightedaverageUSbasisarepublishedbytheDOE/EIA

• UScitygatepricesonbalancereflectthepricesonthehubswherethegasissourcedplustransportationcosts,butmayfromtimetotimeduetolocalsupplyanddemandcircumstancesincludesubstantialpremiumsordiscounts

• Citygatepricesarenotsystematicallydocumentedanywhereelse

End user prices

• Enduserpricesarethepriceschargedtopowersector,industrial,commercialorresidentialendusersattheplantgateortheinlettotheirindividualpipelineconnections

• EnduserpricesfortheOECD/IEAcountriesarepublishedbytheDOE/EIA,EurostatandtheIEA,andbyselectprivatemarketintelligencecompanies

• Enduserpriceinformationisavailableforafewnon-OECDcountriesbutnotformostofthem,andreliabilityisanissue

• Enduserpricesareimportantinsofarasitisatthatlevelinterfuelcompetitiontakesplace

• However,publishers’aggregatingandaveragingmakesignificantpricedifferencesdisappear,limitingtheconclusionsthatcanbedrawnfrompublishedenduserpricemovements

• Moreover,taxesadlocalcircumstancescandistortthepicture• Enduserpricesshouldberesortedtoonlywhennecessaryduetoalackofwholesalepriceinformation

Netback price

• Gassupplychainshavemultiplelinks,andforeachpointoftransferfromonelinktoanotheraso-callednetbackpricemaybecalculatedbydeductingfromtheenduserpricetheunitcostsofbringingthegasfromthatpointtotheenduser


• Thenetbackpricetotheupstreamshowsthevalueperunitofgasproducedleftforsharingbetweentheproducerandthestateafterdistribution,transmission,storageand–intheeventofLNG–regasification,shippingandliquefactioncostshavebeendeductedfromtheenduserprice,andisassuchakeyindicatorofprojectfeasibility

Incompetitivemarkets,withmultiplesellersfacingmultiplebuyers,pricesaredrivenbysupplyanddemand.Pricechangesinturnfeedbackonsupplyanddemandbyprovidingsignalsthat–inprinciple–ensuresmarketequilibrium.Sincesupplyanddemanddependonmorefactorsthanpriceandsinceneitherofthesevariablestypicallymovesmoothlyandpreciselybetweenequilibriumlevelsbuttendtoundershootorovershoot,thesimultaneousprice,supplyanddemandadjustmentprocessneverstops.

Duetothenatureofgasasacommodityandtothedifferenthistoricaloriginsofnationalgasindustriesandmarkets,gaspricesarenoteverywheresetundercompetitiveconditions.Butsomemarketshavebeenliberalised,andothersareatvariousstagesofintroducinggas-on-gascompetitionandcompetitivelysetprices.Thefactorsthatdrivegassupplyanddemand,andhowthesefactorswillevolveandinteractinthefuture,thereforeneedtobeunderstood.

Competitive marketsShort to medium term supply and demand driversEvenmodestshorttermgassupplyordemanddisturbancesmayboostordepresspricessignificantly.Theimpactwilldependonthestateofthemarketattheoutset.Atightmarketwhereeithersupplyordemandorbotharehighlyinelasticatintersectionwilldeliverastrongerpriceresponsetothesamedisturbancethanarelaxedmarket.

Therearemanyexamplesofgasdemandspikesleadingtogaspricespikes.Suchspikesmayoccurbecauseoftemperaturefluctuations.Acoldspellduringwinteror–inplaceswithmuchgasgoingintopowergenerationandmuchpowergoingintoairconditioning–anunusuallyhotsummermayboostseasonalgasdemandandcauseapricespike.Droughtsmaytemporarilycutintohydropowergenerationcapacity,boostdemandforthermalpowerandasaresultincreasepowersectorgasdemand.Spain’sdroughtproblemssincethemiddleofthecurrentdecadehaveimpactedonAtlanticandworldLNGdemand(Chart3.1).

Chart 3.1: Iberian Peninsula: Hydro reservoir levels and LNG imports

Iberian Peninsula: Variations in hydro reservoir level and LNG imports, March 1999 - June 2008

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Businesscyclesaffectgasdemand–especiallyindustrialgasdemand–inthemediumterm.

Therearealsoexamplesofgassupplyinterruptionsboostinggasprices.Suchinterruptionsmaybeduetoextremeweather,accidentsorpoliticalorcommercialtensions.WhenhurricanesKatrinaandRitahittheUSGulfcoasttheresultwasa13,5%dropinUSdrygasproductionfromAugusttoSeptember2005,anda26%increaseinUSgaspricesasrepresentedbytheHenryHubmonthlyaverageoverthesameperiod(Chart3.2).

Chart 3.2: US gas production vs Henry Hub, 1997-2008

US dry gas production vs Henry Hub Jan 97 - Oct 08

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Katrina, Rita

3. Gas price drivers


Examplesofaccidentsorcommercial/politicalsupplycut-offsdrivingpricespikesarehardertofind.EvenanincidentasseriousastheexplosionattheAlgerianSkikdaLNGplantinJanuary2004thatdestroyedthreetrainswithacombinedcapacityofmorethan4mtpadidnothavenoticeableconsequencesforbuyercountrypricesasSonatrachmanagedtoquicklyrearrangesupply.

TheRussian-Ukrainiangasconflictsinlate2005–early2006andagaininthebeginningof2009causedsomenervousnessinEuropeanmarketsbutapparentlydidnothavemuchimpactonspotprices.Theformerconflictoccurredatatimewhenthesepriceshadalreadyincreasedsignificantly.ThedipinRussiangassupplymayhaveonlymarginallyaggravatedthepricespike.ThelatterconflictapparentlydidnotaffectpricesontheNorthEuropeangasexchanges–which,itshouldbenoted,arelocatedfarawayfromwherethesupplyinterruptionsweremostacutelyfelt–atall.Pricesonthesehubskeptfluctuatingaroundasteadilydecliningtrendduringthefinalquarterof2008andinto2009(Chart3.3).

Chart 3.3: North European gas hub prices

Source: WGI

North European gas hub prices Weekly averages, autumn-winter 2008-09

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LongtermsupplyanddemanddriversGaspricesincompetitivemarketsfluctuatearoundlongtermtrendsdeterminedby,graphicallyspeaking:

• Theshapeofthelongtermmarginalgassupplycostcurve• Theextenttowhichthereservesonthemarginalgassupplycostcurvecanactuallybeproduced,giventheregulatory,geopoliticalandotherconstraintsonoilandgasdevelopmentsworldwide

• Shiftsinthedemandcurve

Long term supply side drivers

Chart 3.4:Longtermmarginalsupplycostcurve(illustration)

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Longtermmarginalsupplycostcurvesshow–asChart3.4seekstoillustrate–theincrementalgasvolumesthatbecomeavailabletoagivenmarketassupplycostsareallowedtoincrease.Typicallythecheapestsupplyisindigenousconventionalgasdeliveredviaamortisedpipelines,andthemostexpensivesupplyhighcostLNG,gasimportedvialongdistance,notyetamortisedpipelinesandunconventionalgas.Therearehoweverexceptionsfromthisrule.IntheUS,thesupplyareasonshoreorjustoffshoretheGulfofMexicothatfordecadeshaveconstitutedthebackboneoftheUSgasindustrynolongeraccountforthecheapestportionofsupply.

Snapshotsofagivencountry’slongtermmarginalgassupplycostcurvemaybeinaccurate.Unlikevolumeandtosomeextentpriceinformation,costinformationisnoteasilyavailable.Costcurvesthereforetendtobebasedonassumptionsandgenericdataasmuchasonsolidprojectinformation.Moreover,theshapeofthecurveisboundtochangeovertime.Newupstreamormidstreamtechnologiesmayshiftsomesupplyoptionsdownthecurveand,bydefault,otheroptionsupthesamecurve.Newsupplysourcesmaydisplaceexistingsupplysources.Examplesofsuchdevelopmentsabound.Tightgas,shalegasandcoalbedmethaneusedtobelocatedontheuneconomicportionofthesupplycurve.TodayunconventionalgasispartofthemainstreamsupplyintheUSandisgrowinginimportanceinothercountries.Ontheotherhand,whereasLNGbecamemuchmorecompetitivebetweenthemid1990sand2004,since2005unitcostshavereboundedandmadenewLNGthatseemedeconomicbyawidemarginafewyearsago,lookmarginal.

Forthesereasons,basingpriceanalysisonstaticsupplycurvesisnotrecommendable.

Marginalcostcurvesarebydefinitionslopingupwardsandarenormallybecomingsteeperasmoresupplyisbroughtintothepicture.However,newgasdiscoveriesandtechnologicalprogresscan‘flatten’themandallowdemandtoshiftoutformuchlongerbeforehittingthesteepportion.Pastpredictionsofsupplycostspushingpricesoutsidetheir‘normal’rangeon


apermanentbasishavegenerallyprovedwrong.Forecastershavefailedtotakethecyclicalnatureoftheoilandgasbusiness,withhighpricesdampeningdemandandstimulatingE&Dandtherebypavingthewayforanotherdownturn,aswellasthepotentialfortechnologicalimprovements,fullyintoaccount.Thegaspriceexplosionalldevelopedcountriesexperiencedintheyearsuptothefinancialcrisisbrokewaswidelyassumedtobeofadifferent,morestructuralandpermanentnature.Thepricedeclineinlate2008–early2009putaquestionmarkatthatassumption.

Accesstothereservesonthelongtermmarginalsupplycostcurveisanotherkeygassupplydeterminant.Accessmaybeconstrainedforanumberofreasons.Hostcountrygovernmentsmay:

• Wishtoreservepartsoftheirgasforfuturegenerations• Wishtoreservetheirgas,orpartsofit,fortheirnationaloilindustries,whichhowevermaybeunableforfinancial,technologicalormanpowerreasonstotakeoncomplexdevelopments

• Putupenvironmentalrestrictionssosevereastoeffectivelyblockdevelopments

• Presentoilandgascompanieswithfiscaltermstoooneroustoallowprojectstogoforward

Independentlyofhostgovernmentattitudes,countriesorregionsmaybeinaccessibleforlongperiodsoftimeforgeopoliticalreasonsorbecauseoflocalunrestandpoorsafetyconditions

Arelatedconstraintwhichhasslowedliquefactionplantprojectsinrecentyearsisthelimitedcapacityofkeyequipmentvendorsandthesmallnumberofengineeringcompaniesabletomanagesuchprojects.Thisproblemislikelycyclical.Someproblemsmayalsobeduetotheindustrypushingitsborderswithrespecttoprojectsize(theQatarimegatrains)andclimaticchallenges(theSnøhvitandSakhalinprojects),andmaygoawayasplantbuildersandoperatorsgainexperience.Butbytheautumnof2008projectdelayswereundoubtedlyaggravatinggaspriceinflationandvolatilityworldwide.

Long term demand side drivers

Theprice-volumecurverepresentingacountry’sgasdemandtypicallyshiftstotherightovertimeinresponsetoeconomicgrowth,changesintheenergyintensityofthecountry’seconomy,andchangesinthefuelstructureofthecountry’senergyconsumption.

Economic growth

Economicgrowthdrivesoverallenergydemand.Theimpactwhichiscalledtheincomeelasticityofenergydemandchangeswiththelevelofeconomicdevelopment.Emerging,industrialisingeconomiesaretypicallycharacterisedbyhighelasticities.A1%growthinsuchacountry’sGDPmayrequirea1+%growthinenergyuse.Advanced,servicebasedeconomiesneedlessincrementalenergytosupportagiveneconomicgrowth.

However,noeconomyhasmanagedtobreakthelinkoveranextendedperiodoftimebetweeneconomicgrowthandenergyconsumptiongrowth.

Energy intensity change

Theenergyintensityofacountry’seconomyreferstotheenergyandfuelconsumedperunitofGDPproducedinthecountry.Energyintensitieschangeovertime.Onlyintheunlikelyeventsthattheincomeelasticityofacountry’senergydemandisstableatexactly1,andthereisnoimpactfromenergyorfuelpricechanges,willitsenergyuseperperunitofGDPbethesameyearafteryear.

Moreover,energyintensitiestendtotrenddownwards,dueto

• Normalstructuralchanges,i.e.thetransferofresourcesfromenergyheavytoenergylightsectors

• Autonomousenergyefficiencyimprovements,meaningprogressthathappensbyitself,sotosay,notbecauseofpoliticalsignals

• Policymeasurestomakecarmanufacturersproducemorefuelefficientcars,householdsinsulatetheirhousesbetter,etc.

Thisdoesnotmeanhoweverthatenergyintensitiescannotincreaseincertainperiodsduetoforinstancetemperaturefluctuationsortheadventofnewindustriesorproducts.

Fuel structure change

Companiesandhouseholdsswitchbetweenfuelsmostlyinresponsetochangesinfuelpricerelationships.Suchchangesmayinturnbemarketdrivenorpolicy–i.e.,taxorsubsidy–driven.

Theeasewithwhichconsumerscanswitchbetweenfuelsinresponsetopricesignals,dependsontheflexibilityoftheirfuelusingequipment.Themoredualfiringcapacity,themoreinterfuelcompetition,andviceversa.Consumersthathavetoreplacebigpartsoftheirequipmenttocapitaliseonachangeinrelativefuelprices,needstrongincentivesandconfidencethatthenewpricerelationshipwilllast,totakeaction.

IntheAtlanticmarketsgasinitiallycompetedmainlyagainstselectoilproducts.Gaspriceshavethereforetendedtomoveintandemwiththeregionallightandheavyfueloilprices.InWesternEuropelongtermcontractpricesreferencedtooilhaveprovidedanautomaticlink.IntheUScompetitionhasprovidedasimilarthoughlooserlink(chart3.5).NormallygasintheUStradedbetweenheavyfueloilandgasoil.Butsincethebeginningof2006gasappearstohaveeffectivelydecoupledfromoilproducts.

Asecondaryreasonwhygaspricestendtoshadowoilpricesisthatgasandoilisproducedeitherinoneandthesameprocessoratleastbythesameactorsemployingthesamerigsandotherupstreamequipment.Hencegasandoilprojectsaresubjecttojointfeasibilityevaluationsandareexposedtothesameinputfactorpriceupturnsanddownturns.


Today,withagrowingshareofworldgassupplygoingtofiregaspowerplants,thecoalpricelevelisbecominganotherimportantreference.

Chart 3.5: US natural gas and oil prices

Sources: US DOE EIA

US natural gas and oil product prices Monthly averages, January 1999 - December 2008

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Onedevelopmentthatshouldfavourgasrelativetootherfossilfuelsistheemphasisoncurbinggreenhousegasemissions.Twokeyremediesarefuelconsumptiontaxesdifferentiatedbycarboncontents,andemissiontradingschemes.Bothwillincreasethecoststoconsumersofallfossilfuels,butleavegasrelativelylessaffected.Whethertheneteffectongasdemandwillbepositive(becauseofsubstitutionfromotherfuelstogas)ornegative(becauseenergysavingswillwipeoutthesubstitutiongains)willdependonhowtheseremediesaredesignedandimplementedandhowtheycometointeractwithotherpolicymeasuresandtheforcesofthemarket.

Current scenarios

Willallthesefactorsdrivingordampeninggassupplyanddemandgrowthsustainpricesatorclosetothelevelsobser-vedinearly-mid2008,orhasthefinancialcrisesdeflatedpri-cesonalongtermbasis?Thereareasmanyanswerstothisquestionastherearemarketobservers.However,thewidelyheldviewfromafewyearsbackthatgasastheobviousbrid-gingfuelbetweentheoilintensive20thcenturyandacleaner21stcenturycouldlookforwardtoseveraldecadesofrobustsupplyanddemandgrowth,isbeingchallenged.

TheInternationalEnergyAgencypresentsinits2008WorldEnergyOutlookabusinessasusualscenariowhereworldgasdemandincreasesbysome1500bcmbetween2006and2030,orby1,8%ayear.TheIEAseesUSgasconsumptionpeakatabout650bcmayearin2015beforedecliningtoabout630bcmayearby2030.Allinallthismeansa0,1%ayeargrowthindemandfortheentire2008-30period.

Chart 3.6: US gas consumption

US gas consumption: History, EIA's 2009 reference projection

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TheEnergyInformationAdministrationoftheUSDepartmentofOilandEnergyexpectsinits2009AnnualEnergyOutlookUSgasconsumptiontopeakin2026(Chart3.6).Thoughitimpliesanaveragedemandgrowthexpectationforthe2008-30periodofonly0,2%ayear,thisscenarioismoreoptimisticinvolumetermsthanitspredecessor.TheEIAhaslowereditslongtermgassupplycostandpriceassumptions,withlessdemanddestructionasaresult.

Other market organisationsOECD areaAhighshareofworldgassupplyisnotpricedaccordingtogassupplyanddemand.InContinentalEuropeandDevelopedAsiasmallnumbersofimporters/wholesalershavebeendealingwithsmallnumbersofexportingcountriestypicallyrepresentedbytheirnationaloilcompanies.

InEuropethisstructureisbreakingup.Newentrantsaregainingaccesstotheincumbents’infrastructure.NorwegiangasisnolongersoldbyacommitteedominatedbyStatoilbutbyalltheactorsontheNCSincompetitionwitheachother.Gashubsrepresentingspottradingopportunitiesarepoppingup.HubsneedliquiditytobeusefulforpricingpurposesandsofaronlytheUK’sNBPfulfilthiscriterion,buttwoorthreeotherscouldbeontheirway.ExistingandnewLNGvendorsaredescendingonagrowingnumberofEuropeanLNGterminals,andnewpipedgassuppliersareawaitingaccesstoEuropevianewlongdistanceimportpipelines.

DevelopedAsiaisproceedingataslowerpace,butKogasisnolongertheonlyKoreanLNGimporter,andtheJapanesegasmarketcouldseetheintroductionofcompetitiveelementsintheyearsahead.

ContinentalEurope’sandDevelopedAsia’slongtermgasimportcontractsindexthepriceofthegastothepricesofoilandoilproducts.InEuropetheindicesaremostlylightandheavyfueloil,inDevelopedAsiaitiscrudeoil.Thecontractshaveapriceclausethatincludesabaseyearpriceandaformulathatregulatesthegasprice’strackingofthepricesoftheindices.


Theclausealsoaddressestheneedforregularrevisitstotheformulainresponsetostructuralchangesinthemarketplace.

ContinentalEuropeanandDevelopedAsianbordergaspricesarethusdrivenbythepricesofcrudeoilandrefinedproducts,andindirectlybyallthefactorsthatdrivetheseprices,ratherthanbydevelopmentsinContinentalEuropeanandDevelopedAsiangasdemandorinworldgassupply.

ThisisasimplificationinsofarasthepricesignalscomingfromthespotmarketsaroundEurope,fromtheUKviatheInterconnectorandfromtheUSviaLNGdoinfluenceContinentalEuropeanandDevelopedAsiancontractprices.Longtermimportcontractsalwayshavesomeofftakeflexibility.Ifspotpricesfallsignificantlybelowcontractprices,buyerswillrespondbyofftakingaslittleastheycanundertheircontracts,turninginsteadtothealternatives.Thiswillliftspotpricesbutcouldalsoleadtocontractrenegotiationsandeventuallysomerealignmentofcontractpriceswithgasmarketrealities.

Thecurrenttrendistowardsshorter,moreflexibleimportcontracts,sotheinfluencefromgassupplyanddemandonContinentalEuropeanandAsiancontractpriceswilllikelyincrease.However,aswewillreverttolaterinthisreport,thereiscurrentlylittletoindicatethateitherContinentalEuropeorDevelopedAsiawillabandonoillinkedpricinganytimesoon.

Non-OECD area

OutsidetheOECDareatherearemanygasconsumingcountriesthatneitherallowgassupplyanddemandtodeterminepricesnorpracticeoillinkedpricing.Insteadtheysetpricesadministrativelyaccordingtoprinciplesandproceduresthatarenotalwaystransparent.

Supplycostsmaybeaconsideration,butdonotalwaysreceivesystematicattention.Ifsupplycostsaretakenintoaccount,theymaybedefinedsoastoincludebothoperating,depreciationandfinancialcostsandareturnoninvestments,buttheymayaswellbedefinedsoastocoveroperatingcostsonly,leavingnothingformaintenancenottomentionsystemexpansions.Themoresupplycostsareignoredasadriver,i.e.,thefurtherbelowfullcyclesupplycostspricesareset,thesmalleristherolethatsalesrevenuesplayinfinancingthecountry’sgassupply.Thestateactor(s)involvedthenneedtobefundeddirectlyfromthestatebudget.

Socialandpoliticalconsiderationsareprobablythemostimportantregulatedpricedrivers,withtheregulatorsaimingtosetpricessoasnottohurtindustrialconsumers’competitiveness,overburdenresidentialconsumersandpotentiallytriggerpoliticalunrest.Thesecriteriaarecourseambiguous,reflectingwhatconsumershavegrownaccustomedtoratherthanobjectivethresholds.Thesamegasbillasashareofahousehold’srealdisposableincomemaybeacceptableinonecountryandintolerableinanother.

Insomecountriesgaspricesareregulatedatlowlevelstostimulatesubstitutionfromotherfuelstogas.Thisiscommon

practiceinoilexportingcountriesstrugglingtoincreaseoilproductionandwitnessingrapidgrowthindomesticoiluseerodingtheoilsurplusavailableforexports.

Regulatedgaspricesmaybeadjustedaccordingtosomesimpleformula,e.g.byacertainpercentageperyear.Moretypicalareadhocadjustmentsinresponsetotypicallyconflictingcallsforchangefromdifferentsides–fromthebudget,fromthemacroeconomy,fromcompaniesinvolvedinthesupplyofgastothedomesticmarketdemandinghigherprices,andfromindustrialandresidentialconsumersdemandinglowerprices.

Thedifferentmotivesforgaspriceregulationatbeloweconomiclevelsareinnowaymutuallyexclusive.Moreoftenthatnotgovernmentsthatsubsidisegasdoitinthehopeofkillingseveralbirdswithonestone–attractinginvestmentsinpetrochemicalandothergasintensiveindustries,containinginflation,keepingthepopulationhappyandsustainingoilexports.

Participationininternationalandintercontinentalgastradeinevitablyplaysaroleinshapingmarketactors’viewsonthesustainabilityofdifferentpricingmodels.Trademeanstheimportandexportofpricesignals.Whenacountrydecidestostartimportingorexportinggas,pressurestoaligndomesticpriceswithimportorexportpriceswillinevitablystarttobuild.

Chart 3.7: Impact on domestic pricing of opening for gas imports or exports

Gas imports becoming possibleGas imports becoming possible

Gas exports becoming possible Gas exports becoming possible

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Incentives to grow imports => increased competition in domestic market => domestic prices depressed towards international level

Subsidisation of imported gas or blending with domestic gas or dual pricing needed to allow uptake => incentives to raise domestic prices to minimise budgetary, administrative challenges

If high domestic prices reflect high costs, country’s gas not competitive in world markets => no exports take place

Incentives to reallocate gas from domestic market to exports => need to either introduce export quotas/ enforced supply of domestic demand, or raise domestic prices towards parity in netback terms with export prices, to restore balance

Gaspriceregulationthatdoesnottakecostsfullyintoaccountandinvolvesadegreeofsubsidisationtypicallybecomeshardertosustainwheninternationalgaspricesarehigh.Thiswasthesituationin2008.Importingcountrygovernmentsneedediftheywishedtocontinueshieldingtheirpopulationstoacceptincreasingbudgetdeficits.Producercountrygovernmentsthatcouldexportthegasratherthankeepingitathomehadtoacceptincreasinggrowthinexportandtaxrevenuesforegone.Thelattergovernmentswereontheotherhandtypicallyalsothebiggestbeneficiariesofthe2008oilpriceescalationandthereforeabletocontinueofferingcheapgastothedomesticmarket.

Inresponsetosuchpressuresgovernmentstypicallyderegulatepricestosomemarketsegmentswhileretainingregulatedpricestoother,morevulnerablesegments.

Deregulationmaybealongandcumbersomeprocessasthe


pressures.Delayedresponsestoimbalancescreatedbytryingtokeeptoomanypeoplehappyatthesametimefortoolongmayleadtodraconianpricehikes–andretreats,inresponsetopopularprotestsandunrest.

Chart3.8seekstoillustratehowagovernmentaimingtointroducegasinitiallymayneedtoconsiderandtradeoffonlyalimitednumberoffactorsinareasonablystraightforwardexercise.However,astimepassesandsituationschangeaconsistentlineonpricingmaybecomeincreasinglydifficulttodefineandsupport.

Chart 3.8: Challenges of price regulation

Price riots, accommodating

leadership

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Weproposetodistinguishbetweenthefollowinggaspricingmechanisms:

• Gasongascompetition• Oilpriceescalation• Bilateralmonopoly• Netbackfromfinalproduct• Regulationonacostofservicebasis• Regulationonasocialandpoliticalbasis• Regulationbelowcost• Nopricing

Gas-on-gascompetitionisthedominantpricingmechanismsintheUSandtheUK.Itmeansthatthegaspriceisdeterminedbytheinterplayofgassupplyanddemandoveravarietyofdifferentperiods(daily,weekly,monthly,quarterly,seasonally,annuallyorlonger).Tradingtakesplaceatphysicalhubs,e.g.HenryHub,ornotionalhubssuchastheNBPintheUK.Tradingislikelytobesupportedbydevelopedfuturesmarkets(NYMEXorICE)andonlinecommodityexchanges(ICEorOCM).Notallgasisboughtandsoldonashorttermfixedpricebasis–therearelongertermcontractsbuttheserelyongaspriceindicesratherthancompetingfuelindicesfor,e.g.,monthlypricedetermination.

Gas-on-gascompetitiondoesnotmeanthatcompetingfuelpricesplaynoroleindeterminingthegasprice.Keygroupsofgasconsumerscanswitchbetweengasandoilproducts,orbetweengasandcoal,inresponsetopricesignals.Thissubstitutabilityofgasmeansthatthepricesofgasoil,HFOandatthelowendcoaltypicallyframetherangewithinwhichgaspricesmaymove.However,thismarket(asopposedtocontractual)linkbetweenthepricesofdifferentfuelsisneitherstableovertimenorabletopreventgaspricestomoveoutsidetheirprescribedcorridorforlongperiodsoftime.

Chart 4.1: Pricing under gas-on-gas competition

Price Demand

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Chart4.1illustratespriceformationundergas-on-gascompetition.Itisassumedthatthepriceissetsoastoclearthemarket.

• Thedemandcurveisinelasticathighpricesandlowprices,wherethereislittlescopeforfuel-switching,andelasticinthemiddlerangewheredemandforgascanchangereadilydependingonrelativefuelprices;

• Thesupplycurveisidenticaltothelongrunmarginalcostcurve;and

• Theaveragecostcurvecutsthelongrunmarginalcostcurveatitslowpoint,andthenthedemandcurveatalowerpricethanthecompetitivemarketprice.

Undergas-to-gascompetitionthepriceinanygivenperiodwouldpresumablybeatP1V1.

OilpriceescalationisthedominantpricingmechanisminContinentalEuropeandAsia.Itmeansthatthegaspriceiscontractuallylinked,usuallythroughabasepriceandan

4. Key gas pricing mechanisms


escalationclause,tothepricesofoneormorecompetingfuels,inEuropetypicallygasoiland/orfueloil,inAsiatypicallycrudeoil.Occasionally,coalpricesarepartoftheescalationclause,asareelectricityprices.Theescalationclauseensuresthatwhenanescalatorvaluechanges,thegaspriceisadjustedbyafractionoftheescalatorvaluechangedependingontheso-calledpass-throughfactor.

Inadditiontothelinktothepricesofcompetingfuels,itiscommontoincludealinktoinflationintheescalationclause.

Oilpriceescalationdoesnotmeanthatgassupplyanddemandplaynoroleindeterminingthegasprice.IfContinentalEuropeanorAsianbuyersseetheoillinkedpricestheypayforlongtermgasorLNGfallingoutoflinewiththesupplyanddemanddrivenpricesonthegasexchangesthatareemerging,orontheglobalspotLNGmarket,customerswillswitchtoshorttermgastotheextenttheycan,withcontractpriceadjustmentsasapossibleresult.

Chart4.2showsthepossiblepricesundertheoilpriceescalationmechanism

Chart 4.2: Pricing under oil escalation

Price

Demand

P1

P2

P3

Volume


Average Cost

V1 V3V2


Thegaspriceunderoilpriceescalationwilllikelybeabovethemarket-clearingpriceifoilpricesareveryhigh,andbelowifoilpricesareverylow.Thusbysummer2008,whenoilpriceswereinthe$120-130/bblrange,gaspricesmayhavebeenclosetoP2,whileatlowoilpricestheycouldbearoundP3.Ifoilpricesareinthefuel-switchingrange,theoilindexedgaspriceswillpresumablybeclosetoP1.

Bilateralmonopolynegotiationswerethedominantpricingmechanismininterstategasdealingsintheformer‘EastBloc’includingtheFormerSovietUnion(FSU)andCentralandEasternEurope.Thegaspricewasdeterminedforaperiodoftime–typicallyoneyear–throughbilateralnegotiationsatgovernmentlevel.Therewereoftenelementsofbarterwiththebuyerspayingforportionsoftheirgassupplyintransitservicesorbyparticipatinginfielddevelopmentandpipelinebuildingprojects.

Theunderlyingvaluationofthegas,thecapitalgoodsandthe

servicesthatchangedhandsintheintra-‘EastBloc’gastradewasopaque,withpoliticsplayingamajorrolealongsideeconomics.

Examplesofgaspricingbasedonbilateralnegotiationsmaystillbefoundincountrieswhereonedominantsupplier,e.g.,thenationaloilcompany,facesoneoracoupleofdominantbuyers,say,thestateownedpowercompanyandmaybe1-2largeindustrialcompanies.Anumberofimmaturedevelopingcountrygasmarketshavethisstructure.

