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1 POLITECNICO DI MILANO Scuola di Ingegneria Industriale e dell’Informazione Corso di Laurea in Ingegneria Energetica Shale gas in Europe possibilities and challenges for the natural gas market Supervisor Prof. Fabio Inzoli Correlator Prof. Roberto Carnicer (Universidad Austral, BA) Author Gatti Leandro Matricola 801063 Academic Year 2014-2015

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    POLITECNICO DI MILANO

    Scuola di Ingegneria Industriale e dell’Informazione

    Corso di Laurea in Ingegneria Energetica

    Shale gas in Europe

    possibilities and challenges for the natural gas market

    Supervisor

    Prof. Fabio Inzoli

    Correlator

    Prof. Roberto Carnicer

    (Universidad Austral, BA)

    Author

    Gatti Leandro Matricola

    801063

    Academic Year 2014-2015

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    To my family,

    because none of my achievement

    would have been possible

    without them

    “The Stone Age did not end when mankind run out of stones,

    likewise the Oil Age will end long before we run out of oil”

    Ahmed Zaki Yaman, Saudi Arabian Petroleum Minister

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    1 Abstract

    In the last two decades, several significant development contributed in modifying the global energy

    scenario; however, none of these had the same impact as the US shale gas revolution. Recent

    technological innovation made available large reserves of natural gas held within shale rocks

    enormously increased UD domestic production making them pass the foreseen biggest gas importer

    to the largest world producing country. This domestic surge in production of natural gas led to

    tremendous benefits for the US on both the economy and US CHG emission. This authentic revolution

    arouse enormous success in other country, including Europe, who invested in their domestic shale

    source in order to replicate the US model increasing internal production, enhancing they energy

    security and obtaining a cheap energy source. The US revolution, however, has been the results of an

    ongoing process and it will be unlikely replicate elsewhere, especially in Europe where market

    structure and energy policies greatly differs from the US ones. This works aim in giving a brief but

    exhaustive description of what had been the shale gas revolution and the step that led to this result. In

    order to understand the complexity and the controversies involved shale gas would be described from

    generation to extraction and processing with particular emphasis on the environmental impact. The

    main difference between the union and the US will be asses in order to underline the potential benefits

    of shale extraction for the domestic gas market but, mostly, the challenges that have to be faced in

    order to create an unconventional gas industry in Europe.

    Key Words: natural gas, unconventional hydrocarbon, shale gas, hydraulic fracturing, environmental

    impact, gas market

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    2 Sommario

    Gli ultimi due decenni hanno visto numerosi cambiamenti nello scenario energetico global.

    Nessuno di questi ha però avuto la portata della cosiddetta rivoluzione dello “shale gas” negli Stati

    Uniti. Recenti sviluppi tecnologici hanno consentito l’estrazione di gas da questi depositi non

    convenzionali; grazie allo shale gas gli Stati Uniti sono passati in meno di un decennio da i futuri

    maggiori importatori di gas al primo paese produttore al mondo. Il rapidissimo incremento di

    produzione di gas da scisti ha avuto un notevole impatto sull’economia statunitense e sulle emissioni

    di gas climalteranti. Questa vera e propria rivoluzione ha, prevedibilmente, suscitato enorme interesse

    in molti altri paesi, tra cui l’Europa, disposti a investire nel sfruttamento dei depositi di shale per

    replicare il boom statunitense ottenendo così una fonte di energia a basso prezzo e aumentando la loro

    sicurezza energetica. La rivoluzione statunitense però è stata il risultato di una lunga fare di

    sperimentazione e numerosi fattori ne hanno influenzato la riuscita garantendone il risultato; per

    questa ragione è improbabile che lo stesso boom possa essere ripetuto altrove. Lo scopo di questo

    lavoro è di fornire una descrizione sommaria ma quanto più esaustiva possibile di quello che è stata

    la shale gas revolution sottolineando tutti I fattori che hanno contribuito al risultato. Per comprendere

    l’intrinseca complessità e le controversie legate al processo lo shale gas verrà descritto dalla sua genesi

    al estrazione con particolare riferimento alle tematiche ambientali. Infine si sottolineando le principali

    differenze tra stati uniti ed Europa in modo da comprendere I potenziali benefici sul mercato interno

    del gas e, soprattutto, le sfide che dovranno essere affrontate per sviluppare un estrazione di gas non

    convenzionale in Europa.

    Parole Chiave: gas naturale, idrocarburi non convenzionali, shale gas, fratturazione idraulica, impatto

    ambientale, mercato gas naturale

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    Index of Contents

    Abstract .................................................................................................................................................. 5 Sommario ............................................................................................................................................... 7 Index of Contents .................................................................................................................................... 9 Introduction .......................................................................................................................................... 15 Introduction to Natural Gas ................................................................................................................... 17

    1.1. What is natural gas? .............................................................................................................................. 18 1.1.1. Composition of Natural Gas ....................................................................................................... 18 1.1.2. Natural gas genesis..................................................................................................................... 19 1.1.3. Formation of a gas reservoir ...................................................................................................... 20 1.2. Natural gas final uses ............................................................................................................................ 21 1.2.1. Residential and commercial uses ............................................................................................... 21 1.2.2. Industrial uses ............................................................................................................................ 21 1.2.3. Power generation ....................................................................................................................... 21 1.1.4. Transportation ............................................................................................................................ 22 1.3. Natural gas environmental benefits ...................................................................................................... 23 1.4. Natural gas global consumption ............................................................................................................ 25 1.5. Natural gas global reserves ................................................................................................................... 26

    Natural gas industry and market ............................................................................................................ 29 2.1. Overview of the natural gas supply chain ............................................................................................. 29 2.1.1. Upstream .................................................................................................................................... 30 2.1.2. Midstream .................................................................................................................................. 30 2.2. Gas transportation ................................................................................................................................ 32 2.3. Natural gas market structure ................................................................................................................ 32 2.3.1. Gas market characteristics ........................................................................................................ 34 2.4. The European model: the US gas market .............................................................................................. 36 2.4.1. Physical and financial market .................................................................................................... 37

    The European gas market ...................................................................................................................... 39 3.1. European energy consumption ............................................................................................................. 40 3.2. European energy dependence .............................................................................................................. 44 3.3. European gas market............................................................................................................................. 46 3.3.1. European gas consumption ....................................................................................................... 48 3.3.2. Natural gas production .............................................................................................................. 51 3.3.3. Extra European Imports ............................................................................................................ 52 3.3.4 The European gas network ......................................................................................................... 54 3.4. Future scenario ...................................................................................................................................... 58

    Shale Gas, an Unconventional Global Resource ...................................................................................... 61 4.1. Unconventional gas ............................................................................................................................... 61 4.2. Estimation of Global Resources ............................................................................................................. 64 4.3. Shale Gas ............................................................................................................................................... 66 4.3.1. Shale gas generation process .................................................................................................... 67 4.3.2. Resource estimation and global availability .............................................................................. 72 4.4. Shale gas extraction process ................................................................................................................. 74 4.4.1. Exploratory phase ...................................................................................................................... 74 4.4.2. Site preparation ......................................................................................................................... 74 4.4.3. Well drilling and completion ..................................................................................................... 75

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    4.4.4. Hydraulic fracturing ........................................................................................................................ 78 4.4.5. Shale gas production ...................................................................................................................... 82 Global impact of the US Energy Revolution ............................................................................................ 85 5.2. The Shale Gas Revolution ...................................................................................................................... 86 5.3. Impact on the global LNG market and on European gas pricing .......................................................... 90 5.4. Shale Gas in Europe............................................................................................................................... 91 5.4.1. Shale gas basin characterization ............................................................................................... 93 5.4.2. Exploration activities in Europe ................................................................................................ 96 5.5. Environmental Impact of shale gas recovery ....................................................................................... 98 5.5.1. Impact on water resources ....................................................................................................... 99 5.5.2. Hydraulic fracturing water cycle ............................................................................................. 101 5.5.3. Water consumption ................................................................................................................ 103 5.5.4. Induced Seismicity .................................................................................................................. 105 5.5.5. Land Consumption and Spatial Constraints ............................................................................ 106 5.5.6. Greenhouse-gas Emission of Shale Gas Recovery .................................................................. 107 The European way to shale gas ............................................................................................................ 109 6.1. The shale dream: the case of Poland .................................................................................................. 110 6.1.1. The development of Baltic Basin ............................................................................................ 111 6.2. US success factors and European limits .............................................................................................. 113 6.2.1. Technology development ....................................................................................................... 114 6.2.2. Federal and State policies ....................................................................................................... 115 6.2.3. E&P regulation ........................................................................................................................ 116 6.2.4. Access to land and infrastructure ........................................................................................... 116 6.3. The European way to shale gas .......................................................................................................... 117 6.3.1. The European model .............................................................................................................. 118 6.3.2. Evolution rather than Revolution ........................................................................................... 118 General conclusions and implications for European gas market ............................................................ 121 References ...................................................................................................................................................... 125

