NATURAL GAS DEMAND SURGES AMONG EUROPEAN CUSTOMERS

David Knott
Senior Editor

Europe's view of natural gas as a clean fuel is driving demand faster than European producers can supply the fuel.

By 2010 European gas demand is expected to rise by 50%, so imports will need to rise in step.

There are plenty of gas reserves within and in reach of the European market to meet increasing needs. But current low gas prices in Europe are a barrier to development of gas projects, which are large, long term investments.

Meanwhile, the structure of Europe and its gas markets is changing. There is a trend to privatization and uncertainty over the future role of state gas monopolies.

West European natural gas demand is expected by Purvin & Gertz Inc., London, to increase at an average 2.9%/year to almost 18 tcf by 2010 from more than 10 tcf in 1992. Power generation is expected to account for about half the growth.

In that period, European gas production is expected to increase on the strength of North Sea gas flow. But the rate of increase will lag demand. So western Europe's import dependency will jump to 45% of supply by 2010 from 30% in 1992.

The former Soviet Union (FSU) will remain western Europe's most important source of gas imports--if political, organizational, and economic problems in the FSU do not become insurmountable.

EUROPEAN PRODUCTION

Gas production in western Europe will increase from 7.5 tcf/year to 9.2 tcf/year between 1992 and 2000. This, said Purvin & Gertz, will result mainly from increased production in the U.K. and Norway. A plateau of 9.7 tcf/year is predicted between 2005 and 2610.

Contracted imports to western Europe will rise to 5 tcf by 2000 from 3.17 tcf in 1992, with the extra gas coming mainly from the FSU and Algeria.

The figure includes 4 million metric tons/year of oil equivalent in liquefied natural gas from Nigeria, although the latest schedule for start-up of the Nigeria LNG Ltd. Bonny Island export terminal is late 1999 (OGJ, Dec. 20, p. 33).

Purvin & Gertz tentatively predicts total FSU gas production will remain below the 28.8 tcf/year level of 1990 until after 2000, reaching 34 tcf in 2010. Increased FSU gas production is expected to come from western Siberia and the Yamal Peninsula. Purvin & Gertz says potential FSU gas available for export will be more than western and eastern Europe are expected to require.

In eastern Europe, Purvin & Gertz says gas demand is expected to increase at an average 2%/year to 3.6 tcf in 2010 from 2.5 tcf in 1991. Indigenous production provided 45% of eastern European gas in 1991. Import dependency is expected to rise to 74% in 2010 from 55% in 1991.

PRIMARY ENERGY

Meantime, Shell International Gas Ltd. (SIGL) expects gas demand to increase fastest among primary energy sources, as relatively low economic growth and restructuring in eastern Europe rein European demand.

Gas grew from 14.5% of primary energy demand in 1980 to 17.6% in 1992 and is expected to reach 23% by 2010. Shell predicts the western European gas market will reach 16 tcf/year by 2010, a 50% rise from present consumption.

"Growth potential exists in every sector through the conversion of more households and industrial and commercial premises to cleaner burning gas," SIGL Managing Director Roland Williams told the Association of International Petroleum Negotiators fall conference.

"In the power generation sector too, the high efficiencies and lower capital costs of new gas fired power plants will continue making gas a preferred fuel choice."

Williams said eastern European countries are now looking to gas after national reviews of energy practices. Their gas supplies have come almost entirely from the FSU. They are seeking other supply sources, as are newly emerged republics in the FSU.

In western Europe, less than two thirds of all gas consumed is produced endogenously. The rest comes from the FSU (21%) and Algeria (11%). So if demand grows 50% as predicted, where will supplies come from?

"We can count on 7 tcf/year within Europe's borders to provide a secure supply base, although it will require an investment of some $60 billion to maintain this level over the next two decades," Williams said.

GAS SOURCES

Nick White, director of Arthur D. Little Ltd. (ADL), London, said the European gas market shows potential for rapid growth but appears to be out of balance.

"Consumers are signaling that they require more gas," White said. "There is little doubt that in terms of resource availability there is an abundance of gas within 5,000 km of the West European market,"

White said Algeria, Norway, the FSU, Iran, Qatar, and other Middle East states, along with other countries such as Egypt and Libya, have significant volumes of undeveloped reserves. But there are two barriers to development of those reserves: the cost of delivering gas to Europe and the speed with which the reserves can be developed and delivered.

