niversity geopolitics and world gas trade

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Geopolitics and World Gas Trade

Peter HartleyKenneth Medlock III

James A. Baker III Institute of Public PolicyRICE UNIVERSITY

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Overview and motivation

Worldwide, the demand for natural gas is rising:

Key reasons for the increase in demand :

Environmental pressure for cleaner fuels

Wholesale electricity market competition raised the demand for smaller scale electricity plants, which CCGT (an improved technology relative to older gas turbines) satisfied

The gas share may continue to rise if gas supplies transport fuel needs (GTL, oil shale, fuel cell)

Possible challenges to a gas future include:

Lack of investor confidence in investing in many gas-rich nations

“Resource curse” – might the growing rents from gas provoke political instability?

NIMBY and terrorism – might this stymie regasification plants in the US?

Slowdown to electricity reforms – could disadvantage gas relative to other fuels

Alternative energy technologies – coal gasification, solar, hydro and/or nuclear power, perhaps assisted by falling costs of HVDC, could displace gas in electricity generation

Source: EIA

Petroleum (45%)

Natural Gas (19%)

Coal (26%)

Hydroelectric (6%)

Nuclear (3%)Renewables, waste (1%)

Petroleum (38%)

Natural Gas (22%)

Coal (27%)

Hydroelectric (7%)

Nuclear (6%)

Renewables, waste (1%)

Petroleum (36%)

Natural Gas (24%)

Coal (25%)

Hydroelectric (7%)

Nuclear (7%)

Renewables, waste (1%)1980 1990 2002

289.05×1015

BTU 351.08×1015

BTU 405.12×1015

BTU

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The Challenge: Linking supply with demand

World gas supply potential is large, but:

It is concentrated in areas remote from markets

Substantial production and transport infrastructure is needed

Prices need to rise in real terms to finance the investments

Unstable political regimes may make investments unattractive

Source: USGS

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Likely Institutional Changes

New Market Structures

Falling LNG production and transport costs facilitate global marketsTrades between regions transmit prices as well as gasLNG imports result in gas on gas competition

Increased inter-fuel competition from higher gas share in electricity; while new technologies may link different network industries

Market inter-connections increase risks and potential opportunities

Summary effects: greater reliance onmarket prices (including derivative markets),private operators and financing,short-term opportunistic sales and purchases;

less reliance onregulation,state enterprises,long-term bilateral contracts

Changing Roles for Governments?

From builder to a facilitator

But politics can also block otherwise viable projects

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Geopolitics and World Gas Trade

1. Russia could become a pivotal supplier of natural gasPipeline connections to both Europe and AsiaLNG supply to both the Pacific and Atlantic basinsKey arbitrage point between the major marketsGeopolitics: Does this increase Russian leverage on other issues?

2. US, Europe and Asia all to become major importersUS may also play a key role in arbitraging Pacific/Atlantic pricesAll three may draw on supplies from Russia & Middle EastUS and Europe may also compete for supplies from Africa, S. AmericaGeopolitics: Does such competition influence attitudes on other issues? Does it affect policies toward major producers?

3. Political relations between countries and gas tradePoor inter-governmental relations can scuttle what otherwise would be economically viable projects such as pipelines through the DPR KoreaThe attraction of consummating high surplus trades may also affect other political issues eg. Indian attitude to sanctions on the Islamic Republic of Iran or the Pakistan border dispute

4. Supply SecurityRising dependence on Middle East and Russia for exportsHistorically, there have been few political disruptions to international gas trade, but the risks of these may be greater in the future

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The Rice World Natural Gas Trade Model

RWGTM, based on geological and economic fundamentals, can be used to examine political and economic influences on the world gas market

Model framework: Marketbuilder from Altos Partners, which calculates equilibrium prices and quantities for fixed locations and periods

Non-stochastic, but it allows analysis of many different scenarios

Dynamic spatial general equilibrium linked through time by Hotelling-type optimization of resource extraction

Capacity expansion, both greenfield and brownfield, is based on…… capital costs of expansion,operating and maintenance costs of new and existing capacity, andrevenues resulting from anticipated output and expected future prices…

… so that, at the margin, the maximized net present value of each project for the life of the investment is at least zeroCurrent and future prices determine the optimal size of expansions