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    Index of figure

    Figure 1.1 - Oil and gas temperatures related to depth of burial………………….……………….……............5

    Figure 1.2 - Formation of an oil and gas eservoir……………………………......................................................6

    Figure 1.3 - Scheme of a CCGT power plant………………………………………..…….……………...……..8

    Figure 1.4 - Equivalent carbon dioxide emission for different electricity generation……………..……............10

    Figure 1.5 - Historical gas consumption per region………………………………………………………….....11

    Figure 1.6 - Forecast on natural gas consumption per world region……………………….…….……………..12

    Figure 1.7 - Natural gas proven reserves by region………………………………………………………….…13

    Figure 2.1 - Natural gas supply chain……………………………………………...……….……………….….16

    Figure 2.2 - Natural gas midstream facilities………………………………………………………...…….…..17

    Figure 2.3 - Major gas trade flow worldwide in 2014……………………………………………………….…18

    Figure 2.4 - Gas price in major distinct market…………………………………………………..….…………18

    Figure 2.5 - Major gas market characteristics……………………………………………...…....……….…….19

    Figure 3.1 - Energy balance………………………………………………………………...………….….…...26

    Figure 3.2 - European primary energy consumption for 2013………………………………………………….28

    Figure 3.3 - European final energy consumption (MToe) for 2013……………………………….…….…...…29

    Figure 3.4 - European power generation (2013)…………………………………………………….. ……...…30

    Figure 3.5 - European energy dependency on fossil fuel…………………………………………………….…31

    Figure 3.6 - European dependency on natural gas imports……………………………………………..………32

    Figure 3.7 - European historical gas series………………………………………………………………..……33

    Figure 3.8 - Eu-28 gas consumption breakdown…………………………………………………………...…..34

    Figure 3.9 - Gas consumption breakdown for final use……………………………………………………...…34

    Figure 3.10 - Historical breakdown of European gas consumption…………………………………………….35

    Figure 3.11 - Electricity production with gas-fired power plant (1985 - 2012)……………………………. …..36

    Figure 3.12 - Breakdown of EU-28 supplies…………………………………………………...………………37

    Figure 3.13 - Natural gas production in EU-28 (1981-2013)……………………………………………….. …37

    Figure 3.14 - Extra-EU imports…………………………………………………………...…………………...38

    Figure 3.15 - Natural gas imports, breakdown by importer…………………………………………………….39

    Figure 3.16 - EU imports of LNG, a) exporting country b) importing country………………………................40

    Figure 3.17 - Map of European gas network…………………………………………………………...………42

    Figure 3.18 - a) Maps of Gazprom import price in Europe b) price and transportation costs in the US hub

    ($/mBTU)………………………………………………………………….. …………………………………44

    Figure 3.19 – Breakdown of European gas demand 2010 – 2035……………………………………………..45

    Figure 4.1 - Schematic cross-section of general types of oil and gas resources…………………………...……49

    Figure 4.2 - The natural gas resource triangle……………………………………………………………...…..50

    Figure 4.3 - World natural gas resources classified by typology and world region………………………….…51

    Figure 4.4 - Black shale rock and shale outcrop deposits……………………………………………………....52

    Figure 4.5 - The process of hydrocarbon generation trough thermal maturation of source rock………………..53

    Figure 4.6 - Shale rock turning into a gas-shale source rock………………………………………………….54

    Figure 4.7 - a) Van Krevelen diagram, b) scheme of hydrocarbon generation and yields…………………….56

    Figure 4.8 - Adsorption Isotherm, Gas Content vs. Pressure…………………………………………………...57

    Figure 4.9 - Schematic representation of the steps used in the geological based approach…………………...58

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    Figure 4.10 -World estimate natural gas resource…………………………………………………………..…59

    Figure 4.11 - Drilling site in the Marcellus shale, Pennsylvania………………………………………...…..…61

    Figure 4.12 - Casing and cement job in a shale well, schematic and cross section……………………...………63

    Figure 4.13 - Horizontal shale gas wells, cluster configuration……………………………………………..….63

    Figure 4.14 - a) Hydraulic fracturing equipment in a shale well in the Marcellus shale b) Schematic illustration

    of the hydraulic fracturing process……………………………………………………………………………..64

    Figure 4.15 - Typical volumetric composition of fracturing fluid……………………………………...………65

    Figure 4.16 - a) Microseismic event location for hydraulic fracture treatment b) Fracstage diagram…………67

    Figure 4.17 - Production site of a shale well in the Marcellus area………………………………………..……68

    Figure 4.18 - Shale gas well production profile, Haynesville Shale Louisiana…………………………………69

    Figure 5.1 - Monthly natural gas production and henry Hub spot price…………………………………..…….72

    Figure 5.2 - U.S. dry shale gas production per basin………………………………………………………...…74

    Figure 5.3 - US electricity production per source and CO2 associated emission…………….…………………75

    Figure 5.4 - a) European oil and gas price b) European import of LNG……….………………………….……77

    Figure 5.5 - European shale gas basin with resource estimate……………………………………………….…78

    Figure 5.6 - European regulation regarding shale gas exploration and hydraulic fracturing…………….……..83

    Figure 5.7 - a) The “water tap on fire” clip from Gasland b) Tone of media coverage of shale gas development

    in the USA…………………………………………………………….………………………………....…...84

    Figure 5.8 - Marcellus Mapped Frac Treatment………………………………………………...………….......86

    Figure 5.9 - Hydraulic fracturing water……………………………………………………………..…..…..…88

    Figure 5.10 - Water consumption in electricity generation………………………………………………….....90

    Figure 5.11 - Frequency vs. magnitude for the review event of induced seismicity……………………………91

    Figure 5.12 - a) Map of Texas, population density b) Shale wells drilled in the area in 2010……………...….92

    Figure 5.13 - Comparison of the life-cycle emission for the production of electricity………………………….93

    Figure 6.1 - Process improvement made by Southwestern Energy from 2007 to 2011…………………….…98

    Figure 6.2 - Growth in the number of horizontal wells and customized technologies…………………..…….100

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    Index of tables

    Table 1.1 – Chemical composition of natural gas………………………………………..………...…4

    Table 2.2 – Specific energy, energy density and yielded CO2 for different fossil fuels…………...….10

    Table 1.3 – Air pollutant emissions from fossil fuels steady combustion…………………………...10

    Table 4.1 – Types of Kerogen and their hydrocarbon potential…………………………………..…..55

    Table 5.1 – Eastern Europe prospective shale basin……………………………….…………………80

    Table 5.2 – Western Europe prospective shale basin……………………………….………………...80

    Table 5.3 – Comparison of Eu-28 shale gas estimates with conventional reserves………………..….81

    Table 5.4 – Water consumption during fuel extraction and processing………………………….….90

    Table 6.1 – Shale gas in Europe and the US – Revolution vs Evolution………………………….…105

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    4 Introduction

    If we consider human history, we can gather that all major steps forward in progress can be put

    down to energy exploitation and transformation. Since the beginning of human history, major

    advances in energy usage and transformation led to an improvement in humanity lifestyle. The last

    two centuries have witnessed Incredibles technological and life quality improvements; all of which

    based on the exploit of fossil fuels.

