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This Week's Commentary Previous Commentaries Future Commentaries Objectives

March 10, 2008
Series Editor: Ian Parry
Managing Editor: Felicia Day
Assistant Editors: John Anderson and Adrienne Foerster

Welcome to the RFF Weekly Policy Commentary, which is meant to provide an easy way to learn about important policy issues related to environmental, natural resource, energy, urban, development, and public health problems.

As Steven Gabriel discusses in this week's commentary, the United States is becoming more dependent on foreign supplies of natural gas. This increases our vulnerability to supply disruptions elsewhere in the world and perhaps to abuse of market power by a group of OPEC-like countries. The possibility of instability in natural gas markets also underscores the need for designing flexible cap-and-trade systems to control carbon emissions (for example, allowing firms to borrow permits or purchase additional permits from regulators, should high natural gas prices raise the costs of switching away from coal).

Next week's commentary by Robert Buckley and Jerry Kalarickal will discuss how policy approaches for housing provision in poor-country cities has evolved over the past few decades.

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Why International Natural Gas Markets Matter in Today's Energy and Environmental Picture

Steven A. Gabriel

In recent years, the environmental and economic value of natural gas has soared, making it an ever-important fuel for power generation, industrial operations, as well as residential and commercial use. Natural gas holds a favorable environmental position relative to coal and oil, all the more important given the current move towards a low-carbon world. In the United States, demand for natural gas has risen over 33 percent in the period 1986-2006, driven by a multitude of factors. In Europe, geopolitical issues are more pronounced since almost half of the European Union's imports of gas come from Russia. Additionally, there is now competition in both the Atlantic and Pacific basins for liquefied natural gas (LNG) from exporting countries. The overall picture then is one of a global competition for this important fuel source.(See Map)

Two other trends have emerged over the last 20 years that have helped to spur both domestic and international natural gas consumption. The first was the enactment of regulations geared at liberalizing gas markets. In the United States, the Federal Energy Regulatory Commission required interstate pipeline companies to unbundle, or separate, their sales and transportation services in order to promote competition and mitigate their potential market power. Similar legislative measures were enacted in the European Union that promoted third-party access and legal splitting of gas sellers and network operators.

The second trend is the rise of liquefied natural gas trading. LNG is the liquid form of this fuel, achieved by cooling the normally gaseous substance to about -260 degrees (Fahrenheit) and removing certain components. By using specialized cryogenic tankers, natural gas can be moved much more easily around the world, but this process is costly. While there is not yet a common "world gas price" as in the case with oil, there are some very large producers. Nearly 75 percent of the world's natural gas reserves can be found in the Middle East and Eurasia, with reserves in Russia, Iran, and Qatar combined accounting for nearly 60 percent of this total, resulting in geopolitical market power. For example, the influence of Russian production and control of key pipelines was felt in Ukraine and Western Europe in the winter of 2005-2006, when Russia temporarily cut off gas to Ukraine over a price dispute, which affected downstream Europe.

In the United States, dependence on natural gas from other countries has been rising over time. In the last 20 years, imports of natural gas as a percentage of total consumption have risen from just over 4 percent in 1986 to almost 16 percent in 2006. Colleagues and I have created detailed game theoretic models of market equilibria in which producers (or their marketing arms) may withhold production in order to achieve higher profits. The resulting simulations indicate that market power can raise natural gas prices considerably. Compared with an assumption of perfectly competitive producers in Europe (that is, producers not having the ability to influence market prices by withholding production), the effects of market power raise European prices by some 27 percent. This is further exacerbated if a major supplier such as Algeria is shut down or gas from Russia is curtailed through a transit country such as Ukraine.

While the demand for natural gas is rising, this is not cause for immediate concern if you consider the reserves-to-production ratios, which give an estimate of the number of years left if current production rates hold into the future. For example, the worldwide reserves-to-production ratio is 65 years with higher values for certain regions such as Russia (80 years) and the Middle East (more than 100 years).

Despite a number of years of available gas left, many countries are seeking to diversify their supply sources and mitigate the market power held by the major suppliers. Rather than rely on pipelines to deliver gas, several "downstream" European countries have set up and are increasing their number of LNG regasification (import) terminals which convert natural gas back to gaseous form for use in regional pipelines.

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Steven A. Gabriel, Associate Professor, University of Maryland

Gabriel received his Ph.D. in Mathematical Sciences from Johns Hopkins University in 1992. He was awarded the Gilbert F. White Fellowship by RFF to analyze supply security in natural gas markets in the U.S., E.U. and worldwide. Gabriel's research interests include optimization, equilibrium and statistical modeling in energy, transportation, land use and wastewater treatment.



 
 

 
The impact of building more LNG regasification terminals can be a greater choice of prices and other contractual terms for the downstream countries. More LNG terminals are in the works also for the United States. The current five LNG import terminals,accounting for just over 5.8 billion cubic feet per day, will be supplemented with four new ones being constructed in the Gulf of Mexico, which will more than double LNG import capacity.  Also, Japan already is a huge LNG importer, buying over 40 percent of the worldwide share in 2005. Thus, LNG's importance is a worldwide phenomenon.

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EU Pipeline and LNG Transportation
How will these global and regional factors affect international natural gas markets in the future? First, in order to satisfy growing demand, exploration efforts will need to increase, which will undoubtedly require larger amounts of capital for harder-to-reach sources and thus, all things being equal, lead to higher prices. These prices may be raised further by the effects of market power, especially in Europe, whose dependence on gas from other countries is significant. Second, the formation of a "gas cartel" like OPEC may be in the offing if major producers like Russia, Iran, and Qatar deem it economically in their interests to cooperate with each other, which could have broad ramifications for gas-consuming countries. Third, while downstream customers are looking for ways to insure greater security of supply by building LNG facilities and additional pipelines, producers are also

interested in "demand security." Specifically, they are looking for assurances that if they spend large sums of money on natural gas infrastructure, their investments will be economically viable. Producing countries could start buying stakes in downstream operations and markets to hedge their positions. Lastly, the importance of natural gas in the cap-and-trade carbon markets that are forming should not be underestimated. If the price of natural gas rises significantly, this increase affects these markets as coal then becomes more economically appealing, causing allowance prices to go up.

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Views expressed are those of the author. RFF does not take institutional positions on legislative or policy questions.


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Further Readings:

All of the statistics referenced in this article are drawn from U.S. Energy Information Administration sources (www.eia.doe.gov).

Map sourced are from: www.inogate.org/html/maps/mapsgas.html


"Worldwide Look at Reserves and Production." 2006. Oil and Gas Journal, Vol. 104, no. 47. December 18, pp.22-23.

Egging, R. and S.A. Gabriel. 2006. "Examining Market Power in the European Natural Gas Market."  Energy Policy. 34 (17), 2762-2778.

Egging, R., S.A. Gabriel, F.Holz, J. Zhuang, "A Complementarity Model for the European Natural Gas Market," Energy Policy, January, 2008, accepted.

Gabriel, S. A. J. Zhuang, and S. Kiet. 2005. "A Large-Scale Complementarity Model of the North American Natural Gas Market." Energy Economics. 27, 639-665.

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