NATURAL GAS ECONOMICS AND BUSINESS ISSUES
Dec 22, 2015
NATURAL GAS ECONOMICS AND BUSINESS ISSUES
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What is the natural gas business…
…and how should it be regulated?• Is it a competitive, upstream-driven
business?• Is it an economies of scale, monopoly
midstream-downstream business that affects the public interest?
• How much of direct end use and conversion is competitive?
• If the goal is to build the “natural gas factory,” then policy/regulatory approaches need to facilitate value chain development – “commercial frameworks.”
Where does most profit,
value creation take place?
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Building the Natural Gas FactoryUPSTREAM
Exploration and Production (E&P)
MIDSTREAMProcessing
StoragePipeline Transportation
LNGLiquefaction
ShippingRe-gasification
DOWNSTREAMDistribution and
End UseResidentialCommercial
IndustrialPower
GenerationTransmission
Distribution to End UseInvestor GoalsCommercialize natural gas production, by:•Increasing diversity of midstream options•Gaining access to downstream participation where supported by markets (“power the world with gas”) •Export
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Worldwide Natural Gas System Dynamics: Framework Issues
E&P (LNG)Profit driven; ROR decision based on expected prices; monetize stranded reserves
Power GenProfit driven; ROR decision based on expected prices; fuel competition for gen
Pipelines
TransmissionRegulated asset optimization; market rates?
LDCsRegulated asset optimization; proximity to final customers (gas, power); market rates?
End UsersEnd use based on expected prices; access to competitive supply
Ben
efit
s o
f C
om
pet
itiv
e S
up
ply
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The Overall Challenge:Balancing the Market
LOW Prices HIGH
SUPPLYDEMAND
Mean reversion is a reality if market-clearing participants exist
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Achieving Competitive Supply
COMPETITIVE SALES•Wellhead producers•Third party wholesalers
Pricing Supply The challenges:•Entry of new suppliers•Managing common pools•Developing liquidity to establish locational basis•Protecting market transparency•Dealing with third party wholesalers that are affiliated with regulated infrastructure•Access for new supplies•Balancing short term cycles and long term capital requirements for resource development
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Regulated Infrastructure as the Conduit for Supply Competition
RESERVATION (DEMAND)Fixed cost of investment•Return on equity•Taxes•Long term debt•A&G, DA, O&MCOMMODITY (USAGE)Variable cost of operation•O&M
The challenges:•Rate-making transitions•Setting maximum allowable rates with market transparency•Pricing new capacity•Dealing with access fornew capacity•Determining contestabletransportation markets•Dealing with market power•Balancing short term cycles and long term capital requirements for delivery
Pricing Transport, Distribution
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Achieving Competitive Demand
Wholesale Cost
Retail Cost
Margin
Market Price
The challenges:•Political will to allow wholesale price fluctuations to flow to retail users•Price discovery and transparency•Market structure (unbundling)•Market power•Market oversight•Balancing short term cycles and long term capital requirements for delivery
Pricing Consumption
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Market Trade Off
$0.50
$1.50
$2.50
$3.50
$4.50
$5.50
$6.50
$7.50
$8.50
$9.50
$10.50
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
Pri
ce
s, $
/mc
f
Citygate to Residential
Wellhead to Citygate
Wellhead
As unbundling for C&I customers proceeded, more cost behind the citygate is absorbed by residential.
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Price Volatility and Risk are the Trade Offs for Competition
E&P Pipelines LDCs End Users Power
Commodity price risk flows (blue)
Capacity price risk flows (gray)
Risk accepting entities
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The U.S. CasePre-Natural Gas Restructuring
PRODUCERS PIPELINES LDCs
Locate+
Produce
Sell to Pipelines
Aggregate
Storage
Sell to LDCs
Purchase fromPipelines
Serve End User
FERC PUCs
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The U.S. CasePost-Natural Gas Restructuring
MarketersGatherers & Aggregators
Service
CompaniesEnd Users
ProducersStorage
CompaniesPipelines LDCs
ProductionStorageServices
Transport Distribution
Aggregation Gathering MarketingTransportServices
CapacityBrokering
LNGInformation
ServicesProcessing
RiskManagement
FERC PUCs
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U.S./Canada Natural Gas Value Chains
Industrial
Electric Generation(fuel, bulk marketfor power)
Residential, Small Commercial
PhysicalBypass
InterstatePipelines
“City Gate”
“LDC”
Transportation (pipe) Sales (commodity)
“Unbundling” is the separation of transportation from sales (supply) to allow third party marketing with pipelines providing “open access” and comparable service to all shippers.
Most Competitive Competitive Least Competitive
Commercial
Production1,2
Gathering1,2
Processing1
IntrastatePipelines2
1,2 Often vertically integrated
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U.S. Case – How Well Is the Model Performing?
Market Issues• Transparency of price
signals• Price volatility• Role of pipeline affiliates• Demand response• Problems in retail
competition• Supply security and
capital to drill
Policy/Regulatory Response• Encourage market solution
to price information• No action (but debate)• FERC Order 637• Under discussion• Georgia re-bundling,
absence of state programs• Producer incentives and
LNG
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Investment Trends: IEA Outlook, 2001-2030, U.S.$trillions
E&P $1.73
LNG $0.25
Power Gen $4.20
Pipelines $0.71
Transmission $1.60
LDCs $4.29
WORLD TOTAL
$12.78
Issues:•Impact on cash flow funded E&P with industry consolidation•Energy financing with fewer merchant risk managers•Sovereign debt with fiscal scrutiny and liberalization•Development assistance with budget and performance scrutiny in donor countries•Incentives to attract capital
Source: IEA Global Investment Outlook, 2003
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Strongest progress toward markets
No real progress toward marketization
Progress made, but weak institutions and/or tendency to backtrack; political risk
Canada/U.S.
Mexico
Chile
ColombiaVenezuelaBrazilPeruArgentina
S. Africa
England
Rest ofW. Europe
C/E Europe
Russia and Other CIS
China
Petroleum Heartland
India
Northeast Asia
Australia
New Zealand
Southeast Asia
W. Africa
Uncertain regulatory response on price reporting is inhibiting investment
In general, where options for private investment upstream are limited, midstream/downstream marketization is also limited
World Trends: Gas/Power
“Marketization”