    Fossil fuels are the engine that powers our society but their consumption has led to environmental

    problems, from local pollution to global warming issues: current consumption trends are not

    sustainable in the long run. Despite the recent progress in renewable energy production, these

    technologies are far from being able to fulfill global energy demand. Despite the optimism and the

    high potential renewables still have a long development phase ahead.

    However, there is an energy source that could reduce emissions while acting as “bridge fuel”

    towards a greener future: natural gas. Natural gas is the simplest between all fossil fuels; it is exploited

    in all the final uses (from residential heating to power generation) guaranteeing superior

    environmental and technological performance compared with coal and oil derivatives.

    Despite its versatility and its environmental performance, utilization of natural gas is still

    constrained by its nature. A gaseous fuel is more complex to handle, transport and store with respect

    to a liquid (oil and derivatives) or solid fuel (coal). Natural gas extraction is subjected to an economic

    analysis based on the distance between the field and the final market; for most of its industrial history,

    its transportation and distribution costs have been higher than final market price.

    This constrain prevented natural gas to evolve in a unique global market (as the case of oil),

    generating many regional markets with differences in traded volumes, pricing scheme and final price.

    The lack of a connection created regional market where a bunch of exporting country enjoy a nearly

    monopolistic with excessive influence over volumes trade and market price.

    High market control is particularly evident in the European1 market, which relies mainly on three

    suppliers (Russia, Norway and Algeria) some of which (Russia) are de facto the only supplier of some

    member countries. This high dependency has been particularly aggravated by the recent geopolitical

    events as the war in Ukraine with the growing tensions between western governments and Russia and

    the increasing instability of North African and Middle-Eastern countries.

    The recent boom of gas extraction from unconventional shale formation in the US aroused

    significant interest in Europe as a way to increase domestic gas production reducing import

    dependency and increasing energy security. In 2000, the US, after a thirty-year decline in gas

    production, were foreseen to became the world biggest gas importer; the boom of shale gas totally

    overturned this scenario. This sudden increase in natural gas production has been defined a

    “revolution” and has turned the US from an importer country to a potential exporter.

    1 In all this work “European”, “Eu” and “Europe” would be used as synonyms referring to the European Union member countries and not as the geographical Europe.

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    Predictably, the US experience raised interest for this source in other countries worldwide; shale

    basins, in fact, are much more evenly distributed on the globe than conventional gas deposits.

    Europe has some promising shale basins, many located in Eastern Europe countries in country where

    the high dependency from Russia poses serious threat to energy security and political stability.

    Shale gas extraction is still a widely debated topic within the European Union mostly because of

    its extraction process (hydraulic stimulation of “fracking”); member countries, as general public, are

    divide between the enthusiast those willing to start a national production and the “opponents”, which

    placed a ban on the utilization of this technology. To date, shale gas exploration started in only in

    Poland and the results have been little disappointing and no commercial production has yet started.

    The reason behind this “failure” has to be found can be found in the differences existing between

    Europe and the US in terms shale formation characteristics, geological knowledge and market

    conditions, which makes the US development model only partially applicable. Hence understanding

    different factors that triggered the American shale boom are essential to understand the European

    potential and the challenges that will have to face in the development of the

    “European way” to shale extraction.

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    Chapter 1

    Introduction to Natural Gas

    For more than a century natural gas had been consider as a sort of lower quality oil-surrogate.

    Natural gas is often found associated with oil in conventional deposit; but, contrary to oil, its extraction

    depends on the distance between field and final market. During most of its industrial life, its

    commercial value was lower than its transportation costs and burned (flared) or liberated in the

    atmosphere (vented) on site. Things changed in the seventies after the “oil crises” when it was

    extensively used instead of oil-based fuels. The increased consumption of the last decade, led natural

    gas to become the third energy source employed worldwide. Between all energy sources, natural gas

    is experiencing the fastest growing rate and has the most promising future.

    The main component of natural gas is methane (CH4), the simplest between all the hydrocarbons.

    Its combustion process releases the lowest amount of carbon dioxide of all fossil fuel thus making

    natural gas the “greenest” non-renewable source. This rate of increasing consumption is expected to

    continue in the next years both in developing countries and in industrialized ones. The development

    of African, Middle-Eastern and Central-Asia countries will increase the number of final costumers

    with access to the gas networks. In industrialized countries the increasingly stringent environmental

    policies. On the other hand, in the most industrialized countries the stringent environmental policies

    could led natural gas in becoming more than coal for power generation or oil products for road

    transport.

    Despite its wide final uses and its environmental benefits, natural gas global consumption is still

    constrained by some factors: its gaseous nature make him difficult to transport and store and

    technologies employed are more costly with respect to other fuels. For the same energy content natural

    gas occupies a volume a thousand times greater than crude oil; this is why transporting natural gas

    from the wellhead to the final market has not been feasible or economically convenient for most of

    the last century. Natural gas tend to be exploited as close as possible to production site: only one third

    of the worldwide produced gas is exported.

    Transportation rigidity limits the number of potential importers: high dependence by a restrict

    number of supplier poses some energy security risks. Gas producer have a higher influence and

    political power with respect to oil ones because their costumers have fewer supply alternatives. This

    is the case of the European Union where almost all the gas imported come from just three supplier

    (Russia, Algeria and Norway) and it is sold with very rigid contracts. In the end, an increasing

    employment of natural gas presents several benefits and some major constrains; the evolution of those

    contrasting elements in the next future will determine the possibility for natural gas to become the

    first energy source worldwide overcoming oil and establishing the “end” of the oil age.

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    1.1. What is natural gas?

    Natural gas is composed primarily of methane, but also includes various amounts of other short-

    chained alkanes and a percentage of inert gas or pollutants. Natural gas generates following the

    chemical degradation of organic matter, either because of anaerobic bacteria (biogenic gas) or because

    of a series of chemical reaction happening in a high temperature and pressure environment deep in the

    earth crust (thermogenic gas). Almost all the natural gas consumed worldwide has a thermogenic

    origin and is extracted from deep underground accumulation associated with oil (associated gas) or

    alone (dry gas). Biogenic gas, on the contrary, is found in much smaller amount at a shallow depth as

    a result of the burying of old swamp or marsh (hence the name swamp gas). It can also be produced

    with specifically design processes of organic fermentation; in this case is called “biogas” and it is

    considered a renewable source.

    1.1.1. Composition of Natural Gas

    Natural gas is a hydrocarbon mixture consisting of light saturated paraffin2 (like

    methane and ethane) but it might also contain some heavier hydrocarbons; ranging from propane to

    hexane.

    Table 1.1 – Chemical composition of natural gas (Mokhatab and Poe, 2012)

    Component Chemical Formula Volumetric composition (%)

    Methane CH4 60.0 – 96.0

    Ethane C2H6

    Propane C3H8

    Isobutane C4H10 0 – 20*

    Pentane C5H12

    Hexane C6H14

    Nitrogen N2 0 - 5

    Carbon dioxide CO2 0 - 8

    Hydrogen sulphide H2S 0 - 5

    Oxygen O2 0 - 0.2

    Rare gases A, He, Ne, Xe traces

    * Refers to the overall percentage of NGLs

    While methane and ethane are gaseous under atmospheric conditions heavier hydrocarbons are

    present in gaseous form within the reservoir but liquefy once reached the surface. This liquid fraction

    is called natural gas liquids (NGLs) and, according to the amount present in the gas flow, extracted

    2 Paraffin or alkanes are any of the saturated hydrocarbons having the general formula CnH2n+2

    https://en.wikipedia.org/wiki/Methanehttps://en.wikipedia.org/wiki/Alkaneshttp://www.britannica.com/science/hydrocarbonhttp://www.britannica.com/science/paraffin-hydrocarbonhttp://www.britannica.com/science/methanehttp://www.britannica.com/science/ethanehttp://www.britannica.com/science/liquefied-petroleum-gashttps://en.wikipedia.org/wiki/Alkane

