By Feso Bright
European Gas Consumption versus Production
Europe consumes 36% and produces 33% of world natural gas levels
(International Energy Agency, 2009). As such, Europe is a net consumer of natural gas since it can barely produce enough to sustain its own consumption levels. With only 7.97 tcm (trillion cubic meters) added to proved natural gas reserves in 2008, a reserves to production ratio of 60.4 years (British Pertroleum, 2009, p. 26) and a reducing share of world natural gas reserves- as shown in figure 1- it is only logical that the source of supply for the future are a concern for policy makers.
Figure 1: Distribution of Proved Reserves in last 20 years
Source: (British Pertroleum, 2009, p. 23)
In order to understand the magnitude of the problem it is essential to examine the drivers of demand and supply of natural gas and then assess the impact of transportation economics on supply options.
THE SUPPLY GAP
The laws of demand state that the higher the price, the lower the quantity demanded ceteris paribus. This law applies for the aggregate demand for gas in spite of the relative inelastic demand profile (IEA- World Energy Outlook, 2009, p. 5). The demand for gas can also be influenced by the price of competitive fuels; in fact, there is a predominance of oil-indexation of gas prices in gas supply contracts (IEA- World Energy Outlook, 2009, p. 13). Figure 2 shows the prices of these competitive fuels relative to the price of gas.
Figure 2: Prices of competitive fuels [left axis] vs gas prices [right axis]
Source: (Platts <Brent, caol, NBP>, BAFA<DE Border>, cited in Stiphout, 2010)
Seasonal variation in demand as observed in figure 3 shows that demand for natural gas peaks in the winter months particularly in December and January while the demand troughs in the summer months of June, July and August.
Figure 3: EU27 monthly consumption of natural gas
Source: (Eurostat Energy Statistics, cited in Stiphout, 2010)
Other factors such as economic recession or boom, investment levels, the derived demand for electricity, gas reserves and greenhouse emissions policy combine to shape the demand for gas. The financial recession that started in 2007/2008 has reduced worldwide economic activity; which has naturally translated to a slowdown in consumption and investment demand for gas (IEA- World Energy Outlook, 2009 p. 4); the derived demand for gas via power generation needs is indeed significant (IEA- World Energy Outlook, 2009 p. 4); the finite nature of gas reserves as well as policies to “limit long-term concentration of greenhouse gases in the atmosphere to 450 parts per million of co2-equivalent” (IEA- World Energy Outlook, 2009 p. 3) suggests that demand for gas now and in the future will be influenced to a large extent by targeted government policy on emissions as well as other considerations.
Drivers of supply include the price of gas, prices of other competitive fuels, sources of supply (in terms of reserves and by countries of origin), output/ pipeline capacity and infrastructure, greenhouse emissions policy, economic cycles and investment levels. The law of supply states that the higher the price, the higher the quantity supplied of a good in the market ceteris paribus; this is certainly true for gas as suppliers will try to increase quantity supplied in the market. As shown in figure 3, there is a relationship between the price of gas and the price of other alternative fuels; one must also note that due to oil-indexing in long term contracts, the price of oil may have a direct impact on the price of gas.
The existing or planned pipeline capacity has a direct relationship with the ability of the supplier to meet its supply obligations. As shown in figure 9 below, the existing, committed and planned pipelines link the suppliers with the market; also, figure 10 shows the existing LNG plants and expansions. Due to limited availability of regasification facilities, LNG supply may at times be constrained. Hence the amount of the gas supplied also varies with the sources of supply and the reserves available. The source of supply affects the market structure; which in turn can determine the ability of the supplier to manipulate price or supply to their advantage (Holz et al, 2007). Economic boom and bust cycles also affect the macro economy such that reduced aggregate demand translates to reduced income levels and subsequent reduction in investment demand; lack of Investment has the potential to cause shortfalls in supply (IEA- World Energy Outlook, 2009, p. 5)
Figure 4: Existing, committed & planned pipeline capacity (in bcm/year)
Source: (Clingendael International Energy Programme, 2008, p. 41)
Figure 5: LNG Market at a glance
Source: (Clingendael International Energy Programme, 2008, p. 41)
Policy on greenhouse emissions is also a potentially significant supply driver. Governments are determined to change the energy mix and transition from a dependence on fossil fuels to renewable and cleaner forms of energy; the 450 scenario (as discussed earlier) is gaining momentum around the world (IEA- World Energy Outlook, 2009 p. 3).
The Gap: In pursuit of Energy Security
As Europe is a net importer as well as net consumer of natural gas; within the context of energy security its consumption per annum of 441 mtoe (million tonnes of oil equivalent) and production of 171 mtoe (British Pertroleum, 2009, p. 25 - 29) may not be a very favourable economic or political situation. Also, with reliance on imports of gas set to increase from 57% in 2006 to 84% in 2030 (Commission of the European Communities, 2007, p. 3), in response to this energy challenge the European Union set out to formulate a specific policy on sustainability, competitiveness and security of supply of energy.