No uneconomic decisions are madeThe model iterates on price through time so that markets balance in each time period, and there are no opportunities for either spatial or intertemporal arbitrage

The model predictsRegional supplies and demandsRegional pricesInter-regional flows

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Rice World Gas Trade Model: SupplyOil and Gas Journal (2003), USGS World Resource Assessment (2000), other sources gave…

associated and unassociated natural gas resources,

conventional and CBM gas deposits in North America and Australia, and

conventional gas deposits in the rest of the world

… assessed in three categories:

proved reserves (updated 2003 Oil & Gas Journal estimates)

growth in known reserves (P-50 USGS estimates)

undiscovered resource (P-50 USGS estimates)

North American cost estimates were related to geological characteristics and applied globally

But required return on investment varies by region (using ICRG and World Bank data) and project type

We also allow technological change to reduce mining costs

Some cost of supply curves (indicating the capital cost of developing supplies):

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0 500 1000 1500 2000 2500

Cumulative Reserve Additions (Quadrillion BTU)

Alaska Qatar Saudi Arabia Iran West Siberia

Comparative Cost of Supply Curves for Selected Regions

Sources: USGS, EIA, author calculations

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Rice World Gas Trade Model: Demand

Econometric model for forecasting demand developed using EIA, IEA and World Bank data relates gas demand to:

Economic development (real GDP/capita in PPP),Primary energy demand increases with GDP/capita but at a decreasing rate (see Medlock and Soligo (2001))Natural gas share in primary energy demand increases with development

Population

Prices (in $/MMBTU of natural gas, oil and coal); and

Country-specific effectsThese could reflect, for example, resource endowments or climates

We allow demand to be lost to new technologies from 2020 at prices above $5 with up to 2% lost at $5.50 and 4% lost at $10

Each year, the proportion of demand vulnerable to the backstop at each price above $5 increases until in 2055 all reference case demand could be satisfied at a price of $10

We took coal gasification costs as a benchmark for the cost of the backstop technology, but nuclear or solar are other alternatives

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Rice World Gas Trade Model: Transport

To facilitate calculations of optimal capacity expansions

Supplies and demands are aggregated into discrete “nodes”

Existing parallel pipes are aggregated into a single link that can be expanded

We allow for many potential pipelines including ones that have been discussed and others that might appear profitable at prices calculated in initial iterations of the model

Represent LNG routes by hubs and spokes to allow many potential trading partners

Pipeline costs were split into fixed and variable costs

Fixed costs were based on a regression analysis of EIA cost data (annual cost per unit of capacity) for 52 pipeline projects:

Costs were allowed to be a function of pipeline length, pipeline capacity (to reflect economies of scale), and indicator variables for whether the pipeline crosses mountains, water or populous areas

Variable costs –FERC filed rates in US, tariff based on a rate of return recovery elsewhere

LNG costs were based on a 2003 EIA report and various industry sources

Shipping costs are represented as lease rates

Liquefaction costs represented as fixed costs ($4.11/mcf/yr) plus variable costs (fuel and operating costs, and feed gas cost)

Regasification costs represented as fixed costs (vary by location primarily due to land costs) and variable costs (fuel and operating costs)

Allow for technological change to reduce LNG costs at rates of change based on a statistical fit to the IEA World Energy Investment Outlook

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Reference Case Supply Projections

2002 2006 2010 2014 2018 2022 2026 2030 2034 20380

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Europe

Russia

Other FSU

North America

South America

Qatar

Iran

Saudi Arabia

Other Middle East

North Africa

Other Africa

Australia, NZ, PNG

ASEAN

China

Other Asia

Significant decline in North America and Europe

Pronounced growth in Russia, Middle East and Australasia

Islamic Republic of Iran

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Reference Case Demand Projections

2002 2006 2010 2014 2018 2022 2026 2030 2034 20380

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Europe

Russia

Other FSU

North America

South America

Qatar

Iran

Saudi Arabia

Other Middle East

North Africa

Other Africa

Australia, NZ, PNG

ASEAN

China

Other Asia

Steady growth in North America, Europe and Asia Backstop constrains demand growth long term…


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Reference Case Imports and Exports