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    natural gas could be called “wet” or “dry” gas. NGLs are separated from the gaseous stream and send

    to refinery to be exploit as basic feedstock in the petrochemical industry or to produce LPG3. Other

    commonly found gases are nitrogen, carbon dioxide, hydrogen and trace of noble gases such

    as helium and argon. In addition to inert gas natural gas might contain substantial quantities

    of hydrogen sulfide or other organic-sulphur compounds, which are toxic, corrosive and generated

    hazardous pollutant when burned. This type of gas, known as “sour gas” has to be processed and de-

    sulphurized before being transported to the final markets. Moreover, associated gas present traces of

    water vapor due to the brine4 usually present at the bottom of oil reservoir. To become suitable for the

    market those fractions has to be removed

    1.1.2. Natural gas genesis

    Nearly all natural gas extracted worldwide has a thermogenic origin: like petroleum, it is formed

    following the burial and sequent thermochemical degradation of organic matter. First small aquatic

    organism die and deposit at the bottom of lakes or old seas, subsequent deposition of sand buries them

    below the surface where they undergo a process of diagenesis5. During burial, the mild pressure forces

    water out of the deposited sediments Subsequent chemical reaction and bacteria activities decompose

    the original organic polymers forming kerogen, a waxy mixture of organic compounds. As burial

    depth increases so do pressure and temperature starting thermal degradation (“cracking”) of the long-

    chain kerogene molecules into smaller hydrocarbons. The deeper kerogene is buried the higher is the

    temperature to which it is exposed; higher temperature is associate with faster cracking reaction and

    smaller molecule resulting. So, the deepest the sediment the lightest the final product.

    It has to be said, however, that not all the buried organic matter forms kerogene and not all the

    kerogen typologies are suited to became hydrocarbons, which strictly depends on the typology of

    organic matter present and the temperature at which it is exposed.

    Figure 1.1 – Oil and gas temperatures related to depth of burial

    3 LPG or liquefied petroleum gas is a mixture of butane and propane 4 High salinity water found in deep reservoir (salinity > 5%) 5 Diagenesis is a process of chemical and physical change in deposited sediments during its conversion to rocks

    http://www.britannica.com/science/nitrogenhttp://www.britannica.com/science/carbon-dioxidehttp://www.britannica.com/science/hydrogenhttp://www.britannica.com/science/noble-gashttp://www.britannica.com/science/helium-chemical-elementhttp://www.britannica.com/science/argon-chemical-elementhttp://www.britannica.com/science/hydrogen-sulfidehttp://www.britannica.com/science/sulfurhttps://en.wikipedia.org/wiki/Organic_chemistryhttps://en.wikipedia.org/wiki/Chemical_compoundhttp://www.britannica.com/science/liquefied-petroleum-gas

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    1.1.3. Formation of a gas reservoir

    The kerogen-rich that generates the hydrocarbons is called “source” or “mother rock”; however,

    oil and gas are found elsewhere, in rocks layer that lies closer to the surface, called “reservoir”. The

    process that brings liquid or gaseous hydrocarbons from source rock to the reservoir is called

    “hydrocarbon migration” and it is composed of two consequent steps. Primary migration, where the

    hydrocarbons are expulse from source rocks, and secondary migration, when they flow towards the

    surface being, eventually, trapped in the final reservoir. Hydrocarbons generation within the source

    rock led to a constant increase in the internal pressure within the rock layer that, once overcome the

    surrounding geostatic pressure, ejects them. After the expulsion from hydrocarbons, being lighter than

    water, are pushed upward by buoyancy forces; eventually they could reach the surface originating oil

    or gas seepage. For migration to take place, rocks strata surrounding the source rock have to be

    permeable6 enough; the higher the permeability, the higher the quantity of hydrocarbon that could

    migrate. Finally, in order to develop a reservoir (an oil/gas field), the hydrocarbons have to encounter

    a so-called trap on their way to the surface. A trap requires essentially two elements: a sufficiently

    porous rock to contain the hydrocarbons (reservoir rock) capped with a layer of impermeable rock

    that blocks any further migration (seal rock).

    Figure 1.2 – Formation of an oil and gas reservoir

    6 In earth science, permeability indicate the ability for fluids (gas or liquid) to flow through rocks: it depends by the rock typology (pores dimension and connection) and pressure (high compression state will lower the permeability). It is also distinguished between primary, which depends only on rock lithology, and secondary, which considers fractures and faults formed resulting from tectonic deformation.

  • 21

    1.2. Natural gas final uses

    Natural gas is probably the most versatile between all the primary energy feedstock and it

    extensively employed in all the final energy uses. It is employed as fuel source for its combustion

    characteristics or as basic feedstock in other to produce a wide variety of other chemical component.

    1.2.1. Residential and commercial uses

    The uses of natural in those two sectors consist mainly in space or water heating or cooking, where

    natural gas represents the best choice in terms of both ease of use and cost effectiveness. Cooking

    with natural gas allows an easy temperature control, self-ignition and self-cleaning of the range.

    Regarding water and space heating, gas-fired condensing boiler allows the recovery of its heat of

    vaporization achieving the highest possible efficiency. Methane is a colorless, odorless gas and,

    despite not being toxic, it is particularly dangerous due its ignition-ease. For this reason, a small

    quantity of an odorant is always added to ensure the rapid detection of any leakage that may occur

    during use.

    1.2.2. Industrial uses

    Natural gas is widely employed in industrial process as fuel for industrial furnaces or co-generating

    systems, as basic chemical feedstock or as a cooling media for large refrigeration plant. Natural gas,

    together with electricity, is essential in all the energy-intensive industries such as iron metallurgy,

    cement works and paper mills where it could make up for nearly half of the production costs. Industrial

    cogeneration is a cost-effective solution when the process requires both heat and electricity. Methane

    and NGLs are the basic feedstock for a wide variety of components in the petrochemical or

    pharmaceutical industry. The reaction between methane (CH4) and molecular nitrogen (N2) is the first

    source of ammonia (NH3), which is the base-block of all fertilizer employed worldwide. Beside its

    direct uses it could also be converted in “syngas” (synthesis gas, a mixture of hydrogen and carbon

    oxide), and further process to obtain methanol or pure hydrogen. Recent improvements in refrigeration

    technologies made natural gas the best available solution for large refrigeration system based on a

    gas-absorption cooling cycle. This system exploits the heat generated by natural gas combustion as a

    thermochemical “compressor” to operate the refrigeration cycle: gas absorption cycle do not require

    any electricity and have no moving therefore being much simpler and having limited maintenance

    costs.

    1.2.3. Power generation

    The technological development on high-temperature resisting material and cooling system on

    aircraft gas turbine create a sharp cost reduction, which allowed the employment of this technology

    in power generation system. CCGT (combined- cycle gas turbine) combine two different

  • 22

    thermodynamic cycles: a gas-fired Joule-Bryton and a traditional steam-based Rankine cycle.

    Residual heat contained in the high-temperature flue gas discharge by the gas turbine is employed to

    produce the superheated vapor sent to the steam turbine. The combination of two different cycles and

    the use of gas turbine “waste heat” allows greater efficiency that single cycle power plant. The highest

    efficiency ever achieved in CCGT surpassed 60% in comparison with the 40% of the traditional coal-

    or oil-fired plants. Compared with traditional plants CCGT tends to have higher operational cost (fuel

    costs) but lower initial capital investment. CCGT are easier and faster to build and, given the same

    electricity output the total land requirement is smaller. Moreover, gas turbine could be turned on and

    off very quickly and the output load could be variated with the same rapidity, making them perfectly

    suited as backup generation for the unpredictable and variable renewable generators.

    Figure 1.3 - Scheme of a CCGT power plant

    1.1.4. Transportation

    The high-energy content and high octane number of methane makes it suitable to be employed in

    an internal combustion engine. No particularly design injector or mixer is required since optimal

    mixing and ignition ease are intrinsically ensured by its gaseous nature. Problems associated with

    carrying a gaseous fuel on a vehicle (storage tanks dimension and weight) limited its development as

    a fuel for transport. Recent improvement in storage tank design and stricter emission limit regulations

    are incentivizing automakers to design gas-powered model. Natural gas energy density per unit

    volume is much lower than gasoline. Natural gas cannot be stored at ambient condition ant is either

    pressurized (compressed natural gas or CNG), or liquefied (liquefied natural gas or LNG). Storing a

    liquid at such a low temperature requires special cryogenic tanks that are too expensive to be installed

    on an average passenger car. LNG is, in fact, reserved to heavy-duty vehicles (alone or in a dual-fuel

    combination with diesel) while passenger car or public transportation buses employs CNG systems.