Netbackfromfinalproductmeansthatthepricereceivedbythegassupplierreflectsthepricereceivedbythebuyerforhisfinalproduct.Forinstance,thepricereceivedbythegassupplierfromthepowersectormaybesetinrelationto,andallowedtofluctuatewith,thepriceofelectricity.Netbackbasedpricingisalsocommonwherethegasisusedasafeedstockforchemicalproduction,suchasammoniaormethanol,andrepresentsthemajorvariablecostinproducingtheproduct.

Thismechanismshouldnotbeconfusedwithcontractualarrangementswherebythepricetotheproducer/wholesaleris‘nettedback’fromthewholesalegaspricesincountriesfurtherdownstream.Anetbackarrangementsuchasthiswouldbecategoriseddependingonhowthewholesalegaspriceinthedownstreamcountryisdetermined–throughgas-on-gascompetition,oilpriceescalation,etc.

Directgaspriceregulationremainswidespread.Itwouldhoweverbeunhelpfultolumpallkindsofregulationtogether.Weneedtodistinguishbetweentheprinciplesappliedbytheregulator.

Undercostofservicebasedregulationthepriceisdetermined,orapproved,byaregulatoryauthority,orpossiblyaMinistry,soastocoverthe“costofservice”,includingtherecoveryofinvestmentandareasonablerateofreturn,inthesamewayaspipelineservicetariffsareregulatedintheUS.Normally,costofservicebasedpricesarepublishedbytheregulatoryauthority.Pakistanprovidesanexampleofcostofservicebasedprices,withthewellheadpricebeingthetarget.

Pricesmayalsoberegulatedonanirregularsocialandpoliticalbasisreflectingtheregulator’sperceptionsofsocialneedsand/orgassupplycostdevelopments,orpossiblyasarevenueraisingexerciseforthegovernment.Inallprobabilitythegascompanywouldbestate-owned.

ManyNon-OECDcountriesstillpracticebelowcostregulation,meaningthatthegaspriceisknowinglysetbelowthesumofproductionandtransportationcostsasaformofstatesubsidytothepopulation.Againthegascompanywouldbestate-owned.

Insomecountrieswhereasubstantialproportionofindigenousgassupplycomesfromoilfieldswithgascapsorgas-condensatefields,themarginalcostofproducingthisgasmaybeclosetozeroandassuchitcouldbesoldataverylowwholesalepriceandstillbe‘profitable’.However,totheextentitissoldbelowtheaveragecostofproductionandtransportationitwouldstillbeincludedintheregulationbelowcostcategory.


Theextremeformofbelowcostregulationistoprovidethegasfreeofchargetothepopulationandindustry,e.g.,asafeedstockforchemicalandfertilizerplants.Freegasistypicallyassociatedgastreatedasaby-productwiththeliquidscoveringthecostsofbringingthegastothewellhead.Thegassuppliermuststillsomehowfinancetransportationanddistributioncostscross-subsidisinglocalgassupplyfromhisoilorgasexportrevenues,orthegovernmentmustprovidefundingfromthebudget.

Ashocandbelowcostpriceregulation,andfreegassupply,isonlythinkablewhendomesticgassupplyisinthehandsofoneormorestatecompanies.

Chart4.3illustratespricingunderbilateralmonopolynegotiations,withnetbackpricingandundervarioustypesofregulation.

Chart 4.3: Pricing under regulation

Price Demand

P1P5

P4

Volume


Average Cost

V1 V4V5

Bilateral monopoly, netback pricing, regulation

Underbilateralmonopolyornetbackpricingsituationsthepricecould,intheory,behigherorlowerthanthemarket-clearingpriceP1.Inpractice,aswillbeshownlater,pricesunderthesemechanismsin2005wereprobablyclosetotheP5level,i.e.justaboveorbelowaveragecost.

WithbelowcostregulationthegaspricecouldbeatP4,thatis,materiallybelowtheaveragecost.UndercostofserviceregulationthepricewouldmostlikelybeslightlyabovetheaveragecostatP5.RegulationonsocialandpoliticalgroundswouldlikelyleadtoapricesomewhereintherangebetweenP4andP5.Inallcases,thepriceislikelytobebelowthemarket-clearingpriceP1.


Themaindividinglinewithrespecttogaspricingrunsbetweenmarketbasedpricingwherebuyersarechargedaboveorinlinewithsupplycosts,andregulatedpricingwherebuyersmaybechargedbelowsupplycosts.

Origins of gas or oil market based pricing

Thecountriesthatpracticemarketbasedgaspricinghaveoptedfordifferentmodelsbecauseofdifferencesinthelevelanddegreeofconcentrationoftheirgasresources,inadditiontodifferenthistoricallyandideologicallyrootedpreferences.Countrieswithsignificantgasresourcesdispersedinlargenumbersoffieldstypicallysawthedevelopmentofcom-petitiveindustriesandtheearlyemergenceofthephysicalandinstitutionalpreconditionsforgasmarketbasedpricing.Countrieswithlimitedorzerogasresourcesoftheirowncouldnotaseasilydevelopgasindustrieswithmultiplesel-lersandbuyers.Thesecountriesinsteadtendedtoencouragetheemergenceofnationalorregionalimportmonopoliesthatcouldinteractonanequalfootingwithalimitednumberofmajorforeignsuppliers.Marketvaluepricingwasaresponsetotheneedforrisksharingtounderpinthebuildingofmarketsfromscratchwiththegascomingfrommajorimportcontracts.

North America

USgasproductionhasalwaysinvolvedanumberofcompa-nies,andUSgaspriceshaveasarulebeendeterminedcom-petitivelybysupplyanddemand.Fordecadespriceswereverylow,reflectingproducercompetitionforverylimitedlocalmarkets.AfterWorldWar2rapidexpansionoftheUSpipelinesystemenabledagradualabsorptionofthesurplusreserves.

TheSupremeCourtPhillipsDecisionin1954usheredinaperiodofwellheadpriceregulationthatwastolastfor24years.Theregulationappliedonlytogastradedacrossstateborders.Gasproducedandconsumedinthesamestatewasnotaffectedbythedecision.

ThewellheadpricecontrolswereofthehistoricE&Dcostplustype.TheystimulatedgasdemandbutnotinvestmentintheupstreamandeventuallyledtogasshortagesinthosepartsoftheUSthatdependedonotherstatesfortheirgassupply.TheNaturalGasPolicyActof1978soughttofixtheimbalancebyderegulatinghighcostgaspriceswhileretainingmostinterstategasunderpricecontrolandplacingalsointrastategasunderpriceregulationsoastoeliminatetheparticularshortageproblemsofthe‘importing’states.Thesestepshoweverpavedthewayforafurtherdismantlingofpricecontrolsintheyearsthatfollowed.Deregulation,andtheimpactofthefirstandsecondoilprice

shocks,increasedwellheadgasprices15-foldbetweenthebeginningofthe1970sand1984.USpipelinecompaniessawopportunitiesandcontractedheavilyfornewlongtermsupply.However,USgasdemandprovingunexpectedlysensitivetohigherpricesandsluggisheconomicgrowthdippedbymorethanonequarterintheinthe14yearsbetween1972and1986.Theresultinggas‘bubble’arrestedwellheadpricesandpushedthembackintotheUSD1,60-1,70permcfrange.

FERCOrders380and436inthemid1980scompletedtheliberalisationoftheUSgasmarketbyallowingfirstutilitiesandthenothercustomerstocontractdirectlywithproducersatmarketprices,andhavethegastransportedtotheirsitesonpipelinessubjecttothirdpartyaccessregulation.

The UK

TheUKgasindustrywasnationalisedin1948.TheUKatthattimeneitherproducednorimportedanynaturalgas.However,thereweremorethan1000manufacturedgascom-panies–someprivate,theothermunicipallyowned–thatwerevestedinto12so-calledareagasboards.In1959LNGimportscommencedonatrialbasis.In1964thegovernmentstartedtoissueNorthSeaE&Dlicences.In1965thefirstnaturalgasdiscoveriesweremade.In1966thegovernmentdecidedtointroducenaturalgasintotheUKfuelmixonabigscale.

The1972GasActpavedthewayforfurthercentralisationoftheindustrywiththecreationoftheBritishGasCorporation(BGC).Thisentitywasuntil1986thesolebuyerofUKCSgasandthesoletransmitteranddistributorofthisgastoUKcustomers.Itwasalsoakeyupstreamplayer.

WellheadpriceswereintheseyearssetthroughnegotiationsbetweenBGCandtheproducers.BGC’slegalmonopsonyonUKCSgaspurchases,andgoodgrasponupstreamcoststhankstoitsownUKCSinterests,ensuredpricesthatleftlittlerenttotheproducers.

TheThatcheryearssawageneral,ideologicallydrivenshiftfromstateinvolvementthroughmajorpublicenterprisesintheeconomy,towardsprivatesolutions.Thegassectorexemplifiedthistrend.

The1982OilandGas(Enterprise)ActpermittedUKCSgasproducersandmajorindustrialcustomerstocontractdirectlywitheachother,andorderedBGCtoofferthirdpartyaccesstoitspipelines.Thesefirststepstowardsaliberalisationofthemarketfailedtoboostcompetition.Thecustomersthatproducerscouldnowapproachdirectlyweretoofew,andBGC’sgriponthemarketremainedtoostrong.Thenextstepswerehowevermoreforceful.The1986GasActreturnedthegasindustryto

5. Origins of individual pricing mechanisms


theprivatesector,transformedBGCtoBritishGasPlcandcreatedOfgastoregulatetheindustryandprotecttheinterestsofconsumers.In1989OfgaslimitedBritishGas’purchaseofnewUKCSgassupplyto90%offullcapacityproduction.Duringthe1990stherightforproducersandconsumerstodealdirectlywitheachotherwasextendedfirsttomid-sizedindustrialandcommercialbuyers,andthentotheentiregasmarket.

Throughthe1990sgaspricesintheUKweregenerallylowerthangaspricesinContinentalEurope.Proponentsofliberalisationsawthisasproofoftheefficiencyboostingeffectsofincreasedcompetition.However,priceswerealsoinfluencedbyastrongincreaseinUKCSgasproductionthatcamefromnewdiscoveriesandsteady,technologydrivengrowthindepletionrates.Therelativeimpactofeachofthesedriversonpricedevelopmentsisnoteasilycalculated.

Continental Europe

ThemarketvaluepricingprinciplethatdominatesinConti-nentalEuropeoriginatedintheNetherlands.TheGroningenfielddiscoveredin1959andputon-streamin1964presentedtheDutchgovernmentwithamarketingchallenge.WesternEuropeangasconsumptionin1965wasabout21bcmayear.TheDutchthemselvesconsumedamere1,8Bcmayear2.ContinentalEuropeancrossbordergastradewasnegligible.ThusGroningenhadtobesoldintoasmallandimmaturemarketarea.Thegovernmentdidnotwanttosellthefieldcheaply,thusgivingawayvalue.Delayingitsdevelopmentseemedanequallyunattractiveoption.Therewasapercepti-onofurgencystemmingfromtheemergenceofanewsourceofenergy–nuclear–thatconceivablycouldshortentheeraoffossilfuels.

In1962thethenDutchMinisterofEconomicAffairssuggestedtobasepricesnotonproductioncostswhichwerelowforGroningengasandwouldhaveleftthegovernmentwithlimitedrevenues,butonthemarketorreplacementvalueofthegastoindividualmarketsegmentinindividualcountries.

Specifically,theideawasthatthepriceofGroningengastoagivencustomershouldbebasedonthepriceofthebestalternativetoGroningengas–typicallyheavyfuelorgasoil–forthatcustomer.

ThepriceofGroningengasshouldnotbemechanicallyalignedwiththepriceofthebestalternative.OntheonehandrebatescouldbenecessarytoencouragecustomersthatdidnotalreadyuseGroningengastostartdoingso,anddiscourageexistingcustomersfromswitchingbacktocompetingfuels.Therebatestoattractnewcustomersmightneedtobesubstantialifswitchingwouldrequireinvestmentinnewheatingsystems.Ontheotherhand,dueconsiderationshouldbepaidtotheconvenienceofburninggascomparedtooilproducts,potentiallygivingrisetoapricepremium.Sinceitisnotpossibletopricediscriminateatindividual

customerlevel,buyersinindividualcountriesweresplitintoindividualmarketsegments(typicallytheresidentialsegment,thecommercialsegment,theindustrialsegmentandthepowersegment),asinglepricewascalculatedforeachsegmentineachcountry,aweightedaverageenduserpricewascalculatedforeachcountry,andtransmission,storageanddistributioncostswerefactoredintoarriveataninitialborderpriceforeachcountry.

Theinitial–orstart-upyear–borderpricewouldbecontinuouslyadjustedinresponsetochangesthepricesofthefuelsassumedtobetheclosestcompetitorstogas,andthepricingformulaitselfwouldberenegotiatedfromtimetotimeinresponsetochangesintherelativeimportanceofindividualmarketsegmentsandotherdeepershiftsinthemarket.

WhilethemarketvalueprincipleplacedthepriceriskintheGroningengassalescontractswiththeseller,thetakeorpayprinciple–anotherfeatureofthesecontracts–placedthevolumeriskwiththebuyer.TheseprovisionsonrisksharingpavedthewayforrapidgrowthinDutchgasexportsandforarapidmaturationofEuropeangasmarkets.ThelattereffectwasaccentuatedwhenAlgeria,RussiaandNorwayadoptedbothmarketvaluepricingandtheTOPprincipleintheircontractingwithEuropeangasbuyers..

Asia Pacific

Japanwasa2bcmayeargasmarketuntil1970whenim-ported(Alaskan)LNGenteredthefuelmix.Importgrowthacceleratedinthe1970sand1980sinresponsetothefirstandsecondoilpriceshock.SouthKoreaandTaiwanstartedtoimportLNGin1986and1990respectively.AustraliaandNewZealand–thetwodevelopedeconomiesintheregionwithindigenousgasreserves–startedtoexploitthesereser-vesaround1970.

TheAsiancountriesthatdonothavesignificantdomesticnaturalresourcesandaccesstointernationalpipelinenetworksandundergroundstorageslikeEuropeandtheUS,havecometorelyalmost100%onimportedLNGfortheirnaturalgassupply.Thelargestimporters,JapaneseLNGbuyers,aregasandpowercompaniescarryingoutbusinessinanintegratedmanner,fromprocurementandimportstotransmission,distribution,downstreamgasandpowersupplyandmarketing.WhentheyfirstinitiateddiscussionsonpotentialLNGimports,theyhadtoemphasizelong-termsecurityofsupplytomakesurethattheywouldbeabletofulfiltheirsupplyobligationtoend-users.Atthesametime,sinceLNGprojectsrequireenormousinitialinvestmentsontheseller’sside,thelatterneededsecurityofdemand,meaninglong-termandstableofftakebybuyers.Sellersandbuyersthushadacommoninterestinlong-termandstablerelationships.CommercialLNGprojectshavebeendevelopedbasedoncooperativearrangements,andthisisreflectedinthehistoryofLNGpricingaswell.In1969whenLNGwasfirstimportedintoJapan,andthroughtheearly1970s,thepricewasfixed.Thissuitedthesupplierssincetheycouldrecovertheirhugeinitialinvestmentwithcertainty.Fixedpricesalsoenabledthemtolockintheeconomicsoftheir2 BP Statistical Review of World Energy, 2008


LNGproject,whichwasanimmaturebusinessatthattime.Sincethepriceofoil–themainalternativefueltoJapanesebuyers–wasratherstable,afixedpricingsystemwasacceptabletoJapaneseLNGbuyersaswell.Afterthefirstoilshockin1973,however,theoilpricesurgeleftthepriceofLNGsignificantlylowerthanthatofoil.Inresponsetorequirementsfromsuppliers,thepriceofLNGweregraduallyraisedinlinewiththepriceofoil.TheseLNGpriceincreaseswere,afterthesecondoilshockin1980,codifiedintoaformulabasedontheconceptof“oilparitypricing”.Atthattime,theGovernmentSellingPrice(“GSP”)wasappliedasindexintheformula.Althoughdifferentcrudeswereutilized,mostLNGpriceswere100%indexedtotheGSPprice.AstheOPECcountries’shareofglobaloilproductionwentintodecline,oilturnedfromastrategicproductintoacommodity.Inresponsetothatchange,somecountriesstartedtoselloilatpricesthatdifferedfromtheGSP,andmarketpricesweregraduallyestablished.SincetheGSPwasleftunmodified,theLNGpriceindexedtotheGSPfelloutoflinewithmarketrealities.Furthermore,afterthe1986oilpricecollapse,supplierssellingLNGatoilparitypricesranintodifficultiessecuringtheeconomicsoftheirLNGprojects.Inordertocopewiththatproblem,theLNGpricingformulawasmodifiedagainthroughnegotiationsintoanewpriceformula,whichbecamethebasisforthecurrentformula.Today,mostAsianLNGtransactionsexceptthosethatinvolveIndonesianLNGapplytheweightedaveragepriceofoilimportedintoJapan(theJapaneseCrudeCocktail,JCC)asindex.Thepriceformulaisgenerallyasfollows:

Y (LNG price : $/MMBtu) = A x (oil price : $/bbl) + B

Byapplyingthistypeofformula,theLNGpriceisindexedtotherealizedoilprice(importprice).Theexposuretotheoilprice(JCC)isreducedto80to90%through“A”,andacon-stant“B”makestheLNGpricemorestablethantheoilprice(Chart5.1).ItalsoenablessupplierstosecureeconomicsofLNGprojectssinceacertainamountofincomearesecuredevenwhentheoilpriceislow.

Chart 5.1: LNG pricing with no floor or ceiling

Modified price formula85-90% indexed to oil

Old price formulaOil Parity

LNG price$/MMBTU

Oil price$/BBL

LNG indexed to oil with no floor, ceiling

InJapan,LNGwasintroducedinordertoreduceanatthattimeexcessivedependencyonoil.Japanesepowercompanies

reliedonoilthermalpowerplantsfor70%oftheirpowersupply.Therefore,itwasareasonabledecisionforthemtomakeLNGpricingcompetitiveagainstoil.ForJapanesegascompanies,themaincompetingfuelswereoilproductssuchaskeroseneforheatingandfueloilforindustrialuse.Henceindexationtooilwastoanextentacceptabletothemtoo.JCCisusedasindexsinceitiscalculatedfromdatainJapanExports&ImportsMonthlypublishedbyJapanTariffAssociation,andthereforecanbeconsideredacredible,transparentandneutralindex.Inthe1990s,thegenerallylowoilpriceenvironmentcausedLNGsupplierstosufferfromdeterioratingprojecteconomics.Inresponsetosuppliers’callforahelpinghand,anewpricingmechanismwithlowerslopesatveryloworveryhighoilprices–theso-calledS-curve–wasintroduced(Chart5.2).Later,whentheLNGindustrystartedtosufferfromtheimpactofsluggishdemandrelatedtotheAsiancurrencycrisisinthelate1990s,somebuyersobtainedpricefloorsandceilingsasanextensionoftheS-curvemechanism.

Chart 5.2: LNG pricing with S-curve

?low oil

price zone

LNG price$/MMBTU

Oil price$/BBL

?high oilprice zone

kink-points

LNG indexed to oil: S-curve

Asoilpricesrebounded,LNGcontractswithalowerslopebecamehugelyadvantageoustobuyers.Atthesametime,however,LNGmarkettightnessresultedinsellers’marketconditionsandintheabolishmentoftheS-curveinsomecontracts.

Origins of regulated gas pricing

Regulatedgaspricingmaymeancostofservicebasedpricingaswellaspoliticalpricingwherecostsmaybeconsideredbutgenerallyplaysecondfiddletopoliticalandsocialconcerns.

Regulatedgaspricingwithlongtermmarginalsupplycostsplayingaminorrolerequiresasarulestatecompaniesinthelead,atleastfromthestart.Buildingagasindustrydominatedbyprivateplayersonthebasisofbelowcostpriceswouldlikelybechallenging.Thereareexamplesofstateoilandgascompaniesbeingpartprivatisedwithgaspricestoendusersremainingunderbelowcostregulation,butsuchcombinationstendtocreatetensionsandleadtocalls–from,amongotherquarters,thepartprivatisedcompaniesincharge–forpricereform.Cost-pluspricingispracticedindifferentwaysindifferentcountries.Cost-pluspricingandmarketbasedpricingmayexist


sidebysidewithhouseholdsandvulnerableindustriesbenefitingfromregulationswhileindustrieswithabiggerchoiceoffuelsandsuppliersareexposedtomarketbasedprices.Anotherrecurrentfeatureisthatwellheadpricesaresetonacompetitivebasiswhiletransmissionanddistributiontariffsareregulated.

Costbasedpricingshiftstherentintheaffectedlinksofthevaluechaintotheconsumersandmayassuchboostgasmarketgrowth–atleastforawhile.Butcostbasedpricingtendstodiscourageefficiencyimprovementsalongthesupplychain,andevenhouseholdsandvulnerableindustriesmaybeofferedalternativestoregulatedgas.Thussoonerorlatertheinsensitivityofcostbasedpricingtochangesinthecompetitivelandscapemayleavethegaspricedthiswayunmarketable.

Ontheotherhand,sincecostbasedpricingmaynotprovideverystrongincentivestoinvestinfieldsandpipelines,growthingassupplymayfallbehindgrowthingasdemandatregulatedprices.

Boththesedevelopmentsmaypavethewayforawardingabiggerroletomarketbasedpricing,andhaveindeedtriggeredanumberofpricereformeffortsaroundtheworld.

Chinaisnotoneintegratedgasmarket.Chinahasmultipleregionalmarketsthattraditionallyhavereceivedsupplyfromdifferentproductionareasatdifferentcosts,withdifferentpricesasaresult.Thesecharacteristicsaregraduallygivingwaytothoseofamoreintegratedmarket.Rapidconstructionofnewlongdistancepipelineswillgivesellersaccesstoabiggervarietyofbuyersandbuyersaccesstoabiggervarietyofsellers.

InChinaasinothercentrallyplannedeconomies,gaspriceswerehistoricallyusedforaccountingpurposesratherthanforresourceallocationpurposes.Gasproducedunderthenationalplanwaspriceddifferentlyfromgasproducedoutsidethenationalplan.Enduserpricesdifferednotonlybyregionbutalsobyconsumptionsector;thusthefertiliserindustrypaidlessthanotherindustry.NeitherthecomplexityandrigidityofthegaspricestructurenotthefactthatmanypricesdidnotcoversupplycostsencouragedgasE&D.Ontheotherhand,gaswasmuchmoreexpensiveinenergyequivalencetermsthancoal.Thispreventedgaspenetrationintothepowersectorandothersectorswherecoalwasanoption.

Costpluspricingisstilltherulebutproceduresarebeingstreamlinedandstandardised.Alsoanelementofcompetitivepricingisintroduced.Wholesalebuyersareallowedtonegotiatedirectlywithsuppliers.

InIndiadecisionmakersstartedtotakeaninterestingasonlyinthemid1980s.Consumptionwasbythenaround4,5bcmayear.In1984theGasAuthorityofIndiaLtd.(GAIL)wasestablishedtomanagethedevelopmentofagenuinegasmarket.In1986GAILbegantheconstructionofthe2688kmHazira-Bijapur-Jagdishpurpipelinetogivemajorfuelusersintheinteriorofthecountryaccesstogasdiscoveredalongthewestcoast.Supplyviathispipelinefellshortofdemandalmostfromthestart.Inresponsethegovernmentestablished

theso-calledGasLinkageCommitteetoensurethatsufficientgaswasallocatedtopriorityconsumers–namelythefertiliserindustryandthepowersector–atsubsidisedprices.

TheGulfwarseriouslyweakenedtheIndianeconomyandforcedthegovernmenttoturntotheIMF,theWorldBankandtheAsianDevelopmentBankforsupport.Theseinstitutionstypicallyrequestpolicyreforminreturnforloans,andinthecaseofIndiatheymadesupportconditionalonthestatereducingitsinvolvementinselectsectors,amongthemthehydrocarbonssector.InresponsethegovernmentintroducedtheewExplorationandLicensingPolicy(NELP)and–eventually–themulti-tieredpricingsystemdescribedinchapter3.Inthebeginning,however,theproducerpricewasfixedonthebasisofaparticularcommittee’sestimateofthelongrunmarginalcostsofgasproduction.Thedecisiontoindexthepriceofgasatlandfallpointstoabasketoffueloilpriceswasmadein1990.

InLatinAmericacostbasedpricingwastheruleuntiltheearly1990s.Argentinathende-controlledwellheadpriceswithregulatorEnargascontinuingtoregulatetransmissionanddistributiontariffs.Thesewereoriginallysettoensureafairreturnoninvestmentsinpipelinesandotherfacilities,butemergencylegislationpassedinthewakeofArgentina’seconomiccrisisintheearly2000sauthorisedthegovernmenttore-imposepriceandexchangecontrols,withtheresultthattariffsandpricesindollartermsdroppedsignificantly.

In2004Argentineanauthoritiesandthecountry’smaingasproducersagreedonascheduleforpartiallyliftingthepricefreeze,butprogresshasbeenlimited,althoughmorerecentlyproducersandlargeindustrialandpowersectorendusershavebeenfreetonegotiateprices.

Brazilin2002liberalisedgaspricesbutcontinuestoregulatepricestoqualifyinggaspowerplants.RegulatorANPsetstransportationtariffsonacostofservicebasis.Petrobras’dominatingroleintheupstreamandcontinuedholdonthetransmissionlinklimitstheroleofcompetitioningaspriceformation,withwholesalegaspricesnowincreasinglyfollowingoilprices.

Belowcostpricingwasahallmarkofthe20thcentury’scentrallyplannedeconomies.IntheFSU,pricesservedaccountingpurposesonly.Theywerenotsupposedtocarrysignalsbetweenmarketactorsanddriveresourceallocationdecisions.Insteadhierarchiesofplansprovidedvolumetargetsreflectingtheprevailingprioritisationbetweensociety’sdifferentneeds,andtheplanners’attemptstooptimiseunderallkindsofconstraintsrelatedtotheunwieldinessoftheproductivesectors.Thecentrallyplannedeconomies’biastowardsheavy,energyintensiveindustriesfavouredlowaccountingprices.Ordinarypeoplewereofferedameagreselectionofconsumergoodsbutinreturnreceivedfreeeducationandhealthcare,andcheaphousingandothergoodsincludinggas.

Theformer‘EastBloc’includedastringofcountriesthatreceivedRussiangasinreturnforpipelineconstructionortransitservicesunderthedivisionoflabourwithintheComeconarea,


orcheaplyforpoliticalreasons.Ingeneralterms,constructionsliketheComeconareaneedarrangementsfortheirsustainability,andonearrangementunderpinningRussia’sauthoritywithinthethisareawasMoscow’sprovisionofcheapgasandothercommoditiestoitsneighbours.

EastEuropehasmovedawayfrombelowcostpricingandtheFSUrepublicsareimplementingpricereform.Thecountriesthathaveoptedtoretaingaspriceregulationatbelowcostlevels,atleastfornow,aretheNorthAfricanandMiddleEasternoilproducersandexporters.

Oilproducerstypicallyhaveassociatedgasattheirdisposal.Inthepastassociatedgaswasvented,flaredoratbestreinjected.Thoughflaringcontinuesinsomecountries,globallymuchofthegasthatwaswastedisnowharvested,processedandmarketed.Asafreegoodatthewellhead,associatedgasislowcostgas.Itcanbesuppliedeconomicallyatpricescoveringonlytransmissionanddistributioncosts.Alternativelyitcanbesuppliedatevenlowerpricesorforfreewithan(atleastinitially)manageablesubsidisationburdenfallingonthestate.Problemsariseonlywhengasdemandstartsexceedingassociatedgassupply,i.e.,whenneedarisesformuchmoreexpensivenon-associatedgas.

Iranbeganharnessingassociatesgasinthe1960sandSaudiArabiafollowedsuitwiththeconstructionoftheMasterGasSysteminthelate1970s.Bothcountries,andeventuallyothersintheregion,fundedgasinfrastructureinvestmentsfromtheiroilexportrevenues.Therulers’mainmotivationwastocontainthegrowthindomesticoilconsumption.Thiscouldhavebeendoneindifferentways,probablymostefficientlybyraisingdomesticoilproductprices.Oilpricereformcouldhoweverhavetriggeredpoliticalandsocialunrest.Thenatureofthe

legitimacyofrentierstategovernmentsdictatesgenerosityintheprovisionofbasicgoodsandservicesincludingfuelsandelectricity.Positivepriceandavailabilityincentivestoswitchtogasappearedmuchsafer.

ThoughIraniangasuse(netofreinjection)increasedby10,5%ayearbetween1991and2006,domesticoilconsumptiongrowthcontinuedtooutpaceoilproductiongrowth.Thecountry’spositionasamajoroilexportercameunderincreasingpressure.Iranianrulershavethereforesincethe1990sintensifiedeffortstomakefuelusersswitchfromoilproductstogasbyprovidingforcontinuousgrowthinthegasgridandkeepingdomesticgaspricesatverylowlevels.

SaudiArabiahasalsomaintainedthedomesticgaspriceataverylowlevelforaverylongtime.Between2001and2008nomaterialadjustmentshavetakenplace.SaudiArabiahascomeunderpressureinternationallyforitshighlysubsidizedprices.Tradepartnershaveprotestedthatthecountry–nowafullmemberoftheWTO–isunfairlysupportingSaudiindustriesandutilities.

Inanattempttoaddressthemaindistortionsinthedomesticgassector,SaudiArabiarecentlyadoptedanewpricingpolicythatcouldheraldrealpricereform.In2006,thelocalEasternGasCompanywasawardedatwo-yearcontracttobecomeAramco’sgasdistributortoconsumersintheDhahranindustrialarea.Accordingtoindustryreports,itspurchasepricefromAramcowillbeUSD1,12perMMBtuanditssalepriceUSD1,34/MMBtu.InRiyadh,theNaturalGasDistributionCompanywasgrantedalicensetosupplysmall-scalemanufacturingplantsunderasimilarpricingstructure.Forthetimebeing,thepriceforforeigninvestorsandotherconsumersremainsunchanged.