"There are only relatively small quantities of incremental gas which can be supplied to the European market at the prices now available, that is to say around $2.75/MMBTU," White said.

"Such quantities as are available tend to be relatively small quantities of short haul gas from indigenous resources and incremental volumes available through debottlenecking of existing delivery systems.

"Gas companies with public service obligations will not find it comforting to have to rely on relatively small volumes coming from a relatively small resource base. They are more likely to want to see sizable volumes coming from secure resources in more distant areas."

ADL concluded that gas from new Russian developments could be delivered to Europe at a cost roughly equal to current border prices, using a 10% rate of return on development costs.

PRICE REQUIREMENT

"There are also some lower cost supplies potentially available, particularly from Algeria," White said, "but if Russian gas is not available or is not considered sufficiently secure, then for the market to return to balance at high demand levels gas costing 3.50-4.50/MMBTU at the European border will be required."

Gas at this price is available from parts of the North Sea and Middle East. But development projects for these reserves have long lead times, so development would need to have started this year or last year for gas to reach the market by 2000.

European gas prices are expected to remain low, said Graham Kellas, economist at Petroconsultants (U.K.) Ltd., London. This is despite the continued expansion of international gas markets and the increasing perception of gas as the most environmentally friendly fuel.

Kellas said, "Combined with the fact that the costs of developing and transporting gas reserves are much higher than oil, many gas projects continue to appear marginal at best and financing such projects will remain a problem."

He said France's Cedigaz recently estimated the capital cost of most current European gas projects at $3-5.5/MMBTU, compared with a European gas price of $2.5-3/MMBTU in 1992.

MEGAPROJECTS

"Outside of Russia it is difficult to see projects which could be delivering gas in large quantities within 6 or 7 years of today," said ADL's White. "The Norwegian Sleipner project has taken 7 years from contract signature to first delivery and Troll, when it comes on stream in 1996, will have taken 10 years."

White said it is unlikely new megaprojects will go on stream by the turn of the century, given the need for negotiation of contracts and securing of finance, on top of development itself.

Norway's Den norske stats oljeselskap AS began delivery of gas Oct. 1 from Sleipner field under the Troll contract, billed as the largest gas supply contract in the world.

The deal will involve supply of as much as 1.6 tcf/year through the Zeepipe offshore pipeline to Zeebrugge, Belgium, and on to Germany, France, Netherlands, Spain and Austria.

Mackay Consultants of Inverness says production from Sleipner and Troll fields will allow Norway to boost its share of European gas supply, which has been dominated by Russia, Netherlands, and Algeria.

Norway plans to increase gas exports to 2.12-2.47 tcf/year. Mackay believes achievement of that target will depend on what happens to gas prices during the next decade.

Mackay said, "The Gas Negotiating Committee (GFU) in Norway has been putting great pressure on buyers to increase gas contract prices because higher prices will be needed to develop the more costly fields in the Haltenbanken area.

"Much will depend on the level of production from Russia, particularly from new areas such as the Yamal Peninsula. If Russia can maintain its market share and wishes to do so, gas prices will fall in real terms and demand will be stimulated."

Shell's Williams said current gas prices would militate against further projects on a similar scale in Europe.

He said, "Although existing Norwegian production is fully competitive with Europe's other supply sources, new sources--starting with Troll, which has a capital budget of about $5 billion--require some increase in current prices to reach the lowest end of the range of commercial returns acceptable to private industry investors and project developers.

"Without long term commitments and price support from European buyers, repeat investments on this scale will not happen in future."

MIDDLE EAST PROMISE

Major contributors to European production will continue to be the Netherlands, U.K., and Norway, which together account for three fourths of today's indigenous flow, Shell's Williams said.

But he warned that a sustained return to high reliability of supplies was needed before concerns over reliance on FSU gas were dispersed. Also, large transit distances mean future development costs will exceed current price levels (OGJ, Nov. 29, p. 32).

Williams sees increasing recognition that the Middle East is a potential long term major supplier of gas. More than 30% of world gas reserves are in the Middle East, and much of this can be produced at low cost.

Again, the drawback is transportation costs, which would require an increase in European gas prices to justify pipeline developments.

"With distance from market placing a serious cost penalty on prospective projects," Williams said, "gas from West Siberia or the Middle East will tend to be at the more expensive end of the range compared with incremental projects in the North Sea or onshore Europe."

Williams also warned that other markets would be more attractive to Middle East gas producers if western European prices did not improve.

