World natural gas markets undergoing transformation

By OGJ editors
HOUSTON, July 21 -- Natural gas markets are changing worldwide, and although the pace of change varies by region, the overall challenge for energy companies is to deliver a market model with investment incentives, customer demand, reduced costs, and competitive prices, PricewaterhouseCoopers LLP said in a recent report.

"Certainly for all mature market players, gas no longer is the plentiful fuel source that it used to be, and there is a price to be paid for ensuring the continuance of its supply," PWC said. "Policy makers and industry leaders alike must establish who will pick up the tab and how to create the right environment for its timely payment."

For instance, the mature markets of North America and Europe represent the highest consuming continents, but indigenous supplies for both are decreasing toward a production-supply shortfall.

Strategic investment in pipelines linking Russia and the UK or Canada and the US follow the traditional transportation options while LNG offers an alternative for companies to commercialize reserves currently considered too remote to be economical (OGJ, June 23, 2003, p. 72).

Meanwhile, both pipelines and LNG require significant investment, said the report entitled "Going Global—change and challenge in the gas market."

The process of change began in the US and has spread via the UK first and then to the rest of Europe, spurred by the European Union gas directive (OGJ Online, Oct. 19, 2001). As markets mature, the potential for more dynamic trading conditions are emerging.

"Regulatory policy within liberalized markets has so far been directed at the squeezing of companies to gain greater efficiencies and deliver the benefits to end consumers, yet today, we have a situation that is squeezing potential investors in the gas chain and leading to a growing supply-demand deficit," said Michael Hurley, PWC partner.

"This situation needs a rethink, and ultimately regulatory policy must address the need to create sufficient security of supply and so facilitate increased levels of investment," he said.

In the US, wholesale gas markets have moved toward greater liquidity with the Henry Hub as the main trading point. In Europe, the emergence of a specific gas market has been slower.

Gas contracts remained oil-product driven in Europe, where long-term take-or-pay supply contracts still are common. The UK has established short-term spot trading because its energy markets are fully liberalized and end-customer choice is a reality, PWC said.

"Gas hubs are, however, beginning to emerge in continental Europe. Zeebrugge, on the Belgian coast, which currently has the capacity to handle 40 billion cu m of natural gas/year, has emerged as the first gas trading hub in the region," the report said.

Zeebrugge's importance is expected to grow because it represents the confluence of two principal European gas routes. One route runs east-west from Siberia to Scotland while the other runs north-south between Norway and southern Europe.

European companies will require greater flexibility given changing market conditions, but long-term deals still could survive even though liberalization of gas markets has reduced their role.

"A hybrid solution may evolve, as was the case in the oil market of the 1970s, whereby long-term contracts are still used, but these concerned fixed volumes only, with prices floating to reflect the end market," the report said.

For instance, some UK players have committed to long-term volumes in which the contracts outline a netback arrangement according to the market price.

As markets liberalize with new contracts and new supplies, "a key challenge will be to avoid a roller coaster of supply-demand imbalances," the report said.

Martha Carnes, a PWC global gas partner, said trading and risk management are ital for companies seeking to limit their volatility exposure.

"Attracting new capital within this market is increasingly difficult, and companies active in the gas sector must convince the investment community to accept a lower-return model, and to do so, they'll need to offer clearer explanations of the lower associated risk profile," she said.

"The importance of Europe to Russia's gas sector, and indeed, the Russian economy, means that, ultimately, the impact of EU liberalization will be felt further east," the report said. Russia provides 30% of Continental Europe's total gas supplies, and 65% of Russia's total gas exports go to Europe (OGJ, Mar. 10, 2003, p. 21).

"It is a vital hard-currency source for the Russian economy. Investment in new Russian exploration, production, and transportation will be critical in the coming years, with a consequent need for outside finance," PWC said.

The Russian market will follow European markets in seeking spot trading, the report said, adding that steps toward this already are in place.

"Certainly for all mature market players, gas no longer is the plentiful fuel source that it used to be, and there is a price to be paid for ensuring the continuance of its supply," PricewaterhouseCoopers said. "Policy makers and industry leaders alike must establish who will pick up the tab and how to create the right environmental for its timely payment."

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