    Regardless of the type of storage, it reaches the combustion chamber in gaseous form pre-mixed with

    air to assure the best engine performances. Natural gas could also be converted into liquid synthetic

  • 23

    fuel solving the problems relate to the storage of a high-pressure gas or a cryogenic liquid. Gas to

    liquids (GTL) is a refinery process that converts natural gas or other gaseous hydrocarbons into longer-

    chain hydrocarbons such as gasoline or diesel fuel.

    1.3. Natural gas environmental benefits

    “Global warming” and “climate change” describe the rise in the average temperature of Earth and,

    despite skepticism; it is become a widely accepted fact supported by a wide numbers of scientific

    research and observations. It is undeniable that human activities are emitting in the atmosphere a wide

    range of gaseous substance that contribute to increase the greenhouse effect7. This is the reason why

    the increasing level of carbon dioxide (CO2) in the atmosphere generates so many worries; carbon

    dioxide is an odorless and colorless that is neither toxic nor dangerous to human but it is the most

    common GHG. Carbon dioxide is the product of all combustion reaction8 and the massive reliance on

    fossil fuel contributes significantly to its production: since the industrial revolution the level of

    atmospheric CO2 have been steadily rising.

    In order to decelerate this emission trend 175 countries, which are responsible for more than half

    of the total GHG, subscribed the Kyoto Protocol (1997) pledging to reduce their total GHG emission

    under 1990 level within 2020. In order to achieve this ambitious goal different measure should be

    adopted: from a serious improvement in energy efficiency in all energy end-uses sector to the increase

    of renewable energy generation. Renewable energies, although, still have to face a substantial

    improvement in their technology and scale-economy before being able to replace completely fossil

    fuel.

    Cost-effectiveness and the emission cut made with energy efficiency measure tends to be very

    high at the beginning, when applied to a generally inefficient situation (such as power generation

    sector in developing countries) increasing their cost and reducing the obtainable results as the overall

    efficiency level increase. In Europe, where since the energy crises of the seventies energy efficiency

    has always been a priority, further energy efficiency measure tends to be always less cost-effective.

    The best results, in terms of emission cut, would be a fuel switch in the power generation sector

    employing natural gas instead of the more polluting coal or oil. Methane, in fact, being the simplest

    of all the fossil fuel, has the “greenest” combustion and emits almost half CO2 compared to coal and

    nearly 30% less when compared to oil and oil product. (See table 1.2)

    The low emission combustion of natural gas is enhanced in the power generation sector.

    Because of their high efficiency CCGT have the lowest total emission (considering both direct and

    indirect emission) between all thermal power plants. (See figure 1.4)

    7 Greenhouse effect is the process with whom part of the thermal radiation emitted from a planetary surface is absorbed by the atmospheric layers and re-radiated back maintaining the temperature within atmospheric layers 8 The unique exception is hydrogen (H2) being the only fuel without any carbon atoms its combustion reaction do not generates any carbon dioxide

    https://en.wikipedia.org/wiki/Oil_refineryhttps://en.wikipedia.org/wiki/Natural_gashttps://en.wikipedia.org/wiki/Hydrocarbon

  • 24

    Another problem of great importance regards air pollution and related illness; as for global

    warming a substitution of traditional fuels with methane would reduce in a lower pollutant level.

    Natural gas combustion does not produced any sulphur dioxide or particular matter and has the lowest

    emission of carbon dioxide and nitrogen oxide. (See table 1.3)

    Table 2.2 – Specific energy, energy density and yielded CO2 for different fossil fuels

    Fuel Specific Energy

    (MJ/Kg)

    Energy Density

    (MJ/litre) Chemical Formula

    CO2 emission

    (g CO2/MJ)

    Propane 50.3 25.6* C3H8 59.9

    LPG 46.1 27 C3H8 + C4H10 59.8

    Ethanol 21.6 - 23.4 18.4 - 21.2 CH3 CH2OH 67.2

    Gasoline 45.8 32 - 34.8 C7H16 74.1

    Diesel 48.1 36 - 40.3 C12H26 70.7

    Biodiesel 37.8 33.3 - 35.7 C18H32O2 ~ 75

    Methane 55.5 23* - 23.3* CH4 50 Natural gas 38 - 50 17.7* - 23.2* mainly CH4 50 - 60

    Crude Oil 41.9 28 - 31.4 C14H30 96.8

    Wood 16 - 21 2.6 - 21.8 (C6H10O5)n 94.2

    Coal 29.3 - 33.5 39.8 - 74.4 - 99.2 - 109.8

    Hydrogen 120 - 141.9 8.5* - 10.1* H2 0

    *liquefied

    Figure 1.4 – Equivalent carbon dioxide emission for different electricity generation (NEA, 2009)

    Table 1.3 – Air pollutant emissions from fossil fuels steady combustion (Mokhatab and Poe, 2012)

    Fuel SOX NOX CO2 PM

    Coal (3% Sulphur) 1.935 0.430 85.3 2.532

    Coal (1% Sulphur) 0.645 0.430 85.3 2.293

    Fuel Oil (residual) 1.433 0.406 74.8 0.096

    Fuel Oil (distillate) 0.143 0.215 74.2 0.048

    Natural Gas - 0.287 49.4 -

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    1.4. Natural gas global consumption

    Natural gas development as a worldwide energy sources is very recent: at the beginning of the

    fifties natural gas was covering less than 1% of world primary energy consumption, compared to the

    25% of 2013. This consumption increase has been a worldwide phenomenon but, as fig. 1.3 clearly

    shows, the extent of this increase varied greatly in different world region.

    Figure 1.5 – Historical gas consumption per region (elaboration on EIA database)

    Reliance on natural gas increased in all world region but, while the increase of the United States

    and Europe have been relatively modest, Middle-Eastern and Asiatic countries experienced a dramatic

    surge in their consumption. The reasons of this increase in consumption is country-specific: in Asia

    is related to the economic and population growth of China and India while in the Middle East is related

    to the substitution of oil with gas for electricity production.

    According to all analyst estimation made (Bp, Eia, Iea) natural gas consumption will be the fastest

    growing energy source in the next future. Some of the driving forces behind this increase consumption

    are easy to forecast, as the Chinese and Indian population growth, while some are more complex and

    depends on government decision and environmental policies. In the next year, new power plants

    would be required to cover the increasing electric demand of developing countries and to substitute

    nuclear power station that are going to be shut down following Fukushima disaster. The most

    economical solution to replace nuclear power plant would be with coal-fired power plants. However,

    stricter regulation on maximum pollutant emission combined with an increase in the price of CO2

    could make CCGT competitive or even convenient with respect to coal-fired ones. Moreover, the

    increasing share of non-predictive and erratic renewable electricity generation, such as wind farms

    and solar fields, needs a proportional increase in backup generators able to variate their load very fast

    to compensate production outrages. At the state of the art, the best-suited technologies are CCGT.

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    While the biggest absolute increase in gas consumption will come from residential and power

    generation the highest percentage growth would be seen the transport sector. Nowadays, road

    transportation is dominated by oil products but technological improvement on gas-based engines and

    storage tanks would make natural gas powered cars ever more reliable and convenient. As previously

    stated the entity of these consumption increase rely on the future governments policies; nevertheless

    all those trends are yet visible showing the dawn of what the Energy International Agency defined the

    “Golden Age of Gas”.

    Figure 1.6 – Forecast on natural gas consumption per world region – billion cubic feet /year (BP Energy Outlook)

    1.5. Natural gas global reserves

    For most of the century, natural gas was considered an “economic viable byproducts” in the oil

    extraction process; therefore oil&gas companies were mainly focus on the exploration and

    exploitation of oil reserves. Increased interest in the development of natural gas projects led to a

    dramatic increase in the quantity of proven reserve: 2013 estimation were of 185.7 trillion cubic, 57%

    higher with respect at 1993 level and 32% with respect to 2003. More than two-third of the world

    reserves are located in just two world region: Eurasia9 (or FSU, Former Soviet Union) and Middle

    East. Quantity of gas reserves on itself is somehow difficult to interpret when not compared to the

    9 According to British Petroleum world subdivision Eurasia accounts for Russia and other central Asian countries once part of the Soviet Union.