"Despite even higher gas transportation costs, buyers in the Far East have been prepared to commit to long term supplies for the past two decades," he said.

"With virtually no indigenous gas, there has been considerable support for LNG export developments mainly in the Pacific Rim. The higher market prices of competing fuels in Japan have allowed gas prices to balance the investment and technical risk undertaken by producers.

"Against this background, interest is now growing in importing more Middle East gas despite distances of 11,000 km or more from the Arabian Gulf to Japan.

"The netback to the producer from these destinations looks as though it will largely continue to be more attractive than that from gas distributors less than 5,000 km away in Europe."

Purvin & Gertz said eastern European countries are conscious of their reliance on the FSU and wish to diversify their supply sources. Alternatives under study include a gas pipeline from Iran and LNG from Algeria via a Croatian terminal.

The analyst said Iran's gas is not expected to be required by western Europe before 2005, while turmoil in the former Yugoslavia has put the Algerian LNG plan on hold. Eastern Europe's dependence on FSU gas is expected to continue for some time.

NEW INFRASTRUCTURE

"I envisage the European gas market moving into a period of supply constraint over the latter part of the 1990s and that gas prices will tend to rise relative to other fuels," White said.

"A number of large gas projects are being lined up, such as the Maghreb pipeline and possible subsequent expansion of it, a possible fourth Norwegian pipeline, expansion of Zeepipe, and new Russian pipelines via Poland. All of these have the capability of rebalancing the European market when they come through."

British Gas plc said an expected 40% increase in western European gas demand by 2005 will require increased imports, which already account for nearly half of Europe's supplies.

"By the end of the decade, new pipelines should bring Russian gas to Germany via Poland and to Greece through Romania," said Cedric Brown, chief executive of British Gas.

"Pipelines from Algeria could cross the Mediterranean to Portugal and Spain. The Norwegian delivery infrastructure will be enhanced by Europipe, and from the U.K. pipelines are planned to Ireland and continental Europe.

"We are now talking about the potential free movement of gas across dozens of countries, from North Africa to the Arctic Circle, from the Russian Steppes to the Atlantic seaboard."

Petroconsultants believes the proliferation of connections between potential gas suppliers and potential gas buyers is such that spot markets for gas in Europe may soon emerge.

"This will be increasingly likely once Norwegian gas begins to be exported to the U.K.--as it looks likely to do in the next 5-10 years--and will be even stronger if Russian gas becomes a regular and reliable source of gas into western Europe," Kellas said.

"Environmental pressures, among other reasons, are likely to maintain the growth in gas demand for power generation, and the advent of gas-driven automobiles will strengthen the push for gas."

POWER GENERATION

ADL points out that electrical power generation is undergoing rapid change. Regulatory and political changes, price expectations for various fuels, and capital costs of existing and new power generation technologies are adding momentum to the push for gas.

"In some countries such as the U.K. and Germany, the power generation industry has thrived on the use of domestic coal," White said. "It has now been recognized that this coal has very high production costs and that overt or covert subsidies have been granted to the coal industry, usually through a high transfer price of coal paid by power generators and/or high electricity prices paid by consumers."

Environmental problems with coal burning plants have also made gas fired generation in new plants more attractive. The British approach to bring sulfur dioxide and nitrous oxide emissions from stacks in line with European Commission guidelines is flue gas desulfurization (FGD). This has been installed in two U.K. base load power stations.

White said, "In the privatized electricity generation industry which now exists in the U.R., management and shareholders of these companies seem to prefer the use of natural gas in combined cycle technology rather than the use of flue gas desulfurization retrofitted to existing coal plants.

"This makes good economic sense since the capital cost of an FGD plant retrofitted to a 2 million kw coal fired plant can exceed the capital cost of a new 5 million kw gas fired generating facility."

Mackay Consultants said gas fired electricity generation is responsible for much of the current surge in demand for gas, particularly in England. Once all new stations are operating, however, the rate of growth in gas consumption is expected to slow.

"There will nevertheless be massive investment in new gas transmission pipelines over the next few years," Mackay said.

"Europipe from Sleipner to near Emden, Netherlands, is scheduled to be laid in 1994 and 1995, and discussions are already under way about a fourth Norwegian line. The U. K. also has plans for a continental interconnector to allow it to increase gas exports."

Shell's Williams said increasingly efficient combined cycle, gas fired power stations will underpin the predicted expansion in gas demand.

