NATURAL GAS ECONOMICS AND BUSINESS ISSUES. ©UH IELE, 2 No reproduction, distribution or attribution without permission. What is the natural gas business…

NATURAL GAS ECONOMICS AND BUSINESS ISSUES

©UH IELE, 2No reproduction, distribution or attribution without permission.

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?


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


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


The Overall Challenge:Balancing the Market

LOW Prices HIGH

SUPPLYDEMAND

Mean reversion is a reality if market-clearing participants exist


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


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


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


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.


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


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


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


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


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


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


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”

Documents

NATURAL GAS ECONOMICS AND BUSINESS ISSUES. ©UH IELE, 2 No reproduction, distribution or attribution without permission. What is the natural gas business…