2002 2006 2010 2014 2018 2022 2026 2030 2034 2038-80

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80Europe

Russia

Other FSU

North America

South America

Qatar

Iran

Saudi Arabia

Other Middle East

North Africa

Other Africa

Australia, NZ, PNG

ASEAN

China

Other Asia

Strong growth in imports in North America, Asia and Europe

Strong growth in exports from Russia, Middle East and Asia/Pacific


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Reference Case LNG Exports

2002 2006 2010 2014 2018 2022 2026 2030 2034 20380

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Alaska

Australia

Indonesia

Malaysia

Other SE Asia

Russia Pacific

Iran

Qatar

UAE

Saudi Arabia

Other Middle East

North Africa

Nigeria

Other Africa

South America

Greenland

Norway

Russia Atlantic

Dominant feature is strong growth in theMiddle East

Australia emerges as the largest single LNG exporter

In later periods, there is strong growth in RussianAtlantic LNG


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Reference Case LNG Imports

2002 2006 2010 2014 2018 2022 2026 2030 2034 20380

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South & Central America

Mexico Atlantic

US Atlantic & Gulf

Canada

UK

Belgium

France

Italy

Rest of Europe

India

China

Japan

South Korea

US Pacific

Mexico Pacific

Remaining Pacific

All regions, except Japan and South Korea, experience strong growth. The dominant feature,however, is growth in US imports (shown as US Atlantic and US Pacific)…

Republic of Korea

Rep. of Korea

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Selected Price Projections

Prices are more equal when markets become linked via pipeline and LNG trade.

US and European prices track each other closely until the mid 2020’s.

Seoul prices are initially linked to Tokyo (via LNG) but later more closely track Beijing as both China and the Republic of Korea import gas via pipeline from Russia.

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2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 20401.5

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The gas and oil prices are linked via the estimated cross- elasticity of substitution between gas and oil. In addition, the assumption that the share of gas tends to rise with economic development raises the gas to oil price relativity over time.

The oil price is exogenous in our model. We use the latest EIA median forecast. In principle, one could solve for the oil price in the same way that we solve for the gas price.

Gas and Oil Prices are linked

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2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 20402.5

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Reference Case Results – Summary

Russia becomes the dominant exporter in the global gas market

Russian pipeline gas continues to be important for Europe

Russia also becomes a major supplier of natural gas to China, Republic of Korea and JapanSakhalin gas goes to the Korean peninsula and Japan, and East Siberian gas goes to China next decadeThe Republic of Korea shifts to pipeline gas from Russia at the expense of LNG importsJapan continues to import LNG as a national gas grid is prohibitively costly

Russia also enters the LNG marketSakhalin LNG serves the Pacific Basin near term and holds fairly steady throughout the model time horizon.LNG is provided to the Atlantic Basin beginning in 2022 from deposits in the Barents Sea region. Growth here is strong as supply deficits in Europe and North America grow rapidly.

The Middle East will also become an important supply region, exporting both LNG and pipeline gasMajor exporters in the region are Qatar, Islamic Republic of Iran, UAE and, later on, Saudi ArabiaIslamic Republic of Iran is the primary source of pipeline gas exports from the Middle EastQatar is the largest Middle East supplier of LNG, but Saudi Arabia, UAE and Islamic Republic of Iran also become significant after 2025

Several long-haul international pipelines are constructedThe trans-Saharan pipeline (Nigeria to Algeria) is constructed in 2014India imports gas via pipeline from the Islamic Republic of Iran beginning in 2024European imports from the Middle East via Turkey increase dramatically post-2020Gas is also piped east from West Siberia to western China by 2038 and to East Siberia (& China and the Republic of Korea) by 2045

North America becomes a major importer of LNGAlaska merely offsets declines in other North American production with little effect on priceGas prices in the US eventually exceed prices in Europe and Asia

Europe imports more LNG than Northeast Asia from the early to middle 2030’s

South American gas is consumed primarily in South AmericaTrinidad LNG export growth is limited to the near termPeruvian LNG exports begin in 2010, but do not grow to be largeVenezuelan LNG is significant in later time periods (post-2025)Brazil imports Bolivian and Venezuelan supplies via pipelineArgentina imports from Bolivia, Paraguay and Uruguay via pipelineChilean imports from Argentina are later displaced by Bolivian gas and ultimately some LNG