OECD area

After6to7yearsofgaspricefluctuationsaroundarisingtrend,bymid2008therewasbroadagreementacrossOECDcountriesthatpriceshadshifteduponapermanentbasis(Chart6.1).Thefinancialcrisisintheautumnof2008,thesteepoilpriceandspotgaspricedeclinestowardstheendoftheyearandtheoutlookforoillinkedgaspricestocomedownin2009havehighlightedtherisksofjumpingtocon-clusions.Therewilllikelybemanyrevisitstothequestionofthestructuralorcyclicalnatureofgaspricemovementsinthe2000s.WillpermanentlyhighersupplycostsrestorepricestoUSD10or12perMMBtuoncethecrisispetersoutanddemandpicksup?Orwillthepricehistoryofthefirstthreequartersof2008provetobeaone-offevent?

Chart 6.1: Gas border and hub prices

Source: PIRA

Gas border/hub prices Monthly averages Jan 1997- Dec 2008

02

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Henry HubNBPEurope contractJapan contract

Pricesfirmedinthe2002-08periodfortwomainreasons:

• Gassupply-demandbalancestightened,affectingpricesthroughgas-on-gascompetition,

• Oilpriceswentup,affectinggaspricesinEuropeandAsiathroughthepriceclauseinEuropeanandAsiangasimportcontracts,andgaspriceselsewherethroughthesubstitutionmechanism,i.e.,byraisingthepricethresholdswhereconsumerscansavemoneybyswitchingfromgastocompetingfuels.

Gasmarkettighteningbecameanissueinlate2000whenUSpricesquadrupled.USgasdemandincreasedbymorethan4%in2000,andthepowersector’sdashforgaspromisedfurthergrowth.USgasproductionhadbeenflatforsomeyears,butfewhadbotheredtolookforstructuralreasons;consumptionhadalsobeenflatsotherehadbeennoneedformoresupplythanwasavailableattheprevailingprices.In2000,however,itbecameclearthatthesurplusproductioncapacitythathadensuredlowpricesthroughthe1990swasgone.TheUSgassupplycurvehadsteepenedandpricesrespondedaccordinglytotheincreaseindemand.PricesrevertedtotheUSD2-3/MMBturangeinlate2001

thankstoweatherandothercircumstancesthatwipedoutthepreviousyear’sdemandgrowth,butstartedtoclimbagainin2002,andHenryHubpeakedatclosetoUSD14/MMBtuonamonthlyaveragebasisinthewakeofhurricanesKatrinaandRitaintheautumnof2005.FollowingaperiodofrelativenormalityHenryHubinthesummerof2008againtouchedtheUSD13-14/MMBturange,thistimebecauseofacombinationoffactorsincludinghighdemand,recordhighoilprices,alackofLNGfortheUSandbelowaveragestoragelevels.Indigenousproductionhashoweverstagedanunexpectedrecoverywithhighpricesandnewtechnologymakingshalegasandotherunconventionalgaseconomic.

ContinentalEuropeangasbuyershadafter2007tocopewiththeimpactofsharplyrisingoilprices.GasimportpricesmorethandoubledbetweenJune2007andJanuary2009.

TheUK’sgrowinggasimportdependenceandrecurrentneedtocompetewithotherimportersforsupplyconstituteastronglinkbetweenUKandContinentalEuropeangasimportprices.ThustheNBPpricewasbymid2008forecasttoclimbatanevenfasterpacethanContinentalpricestoensureBritishcompetitivenessduringthewinter.

Becauseoftheaveragingandlaggingnatureofthegasprice–oilpricelink,AsianimportpricesarelikeContinentalEuropeanimportpriceslessvolatilethanUSandNorthwestEuropeanhubprices.Theyhavealsoonbalancebeen1-2dollarsperMMBtuhigherthanUSandEuropeanprices.Thisrelationshiphashoweverbecomelessclearcutsince2005.Asianbuyersstilltendtopaymorefortheirsupplythanotherbuyers,butthedifferenceshaverecentlynarrowedsomewhatandoccasionallytherelationshipshavereversed.

Chart6.1doesnotshowthewiderangeofpricespaidforspotcargosbyJapanese,Korean,Spanishandotherbuyersthatforvariousreasonshaveneededtotopuptheirtermimports.Asianbuyersinearly-mid2008frequentlyofferedUSD15-20/MMBtuforadditionalsupply(Chart6.2).

Chart 6.2: Japanese LNG import prices

6. Recent gas price developments


Japanesecontractpricesin2004-08felloutoflinewithspotpricesduetotheS-curveformulaetypicalforJapaneseLNGimportcontracts.TheseformulaeflattentheLNGprice-oilpricecurveaboveandbelowcertainoilpricelevels.TheupperlevelistypicallyaroundUSD30abarrelwhichwasconsideredarobustpriceatthetimeofcontractsignaturebutcorrespondedtoonly20-25%ofspring-summer2008oilprices.Thelevelsarenotsetinstone–mostcontractsstatethatbuyersandsellersshouldgettogetherandnegotiatenewtermsifitappearsthattheexistingonesnolongerreflectmarketrealities.However,buyershavewaystoputoffsettlements,andmanyhavedoneso.Withrespecttonewcontracts,Asia’smainLNGsuppliersin2008tookadvantageoftheprevailingmarkettightnesstodemandpriceparitywithcrudeoil.AJCCpriceofUSD150/bwouldthentranslateintoanLNGpriceofsomeUSD25-26/MMBtu.AsianLNGbuyersresistedfullparitywithnoS-curveprotectionagainstextremeoilpricesasabasisforlongtermcontracts.Asofearly2009fullparityseemssometimeoff.ThereisevidencethatS-curvesarebeginningtoregaintheirpopularitywithsellersfearfulofcrudeoilpricesintheUSD30-40/bbracketandLNGpricesintheUSD5-6/MMBturange.

Theglobalfinancialcrisishitspotgaspricesintheautumnof2008,reducingHenryHubfrommorethanUSD12/MMbtuinJunetoaroundUSD5,50/MMBtubyendDecember,andtheNBPpricefromUSD12,90/MMBtuinSeptembertoaroundUSD8,20/MMBtuthreemonthslater(Chart3.1).Longtermcontractpricesheldupthrough2008butwerebyearly2009caughtupbytumblingcrudeandoilproductpricesandlookedsettoplummetinthesecondandthirdquarters.

Independentlyofthefinancialcrisis,USgaspriceshavesince2007fluctuatedinarangemakingUSbuyersunpreparedtocompetewithAsianandEuropeanbuyersforspotLNG.TheUShassincethebeginningof2006experiencedaboominunconventionalgasproductionwhich,incombinationwithflatdemand,hasallowedfordeclinesinbothpipedgasandLNGimportsandstillleftthecountrywithadequategasinstorage.Sinceunconventionalgasisrelativelycostlytoproduce,priceslowerthanthoseprevailingbytheendof2008maybeunsustainable.ThenumberofgasrigsinoperationisalreadydowninresponsetotheJuly-December2008pricedownturn.WhethertheUSgassupply-demandbalancewilldrive,andsustain,apricerecoveryanytimesoonishoweverequallyquestionable.

AwiderangeofpossibledevelopmentpathsforUSgasproductionisaddingtotheuncertaintywhetheroilandgaspricesworldwidewilldeclineevenfurther,remaindepressedforalongtimeorrecoverfairlyquickly.Thisconfusionreflectedtheimpossibilityinthemidstofacrisis,withnodistancetothesubjectmatter,offorecastingitsdepthandduration.

However,itneedstoberememberedthat:

• Gaspricesarestillrobustincomparisontothoseprevailingasrecentlyasin2003,

• Thegaspricelevelsof2007andearly-mid2008pointed

towardsdemanddestructiononasignificantscale;thepricedeclinehasdampenedifnoteliminatedthisrisk,

• Gasdevelopmentcostshaveexplodedleavingafairshareoffuturesupplymarginalatearly2009prices,

• Thoughaworldwideeconomicsetbackwilldampencostinflation,

• Thecyclicalcomponentofthisinflation(boomingraw material,engineeringserviceandskilledlabourprices) willnotdisappearovernight,

• Thestructuralcomponentrelatedtotheoilandgas industry’sturntodevelopmentsinmoreremotelocations, deeperwatersandharsherclimateswillnotdisappearatall.

Thus,whilethejuryisstillout,itseemsafairhypothesisthatgaspriceswillrecover–perhapsnotinthemedium-shorttermtolevelscomparabletotheirrecentpeaks,buttolevelsthatwillsupportcontinuedgrowthinsupplyanddemand.

Rest of the world

PriortothefinancialcrisisgaspricesincreasedalsooutsidetheOECDarea,thoughnoteverywhere,andcertainlynotatuniformrates.

CentralandEasternEuropeandtheFSUcountriesthatrelyonRussiangashavehadtoundertakemajorpriceadjustments.Soonafterthebreak-upoftheFSU,theCentralandEasternEuropeancountriesthathadcometorelyoncheapRussianandCentralAsianwerepresentedwithsimilarpriceformulasasthoseunderpinningWesternEurope’sRussiangasimports.MorerecentlytheotherFSUrepublicshavehadtocopewithsimilarsea-changesinthepricingofRussiangas,althoughdifferentcountrieshavebeengranteddifferenttransitionperiodsandwerestillby2008payingsignificantlydifferentprices(Chart6.3)

Chart 6.3: Gazprom prices

TheRussian-Ukrainiandisputeovergasprices,transittariffsandpaymentarrearsthathasreceivedspecialattentionduetoUkraine’sroleastransitcountryfornearlytwothirdsofRussia’s

Source: Spiegel International Online


gasexportstoEurope.Ukraineby2005paidanominalpriceofUSD50per1000cubicmetresorUSD1,38/MMBtuforRussiangas.RussiaraisedthegaspricefirsttoUSD160/1000cmandthentoUSD230/1000cm.Ukrainianpaymentproblemshaveontwooccasions–in2006andagainin2009–ledGazpromtocutitssupplyofgastoUkraineandindirectlytoEurope.AnagreementconcludedinJanuary2009commitsUkrainetopaythe“Europeanstandard”priceminus20%in2009,andthefull“Europeanstandard”pricefrom2010onwards,againstreceivingmarketbasedtransittariffsfortheroughlyfourfifthsofRussia’sgasexportstoEuropethattransitUkraine.ThefinancialcrisiswilllowerRussia’soillinkedexportprices–butwillevidentlyalsoreducetheimportingcountries’abilitytopay.

GazpromcontinuesoadjusttheexistingagreementswithCIScountriesstepbystepinordertomovetocontractualtermsandconditionsandpricingmechanismssimilartothoseeffectiveintheEuropeancountriesbeginningfrom2011.Finallyexportpriceswillreflectfuelmarketconditionsandthepricesofthebestalternativestogas.

Russiaisalsoimplementingdomesticpricereform.Althoughquiteimpressiveinnominalterms(Chart6.4),thepriceadjustmentsmadebetweenthemid1990sand2005onlykeptupwithinflation.Gasbecamesteadilycheapercomparedtooilandcoal.GazpromreportedalossofUSD25billiononitsdomesticsalesbetween1999and2003.ConcernsaboutthesustainabilityofRussia’sgasbalancewithpricesthatfavouredrapidconsumptiongrowthbutdidnotgeneratethefundsneededforthedevelopmentofthenextgenerationofgiantgasfields,wereraised.

Chart 6.4: Russian regulated gas prices to industry

Source: CERA

Russia: Average regulated gas price for industry

In2006thegovernmentrespondedbypresentingaplantoincreasepricestoindustrialconsumerstoparitywithEuropeanborderpricesadjustedfortransportationcosts,by2011.Observersnotingthestrainsthatexposureto‘worldlevel’gaspriceswouldputontheRussianeconomy,greetedthetimelinewithscepticism,andtheoildrivenescalationofEuropeanborderpricesthatstartedin2007madethereformpacerequiredbythe2006planevenfaster.Thegovernmentinmid2008acknowledgedallthisbypostponingthedeadlineforfullalignmentofdomesticindustrial

priceswithexportnetbackprices,to2014-15,andannouncingarevisedscheduleforthe2008-11periodaccordingtowhichpriceswillincreaseby25%in2008,25%in2009,30%in2010and40%in2011.

ThefactthatRussianindustrialandresidentialconsumersin2008paidonlyUSD1,89/MMBtuandUSD1,44/MMBtu3 (netofVAT)forgasindicatesthatthecountryhasalongwaytogotoreachparityinnetbacktermswithEuropeanprices.

TheRussiangovernment’sembraceofthispricingprincipleprobablyinspired–andhasinturnbeenbolsteredby–theCentralAsianrepublics’moreaggressivepricingoftheirgassalestoRussia.Backin2000GazpromtypicallypaidaborderpriceofaroundUSD40/1000cm,orUSD1,10/MMBtu,forTurkmenandotherCentralAsiangas.Inthefirsthalfof2008TurkmenistanreceivedUSD130/1000cmorUSD3,59/MMBtuforitsgas.AtthesametimetheheadsofTurkmenistan’s,Kazakhstan’sandUzbekistan’sstateoilandgascompaniesannouncedthatfrom2009onGazpromwouldneedtopaythepriceofgasonEurope’seasternbordernettedbacktothedeliverypointsforCentralAsiangasonRussia’ssouthernborder.

Inadditiontoraisingregulatedprices,theRussiangovernmentisencouraginggrowthinthehithertotinypartofthegasmarketwithunregulatedprices.AgasexchangeisestablishedandplacedunderGazpromsubsidiaryMezhregiongas.Itremainsembryonic,andexchangepriceshavetodatenotdifferedmuchfromtheregulatedprices.However,itisastart.

TheleadingAsianNon-OECDeconomies,ChinaandIndia,shareadesiretoboostgasconsumption,andaneedtocomplementindigenousgasproductionwithimportedgassupply.Bothcountriesalreadyhavepocketsofdomesticgasdemandreadyforinternationalgasprices.Marketgrowthrequireshowevertheactiveparticipationofthepowersectorandkeyindustriesusedtoburncheapcoalorpriceregulateddomesticgas.ThedifficultiesofacceleratinggaspenetrationinsuchanenvironmenthavestimulatedindigenousgasE&Dinbothcountries.RecentdiscoveriesmayenableamoregradualalignmentofChineseandIndianpriceswiththeJapaneseandKoreanimportpricesthatdefinethealternativecoststosuppliers–butwillnoteliminatetheneedforpricereform.

3 Gazprom reports on its home page regulated prices in 2008 at RUB 1690 per 1000 cubic metres for industrial consumers and RUB 1290/1000 cm for households. The average RUB/USD exchange rate in 2008 was 0,04039.


Chart 6.5: Select Chinese gas prices

Source: ICIS Heren China Gas Markets

Select Chinese gas prices December 08 / January 09

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Retail prices, industry:

Retail prices, households:

Ex-field prices:

LNG prices:

Chinesegaspricesareregulatedbycentralandprovincialauthoritiesandhavetraditionallyvariedacrosslocationsandsectors.Inlate2005anation-widepricereform–thefirstineightyears–wasimplemented,andinlate2007thegovernmentannouncedfurtherpricehikes(withspecial,subsidisedratesremaininginplaceforthefertilizerindustry).Asof2008ex-fieldpriceswereintheUSD4-5/MMBturange,theex-terminalpriceofimportedLNGUSD17-18/MMBtuandretailpricesbetweenUSD5,50andUSD22,50perMMBtudependingonlocationandcustomerclass(Chart6.5).

China’swillingnesstopaytoday’smarketpricesforimportedLNGwaslongindoubt.CNOOC’scontractsforNWSandTangguhLNGweresignedunderthebuyers’marketconditionsthatprevailedintheearly2000sandlaydownDESpricesintheUSD3,00-3,70/MMBtupricerangereflectingoilpriceceilingsofUSD25andUSD38perbarrelrespectively.However,CNOOC’sandPetrochina’smorerecentdealswithPetronas,WoodsideandQatargasarecomparabletotheestablishedAsianimporters’recentcontracts,withtheChinesesideacceptingQatar’s2008insistenceoncrudeoilparitypricing.TheChinesebuyerspresumablyhopetomakeexpensiveLNGmarketablethroughblendingwithmuchcheaperindigenousgas.

InIndiagassupplyhasthreecomponents,eachofwhichispriceddifferently.GasproducedbythestateoilcompaniesONGCandOILissubjecttotheso-calledAdministratedPriceMechanism(APM).In2006-07thisgasmadeupabout65%oftotalsupply.TheAPMpriceisindexedtoabasketoffueloilpricesinsuchawaythatthemarketssegmentseligibleforAPNgasin2008paidwholesalepricesintheUSD2,00-2,40/MMBturangeplustransmissionanddistributionchargesandtaxes.Customersinthenortheastpaidlessaspartofaregionalsupportpolicypackage.Gasproducedbyprivatecompaniesissoldatnegotiatedpriceswithnolinkagetooilandnocaps;recentlypriceshavevariedbetweenUSD3,50andUSD5,70perMMBtu.Finally,regasifiedimportedLNGissoldatpricessetonacostplusbasisandsubjecttogovernmentapproval.

AsChina,IndiasigneditsfirstLNGimportcontracts–withRasGasII–atatimewhenbuyershadtheupperhand.Thus

Petronetbetween2004and2009receivedQatariLNGataconstantpriceofUSD2,53/MMBtu.From2009thepricewillbelinkedtooil,butforseveralyearsthepass-throughfactorwillbemuchlowerthannormalfornewercontracts.Indiahasnotsince20XXsignedanylongtermLNGimportcontractsreflectingthe2008priceenvironmentandalsotheoutlookforrapidgrowthinindigenous–KrishnaGodavaribasin–gasproduction.ButIndianbuyershaveattimesbeenactiveinthespotmarket.

AlsoinLatinAmerica,countriesexperiencinggasdemandpressureandrelyingonimportedgasforsignificantsharesoftheirsupply,arestrugglingtocopewithincreasingpricesofinternationallytradedgas.

OneexampleisBrazilwheregaspricesinnominalUSDtermsincreasedsignificantlyin2003andagainin2005.Anattemptin2004toboostmarketgrowthbyfreezingpriceswasabandonedduetoitsnegativeimpactonE&D.ThepriceoflocallyproducedgasjumpedfromaboutUSD3/MMBtubymid2004toUSD10/MMBtubylate2008(Chart6.6).

Chart 6.6: Brazilian gas prices

Source: Petrobras

Brazilian gas prices Commodity + transportation, 1st quarter '02 - 3rd quarter '08

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IndigenousImportedPower sector rate

In2006Brazilwhichsourcesmorethan40%ofitsgassupplyfromBolivia,waspresentedwitharequestfora120%increaseinthepriceofBoliviangas.LaPazbaseditsclaimon,amongotherthings,thesteepincreaseininternationalgaspricesbetween1999whenBoliviastartedsellinggastoBrazil,and2006.Eventually,thetwocountriessettledforasmallerincrease,buttheepisodeshowedhowinternationalgaspricescanenterintraregionalgaspricenegotiationsasbenchmarkswithouttheexportingcountryhavingtheoptiontoexportgasoutsidetheregionortheimportingcountryhavingtheoptiontoimportgasfromoutsidetheregion,i.e.,withouttheinternationalpriceshavinganyrealsignificanceasalternativecoststoanyofthem.

ArgentineanproducersreceiveonlyaboutUSD1,50/MMBtuforindigenousgas.ThislowpricereflectsdecisionsmadeinthewakeoftheArgentineaneconomiccrisisinthebeginningofthisdecade.ItisaboutonefifthofwhatArgentinapaysforBoliviangasandisnotencouraginggasE&D,whichisonereasonwhyArgentineangasproductionhasstagnatedandshortageproblemshaveemerged.


InMarch2008thegovernmentauthorisedhigherpricesforgasproducedfromnew,remoteortightfieldswithabovenormaldevelopmentcosts.Butthisso-called‘GasPlus’plandoesnotintroducenewpricingprinciples,itonlyamountstoamodernisationofthecostplusapproach.

SeveralLatinAmericancountrieshaveoptedforLNGasameanstoreducetheirdependenceonpipedgasimportsfromtheirneighbours.ExposuretothevolatilityofworldLNGpricesapparentlyseemsalesserevilthantheriskofsupplycut-offsintheeventthattheupstreamcountryneedsthegasforitself.Petrobrasin2008commissionedterminalsatPecéminCearáandatBaíadeGuanabaranearRiodeJaneiro.BothterminalsareLNGtankersmodifiedforonboardregasificationandwilloperatemainlyduringtheBrazilianwinterseason.Argentina’sEnarsain2008commissionedaterminalofthesametypeattheportofBahiaBlanca,400milessouthwestofBuenosAires,partlyinresponsetowarningsthatBoliviawouldnotbeabletomeetissupplycommitmentstoArgentinain2008-09.InChileconstructionofoneterminalatQuinteronearSantiagoandanotheratMejillonersfurthernorthisongoingwithaviewtocommissioningin2009-10,partlyinresponsetotheriskofArgentineangassupplyshortfalls.

Venezuelaalsopracticespriceregulation.Since2001privateproducershavebeenallowedtosellgasdirectlytoend-users,bypassingPdVSA,butbecauseoflimitedaccesstoPdVSA’spipelinesthestatecompanyremainsthemainmarketforprivategas.Moreover,theMinistryofEnergyandPetroleumcapspricesatlevelssupposedlyreflectingAnacoorLakeMaracaibohubcostsandtransportationcostsbutclearlyreflectingother,politicalandsocialconsiderationsaswell.Asimportantly,maximumpricesarequotedinBolivares,andprovisionsforadjustingtheminresponsetoinflationandchangesintheexchangeratedidnotpreventasignificantdropinthedollarvalueofgasintheVenezuelanlocalmarketbetween2000and2004. AfricaandtheMiddleEastarelaggingtheotherNon-OECDregionsinreformingtheirdomesticgasprices.InAlgeriaandLibya,SonatrachandNOCprovidegastobigindustrialandpowersectorcustomersatpricesthatarenotpubliclyavailablebutapparentlylowbyinternationalstandards.Algeriaalsohasasignificantnumberofsmallerscale,residentialandcommercialcustomers,andSonelgazin2006suppliedthesecustomersatafractionofwhatMediterraneanEuropeanresidentialandcommercialgasconsumerspay.InEgypt,EGASpurchasesgasfromvariousupstreamconsortiaatapricelinkedtooilbutuntilrecentlycappedatalowoilprice;forthe2006licensingroundEGASputthemaximumgaspriceatUSD2,57/mcfforoilpricesatoraboveUSD22/b.However,warningsfromkeyupstreamplayersthatEGASneededtopaymoretoenablecompaniestocoverescalatingcostsandsustainE&Din2007broughtresultswithBPandRWEmanagingtonegotiateaceilingofUSD4,84/mcf.Atthesametimehikesinselectendusergaspriceswereannounced,reflectinggovernmentworriesaboutitsfuelsubsidyburdenaswellaswiththesustainabilityofthepaceofgrowthofdomesticgasuse.

In Nigeria,asyettheonlysignificantgasproducersouthofSahara,selectindustrialcustomersreportedlypaypricesthatcoversupplycosts,butthecountry’sbiggestgasuser,statepowerutilityPHCN,in2005paidonlyareported11UScentsperMMBtu.

Nigerianauthoritiesin2008presentedcompanieslookingforopportunitiesinNigerianLNGwitharequesttogetinvolvedalsoindomesticgasandpowersupply.AnewGasMasterPlanpromiseseffortstoturnthecurrentlybadlymismanageddomesticgasandpowersectorsintoattractivetargetsforforeigninvestment.However,theplanremainsshortonspecificsonkeypreconditionslikedomesticgaspricereform,andthecurrentpoliticalsituationinNigeriadoesnotbodewellforconsistentimplementationofpoliciestofixthecountry’sproblems.

TheMiddleEasthasseenevenfewerattemptsatdomesticgaspricereform.InmanyMiddleEasterncountriesgashashistoricallybeenconsideredafreegood,andashighoilpriceshaveboostednationaloilcompanyandstaterevenuesacrosstheregion,theappetiteforfuelsubsidycutsthatonecoulddetectinthelate1990shaswaned.

Iranhaskeptdomesticgaspriceslowwiththepurposeofencouragingsubstitutionfromoilproductstogaswhereverpossible,andalsoforsocialandpoliticalreasons.ThereportingonIranianendusergaspricesisnotparticularlyconsistent.Thehighestestimateavailable–fromFacts–putsthepriceschargedtodifferentmarketsegmentsintheUSD0,20-1,00/MMBturange(Chart6.7).

Chart 6.7: Iranian gas prices

Source: Facts Global Energy

Iranian domestic gas prices, 2007-09

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FuelsubsidiesrepresentamajorburdenontheIranianbudget.Butwithoilbeingmorevaluablethangas,andwithNIOCstrugglingtosustainIran’soilexports,untilspring2008noonesuspectedthegovernmentofplanninggaspricereforminitiatives.

Nevertheless,inMay2008governmentofficialsdidannounceaplantohikedomesticgaspricestoencourageenergyconservationandfreeupgasforexports.


Apparentlytheannouncement–whichcouldberelatedtoTurkmenistan’sdecisiontodoublethepriceofTurkmengastoIran–includedneitherdetailsontheplannedextensivenessofthereformnoratimeline,anditremainstobeseenwhetherandwhenadjustmentswithsufficientbitetohaveanimpactondemandpatterns,willbeenacted.

Saudi Arabiangassalespricesarenotpublicbutarepresumablyconsistentwiththegaspurchasepriceannouncedin2003in

thecontextofthe‘gasopening’,ofUSD0,75/MMBtuattheinlettotheSaudiMasterGasSystem,minusatariffforuseofthissystemforonwardtransportation.SaudiArabiastickstoitspolicyofofferingcheapgastoattractinvestmentsinpetrochemicalandothergasintensiveindustries,eveninthefaceofagasshortagesoseverethatpowerplantsintendedtorunongasrecentlyhaveburnedcrudeoilinstead.

7. Current extensiveness of individual pricing mechanisms

Introduction

ThissectionconsiderscurrentpracticewithrespecttowholesalecontractpriceformationforbothpipelinegasandLNG.Weproceedfromamappingofcurrentpricingmechanismsaroundtheworld,notonlyforgastradedinternationally,butalsoforgasproducedandconsumedwithincountries.IGUmembershaveprovideddataforalmost100countries,andNexanthavecollatedandanalysedthem.Themappingofpricemechanismswasfirstundertakenfortheyear2005andwasrepeatedfor2007.Thissectionreportslargelyonthe2007resultswithsomecomparisonsagainstthe2005results.

Wefocusasnotedonwholesaleprices.Wholesalepricescancoverawiderangeofprices.Theonlypriceswhichareclearlynotincludedarethepricesofgastoendusers.Intradedmarkets,suchastheUSAandtheUK,thewholesalepricewouldtypicallybeahub price(e.g.HenryHubortheNBP).Inmanyothercountries,wheregasisimported,itcouldtypicallybeaborder price.Themoredifficultcasesarecountrieswhereallgasconsumedissuppliedfromindigenousproduction,withnointernationaltrade(eitherimportsorexports)andtheconceptofawholesalepriceisnotrecognised.Insuchcasesthewholesalepricecouldbeapproximatedbywellhead prices or city-gate prices.Generallythewholesalepriceislikelytobedeterminedsomewherebetweentheentrytothemainhighpressuretransmissionsystemandtheexitpointstolocaldistributioncompaniesorverylargeendusers.

Theinitialdatacollectionwasdoneonacountrybasis.ThedatawerethencollatedtoaregionallevelusingthestandardIGUregionsshowninChart7.1.Mostoftheregionsaredefinedalongtheusualgeographiclines,althoughtheIGUincludesMexicoinNorthAmerica,anddividesAsiaintoaregionincludingtheIndiansub-continentplusChina,calledAsia,andanotherregionincludingtherestofAsiaplusAustralasiawhichiscalledAsiaPacific.

Chart 7.1: IGU regions

North America

Latin America

Africa

Europe FSU

Middle East Asia

Asia Pacific

IGU regions

Dataforeachcountrywerecollectedinastandardformat.Asanexample,adatacollectionformfortheUKisshowninthechartbelow.Individualcountrygasdemandmaybesuppliedfromanyonecombinationofthreesources–indigenousproduction,pipelineimportsandLNGimports(storageisignoredforthepurposeofthisanalysis).Foreachofthesethreesourcesseparatelydatawascollectedonwhatpercentageofthewholesalepriceforthatcategoryisdeterminedbyeachmechanism.Insomecountries,onesinglemechanismwasfoundtocoveralltransactionsandthatmechanism,therefore,wasallocated100%.Inmanycases,however,severalmechanismswerefoundtobeoperating,inwhichcasesestimatesweremadeofthepercentagesforeachpricemechanism.Theonlyconstraintisthatthetotalforeachsourceofgasmustaddupto100%.

Informationwasalsocollectedonwholesalepricelevelsin2007and2005.Thiscoveredtheannualaveragepriceandthehighestmonthlyaveragepriceandlowestmonthlyaverageprice.Allpriceswereconvertedto$/MMBtu.Acommentssectionwasincludedtoidentifyandacknowledgethesourceoftheinformationandanyotherusefulinformation.


AlldataintheIGUstudyongasvolumesforconsumption,production,importsandexportsistakenfromtheIEAdatabase,supplementedwherenecessarybytheUSEnergyInformationAdministrationandanyspecificcountryand/orregionalknowledge.

