Dundee University Morten Frisch Paper 24 Feb 2010

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This paper was published electronically on its web site by University of Dundee, Centre for Energy, Petroleum & Mineral Law & Policy (CEPMLP). It is part of the International Energy Law and Policy Research Paper Series. It has a Working Research Paper Series No: 2010/03, and was posted on 18 February 2010.

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<ul><li> 1. CURRENT EUROPEAN GAS PRICING PROBLEMS: SOLUTIONS BASED ON PRICE REVIEW AND PRICE RE-OPENER PROVISIONS 24 FEBRUARY 2010 Morten Frisch Senior Partner Morten Frisch Consulting Morten Frisch Consulting 6 Holmwood Close East Horsley Surrey KT24 6SS United Kingdom Tel: +44-1483-284248 Fax: +44-01483-285099 Email: office@mfcgas.com Web: www.mfcgas.comMorten Frisch Consulting accepts no liability for commercial decisions based on the content of this paper. Although the paper is copyright of Morten FrischConsulting, quotes from the paper are permitted, provided full references to the paper and Morten Frisch Consulting are made. Onwards transmission or copyingof the paper is allowed in its original form only. </li> <li> 2. Current European Gas Pricing Problems: Solutions Based on Price Review and Price Re-opener Provisions Morten Frisch, 24 February 2010Table of ContentsTable of Contents.................................................................................................................................... 2Table of Figures ...................................................................................................................................... 2About the Author .................................................................................................................................... 3Abbreviations .......................................................................................................................................... 4Executive Summary................................................................................................................................. 5Europes Two Level Gas Price System ....................................................................................................... 6Market Forces Behind the Two Level Price System .................................................................................... 7 European Gas Trading Hubs and Their Developments........................................................................ 7 LNG and the North American Gas Market Connection ........................................................................ 9 Market Forces and Gas Flow Patterns across Europe ........................................................................13Price Review and Price Re-opener in a Changing Market...........................................................................15 Methodology of Price Review and Price Re-opener Clauses Explained ................................................15Price and Price Indexation Solutions ........................................................................................................18Table of FiguresFigure 1: Average German Gas Import Prices vs. NBP and NCG Month Ahead Prices ................................... 6Figure 2: Continental European Gas Pricing Formula ................................................................................. 7Figure 3: NW European Gas Trading Hubs and Pipeline Routes .................................................................. 8Figure 4: European Gas Hub Developments in 2009 .................................................................................. 9Figure 5: Additional LNG Liquefaction Capacity.........................................................................................10Figure 6: US Unconventional Gas Reserve Potential..................................................................................11Figure 7: Forecast of US Net LNG Imports ...............................................................................................11Figure 8: US AEO 2010 LNG Demand Projection (Base Case) ....................................................................12Figure 9: UK LNG Imports.......................................................................................................................13Figure 10: North West European Natural Gas Infrastructure......................................................................14Figure 11: Two Tests in the Price Review and Reopener Process...............................................................16Figure 12: Buyers Profitability Test - Decision Diagram ............................................................................17Keywords: 1. European gas prices. 2. Gas price review. 3. Gas price indexation. 4. Gas price clauses.5. Shale gas. 6. Unconventional gas. 7. LNG. 8. European gas market. 9. European gas supply anddemand. 2010 Morten Frisch Consulting 2 </li> <li> 3. Current European Gas Pricing Problems: Solutions Based on Price Review and Price Re-opener Provisions Morten Frisch, 24 February 2010About the AuthorMorten Frisch, Senior Partner, Morten Frisch Consulting (MFC)Morten Frischs career developed in parallel with the gas industry in his home country of Norway. He hasmore than 35 years of hands-on experience addressing strategic, commercial and operational issues alongthe entire value chain for LNG and pipeline gas. This experience stems from work for the NorwegianGovernment, multinational oil companies and as a consultant since 1990.The first time Morten Frisch led a gas sale negotiation was in 1976, the year his first dealings with LNGreceiving terminals (Everett and Cove Point terminals, USA) also took place. His first LNG marketing workwas conducted in 1980 (for the then Phillips Petroleums Bonny LNG project in Nigeria).In 1977 as part of gas price indexation formulae design work, Morten Frisch was instrumental in thedevelopment and drafting of the Norwegian and Swiss law Price Review and Price Re-opener clauses, nowuniversally used in long - term gas sales and purchase contracts for the supply of gas to Continental Europe.In 1993 together with Freshfields solicitors in London he converted this language to English and New Yorklaw. The resulting Price Review and Price Re-opener clauses are now commonly used in long term AtlanticBasin LNG supply agreements.Since 1990 Morten Frisch has conducted extensive work related to natural gas in the Middle East, Iran,Russia, and Central and Western Europe. He has also provided consulting services to clients or projects inNorth and West Africa, Japan, Australia and New Zealand. His consulting practice deals with a variety of gasissues although a high number of assignments have been to address gas pricing issues, commercialoptimisation, risk mitigation strategies and methods, for operations in rapidly changing gas marketenvironments. He has been called upon as an expert