Figure 6: The Gas Supply Gap
Source: (Kjarstad & Johnsson, 2007, p. 875)
OUTLOOK FOR THE INDUSTRY
EU Policy considerations
The European Union has set out to enhance its energy security by encouraging member states to diversify and increase sources of gas, establish more gas hubs, LNG facilities, pipelines and storage capacity (Commission of the European Communities, 2007, p. 10 - 11). Also, the long term contracts, minimum targets for gas storage, the establishment of a gas coordination group, security of supply obligations for companies and so on
(Commission of the European Union, 2004). Nonetheless costs have always influenced a balancing of the energy security requirements with respect to the strategic choices between LNG and pipeline gas.
Economics & Strategy: The Balance between Pipeline gas and LNG
The interaction of demand and supply drivers as well as other environmental considerations has strategic outcomes beyond economics for Europe within its policy framework and implications for allocation of investment and planning resources. With respect to financing costs, capital intensity, utilization/ market size, LNG appears to be a more suitable option than pipeline sourcing (Cornot-Gandolphe et al, 2003 p. 13). This is because majority of gas projects today are not as huge- which is a requirement for pipelines to achieve economies of scale; this has implications for financing. The risk associated with crossing of borders is also a consideration against pipelines (Cornot-Gandolphe et al, 2003 p. 13); a case in point is the political instability and blowing up of pipelines in the Niger-Delta of Nigeria as well as the economic instability of the Ukraine-Russia pipelines. The geographic argument would apply depending on the country receiving gas imports; pipelines are the only choice available for landlocked countries for instance.
Others will argue that pipeline sourcing is more favourable than LNG due to advances in submarine pipeline technology, sensitivity to economies of scale and the ability to meet the needs of large power generation markets (Jensen, 2000) as shown in figure 12 below.
Figure 7: Scale economies Pipeline vs LNG
Source: (Jensen, 2000)
LNG is viewed by some as a more flexible source, allowing consumers to switch from among suppliers and vice versa; this flexibility also allows market entry by operators who would otherwise be unable to do so (Dorigoni & Portatadino, 2008) to the extent that LNG is regarded as the “commodity that will globalize the gas industry” (Clingendael International Energy Programme, 2008, p. 49). There is, however, the emergence of a trend in flexible pipeline gas and flexible LNG whereby long term contracts are increasingly being forgone in place of spot market prices for gas; inspite of the joint benefits this development has negative implications for security of supply (Clingendael International Energy Programme, 2008, p. 49).
On the whole, economics may suggest that reduced cost, demand and supply factors may determine influence the choice of which source of gas is better; we may also find that although pipelines offer better economies of scale, LNG transportation costs are lower over long distances. However it has been established that lower costs do not necessarily translate to reduced prices (and thus attractiveness) of the sources of gas (Sagen, 2009, p.35). Such a situation will put the European Union in a position such that the decision criteria on which gas sourcing option would prove a strategically optimal choice is difficult. A difficult but more wholistic policy choice will have to take into consideration a balance of economic, socio-environmental, political, regulatory and other normative institutional factors
(James A. Baker III Institute for Public Policy, 2005) which provide the most benefit to the European Union and which secure the security of supply to the best extent possible.
Within the balanced decision framework suggested (economic and other factors) it is my view that the European Union should place a higher premium on pipeline sourcing of gas as key to its security of supply. Inpite of the fact that LNG has numerous benefits both on the economic and institutional fronts, the socio-economic benefits of energy security secured through pipeline sourcing outweigh those of gas. LNG necessarily passes through the pipelines at the trains, regasification plants and on to consumers; also the planned and existing capacity of pipeline gas can be more easily secured by long term contracts- inspite of the trend towards spot markets as mentioned earlier. Landlocked countries may necessarily require pipeline sourcing as they cannot berth ships. LNG has come to stay and will play a large role in energy security, however, it is my opinion that it should form a significant but less weighted role in negotiations with source-nations as well as in the order of priority of which sources to supply first. Some nations which are geographically constrained such as tiny islands and nations like Japan may view this differently, however in the case of Europe, the balance of choice for front runner and prime source for security of supply for the future should be pipeline gas.
This study began by with an examination of the world energy mix (in the post: in a bid to dimension the significance of gas in the world energy mix. Once this was established, a cursory review of the dynamics of the European gas market was carried out so as to reveal some intricacies of gas and the value chain involved in the process of getting gas to the market. In doing this the delicate cost elements of pipeline and gas transportation were identified; this allowed us to proceed to appraise the net consumption position of Europe. We discovered that Europe’s net consumption of gas has been perennial and is bound to increase; thus it was necessary to take a look at the economic demand and supply functions which account for this and how this supply gap has led to a security of supply concern. Thus the focus became an analysis of the policy intent and options of the European Union. Various views on the security of supply question as well as the significance of pipeline gas and LNG were appraised. This formed the basis for the recommendations made.
Finally, security of supply may not seem an imminent threat today. The world has 60.4years of gas supply and trillions of cubic meters and millions of tonnes of oil equivalent of gas. However, the perceptive policy makers have adopted various proactive measures to ensure that their economic blocs or nations are not left out in the cold if or when the demand constraint severely hampers the availability of some nations to benefit from the resource to the benefit of others. Thus, the European Union has adopted various policy positions and has prescribed security of energy supply measures for its member countries. One of them is that supply gas must be secured; by long term contracts or spot market arrangements. It is my view that gas constitutes a more significant part of the energy security equation and must be prioritized over but not to the detriment of LNG gas supplies. How is your country securing its energy supply?