  • 27

    level of production. The reserves/production ratio, gives an idea of how many years current field could

    be exploited without any technological improvement or any other new discover.

    This ratio is sometimes confused with “remaining lifetime” of the resource, which is, of course,

    wrong. Reserves indicated the quantity of resource known that could be recover with current

    technological level under current market condition. It is, thus, evident that any technological

    improvement, increase in final price or new discovery will led to an increase in the gas reserves.

    Figure 1.7 – Natural gas proven reserves by region – (BP Statistical review of world energy)

    Despite the environmental superiority with respect to all other fossil fuels increase reliance on

    natural gas is criticize for its intrinsic non-renewable nature. Some environmentalist claim that natural

    gas will not solve any of the environmental problems but just delay them while subtracting funds to

    renewable energy. One of their main point of the critics is that natural gas, as oil and coal, is an

    exhaustive energy sources and, once depleted, will leave our society without any other alternative

    energy source: investment in natural gas project, therefore, should be avoided in favor of renewable

    energies. Oil and gas depletion is a widely discussed topic, especially by general media, which,

    sometimes, are not very accurate in their scientific explanation and could generate baseless worries.

    For example, reporting that the lifespan of gas reserves estimate in 2013 was sixty years could be

    misleading; the “lifespan” (better “remaining lifetime at current rate of production”) does not indicate

    the amount of time before the total depletion of oil or natural gas. This “end of oil and gas” fear is

    largely unfounded and it is based on a misunderstanding of the term “reserves” that is often taken as

    “total quantity of oil and gas present on earth”. “Remaining lifetime” indicates simply the ratio

    between what has been discovered and considered profitable for extraction and the extraction rate.

    For example, according to British Petroleum historical data series, the R/P ratio was of 54 years in

    1983 and is 55 years today.

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  • 29

    Chapter 2

    Natural gas industry and market

    Natural gas is the most versatile and “greenest” of all fossil fuels: it has a high heating value, it

    could be employed in almost all energy end-use sectors and has a smaller environmental impact

    compared to other fossils. Despite all of its advantages, a single aspect prevented it from becoming

    the first energy source employed worldwide: its gaseous state. Technologies required to transport and

    store a gaseous fuel are more challenging, and thus costly, than a solid (coal) or liquid one (oil).

    Natural gas is exploited as close as possible to the production facilities; the first natural gas

    markets were created because of the presence of associated fields (i.e. presence of both oil and gas)

    relatively close to consumption centers. High transportation costs limits cross-border exchanges;

    nowadays only one third of the gas produced exits the producing country border to be exported

    elsewhere, a very low percentage compared with the almost 70% of oil. Moreover, most of the natural

    gas exported is produced by a bunch of countries (roughly the first 10 exporters covers nearly 80% of

    the overall sales on the global market), mainly Russia and the Middle East, which have an incredibly

    high share of the markets and are the much more influential than oil producers.

    The regional separation between markets have been lowered in the last decade by the increased

    number of LNG trading but the total volume exchange are still not sufficient to modify the intrinsic

    characteristics of the gas market.

    2.1. Overview of the natural gas supply chain

    The production, transportation and distribution of natural gas is a complex process that involves a

    high number of actors, from oil majors to final residential customers; any every step of the supply

    chain is defined according to its “position” in the oil & gas industry production stream.

    Generally, the subdivision of the gas supply chain is the same of as the oil one, since they are often

    associated and some steps (especially production) are very similar.

    Upstream (Production & Processing): all facilities and activities required to produce oil and gas;

    well drilling, well completion and production

    Midstream (NG Transmission & Storage): gas treatment operation and its transportation to the

    end market (both via pipeline or shipped) and its storage

    Downstream (Distribution): distribution and marketing of natural gas

  • 30

    Figure 2.1 – Natural gas supply chain

    2.1.1. Upstream

    Upstream refers to the development of a natural gas (or oil) project and comes after exploratory

    phase where, trough geological survey and seismic analysis, natural gas deposits are identified.

    Determining whether to drill a well depends on a variety of factors, mostly the economic potential of

    the hoped-for natural gas reservoir. If the first exploratory well strikes a natural gas deposit a series

    of tests are carried in order to determine the size and production capacity of the reservoir, once this

    consideration are is known, the final decision, whether to start production in the field or not, is taken

    and subsequent development is optimized. Main distinction in the upstream process is not between oil

    and gas wells, which have only minor differences but rather between on- and offshore facilities.

    Onshore facilities employ standard technologies with only minor differences between them offshore

    facilities have a wide range of technical solutions based on geographical location and water depth.

    2.1.2. Midstream

    Midstream section comprises all the process and facilities that are required in the after-production

    phase; gas gathering, treatments and transported to the final markets. The first step is the “gathering”;

    offshore facilities also includes a gathering system and a processing plant on board, onshore facilities

    gathers all the raw gas coming from the wells in the same area and process it in just one plant. Well

    gas, or “raw natural gas”, is purified through a pollutant removal process and then separated into its

    marketable fractions (methane and NGLs).

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    Gas treatment includes all units and processes required to separate methane from unwanted

    components such as acid gases (CO2 and H2S), water vapor and inert. Another process done in the

    processing plant is the so-called calibration: that is the mixing of natural gas with other gases to match

    a specifically required calorific value. Since the required calorific value is normally lower than the

    one of pure methane, the stream could be diluted by adding an inert.

    Once the gas has been processed, it is transported to the final market; by either compressing it and

    sending it through a pipeline system or shipping it, after the liquefaction process, with specifically

    designed cargoes. In order to be sent via pipeline, natural gas has to be pressurized: since internal

    friction will diminish the gas pressure additional compressor stations might be required in case of long

    distance transportation. Pressurization is performed with centrifugal compressors driven by a turbine,

    fueled with part of the incoming gas, or by an electric engine. Once natural gas reaches the distribution

    network it is distributed into smaller and shorter pipe to the final consumers.

    LNG shipping requires a liquefaction process: unlike other gasses natural gas cannot be liquefied

    by simply increasing its pressure but it has to be cooled until it reaches its ambient pressure dew point

    (- 162 °C). Natural gas liquefaction processes are covered by a patent and, in general, are generally

    based on a multi-stage cooling process: pre-cooling (until -30 to -50 °C), liquefaction (from – 30 to –

    125 °C) and sub-cooling (to the final temperature of -162 °C), those three section are normally

    separated and employ different coolants. Once liquefied, natural gas is loaded in the cryogenic tankers

    of an LNG-cargo; even if the insulation is designed to minimize heat losses a part of the cargo will

    still heat up and boil off. To prevent excessive loss of the cargo LNG is stored as “boiling cryogen”;

    so as the vapor boils off, the heat of vaporization is absorbed from the rest of liquid cooling it down

    with an effect called auto-refrigeration.

    Figure 2.2 – Natural gas midstream facilities (ABB – Oil and gas production handbook)

    The receiving terminal is called regasification facility: LNG is stored in local cryogenic tanks and,

    when required, is regasified to ambient temperature, pressurized and sent to the pipeline network.

    Compared to the complexity required for a liquefaction plant the receiving terminal is rather easy;

    rigasifier is normally a simple LNG-seawater heat exchanger.

  • 32

    2.2. Gas transportation

    The transportation choice thus depends on the distance to cover but, mostly, on the possibility of

    building a very long pipeline to export gas. Beside the increasing capital and operation costs required

    for longer pipelines some other geopolitical problem might be involved. Long trans-national pipelines

    often have to cross other countries and pipeline owner should pay what called “gas transit fee”.

    Moreover, the presence of such sensible infrastructures might pose some security risks or generate

    tension between the two countries involved (as for example the Russia-Ukraine gas crisis).