witness in arbitrations and court cases dealing with gascontract related issues, particularly in disputes involving price review/price re-opener clauses. He has actedas a lead negotiator in gas sales and purchase negotiations for clients. In the past he has also advisedgovernments on international gas issues.Morten Frisch also advises clients on the organisational structure and staffing of gas-related projects, and hehas acted as a mentor for their novice commercial gas staff. He is an established provider in the field of gastraining.Morten Frisch is a chartered engineer (Sivil Ingenir) in his home country of Norway and an economist(degrees from University of Newcastle upon Tyne, UK and Massachusetts Institute of Technology (MIT),Mass., USA). He is a member of the Society of Petroleum Engineers (SPE) (since 1975), the InternationalAssociation of Energy Economics (IAEE) and the British Institute of Energy Economics (BIEE). He haspublished a number of articles addressing strategic and commercial gas issues. He is frequently invited togive presentations at major international gas and energy conferences and appears regularly as a guest onmajor TV stations business programmes. 2010 Morten Frisch Consulting 3 </li> <li> 4. Current European Gas Pricing Problems: Solutions Based on Price Review and Price Re-opener Provisions Morten Frisch, 24 February 2010AbbreviationsBAFA = Bundesamt fr Wirtschaft und Ausfuhrkontrolle is the name for the German Federal Office ofEconomics and Export Control. Monthly average unit cost of imported natural gas across all border points ispublished by this Federal Office on a monthly basis in /TJ.BBL = BBL pipeline transmits natural gas from Balgzand in the Netherlands to Bacton in the UnitedKingdom. The pipeline is currently able to carry physical flow only in the direction from The Netherlands tothe UK.Bcm = Billion cubic meters (106).CEGH = the Central European Gas Hub at Baumgarten, established by OMV Gas &amp; Power GmbH. OMV andGazprom have recently signed a Cooperation Agreement to jointly develop the hub with the aim of itbecoming the largest trading platform in Continental Europe (Press Release of 25 January 2010)EIA = The Energy Information Administration of the United States Department of Energy.c = Euro cents.GASPOOL = joint company which operates the market area cooperation of DONG Energy Pipelines GmbH,Gasunie Deutschland Transport Services GmbH, ONTRAS VNG Gastransport GmbH and WINGASTRANSPORT GmbH &amp; Co. KG.GO = Gas Oil.Henry Hub (HH) = Henry Hub is the pricing point for natural gas futures contracts traded on the New YorkMercantile Exchange (NYMEX). It is also a physical point on the natural gas pipeline system in Erath,Louisiana.Interconnector (IC UK) = Interconnector UK is the bi-directional physical natural gas pipeline linkbetween Bacton, UK and Zeebrugge, Belgium.LSFO = low sulphur heavy fuel oil with sulphur content of 1% or less. Frequently referred to as Low SulphurFuel Oil.Mmbtu = Million British Thermal UnitsMt = million tonnes.MWh = Megawatt hours; 1 MWh is equal to 3.4121 mmbtu.NBP = the virtual National Balancing Point in the United Kingdoms pipeline network.NCG/EGT = a joint company which operates the market area cooperation of Bayernets GmbH, Eni GasTransport Deutschland S.p.A., E.ON Gastransport GmbH, GRTgaz Deutschland GmbH, GVS Netz GmbH. Afterits most recent expansion, it is now referred to as simply NCG (Net Connect Germany). In January 2010 itbecame the largest trading hub after TTF in Continental Europe.PEG-Nord = the virtual trading point in the North of France, created in 2009 when the three zones (PEGOUEST, PEG EST, PEG NORD) merged into one.PSV = Punto di Scambio Virtuale, is the name of the Italian Virtual Trading Point established by Snam ReteGas.Sm3 = a standardized cubic meter of pipeline-quality gas with gross calorific value of 39 MJ.Tcm: Trillion cubic meters (109).ToP = Take-or-Pay, referring to purchase commitments in gas sales agreements.TTF = the Title Transfer Facility, the virtual national balancing point in the Dutch pipeline network and inJanuary 2010 the largest trading hub in Continental Europe.ZEE Hub = Physical gas trading hub at Zeebrugge which was the first major gas trading hub in ContinentalEurope.Note: Asterisk [*] denotes an explanation, while numbered footnotes [1, 2 etc.] provide sources andreferences. 2010 Morten Frisch Consulting 4 </li> <li> 5. Current European Gas Pricing Problems: Solutions Based on Price Review and Price Re-opener Provisions Morten Frisch, 24 February 2010Executive SummaryA two tier price system developed for gas in Continental Europe in late 2008, consisting of the pricegenerated by oil-indexed pricing formulae in long-term Take or Pay gas supply contracts and prices resultingfrom commercial activities at European gas trading hubs. Up until the end of December 2009 prices attrading hubs represented a reduction of between 24 and 54 per cent of the average comparable gas priceunder German long-term gas import contracts. This situation has now caused problems for the operation oflong term Take-or-Pay contracts for the supply of pipeline gas as well as LNG delivered to North WestContinental European markets under term gas supply arrangements.The market forces which have caused this two tier gas pricing system to develop in Europe are as follows:Gas demand destruction in Continental Europe caused by oil indexed gas prices; increased LNG supply worldwide coupled with decreased LNG demand in North America due to unconventional gas production and arapidly increasing LNG receiving terminal capacity in North West Europe; the recession which has causedboth pipeline gas and LNG demand to be reduced in most countries of the world; and finally the fact thatContinental European gas markets are becoming increasingly liberalised.The clause in most, if not all, Continental European term contracts which should facilitate providing asolution to the current gas pricing problem either through negotiation or, if this fails, by submitting thedispute for resolution by arbitration, is the Price Review and Price Re-opener Clause. The paper examinesthe operation of this latter clause. The overriding principle this clause is based on, is the fact that no gasbuyer can purchase large quantities of gas over an extended period of time, if the price of gas under theterm contract concerned is such that gas can only be resold at a loss.Although it is understood that some gas market players have argued that the current two-tier gas pricesystem in Continental Europe is of a transient nature and that no changes to current oil-indexed pricearrangements are required, it has been observed that a number of negotiations addressing this very subjectcurrently are taking place between major gas suppliers and Continental European gas wholesalers buyinggas under term contracts with Take or Pay provisions. It is also understood that a number of Price Re-opener a...</li></ul>