Chart 7.2: Data collection formData Collection Form

CountryRegionVolumes 2007: BCM

Pipeline LNG Pipeline LNG91.4 72.4 28.0 1.5 10.4 0.0

Oil Price Escalation

Gas-on-Gas Competition

Bilateral Monopoly

Netback from Final ProductRegulation: Cost of ServiceRegulation: Social and PoliticalRegulation: Below Cost

No Price

Not Known

Total

Comments

Completed By

Estimated 2007 Wholesale Price Range ($/MMBTU)

Average High Low

$5.89 $10.57 $3.35

100.0%

United KingdomEurope

Consumption Production Imports Exports

Wholesale Price Formation

ImportsPipeline LNGDomestic Production

76.5%

100.0%

100.0%

100.0%

23.5%

Mke Fulwood - Nexant

The EU Energy Sector Inquiry found that in the UK around 40% of long term contracts use a marketbased gas price index as the escalator. The remaining 60% predominantly use oil price indexation withsome inflation element. However, les than 40% of domestic UK production is under long term contractwith the other 60% being traded on the spot market and therefore automatically priced on the NBP index(source for this information was an OIES study on the UK gas market updated for recent data from IEAand Heren). It is thought that all pipeline and LNG imports are priced against the NBP. UK importspipeline gas from Norway, Netherlands, Belgium and Germany and LNG from Trinidad, Qatar, Egyptand Algeria.

100.0%

Data Collection Form


Price Formation Mechanisms

Types of Price Formation MechanismInpreparationfortheinitialdatacollectionexercisefor2005,aseriesofdiscussionswereheldatthePGCB2subgroupmeetingsontherangeofdifferenttypesofpossiblepriceformationmechanisms.

Itwasdecidedtouseforcategorisationpurposestheeightwholesalepricingmechanismsoutlinedabove.Fortheremainderofthissectionthefollowingabbreviationswillbeused:

GOG Gas-on-GasCompetitionOPE OilPriceEscalationBIM BilateralMonopolyNET NetbackfromFinalProductRCS RegulationCostofServiceRSP RegulationSocialandPoliticalRBC RegulationBelowCostNP NoPriceNK NotKnown

Inadditiontocategories1-8itprovednecessarytohavea‘notknown’categoryforthoseinstanceswherenoinformationwasfoundonhowaparticularcomponentofgasconsumptioninaparticularcountryispriced.

Results

Format of ResultsInlookingatpriceformationmechanisms,theresultshavegenerallybeenanalysedfromtheperspectiveoftheconsumingcountry.Withineachcountrygasconsumptioncancomefromoneofthreesources,ignoringwithdrawalsfrom(andinjectionsinto)storage–domesticproduction,importedbypipelineandimportedbyLNG.Inmanyinstances,aswillbeshownbelow,domesticproduction,whichisnotexported,ispriceddifferentlyfromgasavailableforexportandalsofromimportedgaswhetherbypipelineorLNG.Informationwascollectedforthese3categoriesseparatelyforeachcountryand,inaddition,pipelineandLNGimportswereaggregatedtogivetotalimportsandaddingtotalimportstodomesticproductiongivestotalconsumption.Foreachcountry,therefore,priceformationcouldbeconsideredin5differentcategories:

• Indigenousproduction(consumedwithinthecountry,i.e.notexported)

• Pipelineimports• LNGimports• Totalimports(pipelineplusLNG)• Totalconsumption(indigenousproductionplustotalimports)

EachcountrywasthenconsideredtobepartofoneoftheIGUregions,asdescribedintheIntroduction,andthe5categoriesreviewedforeachregion.FinallytheIGUregionswereaggregatedtogivetheresultsfortheWorldasawhole.

Intermsofthepresentationofresults,theWorldresultswillbe

consideredfirst,followedbytheRegionalresultsfortheseparateregions–NorthAmerica,LatinAmerica,Europe,FormerSovietUnion,MiddleEast,Africa,AsiaandAsiaPacific.

Aswellascollectinginformationonpriceformationmechanismsbycountry,informationwasalsocollectedonwholesalepricelevelsineachcountry.Theseresultsonacountryandregionalbasisarealsopresentedtogetherwithananalysisofpricetrends.

World Results

Beforeconsideringtheresultsonpriceformationmechanisms,theregionalpatternsofconsumptionandproductionwillbeconsidered.Thediscussionoftheresultsonpriceformationmechanismswillshowcomparisonsbetween2007and2005fortheWorldandwhererelevantforregionsbutthereisanadditionalsub-sectionwhichexplainsdirectlythereasonsforthechanges.

World Consumption and Production

In2007totalworldconsumptionandproductionwasoftheorderof2,980bcm.Chart7.3belowshowsthedistributionofworldconsumption.

Chart 7.3: World gas consumption 2007

World gas consumption 2007

North America27 %

Latin America4 %

Europe18 %

Former Soviet Union23 %

Middle East10 %

Africa3 %

Asia5 % Asia Pacific

10 %

2,982 bcm

Sources: BP, IGU

NorthAmericaandtheFormerSovietUnion,followedbyEuropearethemainconsumingregions,anditistheseregions,therefore,whichwillhavethegreatestinfluenceontheresultsonpriceformationmechanismsattheWorldlevel.TheMiddleEastandAsiaPacificwillalsohaveanimportant,butsmaller,influence.

Withrespecttoworldgasproduction,thelargestconsumingregion–NorthAmerica–waslargelyself-sufficientin2007.TheFormerSovietUnionwasanetexporter,principallytoEurope,whichwasanetimporter.AsiaPacificwasanetimporter,principallyfromtheMiddleEast,whileAfricawasanetexporter,mainlytoEurope.AsiaandLatinAmericawerelargelyself-sufficient.


Chart 7.4: World gas production, 2007

World gas production, 2007

North America26 %

Latin America5 %

Europe10 %Former Soviet

Union28 %

Middle East12 %

Africa6 %

Asia5 %

Asia Pacific8 %

2,988 bcm

Sources: BP, IGU

Concerningimportsbypipeline(bothintra-andinter-regional),Europeaccountsformorethanhalfoftheworldtotal.BothEuropeanintra-regionalgasimports(Norwaytovariouscountries)andEurope’simportsofgasfromoutsideEurope(RussiaandAlgeria)areverysignificant.Intheotherregions,pipelineimportsareallintra-regional.

Chart 7.5: World pipeline gas imports, 2007

World pipeline gas imports, 2007

North America18,4 %

Latin America2,0 %

Europe52,1 %

Former Soviet Union23,0 %

Africa0,2 %

Asia0,4 %

Middle East1,4 %

Asia Pacific2,4 %

710 bcm

Sources: BP, IGU

Withrespecttogasexportsviapipeline,theFormerSovietUnionin2007accountedforsome46%oftheworldtotal.Africa,meaninginthiscaseAlgeria,isalsoasignificantexportertoEurope,whileanytradeintheAsianandAmericanregionsisintra-regional.

Chart 7.6: World pipeline gas exports

World pipeline gas exports, 2007

North America18,4 %

Latin America2,0 %

Europe24,3 %


Middle East1,1 %

Africa6,4 % Asia

1,8 %

Asia Pacific1,0 %

710 bcm

Sources: BP, IGU

LNGimportsaredominatedbyAsiaPacific–principallyJapan,Korea,andTaiwan,withEuropebeingthesecondlargestimportingregion.WhencomparedwiththeLNGExportschart,muchoftheAsiaPacifictradeisintra-regional,buttheregionalsoimportssignificantquantitiesfromtheMiddleEast,whileAfricaandLatinAmerica(Trinidad)arekeyexporterstoEuropeandNorthAmerica.

Chart 7.7: World LNG imports, 2007

World LNG Imports, 2007

North America10,3 %

Latin America0,6 %

Europe23,5 %

Asia Pacific59,5 %

FSU 0,0 %

Africa0,0 %

Asia6,1 %

Middle East0,0 %

225 bcm

Sources: BP, IGU

Chart 7.8: World LNG exports, 2007

World LNG Exports, 2007

Africa27,2 %

Asia0,0 %

Asia Pacific38,5 %

Latin America8,0 %

Europe0,1 % Middle East

25,7 %

FSU 0 %North America

0,6 %

225 bcm

Sources: BP, IGU


Price formation: Indigenous production

Chart 7.9: World price formation 2007 – indigenous production

World price formation 2007: Indigenous production

Oil Price Escalation

5 %


36 %

Bilateral monopoly

1 %Netback1 %

Regulation COS4 %

Regulation social/political

14 %


38 %

Not known0 %

No price1 %

2,048 bcm

Indigenousproduction,consumedinowncountry,accountedforjustover2,000bcmin2007,slightlylessthan70%oftotalworldconsumption.ThetwolargestpriceformationcategorieswereGOG–accountingforsome36%mainlyinNorthAmerica,UKinEuropeandAustraliainAsiaPacific–andRBC–accountingfor38%,largelytheFormerSovietUnionandMiddleEastwithsomeinAfrica.RSPat14%isspreadthroughallregionsapartfromNorthAmerica.RCS,at4%,isprincipallyinAfricaandAsia.ThereisasmallamountofOPEinEuropeandAsia.Comparedto2005thechangeshavebeenminor–marginalincreasesinGOGandRBC.

Chart 7.10: World price formation 2005 – indigenous production


BIM4 %


34 %

Regulation COS4 %

Netback1 %


16 %

No price2 %

Not known 0 % Oil price escalation

4 %


35 %

1,940 bcm

Price Formation: Pipeline Imports

Pipelineimportsat710bcmaccountforsome24%oftotalworldconsumption.Threecategoriesaccountforinternationallytradedpipelinegas–OPEalmostallinEurope;GOGinNorthAmericawithsmallamountinEuropeintoUKandBIMalmostallintra-FormerSovietUniontrade.Comparedto2005,therehavebeenincreasesinGOGandBIMattheexpenseofOPE.

Chart 7.11: World price formation 2007 – pipeline imports

World price formation 2007: Pipeline Imports

Bilateral monopoly27 %


26 %


47 %

710 bcm

Chart 7.12: World price formation 2005 – pipeline imports

World price formation 2005: Pipeline imports

Gas-on-gas competition 22 %


55 %


660 bcm

Price Formation: LNG Imports

LNGimportsat225bcmaccountforsome7,5%oftotalworldgasconsumption.InternationallytradedLNGislargelydominatedbyOPEintoEuropeandAsiaPacific.GOGismainlyNorthAmericawithsomespotLNGcargoesintoEuropeandAsiaPacific,whilethesmallamountofBIMisinAsiareflectingtheLNGcargoestoIndia.Comparedto2005,GOGhasgainedsignificantlyattheexpenseofOPE,largelyreflectingtheincreaseinspotLNGcargoes.

Chart 7.13: World price formation 2007 – LNG imports

World price formation 2007: LNG imports

Oil price escalation70 %

Bilateral monopoly3 %Gas-on gas

competition27 %

225 bcm


Chart 7.14: World price formation 2005 – LNG imports



13 %


Oil price escalation 83 %

190 bcm

Price Formation: Total Imports

Totalimportsat935bcmaccountforsome32%oftotalworldconsumption.53%isOPEwithEurope(pipelinemainly)andAsiaPacific(LNG)dominating.GOGisbothpipelineandLNGimports,withBIMlargelyintra-FormerSovietUnionpipelinetrade.GOGandBIMhavegainedsignificantlyattheexpenseofOPEcomparing2007and2005.

Chart 7.15: World price formation 2007 – total imports



13 %


Oil price escalation 83 %

190 bcm

Chart 7.16: World price formation 2005 – total imports

World price formation 2005: Total Imports


62 %


20 %

Bilateral monopoly

18 %

850 bcm

Price formation: Total consumption

Therespectivesharesoftotalworldconsumptionforeachpriceformationmechanismreflectlargelythedominanceofdomesticproductionconsumedinowncountry.OPEbecomesmoreimportantbecauseofitsdominanceingastradedacrossborders.

Justover50%oftotalconsumptioniseitherOPEorGOG,whilejustunder40%issubjecttosomeformofregulatorycontrolincludingRBC,whereitcouldbesaidgasiseffectivelysubsidised.RegulationofwholesalepricesoccursinallregionsapartfromNorthAmerica.

ThesmallamountofNETpricingisinLatinAmerica(Trinidadtomethanolplants)whileNP(gaseffectivelygivenaway)isprincipallyintheFormerSovietUnion(Turkmenistan),MiddleEastandNorthAmerica(inMexico,wherePemexrefineriesandpetrochemicalplantsusegasasa“free”feedstock).

Comparedto2005,GOGandRBChaveincreasedtheirrespectiveshares,largelyattheexpenseofOPEandRSP.

Chart 7.17: World price formation 2007 – total consumption

World price formation 2007: Total consumption


32 %

Regulation below cost 26 %


Netback from final product 1 %


3 %


9 %

No price1 %

Not known0 %


2,982 bcm

Chart7.18:Worldpriceformation2005–totalconsumption

World price formation 2005: Total Consumption

Regulation below cost23 %



32 %

Regulation cost of service 3 % Bilateral monopoly

8 %Netback from final product

0 %


11 %

No price1 %

Not known0 %

2,790 bcm


Regional resultsInpresentingtheWorldresultsall5identifiedcategories–DomesticProduction,PipelineImports,LNGImports,TotalImportsandTotalConsumption–werereviewedandanalysed,andalsocomparedwith2005.Attheregionallevelnotallthecategorieswillberelevant,forexample,theremaybelittleornoLNGimportsintoaregion,andtheremaybenomaterialchangesfrom2005.Thedataandchartspresentedforeachregion,therefore,willdifferdependingontherelevanceofeachconsumptioncategory,andanychangessince2005.

North America

IntermsofanIGUregion,NorthAmericaconsistsofonly3countries–Canada,USAandMexico–butitisthelargestconsumingregion.

Table 7.1: North America consumption and production 2007 (BCM)

Pipeline LNG Pipeline LNGUSA 652.9 545.9 108.9 20.7 22.0 1.2Canada 94.0 183.7 13.2 107.3Mexico 54.1 46.2 8.8 2.5 1.6Total North America 801.0 775.8 130.9 23.2 130.9 1.2

ExportsCountry Consumption Production Imports

ConsumptionisdominatedbytheUSA,whichisalsobyfartheregion’slargestproducer.Allpipelinetradeisintra-regionalwiththeUSAimportingfromCanada,butalsoexportstobothCanadaandMexico.USALNGexportsarefromAlaskatoJapan,whileLNGimportsareprincipallyfromTrinidadbutalsosignificantamountsfromtheMiddleEastandAfrica.

Chart 7.19: North America price formation 2007 – total consumption

North America price formation 2007: Total consumption


98,7 %

No price1,3 %

800 bcm

ThegasmarketintheUSAiscompletelyderegulatedandallpricesareeffectivelysetbygas-on-gascompetition.Imports,whetherbypipelineorLNGareeffectivelyprice-takers.ThemarketinCanadaislinkedtotheUSAmarketsandthepriceformationmechanismisthesame.MexicoimportsgasfromtheUSatUSprices.Fordomesticallyproducedgas,areferencepriceisset,whichisbasedontheUSpriceattheUS-Mexicoborder,plusthecostoftransportationtotheLosRamones“hub”.FromtheLosRamones“hub”furthersouththereferencepricegetsreducedbasedontransportationcosts.However,some10bcmofgasisestimatedtobeusedbyPemexforitsowninternal

consumption,relatedtofeedstockforpetrochemicalplants,fuelforequipmentinrefineriesandplantsandforsecondaryoilrecovery.ThisgasisnotpricedandhasbeenallocatedtotheNoPricecategory.

Latin America

Table 7.2: Latin America consumption and production 2007 (BCM)

Pipeline LNG Pipeline LNGArgentina 44.1 44.8 1.9 2.5Bolivia 1.8 13.5 11.7Brazil 22.0 11.3 10.0Chile 4.4 2.0 2.4Colombia 7.7 7.7Dominican Republic 0.6 0.6Ecuador 0.3 0.3Peru 2.7 2.7Puerto Rico 0.7 0.7Trinidad 20.9 39.0 18.2Uruguay 0.1 0.1Venezuela 28.5 28.5Total Latin America 133.6 149.8 14.3 1.2 14.2 18.2

Country Consumption Production Imports Exports

LatinAmericangasislargelyproducedandconsumedwithineachindividualcountrywithVenezuela,ColombiaandPerubeingcompletelydomesticmarkets.Allpipelinetradeisintra-regionalwithArgentinaimportingfromBoliviabutalsoexportingtoChile.BoliviaalsoexportsgastoBrazil.EventhenalmostallofArgentina’sconsumptionisdomesticallyproducedandhalfofBrazil’s.

LatinAmericaconsumptionat134bcmaccountsforlessthan5%oftotalworldconsumption.ThetradedpipelinegastoBrazilandChilemainlyaccountformostoftheOPE.Wholesalepricesinthetwolargestconsumingcountries,ArgentinaandVenuezela,arelargelydeterminedbyregulatoryand/orgovernmentcontrol(RSP).SomelargecustomersinArgentinaarefreetonegotiatedirectlywithcompetingsuppliers(GOG),asarepowergeneratorsinTrinidad(BIM).NETisinTrinidadwheregasisprovidedtoMethanolplants.Comparedto2005themainchangesareincreasingsharesofGOG(inArgentina)andOPE(inBrazil)attheexpenseofRSP.

Chart 7.20: Latin America price formation 2007 – total consumption

Latin America price formation 2007: Total consumption


48,2 %

Regulation cost of service8,0 %

Netback from final product11,4 %

Bilateral monopoly4,7 %


8,3 %

Oil price escalation 19,5 %

134 bcm


Chart 7.21: Latin America price formation 2005 – total consumption




2 %



9 %


5 %


60 %

Regulation below cost2 %

125 bcm

Europe

Table 7.3: Europe consumption and production 2007 (Bcm)

Pipeline LNG Pipeline LNGAustria 8.9 1.4 7.5Belgium & Luxembourg 16.9 19.3 3.2 4.5Bosnia-Herzegovina 0.4 0.4Bulgaria 3.1 3.1Croatia 3.1 2.0 1.1Czech Republic 8.9 0.3 8.6Denmark 5.0 10.4 5.3Estonia 1.0 1.0Finland 4.3 4.3France 43.2 1.0 29.1 12.6FYROM 0.1 0.1Germany 82.7 14.3 83.7 16.4Greece 4.0 2.9 0.8Hungary 11.8 1.3 10.5Ireland 4.8 0.6 4.2Italy 84.9 9.7 71.5 2.4 0.1Latvia 1.6 1.6Lithuania 3.8 3.4Netherlands 37.2 64.5 18.9 50.1Norway 4.3 89.7 86.1 0.1Poland 13.7 4.3 9.3Portugal 4.2 1.9 2.3Romania 16.4 11.6 4.8Serbia & Montenegro 2.3 0.2 2.1Slovakia 5.9 0.1 5.8Slovenia 1.1 1.1Spain 35.1 11.0 24.2Sweden 1.0 1.1Switzerland 2.9 3.0Turkey 35.1 30.6 6.0United Kingdom 91.4 72.4 28.0 1.5 10.4Total Europe 539.2 283.8 369.8 53.0 172.7 0.1


EuropeishighlydependentonimportedgasbothbypipelineandLNG.Ofthelargestconsumers,onlytheUKproducedthemajorityofitsgasrequirements,andthissituationisrapidlychanging.NorwayandtheNetherlandsprovidedasignificantproportionoftherestofEurope’spipelinesupplies,butEuroperemainedheavilydependentonRussianandAlgerianpipelinesupplies.ThemajorimportersofLNGwereSpainandFrancewithAlgeriabeingtheprincipalsupplier,butsignificantquantitiesofLNGwerealsosourcedfromWestAfricaandtheMiddleEast.

OutofthetotalEuropeanconsumptionin2007of539bcm,only117bcm(22%)wasproducedandconsumedwithinthecountryandhalfofthiswasintheUKmarket.ThechartbelowshowsthepriceformationmechanismsforthisindigenousproductionwithGOGat44%andOPEat35%dominating.ThiswasintheUK,wheresomeoftheoldercontractsstillretainkeyelementsofOPE,butalsointheNetherlandsandItalywheredomesticproductionislargelyonanOPEbasis.

WholesalepricesfordomesticproductionremainedregulatedonaRSPbasisinPolandandRomania.ThereweresmallelementsofNETinNorwayandBIMinDenmark.NPwasinNorwayreflectingreinjectedgas.

Chart 7.22: Europe price formation 2007 – indigenous production

Europe price formation 2007: Domestic production


13,6 %

No price2,8 %Regulation cost

of service2 %


Netback0,6 %

Oil price escalation35,2 %


45,2 %

123 bcm

Thesituationfortotalimports(bothpipelineandLNG,comprising424bcmor78%oftotalconsumption)ismarkedlydifferent,withOPEdominatingat82%.GOGat16%ispredominantlytheUK,plusIreland,butalsoinothermajorEuropeancountrieswheretradinghubsaredevelopingandinSpain,reflectingspotLNGcargoes.TheBIMcategory(2%)islargelyaccountedforbyimportsintotheBalticStates(Estonia,LatviaandLithuania)andBulgariafromRussia.

Chart 7.23: Europe price formation 2007 – total imports

Europe price formation 2007: Total imports



15,5 %


424 bcm

Intotal,at540bcm,Europeaccountsforaround18%ofworldconsumption.Thedependenceinimports,mostofwhicharepricedonanOPEbasis,isillustratedinthechartabove,withOPEat72%.GOGislargelytheUKmarket,plusthedevelopingtradinghubsincontinentalEurope.Comparedto2005,GOGhasgainedattheexpenseofOPEastradinghubsdevelopedandspotLNGcargoesincreased.


Chart 7.24: Europe price formation 2007 – total consumption

Europe price formation 2007: Total consumption



3,0 %



22,0 %

No price0,6 %


540 bcm


0,1%

Chart 7.25: Europe price formation 2005 – total consumption



Regulation cost of service0,3 %Netback

0,1 %Bilateral monopoly1,6 %


15,5 %


2,7 %No price

0,6 %

540 bcm

Former Soviet Union

Table 7.4: FSU consumption and production 2007 (BCM)

Pipeline LNG Pipeline LNGArmenia 2.1 2.1Azerbaijan 8.3 10.3 0.0 2.0Belarus 20.8 0.2 20.6Georgia 1.7 1.7Kazakhstan 13.3 29.6 7.2 15.2Kyrgyzstan 0.8 0.0 0.8Moldova 2.8 0.1 2.7Russian Federation 481.5 647.0 68.1 233.7Tajikistan 0.7 0.0 0.6Turkmenistan 23.5 72.3 0.0 48.8Ukraine 69.8 20.6 59.2 5.1Uzbekistan 50.6 65.3 0.0 14.7Total FSU 675.9 845.5 163.0 0.0 319.5 0.0


TheFormerSovietUnionregionisdominatedbyRussia,bothasthelargestconsumerandproducerofgas.Alltheimportedgaswithintheregionisintra-FSUtradei.e.noimportscomefromoutsidetheregion.RussiaexportsgastoalmostallitsneighbouringcountriesbutKazakhstan,TurkmenistanandUzbekistanarealsoexporters,includingtoRussia.Russiaisalsoamajorimporterofgas,togetherwithUkraine.

At675bcmtheFormerSovietUnionaccountsforaround23%ofworldconsumption.AllimportedgasispricedonaBIMbasis.Thedominantpriceformationmechanism,however,isRBCinRussia,Turkmenistan,UzbekistanandKazakhstan.

However,thissituationinRussia,atleast,isbeginningtochangewithincreasedpricestodomesticconsumersraisinglevelsabovetheaveragecostofproductionandtransportation.DomesticproductioninUkraineistheRSPcategoryandNPinTurkmenistan.Comparedto2005RBChasincreaseditsshare,inpartduetochangingconsumptionpatternswithintheregion.

Chart 7.26: FSU price formation 2007 – total consumption

FSU price formation 2007: Total consumption


1,1 %Bilateral monopoly

24,1 %


72,7 %


1,6 %

No price0,6 %

675 bcm

Chart 7.27: FSU price formation 2005 – total consumption



1,1 %Bilateral monopoly

24,1 %


72,7 %


1,6 %

No price0,6 %

675 bcm

Middle East

Table 7.5: Middle East consumption and production 2007 (BCM)

Pipeline LNG Pipeline LNGBahrain 11.5 11.5Iran 111.8 111.9 6.1 6.2Iraq 2.5 2.5Israel 0.7 0.7Jordan 2.4 0.2 2.4Kuwait 12.6 12.6Oman 10.9 24.1 1.0 12.2Qatar 20.5 59.8 0.8 38.5Saudi Arabia 75.9 75.9Syria 5.3 5.3United Arab Emirates 43.2 49.2 1.8 7.6Total Middle East 297.3 353.7 10.2 0.0 7.9 58.2


TheMiddleEastregionislargelyaninsulatedmarketintermsofgasconsumptionwithverylittlegasbeingtraded(excludingexports)acrossborders.SmallquantitiesofgasareimportedbyIranfromTurkmenistanandJordanfromEgypt.


MiddleEastconsumptionat297bcmaccountsforaround10%oftotalworldconsumption.ThedominantpriceformationmechanismintheregionisRBCinlargelyIran,SaudiArabia,KuwaitandQatar.TheRSPcategoryisaccountedforbytheUAE,wherepriceisregulatedbyeachemirate.TheBIMcategoryrelatestoIranianimportsfromTurkmenistanandthetradesfromEgypttoJordanandOmantotheUAE.Chartfor2005isnotshownastherehasbeenalmostnochange.

Chart 7.28: Middle East price formation 2007 – total consumption

Middle East price formation 2007: Total consumption


80,3 %

Not known 0,8 %


14,2 %

No price1,3 %

Bilateral monopoly

3,4 %

297 bcm

Africa

Table 7.6: Africa consumption and production 2007 (BCM)

Pipeline LNG Pipeline LNGAlgeria 24.4 83.0 34.0 24.7Angola 0.8 0.8Egypt 32.0 46.5 2.4 13.6Equatorial Guinea 1.3 2.7 1.4Ivory Coast 1.3 1.3Libya 5.2 15.2 9.2 0.8Nigeria 14.8 35.0 21.2South Africa 2.2 2.2Tunisia 4.3 2.5 1.3Total Africa 86.3 189.2 1.3 0.0 45.6 61.6


Excludingitsexporttrade,Africahasvirtuallynotradedgas,withonlyTunisiaimportingsomegasfromAlgeriaviathepipelinetoItaly.

Intermsofconsumption,Africaisthesmallestregionat86bcm,or3%oftotalworldconsumption.Wholesalepricesarehighlyregulated,withRBCaccountingforjustoverhalf,inEgyptandNigeria.RCSispredominantlyAlgeriaandRSPinLibyaandSouthAfrica.TheOPEcategoryreflectstheonlytradedgaswithTunisiaimportingfromAlgeria.Comparedto2005RBChasincreaseditssharelargelyattheexpenseofRCS,reflectingchangingconsumptionpatterns.

Chart 7.29: Africa price formation 2007 – total consumption

Africa price formation 2007: Total consumption



9,0 %


54,2 %


5,0 %No price0,9 %

Netback1,1 %

86 bcm

Chart 7.30: Africa price formation 2005 – total consumption



48,2 %



11,2 %


5,7 %No price

1,1 %Netback

1,2 %

75 bcm

Asia

Table 7.7: Asia consumption and production 2007 (BCM)

Pipeline LNG Pipeline LNGAfghanistan 0.2 0.2Bangladesh 16.3 16.3China 67.3 69.3 3.9 3.0China Hong Kong 3.0 3.0India 40.2 30.2 10.0Myanmar 4.8 14.7 9.9Pakistan 30.8 30.8Total Asia 162.6 161.5 3.0 13.9 12.9 0.0


Againthereisnotalargeamountoftradedgaswithinthisregion–ChinaHongKongimportsfromChina,whileIndiaimportsLNG,principallyfromQatar.China,IndiaandPakistanarethelargestconsumers.ChinaandIndiaareexpectedtoincreasegasconsumptionsignificantlyfrombothindigenousresourcesandimports.

Asiaaccountsforjustover5%ofworldconsumptionat163bcm.Regulationofwholesalepricesiswidespread.RSPat51%ispredominantlyChinaandIndia,RCSinPakistanandRBCinMyanmar.OPEat12%isinBangladeshandLNGintoChina.TheBIMcategoryisIndianLNGimports,andprivategasproductioninIndia,plusHongKongimportsfromChina.GOGisspotLNGcargoesintoIndia.Comparedto2005,RSPandRCShavedeclinedwithOPE,GOGandBIMgaining,inpartreflectingchangingconsumptionpatterns.


Chart 7.31: Asia price formation 2007 – total consumption

Asia price formation 2007: Total consumption



3,4 %




51,2 %


3,0 %

163 bcm

Chart 7.32: Asia price formation 2005 - total consumption




3,4 %




51,2 %


3,0 %

163 bcm

Asia Pacific

Table 7.8: Asia Pacific consumption and production 2007 (BCM)

Pipeline LNG Pipeline LNGAustralia 25.1 40.0 20.2Brunei 2.9 12.3 9.4Indonesia 33.8 66.7 5.4 27.7Japan 90.2 1.4 88.8Malaysia 28.3 60.5 1.8 29.8New Zealand 3.7 4.0Philippines 3.4 3.4Singapore 7.2 7.2South Korea 37.0 2.6 34.4Taiwan 11.8 0.9 10.9Thailand 35.4 25.9 9.9Vietnam 7.7 7.7Total Asia Pacific 286.5 225.4 17.1 134.1 7.2 87.1


AfterEurope,AsiaPacificistheregionmostheavilydependentoninternationallytradedgas,principallyLNGintoJapan,KoreaandTaiwan,althoughmuchoftheLNGcomesfromwithintheregiontogetherwithimportsfromtheMiddleEast.AdistinguishingfeatureofJapan,KoreaandTaiwanisthattheyarevirtuallytotallydependentonLNGimportsforalltheirgasconsumption,leadingtowhatsomemightarguearethepremiumpricespaidforthegas.ThepipelineimportsareintoSingaporefromIndonesiaandMalaysiaandThailandfromMyanmar.At286bcm,AsiaPacificaccountsforjustunder10%oftotalworldconsumption.Over50%ofgasisimportedbycountries.

