1. © Copyright Giacomo Luciani The Politics and Economics of International Energy (Spring 2009- E657) Lecture 6 Introduction to Natural Gas Prof. Giacomo Luciani

2. © Copyright Giacomo Luciani 2 Outline  Definitions  Reserves and production  Economics of natural gas industry – transportation by pipeline or LNG  International gas flows by pipeline  International gas flows by LNG  From regional to global market?

3. © Copyright Giacomo Luciani 3 Important definitions/distinctions  Natural gas is either associated (with oil) or non associated.  Non associated gas can be either wet or dry (more or less).  “Natural gas liquids” (or NGLs, or “condensate”) are those liquids that are extracted from wet non associated gas – not the same concept as LNG or LPG.

4. © Copyright Giacomo Luciani 4 A plurality of gases  “Natural gas” normally means methane (CH 4 )  Other gases: Ethane C 2 H 6 Propane C 3 H 8 Butane C 4 H 10 Pentane C 5 H 12 etc.  Propane+Butane = LPG

5. © BP 2008 Proved natural gas reserves at end 2007

6. © BP 2008 Distribution of proved natural gas reserves

7. © BP 2008 Natural gas production by area

8. © BP 2008 Natural gas reserves-to-production (R/P) ratios

9. © Copyright Giacomo Luciani 9 World Natural Gas Reserves (trillion m 3 )

10. © Copyright Giacomo Luciani 10 Gas Production

11. © Copyright Giacomo Luciani 11 The advantage of natural gas  Low emissions  Clean, directional flame  Available from the network  More efficient than power in industrial applications requiring heat  Greater conversion efficiency in power generation  A promoter of industrial development

12. © Copyright Giacomo Luciani 12 The origins of gas utilization  Urban gas distribution networks were established in the XIX century, primarily for lighting, based on manufactured gas  With the advent of methane, high pressure networks connecting cities were established  Gas networks do not exist everywhere – the gas industry has developed very unevenly

13. © Copyright Giacomo Luciani 13 Drivers of gas demand  Gas is never essential – it can always be substituted for. It is not a utility in the same sense as electricity or water. It must compete with alternative fuels.  Residential: the weather – seasonality.  Industrial: preferential characteristics for some industries  Power generation: lower investment cost, efficiency

14. © Copyright Giacomo Luciani 14 Share of natural gas in primary energy consumption in Eurogas Member Countries - 2004

15. © Copyright Giacomo Luciani 15 European Gas Consumption

16. © Copyright Giacomo Luciani 16 The close link between gas and power

17. © Copyright Giacomo Luciani 17 Natural gas cost structure  For oil the most important cost component is field development. For gas it is transportation.  Natural gas is transported: In gaseous form by gas pipelines In liquefied form in LNG carriers  Methane liquefies under atmospheric pressure at -161,5 C°. This is Liquefied Natural Gas or LNG.

18. © Copyright Giacomo Luciani 18 Gas pipeline or LNG?  Both technologies require very large up front investment – the largest investment typology.  A gas pipeline is a linear structure and lacks flexibility  An LNG chain can serve multiple clients and is more flexible – in theory at least.  In most cases, the choice is determined by cost and circumstances.

19. © Copyright Giacomo Luciani 19 Pipeline advantage  The cost of a pipeline is directly proportional to the distance covered  It is also proportional to the diameter, but volume transported is proportional to the square of diameter: the larger the pipe, the lower the cost per cubic meter  It is also a function of “terrain”: overland or underwater, difficult terrains etc.

20. © Copyright Giacomo Luciani 20 LNG advantage  A significant share of the gas produced is burned to liquefy the rest – independently of distance.  Distance influences the number of required carriers (ships) – but cost increases less than w. pipeline.  For long sea passages, LNG is the sole alternative.

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26. © Copyright Giacomo Luciani 26 NET-BACK PRICING (US EXAMPLE) Gas Producer LiquefactionShippingReceiving Terminal Hub NYMEX Transmission Pipelines Sales Price Index Hub Price 7.50 Less Transport Cost from Terminal to Hub(0.20) Gas Price Out of Terminal7.30 Less Terminal Cost(0.50) Ex-ship LNG Price6.80 Less Shipping Cost(1.00) FOB LNG Price5.80 Less Liquefaction Cost(s)(3.00) Gas Producer Net-back2.80

27. © Copyright Giacomo Luciani 27 Choosing Pipeline or LNG  In most cases, the choice between pipeline and LNG is dictated by geography  In the past, pipelines could be laid only in relatively shallow water, now also in great depths  But need for compression limits undersea distance