    LNG cargoes, on the contrary, do not involved static infrastructure and are much flexible: the same

    liquefaction facilities could supply more receiving facilities located in different countries. Therefore,

    the choice between LNG and pipeline gas depends on a variety of factors, geographical position,

    geopolitical situation and market-related evaluations.

    It is clear, although, that, whatever the chosen solution, technological complexity and related costs

    are much higher with respect to oil. In case of a pipeline, gas transportation requires higher quality

    materials and welding in order to withstand pressure and compressing a gas to make it flow through

    a pipeline is more costly with respect to a liquid. When comparing LNG and oil shipping the difference

    is even greater: while LNG requires a complex cryogenic process while oil needs just to be loaded

    and offloaded. In the end, transportation costs represent a fraction between 40% and 70% of the

    marketable price, much higher than the 10% of oil. This cost gap explains rather easily, what has

    always been (and still is) the limit of the diffusion of natural gas.

    2.3. Natural gas market structure

    Even if technological progress decreased costs in all the supply chain (especially in the LNG

    industry) natural gas remains a regional energy source. In 2014, natural gas global production reached

    3’460 billion cubic meters, of this, only a third crossed national border to be exported; a percentage

    that is nearly half the one of oil. The global gas market is heavily polarized with the 10 biggest

    importers and exporters covering almost 80% of the overall natural gas trade worldwide. As figure

    2.3 clearly shows, there exists a polarization also in the export typology: piped gas trading happens

    in Europe and North America while LNG cargoes are directed mostly to the south Asian markets. This

    heavy regionality gave birth to a different number of gas markets clearly distinguishable for their

    geographical location and their pricing system. The world’s biggest, both in terms of consumption

    and imports, are North American, the European markets and the south Asian markets. Those three

    markets differ primarily in terms of geographic location, availability of natural resources, country

    energy mix and reliance on natural gas.

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    Figure 2.3 – Major gas trade flow worldwide in 2014 (billion cubic meter) - BP Review 2015

    All these factors generated wide differences in the market structure in terms and contract

    typologies as the different prices shows. In fact, while oil has a global price set for specific

    benchmarks10 natural gas has a separate market with separate prices and a very small amount of

    interaction between them.

    Figure 2.4 – Gas price in major distinct market - BP Review 2015

    10 A benchmark crude or marker crude is a crude oil that serves as a reference price for buyers and sellers of crude oil. There are three primary benchmarks: West Texas Intermediate (WTI, US), Brent Blend (extracted in the North Sea, the European benchmark), and Dubai Crude (Persian Gulf benchmark).

    https://en.wikipedia.org/wiki/Petroleumhttps://en.wikipedia.org/wiki/West_Texas_Intermediatehttps://en.wikipedia.org/wiki/Brent_Blendhttps://en.wikipedia.org/wiki/Dubai_Crude

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    2.3.1. Gas market characteristics

    Like other economic goods, the structure of each regional gas market depends mainly on their

    dimensions, number of suppliers and consumers, and the availability of alternative energy sources as

    substitutional goods. Market structure is also influenced by gas infrastructures present within the

    market border (i.e. extent of pipeline network, transport capacity and storage) and its accessibility to

    all market participants. Figure 2.6 summarizes those concepts showing the four typology of existing

    gas markets presented in order of increasing liberalization and competitiveness: from the regulated

    markets typically of countries with nationalized oil and gas industry to the open and well-integrated

    “gas on gas market”.

    Figure 2.5 – Major gas market characteristics

    There are countries where the energy markets are fully liberalized (as the United States) or have

    an ongoing liberalization process (the case of the Europe) and others where oil&gas resources are

    nationalized and the energy markets are operated by state-owned companies. In these countries,

    especially the Middle-East countries and Russia all the natural gas supply chain steps are covered by

    a unique vertical-integrated11 company whose directors and executive are nominated by the

    government (as is the case of Gazprom in Russia); and prices are often fixed. This type of regulated

    markets are associated with a rigid political structure and State control in all the aspects of a country’s

    economy; the main examples are Russia, the Middle East countries and China.

    11 Vertical integration is an arrangement in which a company owns and directly controls all the supply chain of the market specific product or service it sells

  • 35

    At the opposite end, there is the so-called “gas to gas” market typical of North America (Canada

    and the US) and, to a lesser extent, of the United Kingdom. Main characteristic is the high number of

    players (on both the demand and supply side), the presence of a large and well-integrated gas network

    able to reach every customer and the presence of ample storage systems. All the gas-related

    infrastructures (pipelines, storage systems and in some case LNG receiving terminals) are open and

    accessible to all market participants, with so-called “third-party access12” thus increasing

    competitiveness and market efficiency. Market price is determined by the interception of demand and

    supply referred, normally, to regional benchmarks, such as the regional main stock market.

    The second group, which includes Continental Europe and some Asia-Pacific countries (Japan,

    Taiwan and South Korea) present a reduced market dimension, especially on the supply side, and rely

    heavily on foreign imports. The main differences between European and the Asiatic market are: the

    typology of imported gas (via pipeline for Europe and via LNG for Asiatic countries) and connection

    of the market; Europe could be considered a unique market while Japan, South Korea and Taiwan are

    completely separate.

    European gas market has intrinsic different characteristics related to its historical evolution: the

    actual network is the unification of different gas networks specifically designed to meet country

    internal demand. For this reason, the European network is still scattered and not well integrated. Gas

    is imported with long-term contracts (15 to 30 years) based on an oil-indexing. Final gas price is the

    result of a formula that includes volume of natural gas contracted and average prices of oil and oil-

    based fuel.

    Even if the contract formulations are essentially the same, prices vary along the continent in

    relation to the volume contracted and the market power of the exporting country. The insufficient

    connection in the union contributes in creating areas where just one supplier (Russian Gazprom)

    covers all country’s gas demand; this monopolist condition is translated into a high variability in final

    prices that depends, mostly, on political relationships. One of the main goals of the European Union,

    since its formation, has been the creation of a unique European energy market for both electricity and

    natural gas. Despite the oligopolistic situation, some steps into the deregulation process has been taken

    and there are some gas hubs with a still limited, but growing, futures market.

    12 Third Party Access (TPA) is a regime that obliges companies that own or operate transmission and distribution networks (gas and electricity) for offering a non-discriminatory service to the third parties to the extent that there is capacity available. TPA impose the obligation to the network owner/operators to offer capacity if there is available capacity, or if it has not been allocated before. Enforcing TPA in the use of pipelines transmission network is a policy trend observed in all countries that aim to liberalized and increase competitiveness in energy markets

  • 36

    2.4. The European model: the US gas market

    The US natural gas market is the biggest and most competitive gas market worldwide. Market

    mechanisms in the newborn European hub are similar, but not as well developed or complex, even if

    the legislative path takes this as a reference point. The main difference between the United States and

    the European market is the extension of liberalization and deregulation, the dimension of the supply

    side and the important role of gas marketers. Natural gas marketers have a quite complex role, which

    does not fit exactly into a particular step in the natural gas supply chain. In general, gas marketing

    could be described as the sum of all the processes required in order to coordinate the business of

    bringing natural gas from the wellhead to end-users. Before the liberalization process, there was no

    role for natural gas marketers; producers sold natural gas to pipelines transmission companies who

    then sold to local distribution companies who, finally, sold it to the end user. This market structure

    was rigid and separate in blocks; infrastructure ownership and price regulation at all levels of the

    supply chain left no place for other market participants.

    Liberalization process started in 1978 with the “Gas Policy” establishing the end of state authority

    regulation over the wellhead price13. The whole required nearly 25 years and three other fundamental

    steps to result in a fully competitive market. Firstly, the possibility to each end consumer to purchase

    gas directly from the producer was enforced, secondly, The TPA was made mandatory on every

    pipeline of the network (FERC14 order no.436, 1985) and, finally, transport and marketing activities

    were separated (FERC order no.636 in 1992). The creation of financial markets gave marketers the

    possibility and the instruments to hedge (i.e. reduce) the intrinsic risks related to price volatility. In

    the end, it is the predominant role of marketers that ensures the efficiency15, transparency and

    liquidity16 of the American market; the resulting market is fully open to concurrence with a clear

    pricing scheme and without actors with high market power able to influence the final price.