A backstop technology is used almost everywhere by 2040, but is used most in the US, Europe and Japan

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Illustrative Geopolitical Scenarios

The Reference Case solution reflects geology, geography and economics but no constraints arising from politics

Scenario analysis can inform us of possible outcomes in a world where political constraints exist

One type of scenario eliminates specific projects, for example:

Pipelines through the DPR Korea cannot be constructed

Iran-India pipeline is not constructed

Other disruptions could be more pervasive, such as the possibility that OPEC members slow development to earn higher returns on exports

Current gas exports are more concentrated than the distribution of reserves –Russia has 29%, and the top 7 (as of 2004) have 79% of exports – but…

Qatar is the only significant Middle East exporter with 3.8%, andCanada, Norway and Netherlands with 27% of exports are unlikely to join a cartel

Nevertheless, in the Reference Case, OPEC members’ share of exports is around 32% in 2020 and rises to around 43% by 2040

Islamic Republic of Iran shows strong growth in pipeline gasSaudi share (LNG) becomes important after 2030

While more widespread development will create many supply sources, many big consumers will also become big importers, so a cartel might be possible

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No DPR Korea pipes: Effects on the Republic of Korea & China

Republic of Korea –Reference case

Republic of Korea –No DPR Korea pipes

China – Reference case China – No DPR Korea pipes

2002 2006 2010 2014 2018 2022 2026 2030 2034 20380

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Nahodka to South Korea

LNG North Region

LNG South Region

North Backstop

South Backstop

2002 2006 2010 2014 2018 2022 2026 2030 2034 20380

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Beijing to South Korea

LNG North Region

LNG South Region

North Backstop

South Backstop

2002 2006 2010 2014 2018 2022 2026 2030 2034 20380

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Vietnam to South China

East Siberia to China

Nahodka to Northeast China

West Siberia to China

Domestic production

LNG

Backstop

2002 2006 2010 2014 2018 2022 2026 2030 2034 20380

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Vietnam to South China

East Siberia to China

Nahodka to Northeast China

West Siberia to China

Domestic production

LNG

Backstop

Nahodka to Rep. of Korea

Beijing to Rep. of Korea

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No DPR Korea pipes: Some other Effects

Changes in world demand

Changes in world LNG output Changes in select prices

2002 2006 2010 2014 2018 2022 2026 2030 2034 2038-0.3

-0.25

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-0.15

-0.1

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0.15Russia

Remaining FSU

Europe, Greenland

Middle East

South Korea

United States

Japan

ASEAN

Canada, Mexico

Africa

Remaining Asia

Indian sub-continent

Central & South America

Australia, NZ, PNG

China

2002 2006 2010 2014 2018 2022 2026 2030 2034 2038-1

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Australia, NZ, PNG

Nigeria

China

ASEAN

Remaining Africa

Middle East

Remaining Asia


Russia

Europe, Greenland

Remaining FSU

North America

Changes in world supply

2002 2006 2010 2014 2018 2022 2026 2030 2034 2038-0.2

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Russia Pacific

Middle East

Nigeria

Russia Atlantic

South America

Norway, Greenland, Alaska

Australia

Indonesia

Other SE Asia

Other Africa

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2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040-0.75

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Republic of Korea

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No Is. Rep. of Iran-India Pipe: Effects on India & Islamic Republic of Iran

India – Reference case supply India – supply w/o pipeline

Islamic Republic of Iran –Reference case exports

Islamic Republic of Iran –exports w/o pipeline

2002 2006 2010 2014 2018 2022 2026 2030 2034 2038-0.5

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Bangladesh to East India

Pakistan to India

Domestic production East

Domestic production West

LNG South (Dabhol)

LNG West (Dahej/Hazira)

Backstop

2002 2006 2010 2014 2018 2022 2026 2030 2034 2038-1

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Turkmenistan to North Iran

Iran to Azerbaijan

Iran to Iraq

Iran to Pakistan

Iran to Turkey

LNG Export

2002 2006 2010 2014 2018 2022 2026 2030 2034 2038-0.5

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Domestic production East

Domestic production West

LNG East (Calcutta)