"We believe this market can accommodate the somewhat higher prices needed to encourage new supplies while still remaining competitive with other fuels," he said.

"For example, gas could cost up to 50% more than current levels and still produce electricity competitive with conventional state-of-the-art clean coal fired plant."

PRIVATIZATION

Privatization of British Gas and subsequent proposals to increase competition in the U.K. gas market are viewed with great interest from abroad.

Brown of British Gas views his company's case as a model of successful privatization--at least for customers. Gas prices have fallen in real terms by 21% in the U.K. market and 25% in the contract market since privatization in 1990, he said.

"One of the government's main aims in privatizing nationalized industries was to establish a climate for competition to flourish. And indeed it has done so," Brown said.

"Our competitors now hold 66% of the firm contact market and 35% of the total market above 250 MMBTU/year. And those figures are growing almost daily."

But Brown raised concerns that competitors are rapidly reaching agreed limits for penetration of the U.K. gas market, and regulation of the market is tilted in favor of new entrants.

"What we don't have at the moment is a level playing field," Brown said. "Once competition has developed, the field must be leveled. We expect our competitors, if they want to share the same market, to share the same obligations and responsibilities."

Brown also is concerned that some new U.K. gas shippers are partly owned by foreign companies while British Gas is prevented from doing business in their countries.

"These include Utilicorp, which is U.S. owned, Alliance Gas, which is part Norwegian state owned, and Total, the French state company," Brown said. "British Gas cannot as easily take a reciprocal share of gas markets in the U.S., Norway, or France because of the less liberal regulatory regimes in those countries."

Despite this, Brown said British Gas has emerged as the gas company international counterparts see as a powerful competitor and role model. It recently won large gas infrastructure projects outside Europe,

"That's why some companies, like Enegas and Gas Natural in Spain, are merging," Brown said, "so they can hope to compete with large, vertically integrated companies like British Gas."

Brown sees major opportunities opening worldwide as a result of increasing liberalization of energy markets and growth in demand for gas.

"British Gas investments outside the U.K. are being focused on markets where we see the greatest growth potential and where we can apply our expertise upstream or downstream."

Recent British Gas project wins include the purchase of Distribuidora de Gas Metropolitana, Buenos Aires (OGJ, Jan. 11, p. 28), development of Miskar field off Tunisia (OGJ, Oct. 25, p. 28), and joint development of Karachaganak field in Kazakhstan (OGJ, July 13, 1992, p. 24).

THIRD PARTY ACCESS

U.K.'s bid late last year to secure European Commission legislation for access by third party gas transporters to other companies' pipelines was blocked (OGJ, Jan. 4, p. 27).

One month before the EC officially became a single market, the Council of Ministers decided member states should run their gas markets according to their own circumstances.

Although third party access (TPA) is off the European agenda unless it reappears as the EC's gas industry directive is approved by the council, arguments about TPA will continue at national level.

Germany is witnessing the most vigorous debate on TPA at present, as Ruhrgas AG and Wintershall AG await the outcome of a key court case. Last year Wintershall took Ruhrgas affiliate Verbundnetz Gas AG (VNG), Leipzig, to court over VNG's refusal to allow Wintershall to supply a customer via a VNG pipeline (OGJ, Dec. 21, 1992, p. 27).

The companies are awaiting a federal court ruling on the original court's decision to grant Wintershall access. In the meantime, Ruhrgas campaigns against TPA.

"There are considerable differences between the various national gas sectors in Europe," said Wilfried Czernie, Ruhrgas vice-president of government, international, and economic affairs.

"Each national gas industry has its own specific characteristics in terms of gas production, gas consumption, import and export volumes, general sectoral development, ownership structures and organization of the gas industry, integration, and the legal and administrative framework governing the statute, rights, and duties of the gas industry."

Ruhrgas' main argument is that TPA would harm long term planning and ability to make long term gas purchase commitments. This would weaken the gas distributors' position against the producers and lead to higher prices.

Czernie cited a Coopers & Lybrand study that showed TPA would lead to a 9% increase in gas prices and a 13% increase in the supply gap by 2010.

Wintershall Chairman Gert Maichel said TPA is already present on a "vague basis" in German law, He is confident the Federal Court decision on the Wintershall-VNG case will lead to more TPA in Germany.

Copyright 1993 Oil & Gas Journal. All Rights Reserved.