    13 Price of natural gas at the moment of extraction; represents the pure cost of extraction and processing, or the final cost excluding other expenses required to transport and deliver natural gas. 14 Federal Energy Regulatory Commission is the United States federal agency with jurisdiction over interstate electricity sales, wholesale electric rates, hydroelectric licensing, natural gas pricing and oil pipeline rates. 15 Market efficiency refers to the capacity of market players to optimize the allocation of a commodity thus managing the potential and rapid variation, called “swings”, of demand or supply. 16 Market liquidity is a complex concept since it incorporates four distinct characteristics: depth, breadth, immediacy, and resilience. Breadth and depth refer to the market dimension or quantity of different bids and offer present on the market and to the price variation that follows the trading of large volume of the given commodities. Immediacy is the ability to trade large volume in a short period of time, and resilience to the capacity to recover, in a short period of time, the market natural supply/demand equilibrium after a shock

    https://en.wikipedia.org/wiki/United_Stateshttps://en.wikipedia.org/wiki/Independent_agencies_of_the_United_States_governmenthttps://en.wikipedia.org/wiki/Jurisdictionhttps://en.wikipedia.org/wiki/Wholesalehttps://en.wikipedia.org/wiki/Utility_ratemakinghttps://en.wikipedia.org/wiki/Hydroelectricityhttps://en.wikipedia.org/wiki/Licensehttps://en.wikipedia.org/wiki/Natural_gashttps://en.wikipedia.org/wiki/Pipeline_transport

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    2.4.1. Physical and financial market

    Natural gas market in the USA is essentially a commodity market like corn, metals, or oil ones.

    To be considered a commodity, a product must have the same characteristics independently of its

    geographical location and natural gas, once processed, fits the description. The price of each

    commodity is determined by the interaction between supplier (producer or importers) and consumer;

    a variation in one of the two market forces will cause a variation in the resulting price.

    Natural gas trading, as other commodities, involves both physical volumes and financial contracts

    and has two distinct markets according to the time step of the purchased goods: the spot market and

    the futures market. The Spot market is the daily market, where natural gas is bought and sold “right

    now” while futures are contract referred to a future purchased (normally from one month up to 36

    months in advance). Natural gas futures are traded with a number of complex derivatives contracts

    that are essentially employed to reduce market associate risks or to speculate on future trends of gas

    price.

    Physical trading occurs in locations called “market hubs”, physical markets located at the

    intersection of major pipelines or in proximity to major consumption centers. There are over 30 major

    market hubs in the U.S., the principal of which is the Henry Hub, in Erath, Louisiana. Its importance

    is due to its strategic positon: it interconnects nine interstate and four intrastate pipelines and it is the

    access route of all the natural gas produced in the Gulf of Mexico. Being the most important hub its

    price trend is the reference for the rest of the country and the basis for future contracts and speculation.

    Prices in the other hubs could be seen as the Henry Hub price and a quantity called “location

    differential”, which accounts for transportation costs.

    Physical trading contracts are negotiated between buyers and sellers and includes a series of

    standard specification: volume, gas quality specifications, receipt and delivery point, contract length

    and other terms or legal conditions. There are essentially three typology of trading contract: swing

    contracts, baseload contracts, and firm contract; swing and baseload are typical of liquid and

    competitive markets while firm contract, being more rigid, resembles the typology existing in Europe.

    Swing or baseload contracts are characterized by the absence of a delivery obligation: none of the

    parties involved is obligated to deliver or receive the exact volume specified. Firm contract introduces

    this legal obligation introducing legal recourse in case of failing to meet obligation agreements;

    involving a certain rigidity in the purchased volume, delivering time and natural gas pricing thus being

    the closest typology to the one existing in Europe.

    Efficiency and effectiveness of both physical and financial markets are needed to ensure that the

    natural gas price reflects its supply and demand and it is not distorted by the predominant position of

    one of the market actors. Not surprisingly, the most efficient and liberalized market evolved in North

    America (Canada and the US are considered as a unique gas market). Vast internal gas resources, the

    high amount of oil&gas companies operating in the upstream section combined with big industrial or

    consumer, enhance the efficiency in all the natural gas supply chain guaranteeing lower price and

    higher benefits for final consumers.

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    Chapter 3

    The European gas market

    The European17 energy market has historically been the second largest worldwide after the North

    American ones. Even if its role in terms of production is nowadays very limited (301.68 billion cubic

    meter 10% of world production in 2013) nearly half of the global exported gas in imported within the

    Eu. Since the end of the Second World War, one of the goals of European state was to create a common

    and open market with no customs barriers, both for common goods and energy related-commodities.

    The first step made towards the creation of a unique and liberalized energy market (electricity and

    natural gas) has been directive 98/30/CE, which enforced a series of standards in order to modify gas

    market structure basing it on the U.S. liberalized model. The evolution of European gas market toward

    a fully liberalized market follows the steps of North America’s deregulation but there are several

    differences between the United States and the European Union, which complicate, c the deregulation

    process.

    The main problem, when comparing Europe to the United States, is that the different member

    countries have different market structures that depend on their history, economic evolution and

    availability of energy sources. The evolution of the North American gas market benefited from the

    numerous gas fields spread across the country and the presence of heavy industries or big metropolitan

    areas nearby. First, pipelines linked productive fields with consumption centers nearby, and, once the

    consumption of natural gas was established in all the country, the long transmission pipelines were

    built; nowadays almost all the U.S. territory is covered and gas could be moved virtually everywhere

    in the country. European gas networks, on the other hand, cannot be considered unique and integrated.

    Another major problem is the high dependency from foreign exports; two of the three major importers

    (i.e. Russia and Algeria) are extra-EU countries with a rigid political system and a monopolistic

    management of their hydrocarbon resources.

    In the near future Europe has to strengthen its internal networks improving connection between

    member countries, build new import facilities and diversify supply routes, and, wherever possible,

    increase its internal production. Only under these conditions, the European gas market could have the

    possibility to evolve becoming a truly integrated and competitive market similar to the North

    American model.

    17 As mentioned in the introduction, the adjective “European” refers to the European Union and not to the geographical definition of Europe. For example, Norway is in Europe (the continent) but not in the EU and in this chapter, it would be referred as part of the extra-EU imports.

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    3.1. European energy consumption

    To show the importance of natural gas in the European energy mix and its future prospects, it is

    necessary to give a quick description of the overall energy consumption of the union. Three main

    “parameters” are required to give an extensive overview of a country’s energy-mix: primary energy

    consumption, final energy consumption and power generation fuel-mix.

    Primary energy consumption refers to the direct use of the raw energy source, without any other

    transformation. It includes direct employment in final uses, such as natural gas for space heating or

    cooking; or a conversion into a secondary energy source (or energy carriers) such as refined oil

    products or electricity produced in power station. Primary energy sources are fossil fuels (crude oil,

    coal, and natural gas), mineral fuels (natural uranium) or renewable sources (solar energy, wind,

    hydro, and biomass).

    Final energy consumption describes the employment of the energy carrier, either primary

    (natural gas) or secondary (oil refined products, electricity) to generate useful effects such as lighting,

    process heat or motion forces.

    Power generation energy-mix describes the typology of power stations a country employs to

    produce its own electricity.

    Figure 3.1 – Energy balance

    Together these three indicators give an exhaustive description of the country’s energy mix, which

    reflects the structure of its economy, its historical evolution and the availability of energy sources.

    Despite their similarity, all the member countries of the European Union exhibit a different and unique

    energy-mix.

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    The differences existing in the countries energy mix are even wider when specifically describing

    the role of natural gas into this mix: consumption level, end uses and extent of the dependency on

    foreign imports. Because of the geographic, historical and economic differences, existing between all

    the members states the energy-mix would be described separately by country or country groups rather

    than for the entire union. Chosen countries and country groups are the following: France, Germany,

    Italy, the Netherlands, Spain and Portugal, United Kingdom and Ireland, Eastern Europe, while the

    remaining member state are grouped together in other EU countries.

    Germany, France and Italy