LNG South (Dabhol)

LNG West (Dahej/Hazira)

Backstop

2002 2006 2010 2014 2018 2022 2026 2030 2034 2038-1

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Iran to Azerbaijan

Iran to Iraq

Iran to Turkey

LNG Export

Islamic Republic of Iran to Turkey

Islamic Republic of Iran to Pakistan

Islamic Republic of Iran to Iraq

Islamic Republic of Iran to Azerbaijan

Turkmenistan to the North of the Islamic Republic of Iran

Islamic Republic of Iran to Turkey

Islamic Republic of Iran to Iraq

Islamic Republic of Iran to Azerbaijan

Turkmenistan to the North of the Islamic Republic of Iran

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RICEUNIVERSITY Changes in world demand


No Is. Rep. of Iran-India Pipe: Some Other Effects

2002 2006 2010 2014 2018 2022 2026 2030 2034 2038-1

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1Remaining Middle East


North America

Iran

FSU

Australia, NZ, PNG

ASEAN

Remaining Asia

Nigeria

Remaining Africa

Europe, Greenland


2002 2006 2010 2014 2018 2022 2026 2030 2034 2038-0.30

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North America

Europe

Iran


Remaining Australasia

Remaining Middle East

FSU

Africa


Changes in world supply

2002 2006 2010 2014 2018 2022 2026 2030 2034 2038-1

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Iran

Other Middle East

Remaining

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2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040-0.8

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Islamic Republic of Iran Islamic Republic of Iran


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Restricted OPEC Development

We assumed that the return on export infrastructure investment projects from all current OPEC members (Algeria, Nigeria, Libya,Qatar, Saudi Arabia, Islamic Republic of Iran, Iraq, UAE, Kuwait, Venezuela, Indonesia) is increased above the base level

The weighted average cost of capital for export pipeline projects was increased to 20% from the 8–10% assumed in the base caseThe weighted average cost of capital for liquefaction projects also was increased to 20% from the 10–13% assumed in the base case

Changing the required return will operate like a coordinated reduction in the rate of development of gas export projects

A major difference from a genuine cartel is that the higher revenue is not assumed to influence domestic demand in OPEC countries

The alternative would be to postulate a price objective for the member countries and a production sharing agreement to support that objective

The ultimate consequence would be a reduced rate of project development, a higher rate of return on investments but also increased government revenue from the National Oil (or Gas) Company

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Effects of restricted OPEC developmentChanges in world demand Changes in world supply


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2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040-0.6

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2002 2006 2010 2014 2018 2022 2026 2030 2034 2038-4

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OPEC countries

Russia

Australia, NZ, PNG

Remaining FSU

North America

Europe and Greenland

Remaining Africa


Remaining Asia

Remaining S & C America

2002 2006 2010 2014 2018 2022 2026 2030 2034 2038-1.4

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Remaining Asia


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Remaining Africa

Australia, NZ, PNG

2002 2006 2010 2014 2018 2022 2026 2030 2034 2038-4

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Australia, NZ, PNG

Remaining Africa




North America

Remaining Asia

OPEC countries

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Concluding Remarks

The results illustrate the key role Russia will play in the world gas marketRussia not only has a lot of gasIt also is strategically placed to ship gas either east or west and hence is in a position to arbitrage between European and Asian marketsToward the end of the horizon, Russia also becomes a significant exporter of LNG, thus helping to solidify the link between LNG prices and pipeline gas prices around the world

North America and Middle East also link the Pacific and Atlantic marketsMiddle East producers can export LNG east or west, and also can ship gas via pipeline to Europe or the Indian sub-continentIn North America, if Pacific Basin gas prices rise, more Atlantic Basin LNG is imported and the arbitrage point moves toward the west coast

Long distance international gas trade provides opportunities forcountries to gain from cooperation, but also to lose from conflict

Ultimately, there appears to be substantial gas available to satisfy demand at a reasonable price until the second half of the century when alternative backstop technologies should become competitive

The global supply curve for natural gas is reasonably elasticSubstantial known gas reserves may not be exploited since they are likely to be more expensive than the feasible alternatives

niversity geopolitics and world gas trade

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