OPEat52%isthelargestcategoryandcomprisesLNGimportsintoJapan,KoreaandTaiwan,pipelineintoSingaporeanddomesticproductioninThailand.GOGisAustraliaandspotLNGtrade.BIMismainlyimportsintoThailandandsomeinIndonesiaandNewZealand.RSPisthemajorityofwholesalegasinIndonesiaandMalaysia.RCSisVietnam.Comparedto2005,GOGandOPEhavegainedshares,principallyattheexpenseofRSP.

Chart 7.33: Asia Pacific price formation 2007 - total consumption

Asia Pacific price formation 2007: Total consumption



16,3 %




19,3 %

Not known 1,9 %

286 bcm

Chart 7.34: Asia Pacific price formation 2005 - total consumption






24,8 %

Not known 2,0 %


11,8 %

280 bcm

Wholesale Prices

AswellascollectingdataonpriceformationmechanismstheIGUstudyalsocollectedinformationonwholesalepricelevelsin2007.AsnotedintheIntroduction,theresultshereshouldbetreatedasbroadordersofmagnitude,sincethedefinitionofwholesalepricesisquitewide.Itistypicallyahubpriceoraborderpriceinthecaseofinternationallytradedgas,butcouldalsoeasilybeawellheadorcity-gateprice.


Chart 7.35: World average wholesale gas prices by region

World: Average wholesale prices by region 2007

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Middle East

Former Soviet Union

Africa

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Asia

Total world

Asia Pacific

North America

Europe

$/MMBTU

Thechartaboveshowsasnapshotofpricelevelsfor2007.Fromyeartoyear,wholesalepricescanchangesignificantly,asdiscussedbelow.Generallythehighestwholesalepricesareinregionswhere,itcouldbesaidthat,thereismore“economic”pricing–GOGandOPE–inNorthAmerica,EuropeandAsiaPacific.ThelowestwholesalepricesaregenerallywhereregulationdominatesintheMiddleEastandFormerSovietUnion,particularlyRBC.

Theseconclusionsareillustratedmoreclearlyinthechartbelowwhichconsiderswholesalepricesattheindividualcountrylevel,atleastforthosecountrieswithmorethan10bcmannualconsumption.OnlyTurkmenistanismissingwithover10bcmconsumption.Thehighestwholesalepricesin2007werefoundintheLNGdependentcountriesinAsiaPacific(SouthKoreaandTaiwan).ThesewerefollowedbyawholehostofEuropeancountriesheadedbyBelgiumandFrance,andthenNorthAmerica.Atthebottomofthechartweregenerallycountrieswherewholesalepricesweresubjecttosomeformofregulation,typicallyRBC–Iran,Nigeria,SaudiArabia,RussiaandEgypt–plusArgentinaandVenezuela.

Chart 7.36: World average wholesale gas prices by country

Average wholesale prices by country 2007

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NigeriaIran

UzbekistanUAE

Saudi ArabiaQatarOman

BahrainArgentina

VenezuelaKuwait

KazakhstanEgypt

RussianChina

TrinidadAlgeria

MalaysiaBelarus

BangladeshPakistan

IndiaAustraliaUkraine

IndonesiaThailandRomania

BrazilUnited Kingdom

CanadaMexico

SpainUSA

PolandItaly

JapanNetherlands

GermanyTurkey

HungaryFrance

BelgiumTaiwan

South Korea

$/MMBTU

Countries over 10 bcm annual Consumption

World average $4.50

Analternativewayofanalysingthedataistocategorisebypriceformationmechanism.ThehighestwholesalepricesareOPEfollowedbyGOG.Atthebottomend,asmightbeexpected,wholesalepricesdeterminedbyRBCarelessthenRSPwhich,

inturn,arelessthenRCS.ThelowlevelofwholesalepricesforNETarepresumablyaffectedbylowcommoditypricesforthefinalproducts–almostallTrinidadandsomeinNorway.TheresultforBIMislargelyimpactedbythelowerlevelsofwholesalepricesinintra-FormerSovietUniontrade.

Chart 7.37: Wholesale prices by price formation mechanism, 2007

Wholesale prices by price formation mechanism 2007

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Thechartsabovearefor2007onlyandpresent,therefore,onlyasnapshotofpricelevels.ThechartbelowshowspricesovertimeforHenryHubandNBP(bothGOGmarkets)andGermany,Spain,Japan/Korea(allOPEmarkets)andforRussianexportstoFormerSovietUnioncountries(BIM).In2005GOGpriceswereaboveOPEpricesbutsince2006GOGpriceshavegenerallybeenbelowtheOPEmarketprices.Throughthe1990sHenryHub/NBPpricesweregenerallybelowJapan/Korea,GermanyandSpainprices.PricesofRussianexportstoFormerSovietUnioncountrieshaveveryrecentlystartedtoriseasRussiamovestowardsmore“market”pricing.

Chart 7.38: Wholesale price trends 1989 - 2008

Wholesale price indicators

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Henry Hub NBP Germany Spain Jap/Kor Rus to FSU

Thenextchartsimplifiesthelastone,usingspecificcountriesasproxiesfordifferentpriceformationmechanisms.Countriesareweightedtogetherusingtheirannualgasconsumptionastheweights.GOGistheweightedaverageofUKandUS(USonlypriorto1997);OPEistheweightedaverageofGermany,Spain,JapanandKorea;andBIMisRussiaexportstoFormerSovietUnioncountries.Theoilprice(WTI)isalsoshownastheblackline,convertedto$/MMBTU.Itisclearherehow


GOGpricesdroppedbelowOPEpricesfromthebeginningof2006.OPEpriceswouldappeartotrackoilpricesprettycloselyformuchoftheperiod,althoughthesharpincreaseinoilpricesfromthebeginningof2007wasonlypartlypassedthroughintoOPEpriceswithalag,andtherecentfallshavenotyetbeentranslatedintolowerwholesaleprices.InthecaseofJapanandKoreatheeffectsofthe“S”curveclausesintheLNGcontracts,mayberesponsibleforthewholesalepricenotfullyreflectingtheriseinoilprices.

Chart 7.39: Wholesale price trends by price formation mechanism 1989 - 2008

Wholesale prices by price formation mechanism

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Oil Price

Changes between 2005 and 2007

Detailsofthe2005priceformationmapping,wereinpartincludedintheResultssectionbutfulldetailsarecontainedinAppendix1.Changesintherelativeimportanceofthedif-ferentpriceformationmechanismscanoccureitherbecauseofdifferentialgrowthinconsumptionbetweencountriesorbecausepriceformationmechanismsthemselveschange.Thetablebelowshowsthegrowthinconsumptionbyregionbetween2005and2007.

Table 7.9: Growth in gas consumption 2005 to 2007

2005 2007 BCM %North America 768.8 801.0 32.2 4.2%Latin America 125.7 133.6 8.0 6.4%Europe 534.6 539.2 4.6 0.9%Former Soviet Union 593.8 675.9 82.1 13.8%Middle East 276.6 297.3 20.7 7.5%Africa 75.1 86.3 11.2 14.9%Asia 134.7 162.6 27.9 20.7%Asia Pacific 279.3 286.5 7.2 2.6%Total World 2,788.5 2,982.3 193.9 7.0%

Region Consumption Changes

Worldgasconsumptiongrewby7%between2005and2007,withfasterthanaveragegrowthintheFormerSovietUnion,AfricaandAsia.TheRBCpriceformationcategoryisrelativelymoreimportantintheseregionsso,otherthingsbeingequal,theshareofRBCmightbeexpectedtorisebetween2005and2007.

Thechartsbelowshowthechangesinthevolumesattributabletoeachpriceformationmechanismandthechangesinpercentageshares.ItappearsthattheshareofRBChasrisenbetween2005and2007,bothinabsolutevolumetermsandinitspercentageshare.

Chart 7.40: Changes in wholesale price formation mechanisms 2005 to 2007

Volume changes in wholesale price formation mechanisms between 2005 and 2007

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InadditiontotheRBCcategoryincreasingitsshare,theGOGcategoryalsoincreaseditsshare.ThesecategoriesgainedlargelyattheexpenseoftheRSPandOPEcategories.Thechangescanbeexplainedasfollows:

• TheincreaseintheRBCcategoryof130bcm(2.9%increaseinshare)wasmostlyasaresultofthefasterconsumptiongrowthintheFSU,particularlyinRussia.Some110bcmoutofthe130bcmreflectsconsumptiongrowth,withonlythebalanceof20bcmreflectingchangesinpriceformationmechanisms(largelyinRussia);

• ThedeclineintheRSPcategoryofsome24bcm,largelyreflectschangesinpriceformationmechanismsinBrazil(towardsOPE),Argentina(towardsGOG),lowerdomesticproductioninUkraine(whichisallRSP)anddecliningconsumptioninMalaysia(againallRSP);

• TheincreaseintheGOGcategoryofsome100bcmandthedeclineintheOPEcategoryarelargelyrelated.TheswitchtoGOGawayfromOPEreflectedrelativelymorespotLNGcargoestoJapan,Korea,TaiwanandSpain,togetherwithincreasedspotvolumesinEuropedeliveredfromtradinghubsinBelgium,France,Germany,ItalyandtheNetherlandstogetherwithadeclineinproductionfromtraditionallong


termcontractsintheUK.ThedeclineintheOPEcategorywaspartlyoffsetbythechangeinBraziltowardsOPEandconsumptiongrowthinAsia,particularlyLNGimportsintoChina.

OverallmuchofthechangeinrelativeimportanceofthedifferentpriceformationmechanismswasduetochangingconsumptionpatternswiththemainswitchingbetweencategoriesoccurringwithmovesawayfromOPEtoGOGasspotLNGtradeincreasedandtradinghubsdevelopedinEurope.

Inrespectofthelevelsofwholesaleprices,theaveragewholesalepricewaslittlechangedbetween2005and2007-$4.50perMMBTUin2007against$4.53perMMBTUin2005.However,asthechartbelowshows,ineverypriceformationcategory,apartfromGOG,pricesrose,sometimessignificantly.InGOGpricesdeclinedasaconsequenceofthefallsintheUSAandtheUKfromthepeaklevelsin2005.

Chart 7.41: Changes in wholesale price levels 2005 to 2007

Wholesale prices by price formation nechanism 2005 & 2007

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Conclusions

In2007justunder70%oftheworld’sconsumptionofgascomprisedofdomesticproductionconsumedwithinthatcountry,withnotradeacrossinternationalborders.Some24%wastradedthroughpipelinesandsome7.5%LNG.Thewholesalepriceformationmechanismsarelargelyverydifferentforinternationallytradedgascomparedtogaswhichisproducedpurelyfordomesticconsumption.

Table 7.10: World price formation 2007 – total consumption (BCM)

OPE GOG BIM NET RCS RSP RBC NP NK TOTNorth America 0.0 790.3 0.0 0.0 0.0 0.0 0.0 10.7 0.0 801.0Latin America 26.0 11.0 6.3 15.2 10.7 64.4 0.0 0.0 0.0 133.6Europe 389.9 118.6 9.7 0.7 2.0 16.0 0.0 3.3 0.0 540.2Former Soviet Union 0.0 7.2 163.0 0.0 0.0 10.6 491.1 4.0 0.0 675.9Middle East 0.0 0.0 10.2 0.0 0.0 42.2 238.6 3.8 2.5 297.3Africa 4.3 0.0 0.0 0.9 25.7 7.8 46.8 0.8 0.0 86.3Asia 19.7 5.5 18.5 0.0 30.8 83.3 4.8 0.0 0.0 162.6Asia Pacific 148.6 46.7 21.7 0.0 8.6 55.3 0.0 0.0 5.5 286.5Total World 588.5 979.4 229.4 16.8 77.8 279.6 781.4 22.6 8.0 2,983.4

20% 33% 8% 1% 3% 9% 26% 1% 0% 100%

Total ConsumptionRegion

Chart 7.42: World price formation 2007 – total consumption



32,8 %



26,2 %

Netback0,6 %

No price0,8 %

Not known 0,3 %



9,4 %


2,982 bcm

Thechartaboveillustratestheoverallresultsattheworldlevel,whilethetablelooksatthebreakdownbyregion.

• ThelargestpriceformationcategoryisGOGat33%,butthisisduetotheimpactoftheNorthAmericanmarket,whichispredominantlydomesticgasproduction,plussmallerquantitiesintheUKand,inAsiaPacific,AustraliaandspotLNGcargoes;

• TheOPEcategoryat20%,isgenerallyonlyfoundininternationallytradedgas,whichismainlypipelineandLNGinEuropeandLNGinAsiaPacific;

• TogethertheGOGandOPEcategories,whichcouldbesaidtoreflectan“economic”or“market”valueofgas,accountforover50%oftotalworldconsumption;

• Wholesaleprice“regulation”,whichcovers3categories–RCS,RSPandRBC,accountsfor38%oftotalworldconsumption,butisonlyfoundindomesticgasproductionandnotinternationallytradedgas.TheRBCcategoryin2007wasthelargest,asaconsequenceofthelowlevelsofpricesintheFormerSovietUnion,mainlyRussia,andtheMiddleEast.WhilewholesalepricesinRussiahaveremainedregulatedtherehavebeenrecentpriceincreases,whichwouldmeanthatmostofthemarketmaybemovingfromtheRBCcategory,probablytotheRSPcategory;

• TheRSPcategory,at9%,isfoundacrossallregions,apartfromNorthAmerica;

• TheBIMcategory,at8%,ismainlytradedgasbetweentheFormerSovietUnioncountries,principallyRussianexports,plus,inAsiaPacific,importedgasintoIndiaandThailandandpartlydomesticallyproducedgasinIndonesia.

Inrespectofwholesalepricelevelsin2007,thechartbelowshowsthatpricelevelsweregenerallyhigherintheOPEmarketsofAsiaPacificandEurope,followedbyGOG,predominantlyintheUSAandUK.Atthebottomend,asmightbeexpected,wholesalepricesdeterminedbyRBCarelessthenRSPwhich,inturn,arelessthenRCS.TheresultforBIMislargelyimpactedbythelowerlevelsofwholesalepricesinintra-FormerSovietUniontrade.


Chart 7.43: Wholesale prices by price formation 2007


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Therehavebeensomechangesintherelativeimportanceofthedifferentpriceformationmechanismsbetween2005and2007,butmuchofitwasduetochangingconsumptionpatternswiththemainswitchingbetweencategoriesoccurringwithmovesawayfromOPEtoGOGasspotLNGtradeincreasedandtradinghubsdevelopedinEurope.

Partsoftheworldareintransitbetweengaspricingmechanisms.Othersaretryingtofixproblemswiththeirexistingmechanismswithoutplungingintotheunknownsofall-outsystemreform.Yetothersdonotenvisagesignificantchanges,eitherbecausetherearenoperceptionsoftensionscallingforreleasemeasures,orbecausetherearenoperceptionsofbettermodels,orbecausetherisksofreformareconsideredtoohigh.

Sellers’,buyers’andregulators’preferenceswithrespecttoretaining,adjustingorreplacingpricingmechanismsareinfluencedbyanumberoffactors:

• Relativeefficiencyinresourceallocationtermsofalternativemechanisms

• Priceoutlookunderalternativemechanisms• Longtermgassupplyanddemandconsequencesofalternativemechanisms

• Pricevolatilityunderalternativemechanisms• Priceriskmitigationopportunitiesinalternativemechanisms• Budgetaryandmacroeconomicconsequencesofalternativemechanisms

• Politicalrisksofmovingawayfromexistingmechanisms• Othertransitioncosts

8. Trends in the extensiveness of individual pricing mechanisms

Efficiencyargumentsaretypicallyheardfromproponentsofgas-on-gascompetitionbasedpricing.Onlywhengaspricesareallowedtoreflectgassupplyanddemandwillthesociallyoptimalamountofresourcesflowtothegassectorrelativetootherworthycauses.

Theoutlookforgaspricesisoneverybody’smind,anddifferentpricingmodelsmaydeliverdifferentprices.However,theimportanceofthisfactorwillvary,andwhileonemodelmaybethemost(least)attractivefromaseller’s(buyer’s)pointofviewunderonesetofcircumstances,itmayscoredifferentlyunderanothersetofcircumstances.

In2008ContinentalEuropeanandAsianoillinkedpricesoutpacedNorthAmericangas-to-gascompetitionbasedprices.Againthismaybeseenasproofofthegasindustryadvantages,andconsumerdisadvantages,ofoillinkedgaspricing.Buttherehavebeenperiodsinthisdecadewhentherelationshiphasbeentheopposite.

Anotherobservationisthatatleastoverlongperiodsoftimeoillinkedandgas-on-gascompetitionbasedpricestendtomoveprettymuchinparallelduetolinksprovidedbyinterfuelcompetitionandinternationalgastrade.

Theonlyfirm–butalsorathertrivial–conclusionthatcanbemadeontherelationshipbetweengaspricingmodelandgaspricelevel,isthatashiftfromsubsidisedtounsubsidisedpriceswillpushpricesup.

ThelongtermimpactofalternativepricingmechanismsongassupplyanddemandhasbeenahottopicinparticularinEurope.Observers,andthegasindustryitself,in2008notedtheincongruencebetweentheneedforgastoremainthepreferredfueltothepowersectorifweweretoseefurthergrowthinoveralldemand,andthedisincentivesthatoillinkedgaspricesatUSD100-150/boilrepresentedtothedispatchingofexistingandthebuildingofnewgaspowerplants.

Ontheotherhand,demanddestructionfirstbecameabigissueintheUSfollowingthegaspricespikein2005,andthesupplyboostingimpactofthepost2000pricegaspriceenvironmentisnowheremoreobviousthanintheUS.Soagainitisnotsothatonepricingmodelnecessarilyrepresentsabiggerthreattofuturegasdemand,andabiggerencouragementtofuturegassupply,thananother.

Gaspricevolatilityisgenerallyseentobeaproblemmainlyforactorsinliberalisedmarketswithgas-on-gascompetitionbasedpricing.Andindeed,Europe’sandAsia’soillinkedpricesare


lessvolatile,reflectingthewaytheindicesaredefined.Withgaspricessettoreflecttheaverageofoilpricesoveraperiodoftimemanymonthspriortodelivery,shorttermpeaksandtroughsareautomaticallysmoothenedout.

However,apartfromthefactthatpricevolatilitytomanyactorsrepresentsopportunitiesratherthanproblems,itmightnotbeverydifficulttoshapethepriceclauseinacontractbasedongasindexationsoastoobtainthesamesmootheningeffect.

Todecisionmakersincountrieswithheavilyregulatedgasmarketswherepricesareadjustedasrarelyaspossible,thevolatilityaspectmayneverthelessseemastrongdeterrenttoconvertdirectlytogas-to-gascompetitionbasedpricing.

Priceriskmitigationopportunitiesbecomeindispensableaspricevolatilityincreases.Whendemandforsuchtoolsarises,banksandsimilarinstitutionsnormallyrushintoprovidethem.However,alimitedavailabilityofriskmitigationopportunitiesintheearlyphasesofmarketliberalisationmaycontributetotheresistancethatproposalstoshiftfromonepricingmodeltoanothertypicallyencounter.

Thebudgetaryandmacroeconomicconsequencesofleavinggaspricingmechanismsastheyare,orembarkingonreform,andtheinevitablepoliticalrisksofreform,needtobeconsideredinthosecountriesthatpracticebelowcostregulation.Fuelsubsidiesareweighingheavilyonmanyemergingeconomies’budgets.TheIEAestimatedforitsWorldEnergyOutlook2008thatgassubsidiesin2007costtheRussianstateclosetoUSD30billionandtheIranianstatemorethanUSD15billion.Eventheoilexportingcountriesthatrecentlybenefittedfromrecordhighpricesfeelthepinch.Ontheotherhand,raisingdomesticfuelpricestooquicklymightboostinflationandtriggerpoliticalandsocialunrest. Finallytheremaybeothertransitioncostsrelatedtothedismantlingofoldinstitutionsandtheestablishmentofnewones,theteachingofnewrulesofthegametomarketactorsandregulatorsandpossibledislocationsinthetransitionperiodfromtheoldsystemsstopsfunctioningproperlytothenewonestartsworking.

Clearlythedriversforswitchingtootherpricingmodels,andthusthelikelihoodthatchangeswilltakeplace,differstronglyfromregiontoregion:

North America and the UK

IntheUS,CanadaandtheUKthathaveadoptedgas-on-gascompetitionasthepricingmechanismtherearevirtuallynocallsforshiftstoothermechanisms.Thereisconcernaboutthelevelofpricevolatility,andadebateinvolvingmarketactors,regulators,politiciansandobserversabouthowtodealwiththeharmfuleffectsofpricespikesandtroughs.Butthereislittletalkaboutareturntomoreregulationorforashifttosomevariationonthemarketvaluepricingtheme.Assuch,gaspricedeterminationthroughmultiplesellerscompetingformultiple

buyerswithminimalregulatoryinterference(apartfromtariffcontrolofthenaturalmonopolyelementsinthesupplychain,akathetransmissionlink)seemstobewidelyperceivedasanendstatewithoutmoreefficientalternatives.

Continental Europe

WithrespecttoContinentalEurope,theEUcommission’selectricityandgasliberalisationagendasreflecttheviewthattheincumbentsdominatingelectricityandgassupplyandcross-bordertradeinEuropehaveexploitedtheirmonopolistoroligopolistpositionstosecureunreasonablemarginsforthemselvesinsteadofdeliveringmaximumbenefitstotheconsumers.Inanyevent,itisargued,theincumbentsneedtobeexposedtocompetitiontostayefficient.

Specifically,thecommission’sinitiativeshaveaimedatsecuringaccessatequitabletermstoEurope’selectricityandgasgridsfornewplayers,looseningthegripoflongtermtakeorpaycontracts,andpavethewayforgas-to-gascompetitionbasedpricingasanalternativetooilindexedpricing.

TheCommission’sprioritiesarebeingsharedtovaryingdegreesbytheEUmemberstates’governmentsandcommercialactors.Individualmemberstatepositionsdifferbecausetheirincumbentgascompaniesdifferininterestsandinfluence,andbecauseviewsontheoptimalextentofregulationofeconomiclife,andtheproperinfluenceofBrusselsonnationalpolicymaking,stillvaryalot.

Moreover,positionsarechanginginresponsetochangesinthecontextandtothesurfacingofnewissues.Duringthe1990ssignsofglobalwarmingtriggeredadebateonthesustainabilityofpoliciestobringdownfuelpricesbyprovidingformorecompetitioninthefuelsectors,giventheenvironmentaldownsidesofcontinuedfuelconsumptiongrowth.Inrecentyearsgassupplysecurityconcernshavetriggeredadebateonthecompatibilityofopenaccesstogasinfrastructure,ashorteningofcontractsandpricessetthroughgastogascompetitionwiththerequiredfastgrowthininvestmentsinincreasinglyremoteupstreamoptionsandexpensivemidstreamsolutions.

Asforthecommercialactors,withoilpricesatrecordlevelsandwithaseriesofnewgasimportfacilitiesunderconstructionoratthedrawingboard,asof2008Europe’sgassuppliersseemedtobelievethatoillinkedpriceswillholdupbetterthangas-on-gascompetitionbasedprices.

AnotherfactoristheremaininglackoftrustinEurope’sgashubsassourcesofreliablepriceinformation.ApartfromtheUK’sNationalBalancingPoint(whichthoughsignificantisdwarfedbytheUS’HenryHub),Europeanhubsremainsmallandthinlytraded.Illiquidityspellsunpredictabilityandentailsariskofmarketmanipulation.Incontrast,themarketsforthecrudeoilsandrefinedproductsarevast,liquidandwellunderstoodbyeverybodyinvolved.

Thus,whiletherehasbeenconsiderablemovementonthegrid


accessissue,thereisforthemomentstronginterestinretainingoillinkedpricing.Europeangasmarketplayershavealsoputupastrongfightontheprincipleoflongtermcontracts.

Testifyingtothecontinuedsympathyforoillinkedpricing,Gazpromin2006-07renewedastringofmajorgassalesagreementswithWesternEuropeanbuyersonoilterms.

Sellers’andbuyers’perceptionsoftheprosandconsofalternativecontractformsandpricingmodelsarenotsetinstone.Gas-on-gascompetitionbasedpricingwilllikelygaingroundasmorehubsmature.Additionallycoalindexationcouldcometobeseenasanalternative.Thefactremainsthatthegasindustryneedstolooktoasectorwhereoilisnolongeraninterestingalternativeforfurthergrowthopportunities(Chart8.1).Gaspricesmirroringrecordhighoilpricescouldasnotedstopthatgrowthinitstracks.

Chart 8.1: Electricity generation by source in IEA Europe

IEA Europe: Electricity generation by source, 1973-2004

0 %10 %20 %30 %40 %50 %60 %70 %80 %90 %

100 %

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OthersHydroNuclearGasOilCoal

1974: Oil share 25%

2004: Oil share 4%

Source: IEA

Thisbeingsaid,thetransformationoftheContinentalEuropeangasmarketwillneitherbefastnorproceedatthesamepaceacrosscountries.Gasmarketbasedpricing,oillinkedpricingandformulaeinvolvinglinkstoinflation,tocoalortoelectricity(the“sparkspread”)willlikelycontinuetocoexistformanyyears.

Asia Pacific

TheestablishedAsianLNGimportersarestickingtocrudeoilindexationasthedominantimportedgaspricingmechanism.Gas-on-gascompetitionbasedpricingisnotatarget.Gasmar-ketbasedpricingisforthetimebeingnotanoptionotherthanforspotcargosanywaysincetheOECDPacificgasmarketsarecharacterisedbylimitedcompetitionandhavenogashubs.

TheJapanesegasandpowerutilities,KogasandTaiwan’sCPChavetraditionallypaidmorethanEuropeanandNorthAmericanbuyersfortheirLNGimports.Thisismainlybecauseoftheirtraditionalpreoccupationwithsupplysecurityandabilitytopassthecostsofaddedsecurityontotheircustomers.Japaneseenduserprices,totakethemasanexample,havebeenregulatedbytheMinistryofEconomy,TradeandIndustryonacostplusbasis.Someofthesecompaniescampaignedforlowerpricesintheearly2000s,inresponsetoIndia’sandChina’ssuccessesinsecuring

cheapLNG,butsinceIndonesia’ssupplychallengesbecamemanifesttheirmaininteresthasagainbeentosecurevolumes.

TheJapanesegasmarkethastraditionallybeenhighlyfragmentedwithregionalmonopoliestoleratingnocompetitionwithintheirconcessionareasandrefrainingfromgoingforcustomersinneighbouringregions.Thisischanging,withtherevisedGasUtilityLawinJapanprovidingforthirdpartyaccesstoLNGterminalsandpipelines.Also,customersusinginexcessof100,000cmofgasayeararenowallowedtonegotiatetheirownpriceswithsuppliers.Butregulatoryreformisonlythefirststeptowardsalevelplayingfieldandrealcompetition.

ThechangesthatareoccurringinAsianLNGimportandgasenduserpricingarechangeswithintheparadigmofoillinkedprices.AstheAsianLNGmarkettightened,thegasprice–oilpricecurvesteepenedtowardsfullparityinenergyequivalencetermsbetweenLNGandcrudeoilimportprices.AlsotheSshapeofthecurvethatJapanesebuyersprefer–i.e.,theceilingofferingprotectiontothebuyerifoilpricesshouldincreaseaboveapresetlevelandthefloorofferingprotectiontothesellerifoilpricesshouldbecometoolow–cameunderpressure.ThefinancialcrisisandthecurrentoutlookforslowergrowthinLNGdemandinaperiodwhenmuchnewLNGwillcomeonthemarket,havereversedthesetrendsbutnotaffectedtheoillink.

However,theglobalisationoftheLNGbusiness,thegrowthinLNGspottransactionsasashareoftotalLNGsalesandpurchases(Chart8.2)andinthefuturetheemergenceofLNGtransactionsacrossthePacificwillshapeAsianbuyers’pricinghabitstoo.KogasusesthespotmarkettomanageseasonalswinginKorea’sgasdemand.Asaresultofseveralnuclearincidents,since2006alsoJapanesebuyershavebeenactiveinthespotmarket.Japanin2007hadtocompeteonpriceforaround20%itstotalLNGsupply.Forthemoment(1stquarter2009)AsianbuyersarenotveryactiveintheLNGspotmarketbutdemandcouldbouncebackoncethefinancialcrisisisover.AsianbuyerswillthenneedtoreckonwithHenryHubandtheNBP–i.e.,indirectlywithsupplyanddemandconditionsinNorthAmericaandEurope–asreferencesthatsometimeskickinasfloors,othertimesasceilings.

Chart 8.2: Asian LNG importers’ spot purchases

Established Asian LNG importers' spot purchases, 1995-2007

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Non OECD Incountrieswheregasenduserpricesaresetbelowsupplycostsandwherethegovernmentisabletoensurethatgasdemandgrowthisaccommodatedbysupplygrowth,gassubsidisationmayincreasetothepointofrepresentingaseriousdrainonthebudget.AccordingtoIEAestimates,gassubsidisationisanissueforIran,Russia,Ukraine,Kazakhstan,PakistanandArgentinainparticular(Chart8.3).

Chart 8.3: Energy subsidies by fuel in non-OECD countries, 2007

Energy subsidies by fuel in non-OECD countries, 2007

Source: IEA: World Energy Outlook 2008

Gassubsidisationtakesaparticularlyheavytollinperiodsofextraordinaryhighinternationalgaspriceslike2007and2008.Countriesthatimportorneedtostartimportinggasfinditincreasinglyhardinsuchperiodstosustaindomesticpricefreezesorveryslowpriceadjustmentschedules.

