Natural Gas Business Drivers
Lesson Overview
The Business Drivers Lesson consists of the following topics:
- Learning Objectives
- Natural Gas Market Drivers
- Unconventional Gas – Types of Development
- Unconventional Gas – US Importance
- Future Importance of NGL’s
- LNG Market Drivers
- LNG US Pricing Drivers
- Gas Contracting Drivers
- Growth in Risk Management Tools
- Market Driver – Power Generation
- Gas Producers & LDC Drivers – US Example
- Pipeline Expansions
- Pipeline Transmission Drivers
- Storage Drivers
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Natural Gas Market Drivers
The key business drivers affecting global natural gas markets fall into three categories:
- Security of supply, including diversification of supply via unconventional reserves, NGL’s and LNG
- Market changes, both in the structure of the commercial transactions and the desire to use more natural gas to help with carbon emission challenges
- Infrastructure changes needed and especially the increasing attention paid to the environmental impact of pipeline routes and LNG regasification terminals.
This lesson discusses these drivers in detail.
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Unconventional Gas
Interest in unconventional natural gas resources is growing around the world but particularly in the US as demand continues to increase and domestic production has leveled off in mature gas fields. Today, almost 40% of US gas production is from unconventional sources which include:
- Coal bed methane (CBM), which is natural gas trapped in coal, can be extracted and produced through shallow production wells. CBM is available wherever there are large reserves of “soft” coal such as China, India, Australia and the US (Montana and Wyoming).
- Tight gas formations which refer to low permeability sandstone reservoirs that require fracturing and advanced production technology to produce.
- Shale gas formations are another type of geological host which tend to act like the tight gas formations. US shale gas discoveries of the 1950’s are now economically viable, thanks to advanced production technologies like horizontal wells used to help drain the complete reservoir.
Large tight gas and shale gas formations and reservoirs also exist in other parts of the world. It is expected that they will be developed:
- as the current conventional gas reservoirs deplete,
- economics warrant development and
- the recovery technologies are more widely understood and adopted.
Importance in US
The shale gas reservoirs are so prevalent in the US that their potential and current drilling success is changing the US reserve picture, pricing structure, and pipeline landscape to bring these valuable hydrocarbons to market.
As the chart from a 2008 study indicates, the current success in extracting gas from shale could double America’s natural gas reserves. Add the US results to similar prolific shale reserves in Canada, and North America could potentially have a 120-year supply of gas.
Shale gas development is costly and complex, and requires a gas price in excess of $8/MCFD to be economically justified.
The sizable US unconventional gas reserves could alter the economics of future LNG imports.
Importance of Natural Gas Liquids (NGLs)
According to OPEC’s recent forecast, production of NGLs will be a significant addition to their liquids production capability.
Some forecasters say that the OPEC NGL production can double from the 2006 level of approximately of 5 MMbd, and can be over 16 MMbd when non-OPEC production fields also are included. For example, there are large investments in NGL capacity in Africa which will come on-stream in 2009-2010.
Global NGL growth could reach as much as 20% of the world’s crude oil production – making up for some of the production declines in existing oil fields.
Note that NGLs are not subject to OPEC production quotas, so there is every incentive to increase NGL recovery and production.
Future growth in NGL production-recovery capacity is directly related to:
- The volume of crude and natural gas production,
- The investments made in processing or recovery facilities, and
- The availability of markets for NGL’s, such as LPG and or petrochemical plants.
Additionally, in the US, NGL’s are expected to grow substantially as the result of more liquids in the Barnett (and other) shale plays now being developed.
Once the investments are made, NGLs could account for a potential addition or replacement for 18%-19% of the global crude oil requirements.
LNG Market Drivers
Historically, LNG was not a viable supply source to high-demand areas where indigenous gas supplies existed, such as the US.
The US is a latecomer to the LNG world markets.
- In 1964, the UK became the world’s first LNG importer and Algeria the first LNG exporter. Algeria has since become a major world supplier LNG. Spain is another large LNG importer from Algeria.
- In 1969 Alaskan LNG was sent to Japan. Japan has been receiving LNG exports from Indonesia’s Arun gas field, since the late 1970’s.
- Interest in the US did not develop until two mothballed LNG receiving terminals were reactivated in 2000 – 2003 (Elba Island and Cove Point).
As the chart indicates, US imports will now need to compete with these much more mature markets.
Additionally, large regasification terminals are being constructed in Mexico intensifying the Pacific Basin competition for the LNG trade.
LNG US Pricing Drivers
The pricing environment for natural gas has been the driver for large scale escalation of the world’s LNG industry. This was due to the fact that LNG delivered costs included components for:
- lifting costs,
- liquefaction,
- shipping, and
- regasification at the demand center.