28. © Copyright Giacomo Luciani 28 S - Lay J - Lay From S-Lay to J-Lay

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30. © Copyright Giacomo Luciani 30  The large up front cost of all gas export projects means that the supplier must be assured of his market before he invests. Vicious circle of uncertain demand and supply  Take or Pay, ship or pay, destination clauses  Price indexation with reopeners  Buyer takes the market risk, seller takes the price risk Contractual implications

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32. © Copyright Giacomo Luciani 32 Gas Storage  Because of demand seasonality, imported gas must be stored for use at times of peak demand.  Seasonal and strategic storage.  Availability of storage is essential for gas industry development and security

33. © Copyright Giacomo Luciani 33 Seasonality examples - 2000 to 2003 0 2000 4000 6000 8000 10000 12000 14000 Jan-99 Mar-99 May-99 Jul-99 Sep-99Nov-99 Jan-00 Mar-00 May-00 Jul-00 Sep-00 Nov-00 Jan-01 Mar-01 May-01 Jul-01 Sep-01 Nov-01 Jan-02 Mar-02 May-02 Jul-02 Sep-02Nov-02 Jan-03 Mar-03 May-03 Jul-03 Sep-03 Nov-03 MCM 00  1000  2000  3000  4000  5000  6000  7000  8000  9000  Jan-99  Mar-99  May-99  Jul-99  Sep-99  Nov-99  Jan-00  Mar-00  May-00  Jul-00  Sep-00  Nov-00  Jan-01  Mar-01  May-01  Jul-01  Sep-01  Nov-01  Jan-02  Mar-02  May-02  Jul-02  Sep-02  Nov-02  Jan-03  Mar-03  May-03  Jul-03  Sep-03  Nov-03  MCM 00  5000  10000  15000  20000  25000  30000  35000  40000  45000  Jan-99  Mar-99  May-99  Jul-99  Sep-99  Nov-99  Jan-00  Mar-00  May-00  Jul-00  Sep-00  Nov-00  Jan-01  Mar-01  May-01  Jul-01  Sep-01  Nov-01  Jan-02  Mar-02  May-02  Jul-02  Sep-02  Nov-02  Jan-03  Mar-03  May-03  Jul-03  Sep-03  Nov-03  MCM Continental Europe France UK

34. © Copyright Giacomo Luciani 34 Storage solution  Three main solutions for gas storage: Depleted gas reservoirs – by far the largest capacity Salt caverns Acquifers  LNG can also be stored

35. © Copyright Giacomo Luciani 35 Trade Movements 2007 by pipeline - America Billion cubic metresFrom ToUSCanadaMexicoBolivia Other Latin America North America US-107.301.60-- Canada13.20---- Mexico8.81---- S. & Cent. America Argentina---1.85 Brazil---9.880.12 Chile----2.38 Others----0.19 TOTAL EXPORTS22.01107.301.6011.732.69

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38. © BP 2005 38 Major natural gas trade movements Major Natural Gas Trade Movements 2007

39. © BP 2005 39 Where Europe gets its gas. Growing dependence on imports in the future Source: BP Energy Stats 2004/Gas Strategies Declining indigenous production Pipeline imports including “extensions” LNG - “swing supplier”

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48. © Copyright Giacomo Luciani 48 The Henry Hub  Sabine Pipe Line LLC owns and operates the Henry Hub, which is the centralized point for natural gas futures trading in the U. S. The Henry Hub offers shippers access to pipelines that have markets in the Midwest, Northeast, Southeast and Gulf Coast regions of the United States. The Henry Hub interconnects with nine interstate and four intrastate pipelines. Sabine currently possesses the ability to transport 1.8 Bcf/d across the Henry Hub.  NYMEX Connection  In November 1989, Sabine was selected by NYMEX as the official delivery mechanism for the world's first natural gas futures contract. The contract began trading on April 3, 1990 and is currently traded 18 months into the future.

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53. Major Net Inter-Regional Gas Trade Flows Inter-regional gas trade triples by 2030, with most new exports coming from the Middle East, Africa and Russia

54. © Copyright Giacomo Luciani 54 Main trends for the future  Pipeline gas is likely to continue to dominate but LNG is marginal volume and influences price  Oil/gas price decoupling?  Qatar emerging as global LNG supplier, capable of arbitraging between regional markets

55. © Copyright Giacomo Luciani 55 A Gas OPEC  Gas producing countries have been holding meetings and coordinating  But a “Gas OPEC” is unlikely because production is more scattered and most producers compete for market access  Once the investment is made, the producer must produce…