Whiledomesticpricingoptionsnarrowedforanumberofgasimportingcountries,theywidenedin2007-08forsomeoilandgasproducersandexporters.Thesecountrieshadspendingpowersthenthattheydidnothaveinthelate1990s,andmayhavefeltemboldenedtocontinueignoringrecommendationstodismantlesubsidyarrangements.

Thefinancialcrisishasinasensereversedthesituation.Gashasbecomemoreaffordableandthesubsidisationofgasenduserpriceshasbecomelessburdensomeinabsoluteterms.However,oilandgasexportersneedtocopewithmountingcurrentaccountandbudgetdeficitsandmaybelessabletosustainsubsidiesnowthanbeforethecrisisbroke–andsincethecrisishasweakenednotonlyoilandgaspricesbutmostcommodityprices,allcountriesontheIEA’slistareprobablynowfacingbiggersubsidyburdensrelativetotheirabilitytopay.

Governmentsasarulerespondintwoways:byliberalisingpricestoselect,presumablyrobust,customers,andbyraisingremainingregulatedpricestotheextentpoliticallypossible.Typically,householdsandimportantindustriessuchasthefertilizersectorcontinuetoenjoysomeprotection.

Russia–theworld’sbiggestgasproducerandexporter–hasembarkedonaprocessofaligningdomesticpriceswiththeopportunitycostsofsellingthegasathome,i.e.,withthenetback

totheproducersiftheyhadexporteditinstead,andthereiseveryreasontobelievethatthisprocesswillbecompleted,ifnotnecessarilyonschedule.

Othergasproducersareproceedingmorecarefully.Theycanholdbackforawhilebutnotnecessarilyforever.

ChinaandIndiafacethedilemmathatifgasistobecomeakeyfueltothepowersector,andnotjustamarginalfuelforpeakloadgeneration,andifimportedgasistobecomeanimportantpartofthesupplypicture,coalpricesneedtoberaisedtomakegascompetitive.

WhiletheMiddleEast’sandNorthAfrica’sneedsforgasforpowergenerationanddesalinationisbooming,thetworegions’associatedgasproductionistypicallystagnantordeclining,forcinggovernmentstoaddnon-associatedgastodomesticgassupplytomakeendsmeet.Sincenon-associatedgasdevelopmentsrequireupstreaminvestmentsandcarrymuchhighercoststhanassociatedgas,thisaggravatesthebudgetaryconsequencesofcontinuedgassubsidisation.

Inthelate1990swhenoilpricesdippedbelowUSD10abarrelandtheoilexportersranuprecordtradeandfiscaldeficits,apreparednesstodiscussdomesticpricereformcouldbedetectedacrossarangeofgasproducingcountries.SaudiArabia,VenezuelaandothersthattookstepstoinvolveIOCsinnon-associatedgasE&Dneededtomaketheeconomicsofinvolvementlookviable.However,asoilpriceshavereboundedandtheoilexportersareagainaccumulatingtradeandfiscalsurpluses,the“gasopenings”ofthelate1990s/early2000sseemhavelostmomentum.

Towards a globalisation of gas pricing?

Internationalgastradeservestoalignpricesacrosscountriesand–possibly–continents.Thisis,simplyspeaking,becausetradeallowsgastoflowfromtheareaswiththelowestpricestotheareaswiththehighestprices(adjustedfordifferencesintransportationcosts;itisthenetbackthatdrivessellers’prioritisationbetweenmarkets).Intheformerareasthegassupplycurveshiftstotheleft,upthedemandcurve.Inthelatterareasthesupplycurveshiftstotheright,downthedemandcurve.

Themostinterestingcountriesinthiscontextarethosethatentertheglobalmarketplacewithlowerdomesticpricesthaninternationalprices.Theimportersinthisgroupthencomeunderpressuretoraisedomesticpricesnottobeleftwithunsellableimportedgasorincreasedsubsidisationcommitments.Theexporterscomeunderpressuretoraisedomesticpricesbecauseofthelossesincurredbysupplyingdomesticusersatbelowopportunitycosts,and/orbecauseunconstrainedgrowthindomesticconsumptioncouldchokeexportsoff.

Internationalgastradeisgrowing.BPestimatesthatinvolumeterms,worldgasimportsandexportsincreasedfrom335Bcmin1992to776Bcmin2007orbyanaverageof5,8%ayear.Asashareofworldgasconsumption–whichonlyincreasedby


2,5%ayearinthisperiod–importsandexportsnearlydoubledbetween1992and2008.

ContinentalEurope’sinterfacingwithothermarketstructureshasconsiderablymodifieditspricedynamics.TheopeningoftheInterconnectorgaspipelineinOctober1998createdalinkbetweentheoil-indexedNorthEuropeangasmarketsandtheliberalisedUKmarket.TheUK’sseasonaldemandandrelativelyflatproductioncreatedarbitrageopportunitiesforcontinentalbuyerswhocouldbuyUKspotgasinsteadofcontractgaswithintheirTakeorPay(TOP)–AnnualContractQuantity(ACQ)rangesandusestoragetofurtheroptimisetheirpositions.

Thisdevelopmentlookssettocontinue.Severalnewimport-exportpipelinesareunderconstructionornearingtheconstructionstage.Unsurprisingly,Europewhichitslarge,dynamic,oillinkedandincreasinglyintegratedgasmarkets,anditslocationinbetweenhalfadozenorsoofleadinggasproducersandexporters,isthetargetofamultitudeofpipelineprojects.ExamplesonEurope’seasternbordersincludetheRussianNorthandSouthStreampipelines,andNabucco,theIGIprojectandtheTAPprojectthatcompeteamongthemselvesandwithSouthStreamforsupplyfromtheCaspianandGulfareas.Furthertothesouth,onenewAlgerianexportpipeline–MedgaztoSpain–isclosetocompletion,andanother–GalsitoItaly–isgoingforward,LibyaisplanningtoextendthecapacityofitsGreenStreampipeline,andEgypt’sArabGasPipelinehasreachedSyriaandcould,dependingontheavailabilityofgasforpipelineexports,beextendedtoLebanonandTurkey.InthemoredistantfutureapipelinecouldlinkNigeriaandEuropeviaAlgeria.InChinathesecondWest-Eastpipelineisunderconstruction,andwillbeextendedtopickupCentralAsiangas.ChinaisalsolikelysoonerorlatertogainaccesstoRussianpipedgas.

Howeveritistheinternationaltradeinliquefiedgasthatisseeingthefastestgrowthandmakesobserverswonderhowsoonthecharacteristicsofanintegratedglobalgasmarketwillbeinplace.

ThoughLNGmakesuponlyabout30%ofworldgastrade,andlessthan8%ofworldgassupply,LNGisbeginningtodynamicallylinkmorethanhalfofglobalgasconsumption.AndthelistofcountriesimportingLNGandgaininganexposuretoglobalgaspricesissteadilygrowing.In2008BrazilandArgentinacommissionedregasificationterminals,andCanada,Chile,Croatia,Poland,Singapore,theNetherlands,Germany,Indonesiahavealltakenstepstoenterthissegmentoftheglobalgasmarket.

Chart 8.4: LNG imports and exports by country

LNG exports by country 1964-2007

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196419

6819

7219

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2199

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NorwayEq. GuineaEgyptOmanTrinidad NigeriaQatarAustraliaMalaysiaIndonesiaAbu DhabiBruneiLibyaUSAlgeria

LNG imports by country 1964-2007

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1964196

8197

2197

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8199

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9620

0020

04

Bcm

MexicoChinaIndiaDom.Rep.Puerto RicoPortugalGreeceTurkeyTaiwanSouth KoreaGermanyBelgiumItalyUSASpain JapanFranceUK

Source: Cedigaz

ThegrowthinUSLNGimportsintheearly2000sandthereemergencesince2005oftheUKasanLNGimportermeantadditionalopportunitiesandpriceinfluencesforContinentalEuropeangasbuyers: • ContractLNGdivertedtoUS/UKmarkets:Attimeswhen

HenryHubwashigherthanEuropeancontractprices,FranceandSpainwereabletosellcontractedLNGintheUSandobtain‘back-fill’volumesbyincreasingofftakeundertheirlong-termpipelinegascontractswithintheTOP–ACQband.

• FlexibleLNGdivertedfromUS/UKmarkets:WhenContinentalEuropeanoilindexedpriceshaveexceededHenryHubortheNBPprice,LNGintendedfordeliverytotheUSortheUKmayinsteadbeimportedtocontinentalEurope,withtheimportersloweringofftakeundertheirlongtermpipelinegasimportcontractscorrespondinglywithintheTOP–ACQband.ThishasbeenmadeeasierbythelackoffirmlongtermcontractswithmarketparticipantsintheUKorUS.

TheUKmarketissubjecttotheInterconnectorandLNGdiversiondynamicsdescribedabove.AconflictofmarketmodelsaroseinNovember2005when,facingasupplyshortage,theUKwasexpectingContinentalEuropeanplayerstosendgasboughtfromtheUKtheprevioussummerbacktotheUKinresponsetopricesignals.Thisdidnotoccur.Thecontinentalplayersweremoreconcernedwithensuringadequatesuppliesfordomesticcustomersduringthefirstquarterof2006.

Aninterestingdevelopmentin2007-08wastherapidgrowthinAsianimportsofAtlantic–i.e.,NorthandWestAfrican,CaribbeanandevenNorwegian–LNG.Thistradeincreasedfromsome4,8bcmin2006to9,6bcmin2007andcloseto20bcmin2008.OfferinghighernetbackstheAsianimportersmadeAtlanticsuppliersdivertasmanycargosastheycould,giventheircontractualcommitments,fromtheirregularmarkets.USimportsinthefirst10monthsof2008plummetedbyalmost60%yearonyear. TheAsianimporters’dipsintothepoolofLNGsupplywhichotherwisewouldbedeliveredtotheAtlanticBasinmarketshadconsequencesforoverallLNGavailabilityandrequiredEuropeandNorthAmericatorelymoreongasinstorage.WhileAsian


LNGcontractpricesarelinkedtotheoilprice,spotpurchaseswereapparentlypricedonanAtlanticbasinnetbackbasis,thoughtheycouldalsoreflectsubstitutefuelprices(usuallyinJapanandusuallydistillateprices).

TherewereparticularreasonsfortheAsiancountries’needsforAtlanticLNGin2007-08–inthecaseofJapanTEPCO’stemporarylossofbigpartsofitsnuclearcapacity,inthecaseofSouthKoreaafuzzyregulatorysituationthatpreventedKogasfromsigningnewlongtermcontracts,andinbothcasespoorutilisationofstoragetankstomanageseasonaldemandandIndonesia’sproblemsdeliveringonitscommitments.Someofthesedriverswillweaken,andtheglobalrecessionhasputanendtothesellers’marketconditionsthatcharacterisedLNGin2007-08.In2009fewAtlanticcargoshaveendedupwithAsianbuyers.Onthecontrary,AsiaPacificexportershaveneededtoplaceafewcargoswithAtlanticbuyers.Thesedevelopmentsdonotconstituteevidencethattheintegrationofregionalgasmarketshasstoppedinitstracks,butserveasareminderthattheroadtowardsglobalisedgaspricingmayseeset-backsandcouldtakelongerthanexpected.

Bumps in the road toward globalised gas pricing

Thoughthedifferencesbetweenhowgasispricedinindividualregionsmaynarrow,thedrivingforcesexpectedtodeliverpricealignmentdonotlookaspowerfulastheydidsomeyearsago.TheremayforinstancebereasonstorevisitthequestionhoweffectivelyLNGwillservetointegrateworldmarkets.

ItseemsafairassumptionthattheLNGshareofworldgassupplyneedstoreachacertainthreshold–whateverthatthresholdmaybe–ifLNGistoplayakeyroleindeliveringmarketintegrationandpriceglobalisation.By2008theLNGshareofworldgastradewasabout28%,butregasifiedLNGstillmadeuponly7,5%ofworldgasconsumption.TheconclusionthatLNGremainsanicheproductwithlimitedcapacitytodriveprices,seemstobestillvalid.Moreover,mostLNGchainsarenolessrigidthanpipelinegaschains,withvolumes,sourcesanddestinationslaiddowninlongtermcontracts.ItisonlytheflexibleportionofLNG–thevolumespurchasedbyportfolioplayers,thevolumesavailablefromliquefactionplantsaftercontractualcommitmentshavebeenfulfilled,etc.–thatcanberoutedatshortnoticetothehighestpayingmarkets.

Clearly,evensmallsupplyincrementscanmakeadifferenceintightmarkets.ThusundercertaincircumstancesflexibleLNGmayalreadyhavereached‘criticalmass’initsroleasglobalisationpurveyor.Underothermarketcircumstances,however,thecargosavailableforreroutingwillprobablynotmattermuchtoregionalpricedifferences.

DuringthefirsthalfofthisdecadeforecastersexpectedrapidgrowthinLNGexportsandimports.Thisoptimismreflectedabullishoutlookforgasingeneral,anapparentabundanceofgasreservessuitableforcommercialisationasLNG,favourablegasprice/LNGcostdevelopmentsandotherattractionsofLNGincomparisontopipelinegas–securityofsupplyadvantages

fromthepointofviewofconsumers,arbitrageopportunitiesfromthepointofviewofsuppliers.

Thereisstillmuchenthusiasm,andfairlyrobustgrowthprojections,forLNG.ThereferencescenariointheInternationalEnergyAgency’s2008WorldEnergyOutlookhadLNGsupplyanddemandgrowingby6%ayearbetween2005and2015,and4,7%ayearbetween2015and2020.TheserateswerelowerthanthosesuggestedinpreviousWEOsbutstillalothigherthattheAgency’s2008projectionsfortotalgassupplyanddemand.TheIEAlastyearbelievedthatinabusinessasusualfuturetheLNGshareoftotalgaswouldincreasefrom6,7%in2005to16-17%in2030.

TheglobalizationtrendwillgetaboostfromLNGintheyearsto2011-12.Duringthisperiodsome90mtpaofnewliquefactioncapacitywillbecommissioned.Some15newLNGtrains,includingseveralverybigones,areunderconstructionwithaviewtocompletionbeforetheendof2011.NearlyallthiscapacityistiedintolongtermLNGsalesandpurchasecontracts.However,35%ofthecapacityiscontractedtothemarketingarmsoftheIOCparticipantsintheprojects,andanother24%iscontractedtoQatarPetroleum.Thusalmost60%ofthecapacitytocomeonstreambetweennowandtheendof2011maybecharacterizedasflexible–anditcannotberuledourthatthegasandpowercompaniesandendusersthathavecontractedfortheremainderofthenewcapacityhaveplansoftheirowntoengageinarbitrageplays.

However,thepaceofLNGsupplygrowthbeyond2012isforthemomenthighlyuncertain.In2006-08onlyfiveliquefactionprojectstookfinalinvestmentdecisions.The22-23mtpaofcapacitythattheseprojectswilladdtotheglobaltotalcorrespondstoonlyabouthalfofrequiredincrementalcapacityovertheyearswhentheprojectsmaybeexpectedtocomeonstream–if,thatis,LNGdemandgrowsataround6%ayear.Thelatterassumptionisofcourseopentoquestion.ThecreditcrunchmaywellslowLNGdemandgrowthdownforawhile.Still,theassumptionthattherewillbeenoughflexibleLNGaroundtosupportanyconceivablegrowthinarbitrageoperationsandpricealignmentacrossregionsandbasinsalsobeyond2012,nowseemsbold.

Themostintriguingaspectoftheslowdowninthesanctioningofnewliquefactionprojects,isthatittookplaceinaperiodcharacterizedbyrecordhighoilandgaspricesandextremetightnessintheglobalLNGmarket.In2008LNGbuyerspurchasedspotcargosandsignedshort-mediumtermcontractsatpricesrepresentingparitywithoilatUSD100-150/b.Itwaswidelyassumedthatparitywouldbecomethenormalsoforlongertermcontracts.ThisstilldidnotpersuademanyLNGprojectsponsorstoproceedfromtheplanningtotheimplementationphase.

AstringoffactorshaverecentlythrownspannersinthewheelsofLNGsupplyprojects:


• ProblemsgainingaccesstogasreservessuitableforLNGduetohostcountrygovernmentdecisionstoprioritisesupplyforthedomesticmarketand/orforfuturegenerationsratherthan(additional)LNGexports,

• Shortagesofinputfactors,contractorcapacityandskilledlabourdrivingcostsandunderminingthepretaxeconomicsofLNG;projectsthatseemedrobustsomeyearsagonowlookmarginal,

• Increasinglytoughfiscaltermsashostcountrygovernmentsrespondedtotheshiftfrombuyers’tosellers’marketconditionsbyseekingtoincreasegovernmenttake,

• Persistentlyhighpoliticalriskinkeysuppliercountries,• Projectpartnermisalignment,• TechnicalchallengesrelatedtotheincreasingsizeofLNGplants,andtothelocationofplantstomorechallengingenvironments.

Itremainstobeseenhowquicklythesehurdleswillbeclearedawayoratleastmademoremanageable.Certaincostcomponents,inparticularmaterialcosts,areontheirwaydown.Othersseemquiteresilienttothefinancialcrisis.

Howquicklytheflexible,divertibleshareoftotalLNGwillincreaseisjustasuncertain.Thereareprojectionsofthissharedoublingfrom15%to30%overthenextdecadeaswellasexpectationsofadecline.Unsurprisingly,theAtlanticandMidEastactorsthathavepositionedtobecomeprovidersofLNGhubservicesarethemostoptimistic.AttheotherendofthescalearecertainAsianandEuropeanincumbentspointingtotheJapanesenuclearproblemsandotherspecialcircumstancesthatdrovethegrowthinflexibleLNGin2007-08,andclaimingthatwiththeseproblemsoutofthewayitwillbeineverybody’sinteresttorefocusonlongtermcontracts.

Independentlyofindividualactors’preferences,atriplingofflexibleLNGoveradecade(adoublingoftheflexibleshareofatotalincreasingbyaround50%)couldrequiremoreprojectstobesanctionedwithsmallersharesofoutputunderlongtermcontracts,thanhostgovernments,companysponsorsandthefinancialcommunityseemtobereadyfor.

LNGprojectsponsorsmayhavehesitatedtoproceedtoFIDalsobecauseofdoubtsaboutthesustainabilityofthe2007-08LNGmarketboom.Inthefirstplace,thereweresignsthatthepricesin2007andthefirstquartersof2008wouldleadtodemanddestruction.Secondlysomeplayersmayhavesuspectedthatthepriceexplosionin2008waspartofabubblethatwouldburst(althoughveryfewseemedtohaveanticipatedsomethinglikethecurrentpriceanddemandcollapse).

SponsorsprobablyalsonoticedthatUSLNGdemandwasnotdevelopingasexpectedintheearly2000s.

NorthAmericawas–andis–akeypieceofthepuzzleexpectedtogiverisetooneintegratedworldgasmarketandglobalisedgaspricing.ItwasthenewoutlookforUSLNGrequirementsthatemergedafterthe2000-2001USgaspricespike,andFERC’s2002“Hackberrydecision”tostoprequiringso-called

openseasonsfornewregasterminals,thatgottheglobalizationdebatestarted.

TheUSmarkethad,itwasargued,whatnoothersinglenationalmarketorclusterofnationalmarketshad:Thesize,thehubsandthestoragecapacitytoprovideswingservicestoeverybodyelsewithoutbeingdestabilizeditselfintheprocess.AssuchUSgasprices(adjustedfordifferencesintransportationcosts)–principallytheHenryHubspotprice–wereuniquelypositionedtobecomeworldbenchmarks.PriceselsewherecouldnotdropmuchbelowHH;iftheydid,flexibleLNGwouldflowtotheUSandstabilizepriceselsewhere.PriceselsewherecouldontheotherhandnotincreasemuchaboveHH;iftheydid,LNGdestinedfortheUSwouldbereroutedtothehigherpricedmarketsandagainalignpricesacrosscontinents.

OnethingnecessarytomakethisvisionarealitywasrobustgrowthinUSLNGdemand,andthatseemedanalmostdonedeal.Ontheonehand,USgasdemandlookedsettoincreaseonthebackofmassiveinvestmentsingasfiredpowergenerationcapacity.Ontheother,USgasproduction,andtheavailabilitytotheUSofCanadianpipelinegas,appearedtobeinirreversibledecline.Mexicoalsostruggledtoincreasedomesticgasproductioninlinewithdemand.Inshort,theNorthAmericangassupply-demandgapthatcouldonlybefilledbyLNGlookedsettowidenrapidly.

USLNGimportsarebynaturevolatilesincetheyarenotnormallyunderpinnedbylongtermtakeorpaycontracts.ThustheflowofLNGtoNorthAmericawasbelowexpectationsin2006withEuropeanbuyersstockingupgasintheaftermathofacoldwinterandwiththeRussian-Ukrainiangascrisisstillonpeople’smind,andaboveexpectationsinfirsthalf2007asawarmwinterhadleftEuropeanstorageinventoriesabnormallyhigh.Untilthen,however,thetrendseemedtobepointingsquarelyupwards.

WhatmanyobserversmissedforalongtimewastheunconventionalgasrevolutionunderwayintheUS.Tightgas,shalegasandcoalbedmethanehasbeensuppliedinincreasingamountsatincreasinglycompetitivecosts.USgasproductivecapacitywhichhadbeenonadecliningcurvesince2001bottomedoutinlate2005.LNGlargelypriceditselfoutoftheUSmarketin2007andfailedtore-enterin2008(Chart8.5).

Chart 8.5: US dry gas production and LNG imports

US monthly dry gas production Jan 97 - Oct 08

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jan.98

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US monthly LNG imports Jan 97 - Oct 08

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.08

Bcm

Trend line

Trend line

Source: US DOE EIA


Observers/stakeholdersliketheUSDOEhaveloweredtheirUSLNGimportassumptionsyearbyyearinresponsetothesignsofdemanddestructionandthebreak-throughforunconventionalgas.TheDOE’sEnergyInformationAdministrationalmostcomesfullcircleinits2009AnnualEnergyOutlook.BytheturnofthedecadetheEIAbelievedthatUSLNGimportswouldstagnateat0,33tcf(9,3bcm)ayear.In2005theEIAputLNGimportsby2025at6,37tcf(180bcm)ayear.InitsmostrecentOutlooktheEIAseesLNGimportspeakingat1,51tcf(43bcm)ayearby2018beforedroppingto0,84tcf(24bcm)ayearby2030(Chart8.6).

Chart 8.6: US LNG import forecasts

US LNG imports DOE/EIA's forecasts 2000-2009

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20052006

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Source: US DOE/EIA: Annual Energy Outlook, various editions

ThesituationisnotthattheUSmaynotreceiveincreasingamountsofLNG.AsamarketoflastresorttheUSwilllikelyreceiveasignificantshareoftheLNGfromthe15newtrainssetthatwillstartproducingintheyearsto2012.ButtherewillatleastinitiallybenobidwarsforthisLNG.ThesellerswillhavetoacceptorrejecttheprevailingUSpricesdependingonrelativenetbacks.InextremesituationstheymayhavenochoicebecauseotherdestinationsarephysicallyunabletoreceivemoreLNG.TheUSwillthenprovideafloortoworldgaspricesandassuchplayitspartinthepriceglobalisationprocess.

TheUSgasmarketisnotonlylargeenoughandwellenoughequippedwithstoragecapacitytoaccommodatesuchadevelopment,itnowalsohassufficientregascapacity.Bytheendof2008theUShadanestimatedtotalof62,3mtpa(8,2bcfd)ofcapacityupandrunning,andMexicohadanadditional9,5mtpa(1,2bcfd).Bytheendof2009theUStotalwillbealmost100mtpa(13,1bcfd)withMexicoandCanadacontributing19mtpa(2,5bcfd).

WholesalegaspricesintheUSwillreflectthelongtermmarginalcostsofUSunconventionalgas.ThesecostsareoftenreportedtobeintheUS$5-7/MMBturange,thoughestimatestendtocomewithwarningsabouttheirsensitivitytofurtherimprovementsinE&Dtechnology,positiveornegativesurprisesinnewbasins,generaloilandgasindustrycostdevelopmentsandahostofotherfactors.Anyway,ifHenryHubdropsbelowlongtermmarginalcosts–whichcertainlymayhappen–drillingandeventuallysupplywilldecline,pushingpricesbackintotheviabilityrange.

WhethertheUSalsowillprovideaceilingtoworldLNGpricesasandwhenmarketsrecover,andassuchcontinuetoserveasmarketintegrator,isadifferentissue.

IfUSLNGimportsincreaseintheshortterm,arecoveryinworldLNGdemandinthemediumtermcouldtoanextentbesuppliedfromtheseimports.EuropeanandAsianbuyerswouldonlyneedtoincreasetheirpriceoffersenoughtoshiftnetbacksmarginallyintheirfavour.There-routingpotentialwouldhowevereventuallybecomeexhaustedjustasitwasin2007-08whenlittleelsethanTrinidadcargosunderlongtermcontractsfoundtheirwayintotheUS(Chart8.7).

Chart 8.7: US LNG imports by supplier

US monthly LNG imports by supplier

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jan.06

apr.06

jul.06

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7jul

.07okt.

07jan

.08ap

r.08

jul.08

okt.08

Mcm

TrinidadQatarNorwayNigeriaEq. GuineaEgyptAlgeria

Source: US DOE EIA

LNGpricescouldthendecouplefromtheUSpricelevelwhich–ifUSgasdemandand/orindigenousgassupplyisflexibleenoughtoquicklyaccommodateanylossofflexibleLNGtoothermarketregions–mightnotchangeatall.

IftheUSinsteaddevelopsthedependenceonLNGthatobserversintheearly2000sthoughttheycouldseearoundthecorner,butnowtendtodiscard,USbuyerswouldneedtocompeteonpricewiththerestoftheworldforLNGsupply.ThentheLNGpriceceilingprovidedbyUSindigenousgassupplycostscoulddisintegrate–butwewouldstillinthisscenariocharacterisedbyintercontinentalcompetitivebiddingseegasmarketintegrationandpriceglobalisation.

ThedifferencesbetweenrecentlongtermUSLNGimportforecaststestifytothecomplicatednatureofthisissue.USgasdemandgrowthwillplayakeyrole,implyingthateconomicgrowthandthecurrentadministration’senergyandenvironmentalpolicieswillbeimportantdrivers.TheexactshapeoftheNorthAmericanunconventionalgassupplycurve,todayand5,10and20yearsfromnowconsideringtheresourcebaseandthescopeforfurthertechnologicalprogress,isanotherkeytotheoutlookforLNG.WhetherincrementalLNGsupplycostswillstayattoday’slevelorfallbacktowardstheir2004levelisyetanotherkey.


Tostatetheobvious:If

• USgasdemandpicksuponthebackofaneconomicrecoveryandpoliciesfavouringgasovercompetingfuelsformid-andbaseloadpowergeneration,

• unconventionalgasprovestohaveitslimits,and• globalLNGsupplycostsdeclinetothelevelofensuringcompetitivenessinnetbacktermstothealternativesintheUSmarket,

thenLNGmayonlybetemporarydownasacomponentoftheUSfuelmix,andthegrowthinLNGsupplytotheUSthatmanyobserverstookforgrantedafewyearsagocouldstillmaterialise.IfontheotherhandUSgasdemand,unconventional

gassupplyand/orLNGcostsdevelopdifferently,thentheanticipatedrecoveryinUSLNGimportslinkedtotheneedfornewQatari,Russian,Indonesian,Yemenietc.liquefactioncapacitytobeaccommodated,couldbeshortlived.

Theformerscenariowouldunderpinarapiddevelopmentofaglobalgasmarketwithunifiedpricing.Thelatterwouldmeanthatavitalglobalisationandunificationdriverwoulddisappearfromthescenewiththeresultthattheprocessesmighttakemuchlonger.


General

Ingeneralterms,pricevolatilityreferstothefrequencyandamplitudeofpricefluctuations.Infinancialtermsvolatilityreferstothemagnitudeofstockvariations.Theconceptofvolatilityisusedtoquantifyyieldandpricerisk.Thestrongerthevolatility,thebiggerthepotentialyieldbutalsothebiggertherisk.Theconceptistypicallyusedtodescribeshorttermvariationsratherthanlongtermoscillations,butmayinprin-ciplebeusedtodiscussallkindsoffluctuations.

Thereisastrongpopularperceptionthatgaspricesfluctuatemoreoftenandmorestronglynowthaninthepast.Aglanceatselectwholesalegaspricesinthemarketsrelyingongas-to-gascompetitionsupportsthisnotion(chart9.1).

Chart 9.1: Henry Hub and NBP price fluctuations

Henry Hub next month delivery contract price

Jan 94 - Dec 08, daily basis

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/MM

Btu

NBP spot price Jan 97 - Dec 08, monthly basis

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USD/

MM

Btu

Sources: US DOE EIA, CERA

Itishowevernotevidentthattherehasbeenacontinuedandconsistentincreaseinvolatilitythroughthe2000s.Pricesfluctuatedlessin2002-04andagainin2006-07thanin2000and2001.(Charts9.2and9.3).

Chart 9.2: Henry Hub means, highs, lows

Henry Hub next month delivery contract price Annual means, highs, lows

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18

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

USD

/MM

Btu

Source: US DOE EIA

Chart 9.3: Henry Hub standard deviation

Henry Hub next month delivery contract price Standard deviation of daily observations

0,00

0,50

1,00

1,50

2,00

2,50

3,00

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008US

D/M

MBt

u

Source: US DOE EIA

Theimportanceofnotjumpingtoconclusionsonvolatilitydevelopmentsbecomesevenclearerwhenwelookatpricechangesratherthanabsoluteprices.Tradersandriskmanagerstypicallymeasurevolatilityintermsofthe“return”onaninvestmentinacommodity,withreturnscalculatedonalog-normalbasisusingtheform

Return(t) = ln(Price(t)/Price(t-1)).