As such, the pricing of natural gas had to exceed some pricing threshold on a sustained basis (generally $3 to $4 per MMBTU) to make LNG imports viable.
The pattern of US (and global) natural gas price increases has continued, with natural gas prices in the US spiking to nearly $12 per thousand cubic feet from $7.50 at the beginning of 2008…making large scale LNG development in North America potentially viable.
Natural Gas Contracting
Like transportation and storage facility operators, gas marketers seek to optimize the supply-demand balance through flexibility – contract flexibility. This leads them to develop ever more sophisticated service offerings and commodity contracts.
Like all the commercial sectors of the industry, gas users seek options. The more options a user has – from competing suppliers to alternative fuels to real-time demand management – the greater leverage it has in lowering its delivered cost of gas.
To manage price volatility, all sectors may trade gas through standardized short-term contracts – i.e., for terms of 30 days or less – on the spot market. Spot market contracts comprise mutual obligations to sell and buy a standard quantity of gas to be delivered and taken at a specific location at a uniform daily flow rate over the contract period.
Often the gas contract price is indexed to prices of futures. If the delivery point is other than the Henry Hub, the contract price typically includes a basis differential – that is, the difference in market price between the Henry Hub and the contract delivery point.
Growth in Risk Management Tools
Financial risk management helps insure against the consequences of supply disruptions and price volatility.
Trading instruments called futures or derivatives are tools which enable all market participants to manage the volatility inherent in gas prices. Most gas futures are publicly traded on the New York Mercantile Exchange (NYMEX).
As the chart shows, the futures market for natural gas has grown rapidly since its inception in 1990.
The availability of futures allows both producer and end-user to have more flexibility in addressing the price variations that occur in the natural gas market.
Market Driver – Power Generation
Historically in the US, the industrial and residential sectors were the largest end-users of natural gas. However, since the late 1990’s, natural gas for power generation increased markedly, primarily because it was easier to get a permit for the clean-burning fuel.
All major power capacity additions in the past five years in the US have been either gas-fired or renewable, with gas additions being by far the dominant fuel type addition.
The new availability of gas, with the successful development of shale gas, will increase the emphasis on use of natural gas, instead of coal, in power plants in the US.
Gas Producers and LDC Drivers
Gas producers want predictable prices to lower their project risk. With US deregulation in the 1980’s, they began forming marketing affiliates to bypass pipeline-merchants and sell gas directly to end users.
Today, these marketing affiliates not only directly negotiate long-term sales agreements with end users, but also actively participate in gas spot and futures markets to manage their financial risk.
Some take it a few steps further, trading capacity on interstate pipelines and marketing gas directly to small, retail end-users. In this way, they are rebuilding the integrated gas company to capture multiple margins at each link of the value chain.
LDCs also can rebuild the integrated gas company from the other direction by purchasing dedicated production and transportation capacity.
Pipeline Expansions
Historically, pipelines have played the critical role of connecting and balancing natural gas supply and demand, usually across vast distances.
A commitment to build such a connection is not undertaken lightly because it requires a huge investment – typically $1 million or more per mile. Once built, this network of physical assets (for all practical purposes) cannot be moved or put to another use.
To recover their investment, pipeline developers need to know that the supplies at one end of the pipeline, and the demand at the other end of the pipeline, will be there for decades to come.
Deliverability is the term defining the measure of how many years (going forward) a pipeline can meet its existing annual commitments to deliver gas from its presently committed sources of supply. This is a function of the:
- physical, contractual, economic and regulatory constraints on upstream gas supplies,
- downstream demand, and
- the pipeline’s diameter and compression capacity.
Pipeline Transmission Drivers
The key driver of pipeline transmission operators is to routinely and efficiently balance supply and demand, as the flow fluctuates on both the receiving side from the producers and the demand side – especially from large commercial customers and power plants.
- Pipelines develop the necessary infrastructure flexibility by investing in compression, storage, and even capacity on other pipelines to accomplish this objective.
- Another objective is to optimize their load factor – the ratio of their average load to peak load.
- In the US, transaction standardization has also enabled the development of electronic bulletin boards (EBB’s) and other efficiencies to provide better service response and transparency to customers.
Storage Drivers
Some marketers and large customers use storage as a pure financial play, purchasing and injecting gas into storage when prices are low, and withdrawing from storage and resale when prices are high. Production-area, as well as market-area, storage can be used for this purpose.
Storage is also used as insurance against natural or man-made disruptions of gas production or transportation. For example, a New York LDC could purchase gas under long-term contract from a producer in the Gulf of Mexico. If a hurricane disrupts gas flow from the offshore wells, the LDC, nevertheless, somehow must meet its firm commitments.
Purchasing gas on the fly just as supplies are constricted will be expensive. So, in the long run, it could be more economical for the LDC to store some gas nearby that can be withdrawn in an emergency.
Related Resources:
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