InthisperspectivewhereaUSD2increaseinaUSD10/MMBtupricerepresentsthesamelevelofvolatilityasa40centsincreaseinaUSD2/MMBtuprice,itbecomesdifficulttoseeanycleartrendinvolatilityoverthe1994-2007period(Chart9.4).

Chart 9.4: Henry Hub daily returns

Henry Hub next month delivery contract price Daily returns, January 2004 - December 2008

-50 %

-40 %

-30 %

-20 %

-10 %

0 %

10 %

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14.0

1.94

14.0

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1.99

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14.0

1.06

14.0

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14.0

1.08

Source: US DOE EIA

Whateffectspricevolatilityhasontheaffectedmarketsandeconomiesisalsoacontroversialissue.

9. Price volatility


Inthe1980sand1990soilpricevolatilitywasmuchdebated.Manypoliticiansandmarketactorsrecommendedproducertoconsumercooperationtodampenpricefluctuations.Whiletheoilpriceincreasesin1973and1979-80triggeredconsumercountryinterestinthisconcept,theoilpricecollapsein1986persuadedmanyproducercountriestosupportittoo.The1990‘mini-shock’relatedtotheIraqiinvasionofKuwaitfurtherboostedenthusiasmforsomekindofdialogue.

Economistshowevercautionedagainstpoliticisingmarketsinthisway.Onestudy5examinedtheallegationsthatoilpricevolatilityhadboostedinflationanddampenedeconomicgrowthby:

• Boostingoilprices• Reducingoilindustryinvestmentsandtherebyoilsupply,• Boostingtransactioncosts–e.g.,costsassociatedwith

investmentsinfacilitiestoincreaseflexibility–forconsumersandproducers

Thestudyfailedtofindconclusiveproofforanyofthem.Pricevolatilityassuchdidnotseemtobethereasonforanyofthesethreesituations.

Pricevolatilitymaykeepinvestorsthatpursuelowriskactivitieswithcorrespondinglylowreturns,andlookforastableenvironment,fromlaunchingnewinvestments.Assuch,volatilitymaybeanissuefromagassupplysecuritypointofview.However,tootherinvestorspricevolatilitymay,byprovidingarbitrageopportunities,beseenaspreferabletopricestabilityintermsofvalueadded.Itisimportanttonuancetheperceptionofvolatilityasaproblemfortheindustry.Itneedstobeacknowledgedthatdifferenttypesofstakeholderslookfordifferentpricecontexts.

Thisdifferenceisrelatedtotheonebetweenlongtermoilindexedgaspricesandshortertermgastogascompetitionbasedpricesongasexchanges.

Causes of volatility

Manyexplanationshavebeenofferedfortheperceivedincreaseingaspricevolatilityinthe2000s.Thosethataremostpopularwiththemediaarenotnecessarilyontopintermsofexplanatorypower.

Blamingfingersarepointedatcommoditytradingtechniquesresultingfromtimetotimeinwavesofspeculativegassalesorpurchases.Thepublicisalsooccasionallyfiredupbyreportsondownrightmarketmanipulation.Howeverneithertradingtechniquesnorcriminalactivityarecredibleexplanationsforageneralincreaseinpricevolatility.

Basicgassupplyanddemandfundamentalsgoalongwaytowardsexplainingthisincrease.

Pricevolatilityistheconsequenceofsupplyfailingtorespondimmediately,smoothlyandpreciselytopricesignalscausedby

changesindemand,ordemandfailingtoaccommodatepricesignalsduetochangesinsupply.

Howquicklysupplyisabletorespondtoashiftindemanddependsonthestateofthemarket–i.e.,ontheshapeofthesupplycurveatthepointofintersectionwiththedemandcurve–whentheshiftoccurs.

Chart 9.5: Price volatility and the flexibility of supply

S

Volume

Price

D11 D21

P2

P1

If the market at the outset is at A, with plenty of flexibility on the supply side, an increase in demand from D11 to D12 will increase prices only by P1. If the market at the outset is at B, with limited flexibility on the supply side, the same increase in demand will raise prices by P2.

A

B

D12 D22

Price volatility and the flexibility of supply

Thelesssuppliersareabletoaccommodateanincreaseindemandbyactivatingsparecapacity,thestrongerwillthepriceimpactbe.

Howquicklydemandisabletorespondtoashiftinsupplydependsontheshapeofthedemandcurveatthepointofintersectionwiththesupplycurvewhentheshiftoccurs

Chart 9.6: Price volatility and the flexibility of demand

Volume

Price

D1

P1P2

If the market is at A when supply shifts from S1 to S2, then if demand is flexible (the D1 curve) prices only increase by P1, whereas if demand is inflexible (the D2 curve) prices increase by P2.

A

D2 S1S2

Price volatility and the flexibility of demand

Thelessconsumersareabletoaccommodateadeclineinsupplybyswitchingtootherfuelsorjustcuttingconsumption,thestrongerwillthepriceimpactbe.

Onthemargin,ifsupplyhasbecomesostretchedthatthemarketisontheverticalpartofthesupplycurve,orifdemandhasbecomesorigidthatthemarketisontheverticalpartofthedemandcurve,disturbanceswillneedtobeaccommodated100%bypriceadjustments.Sincegasmarketsare‘disturbed’allthetimebychangesintheweather,maintenanceofsupplyfacilities,etc.,undersuchconditionstherewillinevitablybefrequentandsometimesviolentpricefluctuations.5 Philip K. Verleger, Jr.: Adjusting to Volatile Energy Prices, Washington DC 1993


Gasexchangepricesreflectthesupplyanddemandcircumstancesoftheday.Bothvariablesarecharacterisedbyfrequentdeviationsfromtrend,anddelayedandimpreciseresponsesaretheruleratherthantheexceptions.Gasexchangepricesarethereforeinevitablycharacterisedbyfluctuations.

Volatility associated with gas price increases

Gaspriceincreasesincentiviseproducerstoincreasesupply,butliberalisedmarketsasarulehavelittlespareproductivecapacitythatcanquicklybebroughton-stream.IntheUSthegassectorrestructuringthatwastriggeredbythepassingoftheNaturalGasPolicyActin1978ledtoefficiencyimpro-vements,costcutsandaperiodoflowgasprices,butalsotoadeclineinunderutiliseddeliveryinfrastructureavailabletodampenvolatility.

Gaspriceincreasesincentivisebuyerstocuttheirgaspur-chaseswithinthelimitssetbytheirflexibilitytoswitchtoalternativefuels.Typically,powersectorgasdemanddeclinesasgeneratorsswitchfromgastocoaloroil-firedcapacity,whileindustrialgasdemanddeclinesasfirmsrelyingongasforprocessheatswitchtooilproductsandfirmsusinggasasaprocessfeedstocktemporarilyshutdownfacilities.

However,onlyaportionofgasuserscaneasilyandquicklyswitchtoalternativefuels,andthisportionisshrinking,be-causeofefficiencyconsiderationsandalsosinceenvironmen-talandlandusepoliciesmanyplaceshavepreventedduelfuelpowergeneratingunitsfrombeingconstructed.

Prolongedperiodsofhighgaspricestriggermoredrillingforgas.TraditionallyinNorthAmericatherigcounthasrespondedquicklytopricesignals,andproductionhasinturnrespondedquicklytochangesintherigcount.Thelatterrelationshipseemednottoapplybetweenearly2002andlate2006whenpricesmorethantripledandthenumberofgasrigsincreasedfromfewerthan600tomorethan1400,butproductiontrendeddownwards.However,growthinuncon-ventionalgasproductionhassinceearly2006beenstrongenoughtodeliverarecoveryintotalgas,anddemonstratedthattheoldrelationshipstillholds–atleastfornow.

TheUKindustrywouldbestimulatedbyprolongedhighpricestoharvesttheremaininggasaccumulations–probablythroughstep-outsandextensionsofexistingfields.Aggregateadditionalproductionisnotexpectedtobesignificant.

Asfordemand,prolongedperiodsofhighgaspricesreducepowersectorgasneedsbyencouraginginvestmentinalterna-tive(typicallycoalfired)capacity,industrialsectordemandbyencouragingplantownerstore-locatetocountriesofferingcheapergas,andresidentialandcommercialsectordemandbytriggeringconservationmeasuressuchasimprovedbuild-inginsulation,doubleglazingandmoreefficientheatingboilers.

Volatility associated with gas price declines

Gaspricedeclinesincentiveproducerstocurtaildrilling.Whendrillinggoesdown,lostproductionfromwellsindeclineisnotfullyreplacedandaggregateproductionstartsgoingdown.Butallthistakestime,andwhenproductioneventuallystartstosaginresponsetolowerprices,theresponseisinitiallyverygentle.Thisisbecauseitpaystoshutinwellsonlyatextremelylowpricelevels.

IntheUKsomefieldswhicharenearingtheendoftheirlivesaretypicallyreducingproductioninthesummermonthswhenpricesaresoftintheexpectationofusingthe‘saved’gasattheendoftheirfieldlivesandinadditioncapturingawinter’spricepremium.

Howsupplyrespondstopricechangesdependsalsoonhowstorageinventoriesaremanaged.Apriceincreaseencouragesacceleratedwithdrawalofgasfromstorage,andviceversa.

Gaspricedeclinesincentivisebuyerstoincreasetheirgasuse,againwithinthelimitssetbytheirflexibilitytoswitchfromalternativefuelstogas.Typically,powergeneratorsbringunusedgasfiredcapacityonlineattheexpenseofcoalfiredcapacity.Industrialgasdemandisunlikelytochange.

Prolongedperiodsoflowgaspriceswouldstrengthenthecasefornewinvestmentingasfiredpowergeneration,andslowtherelocationofgasintensiveindustrytootherpartsoftheworld,butprobablydonotaffectresidentialandcommercialsectordemandnoticeablysincepastconservationmeasuresreflectedin,e.g.,buildingstandardsfornewpremiseswouldhardlybereversed.

Onthesupplyside,theintensityofgasdrillingintheUSandCanadiangasdrillingwoulddeclinefromcurrentlevelsandrapidlydepressproduction,theAlaskaandMacKenzieDeltaprojectswouldbefurtherdeferred,andUKfieldswouldbeshut-inandabandonedonearliertimings.

Insum,therearerigiditiesinbothgassupplyandgasdemandthatresultsinpricevolatilityincompetitivemarkets,andtheserigiditiesappeartohavehardened.

Anincreaseingasdemanddueperhapstoacoldsnapdoesnottriggeranyappreciableproductionresponse.Adeclineingassupplydueperhapstoahurricanedamagingcriticalpiecesofinfrastructuredoesnottriggeranyappreciabledemandresponse.Pricesrisetoactivatewhateverfuel-switchingcapacityexistsinthepowersector.Ifthisadditionalcushionisinsufficienttorestorebalance,pricescontinuetorisetothepointwherestoragewithdrawalreachextraordinarylevels,ortothepointwheredemandis‘rationed’–i.e.industryshutsdownplantandallalternativepowergenerationoptionstogasareexhausted.


Volatility of oil indexed prices

InContinentalEuropeandAsiagaspricesareasnotedindexedtooilpricesdependonimportedgastosatisfysignificantportionsoftheirneeds.Thisgastypicallytravelssignificantdistancesfromthewell-headtothecity-gate.

Importantly,theindicesarenotcrudeorproductspotprices,whicharehighlyvolatile,butrollingpriceaveragestypicallyironingoutfluctuationsover6-9monthperiodsinEuropeanpipelinecontractsand3-6monthsinLNGcontracts.Thisaveraging(andwhereapplicable,upperandlowerlimitstotheoilpricerangewhereindexationapplies)significantlydampentheimpactoftheunderlyingoilcommoditypricevolatilityongasprices.Theresultis‘longwavelength’oilpricedrivenvolatility

Fromtheperspectiveofpricevolatility,thelong-termoilindexedcontractmarketstructuregivesrisetothefollowingdynamics:

Supplyanddemandinthesemarketsaremanagedthroughcontractvolumenominationsandstorageoperations.Thegaspricedoesnotautomaticallyrespondtogasdemand.Thebuyerisimplicitlypayingthesellertomaintainasurplussupplycapacityinexcessofthebasecapacitythebuyerundernormalcircumstanceswillneed.Citygatepricesreflectcontractborderpricesandinadditionin-countrytransmissionandstoragecosts.Thelatterarespreadacrosstheyear–hencethereisnoseasonalshapetocitygategasprices.

Chart9.7confirmsthat‘shortwavelength’pricevolatilitydoesnotreallyfeaturein‘pureform’oil-indexedmarkets.Fromtheperspectiveof,say,alargeContinentalEuropeangasandpowerutilitycompany,priceuncertaintyunderthelooseheadingof‘volatility’wouldlargelybeconfinedtotheexistenceofcontractre-openers.Whethertriggeredbythebuyerortheseller,re-openerscanresultinsignificantre-basingoftheunderlyingcontractprice.

Chart 9.7: Standard deviations of monthly observations of sample of gas prices



Bilateral monopoly





No price

North America, UK




Bilateral monopoly





No price

Select Non-OECD

2008 2020

Russia

, Chin


Select Non-OECD

Select Non-OECD

Source of price data: PIRA

Volatility and LNG

LNGundertraditionallongtermtake-or-paycontractsisnodifferentfrompipelinegasundersimilarcontractsinitscapacitytoaggravateordampenpricevolatility.ThusashiftingassupplyfromlongtermpipelinegastolongtermLNGwillnotinitselfmattertopricevolatility.However,amate-rialshiftinsidetheLNGportionofgassupplyfromlongtermcontractedtoflexibleLNGwouldimplyfurthercommoditi-zationofgasanddifferentvolatilitypatternsacrosscountries.

FlexibleLNGisdivertedaccordingtopricesignals.ThussomecountriesmaybedeprivedofLNGtheyhadcountedon,withtheresultthatlocalorevennationalpricesescalate.OntheotherhandtherecipientcountriesmayreceiveLNGtheyhadnotcountedonwiththeresultthatthepriceincreasesthattriggeredthediversionsinthefirstplacearearrested.

Toanextentthishappenedin2008whenAsia–promptedbystrongeconomicandenergydemandgrowth,Japan’sproblemswithitsKashiwazaki-KariwanuclearpowercomplexandaseveredropinIndonesianLNGsupply–playedthepricecardtoattractnumerousflexiblecargosfromtheAtlanticbasin.Ifthesediversionshadnotbeenpossible,AsianpriceswouldhavegoneevenhigherwhileUSpriceswouldhavebeenevenlowerthantheywere.

IfAtlanticmarketsingeneral,andtheUSmarketinparticular,hadbeentighterthantheywerein2008,theonlybufferingmechanismswouldhavebeenNorthAmericanproducers’flexibilitytoboostsupply,Europeanbuyers’possibilitiestovarytheirnominationsoflongtermpipelinegasinEurope,andstorageinventoriesaboveannualnorms.

BymakinglocalsupplycurveslessrigidtheadventofflexibleLNGwilllikelydampenaveragepricevolatility.Ontheotherhand,thecommoditizationofgasthatistakingplaceisalsoattractingtheinterestoffinancialinvestors,anddoesassuchimplyariskofspeculativeboomsandbusts.


NeithertheIEAnortheDOE/EIAanticipatesmuchchangeingaspricingmechanisms–atleastnotintheirrespectivereferencescenarios.

TheEIAderivesitsUSpriceassumptionsmainlyfromitssupplycostassumptions.TheIEAexpectsthatgaspriceswillremainlinkedtooilpricesthroughcontractsorsubstitution.

TheIEAfurtherassumesthatgaswillcontinuetobepricedatadiscounttooil.Theimportedgas/importedcrudeoilratiowasby2008assumedtostabilisearound75%fortheUSandJapan,andaroundtwothirdsforEurope(Chart10.1)

Chart 10.1: Oil and gas price assumptions in WEO 2008

Oil and gas prices assumptions in the IEA's WEO 2008

0,00

5,00

10,00

15,00

20,00

25,00

2007 2010 2015 2020 2025 2030

US

D/M

MB

tu

Crude oil - IEA importsGas - US importsGas - Japan LNG importsGas - European imports

Source: IEA: World Energy Outlook 2008

Thesplitofgastransactionsbypriceformationmechanismcouldhoweverchangesignificantlybetweennowand2020.

Asnotedthereislittletoindicatethatthecountriesthathaveadoptedgas-to-gascompetitionbasedpricing–mainlyNorthAmericaandtheUK–willturnawayfromthismechanism.Onthecontrary,thestillfairlysignificantshareofoillinkedcontractsintheUKmarketwilllikelydiminishwithbuyersinsistingoncompetitivepricingasopportunitiestodosoarise.

InContinentalEuropeandinbigpartsofAsia,variouspricingmechanismsco-existwithoilindexationplayingadominantrole.Opinionsonthesustainabilityofthissituationdiffer. Theoriginalrationaleforoilindexationhasweakened.Gasstillcompeteswithoilinindustrybutfacesmostlyotherfuelsinthebattlesforresidential,commercialandpowersectormarketshare.

Thepossibilityofoillinkedgasfallingoutoffavourwiththekeypowersectorisparticularlyworrisome.Heregasneedstobeperceivedascompetitivewithcoalandinthefutureincreasinglywithbiomass,wind,solar,etc.Thecompetitionfromcoalisbluntedbydifferencesincapitalcosts,leadtimes,taxationandregulatoryprovisions.Thecompetitionfromrenewablesotherthanhydroisbluntedbythestillhighcostsoftheseoptions.Extendedoildrivengaspriceralliescouldstillerodegas’positionasthepreferredfuel.

Industrialbuyersbenefitfromoilindexationwhenoilpricesaresufficientlylowforsufficientlylongtomakeoillinkedgascheaperthanspotgas.Sellersofcoursebenefitfromtheoppositesituation.Oilmarketcyclesincombinationwithpricerenegotiationclausesinlongtermcontractsmaydeliverabalanceddistributionofcostsandbenefitsovertime.Oildrivengaspriceralliesliketheonein2007-08thatledtosignificantindustrialdemanddestructionareneverthelessbadforgas’imageasareliableandaffordablefuelacrosscycles.

Moregas-on-gascompetitionandmoreuseofgasexchangepriceswouldtoanextentdecouplegaspricesfromoilprices.Itwouldhoweverincreaseshorttermpricevolatility,andwhetheritwouldeliminatetheriskoflongertermpriceralliesisanopenquestion.BasicallythatwoulddependonContinentalEurope’sandDevelopedAsia’sfuturegassupply-demandbalances.

ForthemomentthereisamplesparecapacityinEurope’spipelinegassupplychainsaswellasintheworld’sLNGsupplysystem.Thefinancialcrisis,therecessionandtheconsequentdropingasdemandnearlyeverywherehaveforcedgassupplierstosignificantlylowercapacityutilisation.Sharpdeclinesinsalesrevenuesanddoubtsaboutthetimingandshapeoftheanticipatedrecoveryarehoweverdelayingvitalup-andmidstreaminvestments.TheIEAandothersareconcernedthatthecurrentglobalgasmarketdownturnwillonlypavethewayforanotherrally.

EvidencefromNorthAmericaunderlinesthequestionmarkatthelongtermconsequencesforgaspricesofswitchingfromoilescalationtogas-on-gascompetition.AlthoughgaspricesarenotinanywaylinkedtooilpricesinUScontracts,gashasovertheyears–acrossfrequent,sometimesviolentshort-mediumtermdisturbances–tendedtotrackoilinafairlystablelongtermrelationship.Thisisprobablybecausegasandoilpricesbesidesbeinglinkedbyinterfuelcompetitionintheindustrialsectorareinfluencedinthesamemannerandtothesameextentbytheoilandgasindustry’scostcycles,andwithdeviationsalsobeingarrested,eventually,bychangesinoilandgasindustryinvestmentpriorities.

10. Towards further changes in the extensiveness of individual pricing mechanisms?


Oilindexationwillinanyeventnotdisappearanytimesoon,forseveralreasons.

ContinentalEuropeanbuyershavesignedmedium-longtermcontracts6foranestimated350-350bcmofgasayear,andaveryhighshareofthesecontractsareofthestandardoillinkedtype.Annualcommitmentsstartdecliningonlyfromaround2015.

By2008existingmedium-longtermcontractscorrespondedtomorethan80%ofContinentalEuropeangasconsumption(withtherestbeingshorttermpurchases).Goingforward,thissharewillofcoursedecline(Chart10.2).Ifgasdemandincreasesby2,4%ayear,inlinewithaverageannualgrowthbetween1987and2007,alreadycontractedsupplywillmeetaroundtwothirdsofContinentalEuropeangasdemandby2015andlessthanaquarterofdemandby2025.Moreover,thetakeorpayprovisionsinmostcontractsgivecustomerstheoptiontoofftakesomewhatlessthan100%ofannualcontractedvolumes.

Chart 10.2: Continental Europe’s contracted gas supply, mid 2008

Continental Europe's contracted gas supply, mid 2008

050

100150

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2007

2008

2009

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2011

2012

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2018

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bcm

Source: Wood Mackenzie

Still,theexistingbodyofoillinkedcontractsconsiderablyreducesthemaximumpaceatwhichashifttowards,e.g.,gasindexationcouldproceed.

Thisisnottosaythatthereisadesireamonggassellersandbuyerstogetridoftheoillinkovernighteveniftheycould.Asnoted,theincumbentsonbothsidesofthetableseemforthemomenttobebroadlyinfavourofretainingoilindexation.

TheEUCommissionwilllikelycontinuetopushforgas-on-gascompetitionbasedpricing,butitcannotpushveryhardintheabsenceoftradingplacesofferingreliablepriceinformationandthefullrangeoftradingfacilitiesandservices.ContinentalEurope’sgashubswilltakeonthesecharacteristicsandfunctionsbutthatwilltaketime.

Japanese,SouthKoreanandTaiwanesegasimportershaveonbalancebeenevenmorehesitantthantheirContinentalEuropeancounterpartstoswitchfromoilindexedimportpricesandcostplusbaseddomesticpricestomorecompetitivearrangements.

GainingacceptanceforalternativepricingmodelswilllikelytakelongerinAsiathaninEurope.

Legislationtomakethesecountries’domesticgasmarketssomewhatmorecompetitivehavebeenpassed,andtheirrecurrentneedstopurchasespotLNGwillconstantlybringthemintocontactwiththeHenryHuborNBPpricelevels.However,thereseemedbymid2009tobefewchampionsintheregionfordramaticreforms.

Moreover,Japan,SouthKoreaandTaiwanhavejustasContinentalEuropeenteredintoalargenumberofoillinkedmedium-longtermgasimportcontractsthatconstitutealimittothepossiblepaceofintroducingalternativepricingprinciples(Chart10.3).Theratioofcontractedsupplytototaldemandwasin2007–whenspotpurchasesreachedunprecedentedhighs–around80%.Ifgasdemandincreasesby6%ayearthesharewillfalltoaround50%by2015andlessthan10%by2025.A6%annualgrowthwouldbeinlinewiththeaveragefor1987-2007butnooneexpectsthesecomparativelymaturemarketstocontinuetoexpandthisfast.Aperhapsmorerealistic3%ayeardemandgrowthassumptiongivesratiosofalreadycontractedsupplytofuturedemandmuchinlinewiththoseofContinentalEurope.

Chart 10.3: Japan’s, South Korea’s and Taiwan’s contracted gas supply

Japan's, South Korea's and Taiwan's contracted gas supply, mid 2008

0

20

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2007

2008

2009

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2011

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bcm

Source: Wood Mackenzie

ChinaandIndiaareinthemidstofpainfuladjustmentsto‘worldlevel’gasprices.Theseadjustmentsaredrivenbyaneedforimportedgasthatisunlikelytopeakanytimesoon,inspiteofgasdiscoveriesthatwillallowsignificantgrowthinindigenousproductioninbothcountries.Theyproceed,broadlyspeaking,byintroducingcompetitivepricingforthecustomersabletocopewithsteepgascostincreaseswhileretainingpriceregulationforeverybodyelse,butinadifferentiatedmanner,andwiththeaimofgraduallyincreasingpricesacrosstheboard.Inotherwords,theyareontheirwayfromdomesticpricingsystemsdominatedbybelowcostregulation,toalternativescharacterisedbyamixtureofbelowcostregulation,somesortofcostbasedregulationandgas-to-gascompetitionbasedpricing,withthesplitofsalesgraduallyshiftingfromthefirsttothesecondandthirdpricingprinciple.

6 Including deals at HoA or MoU level as well as firm sales and purchase contracts


MorecountriesthanChinaandIndia–possiblythemajorityofcountriesinAsiaandLatinAmerica,apartfromtherichestones,andthegasimportingFSUrepublics–arestrugglingtoaccomplishsimilartransitions.Thetimelinesforgettingtherevaryacrosscountriesandasrulerscomeandgo.Asnoted,pricereformisriskybusiness.Factorssuchasthepaceofeconomicgrowth,inflationandthepopularityandleewayoftheincumbentgovernmentneedtobeconstantlyconsidered.

Russiaappearstobeonabroadlyparallelcoursealthoughfromadifferentstartingpointastheworld’sbiggestgasproducerandexporter.Russia’straditionallyuneconomicdomesticgaspricesthathaveover-stimulateddomesticgasuseandlimitedGazprom’sandothercompanies’abilitytoinvestinnewfieldsandsupplyinfrastructure,areasnotedtobepartlyreplacedbyopportunitycostbasedpricesoveraperiodof4-5years.

TotheextentEuropeanborderprices–thestartingpointfornetbackcalculations–remainoillinked,Russianwholesalepriceswillcometoreflectoilpricestoo.ThiscouldtransfertheproblemsofoillinkedpricingintoaRussianmarketpoorlypreparedtodealwiththem,possiblyleadingtodelays,exemptionsandspecialarrangementsthatwouldreducethetransparencyoftheprocess.

AfairnumberofNon-OECDcountries–inparticularthoseintheMiddleEastandNorthAfricathatbenefitfromhighoilprices–willlikelyseektocontinuesubsidisingdomesticgasprices.Cheapelectricity,gasandmotorfuelsarewidelyseenasobligatorygovernmentdeliverablesinthesepartsoftheworld,andalsoindispensabletotheglobalcompetitivenessoftheregions’petrochemicalindustry.Inperiodswithhighoilexportrevenuestherehashistoricallybeenlimitedinterestin

challengingtheseperceptions.Now,withoilexportrevenuesconsiderablydownontheir2007-08levels,concernsaboutthebudgetaryconsequencesofsubsidisationarelikelyresurfacing.

Atthesametime,withmanyNorthAfricanandMiddleEasterncountriesbeginningtofeelthepinchofstagnantindigenousgassupply,intraregionalgasexportsandimportslooksettoincrease,andthistradewillnotbeatsubsidisedprices.QataraimsforthesamenetbackfromitsLNGsalestoKuwaitandDubaiasfromitsotherLNGsales,andifDohadecidestocontractadditionalpipelinegastotheUAEorOmanitwillbeatinternationalmarketprices.Thiswillincreasesubsidisationburdensintheimportingcountriesandcouldeventuallypavethewayfordomesticpriceadjustments.

Chart10.4isanattempttosummarisethesehypotheses.

Chart 10.4: Hypotheses on future changes in the extensiveness of individual pricing mechanisms in individual regions



Bilateral monopoly





No price

North America, UK




Bilateral monopoly





No price

Select Non-OECD

2008 2020

Russia

, Chin


Select Non-OECD

Select Non-OECD


Format of ResultsInlookingatpriceformationmechanisms,theresultshavegenerallybeenanalysedfromtheperspectiveoftheconsumingcountry.Withineachcountrygasconsumptioncancomefromoneofthreesources,ignoringwithdrawalsfrom(andinjectionsinto)storage–domesticproduction,importedbypipelineandimportedbyLNG.Inmanyinstances,aswillbeshownbelow,domesticproduction,whichisnotexported,ispriceddifferentlyfromgasavailableforexportandalsofromimportedgaswhetherbypipelineorLNG.Informationwascollectedforthese3categoriesseparatelyforeachcountryand,inaddition,pipelineandLNGimportswereaggregatedtogivetotalimportsandaddingtotalimportstodomesticproductiongivestotalconsumption.Foreachcountry,therefore,priceformationcouldbeconsideredin5differentcategories:

• DomesticProduction(consumedwithinthecountry,i.e.notexported)

• PipelineImports• LNGImports• TotalImports(PipelineplusLNG)• TotalConsumption(DomesticProductionplusTotalImports)

EachcountrywasthenconsideredtobepartofoneoftheIGUregions,asdescribedintheIntroduction,andthe5categoriesreviewedforeachregion.FinallytheIGUregionswereaggregatedtogivetheresultsfortheWorldasawholefor2005.

Intermsofthepresentationofresults,theWorldresultswillbeconsideredfirst,followedbytheRegionalresultsfortheseparateregions–NorthAmerica,LatinAmerica,Europe,FormerSovietUnion,MiddleEast,Africa,AsiaandAsiaPacific.

Aswellascollectinginformationonpriceformationmechanismsbycountry,informationwasalsocollectedonwholesalepricelevelsineachcountryin2005.Theseresultsonacountryandregionalbasisarealsopresentedtogetherwithananalysisofpricetrends.

World Results World Consumption and Production

Beforeconsideringtheresultsonpriceformationmechanismsfor2005,itisusefultoconsidertheregionalpatternofconsumptionandproduction.In2005totalworldconsumptionandproductionwasoftheorderof2,800bcm.ChartA??belowshowsthedistributionofworldconsumption.

Chart A1: World gas consumption 2005

World gas consumption 2005

Latin America5 %

Europe19 %

Former Soviet Union21 %

Middle East10 %

Africa3 %

North America27 %

Asia5 %

Asia Pacific10 %

2,790 bcm

NorthAmericaandtheFormerSovietUnion,followedbyEuropearethemainconsumingregions,anditistheseregions,therefore,whichwillhavethegreatestinfluenceontheresultsonpriceformationmechanismsattheWorldlevel.TheMiddleEastandAsiaPacificwillalsohaveanimportant,butsmaller,influence.

TheChartonthenextpageshowsWorldProductionbyregion.Thelargestconsumingregion–NorthAmerica–waslargelyself-sufficientin2005.TheFormerSovietUnionwasanetexporter,principallytoEurope,whichwasanetimporter.AsiaPacificwasanetimporter,principallyfromtheMiddleEast,whileAfricawasanetexporter,mainlytoEurope.AsiaandLatinAmericawerelargelyself-sufficient.

Appendix1– Price Formation Mechanisms 2005 Survey


Chart A2: World gas production 2005

World gas production 2005

North America26 %

Latin America5 %


Union28 %

Middle East11 %

Africa6 %

Asia5 %

Asia Pacific8 %

2,785 bcm

Withrespecttoimportsbypipeline(bothintra-andinter-regional),Europeaccountsformorethanhalfoftheworldtotal.BothEuropeanintra-regionalgasimports(Norwaytovariouscountries)andEurope’simportsofgasfromoutsideEurope(RussiaandAlgeria)areverysignificant.Intheotherregions,pipelineimportsareallintra-regional.

Chart A3: Pipeline imports 2005

World gas production 2005

North America26 %

Latin America5 %


Union28 %

Middle East11 %

Africa6 %

Asia5 %

Asia Pacific8 %

2,785 bcm

Withrespecttogasexportsviapipeline,theFormerSovietUnionin2005accountedforsome44%oftheworldtotal.Africa,meaninginthiscaseAlgeria,isalsoasignificantexportertoEurope,whileanytradeintheAsianandAmericanregionsisintra-regional.

Chart A4: Pipeline exports 2005

Pipeline exports 2005

North America18,8 %

Latin America2,6 %

Europe23,4 %


Africa6,7 %

Asia1,8 %

Middle East0,9 %

Asia Pacific1,0 %

663 bcm

Chart A5: LNG imports 2005

LNG imports 2005

Europe25,2 %

Asia Pacific61,6 %

Latin America0,5 %

North America9,5 %

Asia3,2 %

190 bcm


LNGimportsaredominatedbyAsiaPacific–principallyJapan,Korea,andTaiwan,withEuropebeingthesecondlargestimportingregion.WhencomparedwiththeLNGExportschart,muchoftheAsiaPacifictradeisintra-regional,buttheregionalsoimportssignificantquantitiesfromtheMiddleEast,whileAfricaandLatinAmerica(Trinidad)arekeyexporterstoEuropeandNorthAmerica.

Chart A6: LNG exports 2005

LNG exports 2005

Latin America7,4 %

Middle East23,0 %

Africa24,1 %

Asia Pacific44,5 %

North America1,0 %

190 bcm

Price Formation: Domestic Production

Chart A7: World price formation 2005 – indigenous production



36,3 %


33,6 %



15,6 %

Netback0,7 %



Not known 0,4 %No price

1,7 %

1,940 bcm

Domesticproduction,consumedinowncountry,accountedforjustunder2,000bcmin2005,around70%oftotalworldconsumption.ThetwolargestpriceformationcategorieswereGOG–accountingforsome35%mainlyinNorthAmerica,UKinEuropeandAustraliainAsiaPacific–andRBC–accountingfor34%,largelytheFormerSovietUnionandMiddleEastwithsomeinAfrica.RSPat16%isspreadthroughallregionsapartfromNorthAmerica.RCS,at4%,isprincipallyinAfricaandAsia,whileBIM,at5%,ismainlytheFormerSovietUnionandAsiaPacific.ThereisasmallamountofOPEinEuropeandAsia.

Price Formation: Pipeline Imports

Chart A8: World price formation 2005 – pipeline imports

World price formation 2005: Pipeline imports

Oil price escalation54,8 %Gas-on-gas

competition22,4 %


660 bcm

Pipelineimportsat660bcmaccountforsome22%oftotalworldconsumption.Threecategoriesaccountforinternationally–tradedpipelinegas–OPEalmostallinEurope;GOGinNorthAmericawithsmallamountinEuropeintoUKandBIMalmostallintra-FormerSovietUniontrade.

Price Formation: LNG Imports

Chart A9: World price formation 2005 – LNG imports





13,4 %

190 bcm

LNGimportsat190bcmaccountforsome6%oftotalworldconsumption.Internationally-tradedLNGislargelydominatedbyOPEintoEuropeandAsiaPacific.GOGismainlyNorthAmericawithsomespotLNGcargoesintoAsiaPacific,whileBIMisinAsiareflectingtheLNGcargoestoIndia.


Price Formation: Total Imports

Chart A10: World price formation 2005 – total imports

World price formation 2005: Total imports




20,4 %

850 bcm

Totalimportsat850bcmaccountforsome30%oftotalworldconsumption.60%isOPEwithEurope(pipelinemainly)andAsiaPacific(LNG)dominating.GOGisbothpipelineandLNGimports,withBIMlargelyintra-FormerSovietUnionpipelinetrade.

Price Formation: Total Consumption

Chart A11: World price formation 2005 – total consumption



23,3 %


31,4 %



10,9 %

No price1,2 %

Not known 0,3 %

Netback0,5 %



2,790 bcm

Therespectivesharesoftotalworldconsumptionforeachpriceformationmechanismreflectlargelythedominanceofdomesticproductionconsumedinowncountry.OPEbecomesmoreimportantbecauseofitsdominanceingastradedacrossborders.

Justover50%oftotalconsumptioniseitherOPEorGOG,whileover1/3rdissubjecttosomeformofregulatorycontrolincludingRBC,whereitcouldbesaidgasiseffectivelysubsidised.RegulationofwholesalepricesoccursinallregionsapartfromNorthAmerica.

ThesmallamountofNETpricingisinLatinAmerica(Trinidadtomethanolplants)whileNP(gaseffectivelygivenaway)isprincipallyintheFormerSovietUnion(Turkmenistan)andNorthAmerica(inMexico,wherePemexrefineriesandpetrochemicalplantsusegasasa“free”feedstock).

Regional ResultsInpresentingtheWorldresultsall5identifiedcategories–DomesticProduction,PipelineImports,LNGImports,TotalImportsandTotalConsumption–werereviewedandanalysed.Attheregionallevelnotallthecategorieswillberelevant,forexample,theremaybelittleornoLNGimportsintoaregion.Thedataandchartspresentedforeachregion,therefore,willdifferdependingontherelevanceofeachconsumptioncategory.

North America

IntermsofanIGUregion,NorthAmericaconsistsofonly3countries–Canada,USAandMexico–butitisthelargestconsumingregion.

Table A1: North America consumption and production 2005 (BCM)

Pipeline LNG Pipeline LNGUSA 629.8 511.8 104.2 17.9 20.3 1.8Canada 91.4 185.9 10.1 104.2Mexico 47.6 39.2 10.1 0.0Total North America 768.8 736.9 124.5 17.9 124.5 1.8


ConsumptionisdominatedbytheUSA,whichisalsobyfartheregion’slargestproducer.Allpipelinetradeisintra-regionalwiththeUSAimportingfromCanada,butalsoexportstobothCanadaandMexico.USALNGexportsarefromAlaskatoJapan,whileLNGimportsareprincipallyfromTrinidadbutalsosmallamountsfromtheMiddleEastandAfrica.

Chart A12: North America price formation 2005 – total consumption

North America price formation 2005: Total consumption


98,8 %

No price1,2 %

770 bcm

ThegasmarketintheUSAiscompletelyderegulatedandallpricesareeffectivelysetbygas-on-gascompetition.Imports,whetherbypipelineorLNGareeffectivelyprice-takers.ThemarketinCanadaislinkedtotheUSAmarketsandthepriceformationmechanismisthesame.MexicoimportsgasfromtheUSatUSprices.Fordomesticallyproducedgas,areferencepriceisset,whichisbasedontheUSpriceattheUS-Mexicoborder,plusthecostoftransportationtotheLosRamones“hub”.FromtheLosRamones“hub”furthersouththereferencepricegetsreducedbasedontransportationcosts.However,some10bcmofgasisestimatedtobeusedbyPemexforitsowninternal


consumption,relatedtofeedstockforpetrochemicalplants,fuelforequipmentinrefineriesandplantsandforsecondaryoilrecovery.ThisgasisnotpricedandhasbeenallocatedtotheNoPricecategory.

Latin America

Table A2: Latin America consumption and production 2005 (BCM)

Pipeline LNG Pipeline LNGArgentina 40.4 45.6 1.7 6.8Bolivia 2.1 12.4 10.4Brazil 19.9 11.4 8.8Chile 8.5 2.0 6.5Colombia 6.8 6.8Dominican Republic 0.3 0.3Ecuador 0.3 0.3Peru 1.5 1.6Puerto Rico 0.7 0.7Trinidad 16.3 30.3 14.0Uruguay 0.1 0.1Venezuela 28.9 28.9Total Latin America 125.7 139.2 17.2 0.9 17.2 14.0


LatinAmericangasislargelyproducedandconsumedwithineachindividualcountrywithVenezuela,ColombiaandPerubeingcompletelydomesticmarkets.Allpipelinetradeisintra-regionalwithArgentinaimportingfromBoliviabutalsoexportingtoChile.BoliviaalsoexportsgastoBrazil.EventhenalmostallofArgentina’sconsumptionisdomesticallyproducedandoverhalfofBrazil’s.

Chart A13: Latin America price formation 2005 – total consumption




1,6 %


Netback9,5 %



59,5 %


2,5 %

125 bcm

LatinAmericaconsumptionat125bcmaccountsforlessthan5%oftotalworldconsumption.ThetradedpipelinegastoBrazilandChilemainlyaccountformostoftheOPE.Wholesalepricesinthe2largestconsumingcountries,ArgentinaandVenuezela,arelargelydeterminedbyregulatoryand/orgovernmentcontrol(RSP).SomelargecustomersinArgentinaarefreetonegotiatedirectlywithsuppliers(BIM),asarepowergeneratorsinTrinidad.NETisinTrinidadwheregasisprovidedtoMethanolplants.ThereisasmallamountofGOGinChile.

Europe

Table A3: Europe consumption and production 2005 (BCM)

Pipeline LNG Pipeline LNGAustria 10.0 1.6 8.7Belgium & Luxembourg 16.6 18.0 3.0 4.4Bosnia-Herzegovina 0.4 0.4Bulgaria 3.0 2.9Croatia 2.7 1.5 1.2Czech Republic 8.5 0.2 9.5Denmark 5.0 10.4 5.3Estonia 1.5 0.7Finland 4.0 4.2France 45.8 1.2 36.2 12.8Germany 86.2 15.8 90.7 9.8Greece 2.8 2.3 0.5Hungary 13.2 3.0 10.8Ireland 3.9 0.6 3.1Italy 78.7 12.1 71.0 2.5Latvia 1.8 1.2Lithuania 3.3 2.9Netherlands 39.5 62.9 23.0 46.8Norway 4.5 85.0 79.5Poland 13.6 4.3 10.2Portugal 4.2 2.6 1.6Romania 17.3 12.1 6.3Serbia & Montenegro 2.2 0.3 1.9Slovakia 6.6 0.2 6.4Slovenia 1.1 1.1Spain 32.4 0.2 11.6 21.9Sweden 0.8 1.0Switzerland 3.1 2.8Turkey 26.9 0.9 22.2 4.9United Kingdom 95.1 87.5 14.7 0.5 9.7Total Europe 534.6 299.7 367.4 47.6 155.4 0.0

Imports ExportsCountry Consumption Production

EuropeishighlydependentonimportedgasbothbypipelineandLNG.Ofthelargestconsumers,onlytheUKproducedalmostallofitsgasrequirements,andthissituationisrapidlychanging.NorwayandtheNetherlandsprovidedasignificantproportionoftherestofEurope’spipelinesupplies,butEuroperemainedheavilydependentonRussianandAlgerianpipelinesupplies.ThemajorimportersofLNGwereSpainandFrancewithAlgeriabeingtheprincipalsupplier,butsignificantquantitiesofLNGwerealsosourcedfromWestAfricaandtheMiddleEast.

OutofthetotalEuropeanconsumptionin2005of535bcm,only124bcm(23%)wasproducedandconsumedwithinthecountryand2/3rdsofthiswasintheUKmarket.ThechartbelowshowsthepriceformationmechanismsforthisdomesticproductionwithGOGat46%andOPEat36%dominating.ThiswaslargelytheUK,wheresomeoftheoldercontractsstillretainkeyelementsofcompetingfuelindexation,butalsodomesticproductionintheNetherlandsandItalyislargelyonanOPEbasis.WholesalepricesfordomesticproductionremainedregulatedonaRSPbasisinPolandandRomania.ThereweresmallelementsofNETinNorwayandBIMinDenmark.


Chart A14: Europe price formation 2005 – indigenous production

Europe price formation 2005: Indigenous production


47,0 %

No price2,8 %

Netback0,6 %





11,6 %

124 bcm

Chart A15: Europe price formation 2005 – total imports

Europe price formation 2005: Total imports




6,0 %

415 bcm

Thesituationfortotalimports(bothpipelineandLNG,comprising415bcmor78%oftotalconsumption)ismarkedlydifferent,withOPEdominatingat92%.ThesmallamountofGOG(6%)ispredominantlytheUK,plusIrelandandasmallamountintheNetherlands.TheBIMcategory(2%)isaccountedforbyimportsintotheBalticStates(Estonia,LatviaandLithuania)fromRussia.

Chart A16: Europe price formation 2005 – total consumption





15,5 %


0,3 %


2,7 %No price

0,6 %

Netback0,1 %

540 bcm

Intotal,at540bcm,Europeaccountsforaround20%ofworldconsumption.Thedependenceinimports,mostofwhicharepricedonanOPEbasis,isillustratedinthechartabove,withOPEat79%.GOGislargelytheUKmarket.

Former Soviet Union

Table A4: FSU consumption and production 2005 (BCM)

Pipeline LNG Pipeline LNGArmenia 1.7 1.7Azerbaijan 8.9 5.3 4.5Belarus 18.9 0.3 20.1Georgia 1.5 0.2 1.5Kazakhstan 19.6 23.3 11.6 7.6Kyrgyzstan 0.7 0.0 0.7Moldova 2.5 0.1 2.5Russian Federation 405.1 598.0 25.6 229.0Tajikistan 1.4 0.0 1.4Turkmenistan 16.6 58.8 0.0 45.2Ukraine 72.9 19.4 55.3 2.5Uzbekistan 44.0 55.0 0.0 12.4Total FSU 593.8 760.5 124.8 0.0 296.7 0.0


TheFormerSovietUnionregionisdominatedbyRussia,bothasthelargestconsumerandproducerofgas.Alltheimportedgaswithintheregionisintra-FSUtradei.e.noimportscomefromoutsidetheregion.RussiaexportsgastoalmostallitsneighbouringcountriesbutKazakhstan,TurkmenistanandUzbekistanarealsoexporters,includingtoRussia.Ukraineisthemajorimporterofgas.

Chart A17: FSU price formation 2005 – total consumption




65,1 %

No price2,8 %


3,0 %

595 bcm

At595bcmtheFormerSovietUnionaccountsforjustover20%ofworldconsumption.AllimportedgasispricedonaBIMbasis,togetherwithsomeRussiadomesticproductionsoldtolargeusers.Thedominantpriceformationmechanism,however,isRBCinRussia,UzbekistanandKazakhstan.Since2005,however,thissituationinRussia,atleast,islikelytohavechangedwithincreasedpricestodomesticconsumersraisinglevelsabovetheaveragecostofproductionandtransportation.DomesticproductioninUkraineistheRSPcategoryandNPinTurkmenistan.


Middle East

Table A5: Middle East consumption and production 2005 (BCM)

Pipeline LNG Pipeline LNGBahrain 10.7 10.7Iran 102.4 100.9 5.8 4.3Iraq 2.5 2.5Israel 0.7 0.7Jordan 1.6 0.3 1.3Kuwait 12.3 12.3Oman 9.2 19.8 1.4 9.2Qatar 18.7 45.8 27.1Saudi Arabia 71.2 71.2Syria 6.1 5.4United Arab Emirates 41.3 47.0 1.4 7.1Total Middle East 276.6 316.6 8.5 0.0 5.7 43.5

Imports ExportsCountry Consumption Production

TheMiddleEastregionislargelyaninsulatedmarketintermsofgasconsumptionwithverylittlegasbeingtraded(excludingexports)acrossborders.SmallquantitiesofgasareimportedbyIranfromTurkmenistanandJordanfromEgypt.

Chart A18: Middle East price formation 2005 – total consumption

Middle East price formation 2005: Total consumption


80,4 %


14,8 %

No price1,3 %

Not known 0,9 %


275 bcm

MiddleEastconsumptionat275bcmaccountsforalmost10%oftotalworldconsumption.ThedominantpriceformationmechanismintheregionisRBCinlargelyIran,SaudiArabia,KuwaitandQatar.TheRSPcategoryisaccountedforbytheUAE,wherepriceisregulatedbyeachemirate.TheBIMcategoryrelatestoIranianimportsfromTurkmenistanandthetradefromOmantotheUAE.

Africa

Table A6: Africa consumption and production 2005 (BCM)

Pipeline LNG Pipeline LNGAlgeria 23.2 88.2 39.1 25.7Angola 0.8 0.8Egypt 25.8 34.6 1.1 6.9Equatorial Guinea 1.3 1.3Ivory Coast 1.3 1.3Libya 5.8 11.3 4.5 0.9Nigeria 10.4 22.4 12.0South Africa 2.2 2.2Tunisia 4.3 2.5 1.8Total Africa 75.1 164.6 1.8 0.0 44.7 45.5


Excludingitsexporttrade,Africahasvirtuallynottradedgas,withonlyTunisiaimportingsomegasfromAlgeriaviathepipelinetoItaly.

Chart A19: Africa price formation 2005 – total consumption



11,2 %


48,2 %


No price1,1 %

Oil price escalation5,7 % Netback

1,2 %

75 bcm

Intermsofconsumption,Africaisthesmallestregionat75bcm,or2.5%oftotalworldconsumption.Wholesalepricesarehighlyregulated,withRBCaccountingforjustunderhalf,inEgyptandNigeria.RCSispredominantlyAlgeriaandRSPinLibyaandSouthAfrica.TheOPEcategoryreflectstheonlytradedgaswithTunisiaimportingfromAlgeria.

Asia

Table A7: Asia consumption and production 2005 (BCM)

Pipeline LNG Pipeline LNGAfghanistan 0.2 0.2Bangladesh 14.2 14.2China 45.7 50.0 3.1China Hong Kong 3.1 3.1India 38.1 32.1 6.0Myanmar 4.1 13.0 8.9Pakistan 29.3 29.3Total Asia 134.7 138.8 3.1 6.0 12.0 0.0


Againthereisnotalargeamountoftradedgaswithinthisregion–ChinaHongKongimportsfromChina,whileIndiaimportsLNG,principallyfromQatar.China,IndiaandPakistanarethelargestconsumers.ChinaandIndiaareexpectedtoincreasegasconsumptionsignificantlyfrombothindigenousresourcesandimports.

Chart A20: Asia price formation 2005 – total consumption






57,9 %


3,0 %

135 bcm


Asiaaccountsforlessthan5%ofworldconsumptionat135bcm.Regulationofwholesalepricesiswidespread.RSPat57%ispredominantlyChinaandIndia,RCSinPakistanandRBCinMyanmar.OPEat11%isallinBangladesh.TheBIMcategoryisIndianLNGimportsandHongKongimportsfromChina.

Asia Pacific

Table A8: Asia Pacific consumption and production 2005 (BCM)

Pipeline LNG Pipeline LNGAustralia 26.8 40.3 14.9Brunei 2.4 11.5 9.2Indonesia 37.5 73.8 4.8 31.5Japan 79.0 5.1 76.3Malaysia 39.3 59.9 1.8 28.5New Zealand 3.5 3.8Philippines 3.0 2.9Singapore 6.6 6.6South Korea 33.7 0.5 30.5Taiwan 10.7 0.8 9.6Thailand 29.9 23.7 8.9Vietnam 6.9 6.9Total Asia Pacific 279.3 229.2 15.5 116.4 6.6 84.0


AfterEurope,AsiaPacificistheregionmostheavilydependentoninternationallytradedgas,principallyLNGintoJapan,KoreaandTaiwan,althoughmuchoftheLNGcomesfromwithintheregiontogetherwithimportsfromtheMiddleEast.AdistinguishingfeatureofJapan,KoreaandTaiwanisthattheyarevirtuallytotallydependentonLNGimportsforalltheirgasconsumption,leadingtowhatsomemightarguearethepremiumpricespaidforthegas.ThepipelineimportsareintoSingaporefromIndonesiaandMalaysiaandThailandfromMyanmar.

Chart A21: Asia Pacific price formation 2005 – total consumption



11,8 %




24,8 %

Not known 2,0 %


50,4 %

280 bcm

At280bcm,AsiaPacificaccountsfor10%oftotalworldconsumption.Some50%ofgasisimportedbycountries.OPEat50%isthelargestcategoryandcomprisesLNGimportsintoJapan,KoreaandTaiwan,pipelineintoSingaporeanddomesticallyproducedgasinThailand.GOGisAustraliaandspotLNGtrade.BIMismainlyimportsintoThailandandsomedomesticproductioninIndonesiaandNewZealand.RSPisthemajorityofwholesalegasinIndonesiaandMalaysia.RCSisVietnam.

Wholesale PricesAswellascollectingdataonpriceformationmechanismstheIGUstudyalsocollectedinformationonwholesalepricelevelsin2005.Asnotedelsewhere,theresultshereshouldbetreatedasbroadordersofmagnitude,sincethedefinitionofwholesalepricesisquitewide.Itistypicallyahubpriceoraborderpriceinthecaseofinternationallytradedgas,butcouldalsoeasilybeawellheadorcity-gateprice.

Chart A22: Wholesale prices by region 2005

World: Average wholesale prices 2005

$0,00 $1,00 $2,00 $3,00 $4,00 $5,00 $6,00 $7,00 $8,00 $9,00

Middle East

Former Soviet Union

Latin America

Africa

Asia

Total World

Asia Pacific

Europe

North America

$/MMBTU

Thechartaboveshowsasnapshotofpricelevelsfor2005.Wholesalepriceshavechangedsince2005,asdiscussedelsewhere.Generallythehighestwholesalepricesareinregionswhere,itcouldbesaidthat,thereismore“economic”pricing–GOGandOPE–inNorthAmerica,EuropeandAsiaPacific.ThelowestwholesalepricesaregenerallywhereregulationdominatesintheMiddleEastandFormerSovietUnion,particularlyRBC.

Theseconclusionsareillustratedmoreclearlyinthechartbelowwhichconsiderswholesalepricesattheindividualcountrylevel,atleastforthosecountrieswithmorethan10bcmannualconsumption.OnlyBahrain,UAEandTurkmenistanaremissingwithover10bcmconsumption.Thehighestwholesalepricesin2005werefoundinNorthAmerica(USA,CanadaandMexico).TheLNGdependentcountriesofJapan,KoreaandTaiwanalsohadrelativelyhighwholesaleprices.ThesewerefollowedbyawholehostofEuropeancountriesheadedbyUKandFrance.Atthebottomofthechartweregenerallycountrieswherewholesalepricesweresubjecttosomeformofregulation,typicallyRBC–Iran,Nigeria,SaudiArabia,RussiaandEgypt.


Chart A23: Wholesale prices by country 2005

Average wholesale prices 2005

$0,00 $1,00 $2,00 $3,00 $4,00 $5,00 $6,00 $7,00 $8,00 $9,00 $10,00

IranNigeria

UzbekistanSaudi Arabia

QatarArgentina

VenezuelaKazakhstan

KuwaitEgypt

Russian FederationBelarusUkraineTrinidad

MalaysiaIndia

AlgeriaChina

PakistanAustralia

BangladeshBrazil

RomaniaIndonesiaThailand

SpainItaly

GermanyTurkeyPolandAustria

HungaryBelgium & Luxembourg

NetherlandsJapan

United KingdomFrance

South KoreaCanadaMexicoTaiwan

USA

$/MMBTU

Countries over 10 bcm Annual Consumption

World Average

Chart A24: Wholesale prices by price formation mechanism 2005


$0,00$1,00$2,00$3,00$4,00$5,00$6,00$7,00$8,00$9,00

Oil pric

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$/M

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Analternativewayofanalysingthedataistocategorisebypriceformationmechanism.ThehighestwholesalepricesareGOGfollowedbyOPE.Atthebottomend,asmightbeexpected,wholesalepricesdeterminedbyRBCarelessthenRSPwhich,inturn,arelessthenRCS.ThelowlevelofwholesalepricesforNETarepresumablyaffectedbylowcommoditypricesforthefinalproducts–almostallTrinidadandsomeinNorway.TheresultforBIMislargelyimpactedbythelowlevelsofwholesalepricesinintra-FormerSovietUniontrade.

Conclusions

In2005justover70%oftheworld’sconsumptionofgascomprisedofdomesticproductionconsumedwithinthatcountry,withnotradeacrossinternationalborders.Some22%wastradedthroughpipelinesandsome6%LNG.Thewholesalepriceformationmechanismsarelargelyverydifferentforinternationallytradedgascomparedtogaswhichisproducedpurelyfordomesticconsumption.

Chart A25: World price formation 2005 – total consumption



23,3 %


31,4 %



10,9 %

No price1,2 %

Not known 0,3 %

Netback0,5 %



2,790 bcm

Table A9: World price formation 2005 – total consumption (BCM)

OPE GOG BIM NET RCS RSP RBC NP NK TOTNorth America 0.0 759.4 0.0 0.0 0.0 0.0 0.0 9.4 0.0 768.8Latin America 18.7 2.0 8.4 11.9 6.8 74.8 3.1 0.0 0.0 125.7Europe 426.6 83.4 8.7 0.7 1.7 14.4 0.0 3.5 0.0 539.1Former Soviet Union 0.0 0.0 172.9 0.0 0.0 17.6 386.6 16.6 0.0 593.7Middle East 0.0 0.0 7.2 0.0 0.0 40.6 221.5 3.6 2.5 275.3Africa 4.3 0.0 0.0 0.9 24.5 8.4 36.2 0.8 0.0 75.1Asia 14.2 0.0 9.1 0.0 29.3 78.0 4.1 0.0 0.0 134.7Asia Pacific 140.8 33.0 22.6 0.0 8.0 69.3 0.0 0.0 5.6 279.3Total World 604.6 877.9 228.9 13.5 70.3 303.2 651.4 33.8 8.1 2,791.7

22% 31% 8% 0% 3% 11% 23% 1% 0% 100%

Region Total Consumption

Thechartaboveillustratestheoverallresultsattheworldlevel,whilethetablelooksatthebreakdownbyregion.

• ThelargestpriceformationcategoryisGOGat31%,butthisisduetotheimpactoftheNorthAmericanmarket,whichispredominantlydomesticgasproduction,plussmallerquantitiesintheUKand,inAsiaPacific,AustraliaandspotLNGcargoes;

• TheOPEcategoryat22%,isgenerallyonlyfoundininternationallytradedgas,whichismainlypipelineandLNGinEuropeandLNGinAsiaPacific;

• TogethertheGOGandOPEcategories,whichcouldbesaidtoreflectan“economic”or“market”valueofgas,accountforjustover50%oftotalworldconsumption;

• Wholesaleprice“regulation”,whichcovers3categories–RCS,RSPandRBC,accountsfor37%oftotalworldconsumption,butisonlyfoundindomesticgasproductionandnotinternationallytradedgas.TheRBCcategoryin2005wasthelargest,asaconsequenceofthelowlevelsofpricesintheFormerSovietUnion,mainlyRussia,andtheMiddleEast.WhilewholesalepricesinRussiahaveremainedregulatedtherehavebeenpriceincreases,whichwouldmeanthat,by2007,mostofthemarketwouldnotbeintheRBCcategory,probablymovingtotheRSPcategory;

• TheRSPcategory,at11%,isfoundacrossallregions,apartfromNorthAmerica;

• TheBIMcategory,at8%,ismainlytradedgasbetweentheFormerSovietUnioncountries,principallyRussianexports,plus,inAsiaPacific,importedgasinIndiaandThailandandpartlydomesticallyproducedgasinIndonesia.


Inrespectofwholesalepricelevelsin2005,thechartbelowshowsthatpricelevelsweregenerallyhigherintheGOGmarketsoftheUSandtheUK,aspricespeakedathighlevelsduringtheyear,followedbyOPE.Atthebottomend,asmightbeexpected,wholesalepricesdeterminedbyRBCarelessthenRSPwhich,inturn,arelessthenRCS.TheresultforBIMislargelyimpactedbythelowlevelsofwholesalepricesinintra-FormerSovietUniontrade.In2006/7,however,GOGpriceshavedeclinedtobelowcomparableOPEprices.

ChartA26:Wholesalepricesbypriceformation2005


$0,00$1,00$2,00$3,00$4,00$5,00$6,00$7,00$8,00$9,00

Oil pric

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International Gas Union

OfficeoftheSecretaryGeneral c/oStatoilASA 0246 Oslo Norway

Telephone: +4751990000 Fax: +4722534340 Email: [email protected] Website: www.igu.org

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IGU members

IGUTheInternationalGasUnionisaworldwidenon-profit organisation aimed at promoting the technical andeconomicprogressofthegasindustry.TheUnionhasmorethan100membersworldwideonallcontinents. Themembers of IGU are national associations and corporationsofthegasindustry.IGU’sworkingorgani- sationcoversallaspectsofthegasindustry,includingexploration and production, storage, LNG, distribu-tionandnaturalgasutilisationinallmarketsegments.IGU promotes technical and economic progress ofthegasindustryemphasisingenvironmentalperform-anceworldwide. Formore information, please visit www.igu.org

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