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Weekly Updates1. INTRODUCTION
Around the globe, natural gas consuming markets are adjusting to limits on their own resources and the need for additional supplies from beyond their borders.
These conditions have ushered in a flurry of new building of pipeline infrastructure and liquefied natural gas (LNG) plants. (1) As natural gas trade grows and expands into new producer and end-user markets, regional prices will adjust to the new market balances. (2) Strong, well-integrated natural gas markets will have significant implications for the success of policies geared towards mitigating greenhouse gas emissions. Decision makers and analysts can no longer ignore the interregional and dynamic interrelationships that are growing within this industry.
This volume includes papers prepared by international natural gas modelers and other natural gas experts who participated in a recent Stanford University Energy Modeling Forum (EMF) study on this topic. A previous report discusses the main conclusion of the EMF working group (Energy Modeling Forum, 2007). Each modeling team simulated scenarios with standardized assumptions and reported back to the group common output variables. Comparison of these results led directly to a range of different conclusions about the future natural gas market as well as the current state of the available analytical frameworks. For the most part, the scenarios represented constraints on various supply options (like Russian or Middle Eastern export capacity) or more vigorous demand or economic growth around the world.
Two results from this study appeared to be quite pronounced and bear some repeating here. First, restricting the total amount of natural gas trade may not be the best approach for achieving energy security. There appeared to be broad agreement that security could be achieved more effectively by expanding an efficient, integrated natural gas market. This development would particularly be the case if it fostered many different supply options with varying risks of being interrupted by surprise events or geopolitical interests. And second, long-run price paths will tend to be more resilient to (and change less with) shifts in underlying supply constraints or demand growths in the future than they are today. The key determining factor in each model was the response of producers and consumers to price deviations from one scenario to another. Higher responses created smaller adjustments in these long-run price paths. Generally, a model that showed smaller price changes for one set of exogenous changes in market conditions also indicated smaller changes in other cases.
Rather than asking each modeling team to repeat exactly what they did in the study, the editor decided to ask them to produce an interesting paper based upon their model. Thus, the range of issues is wider than what the working group considered in the study. Since much of the work and interesting discussion also included other analyses that did not quite fit neatly into a "model", we have supplemented these modeler papers with supporting analyses that provide a broader appreciation of this growing trend in the natural gas industry.
2. MODELING FOR INSIGHT
The volume begins with a contribution by Robert Stibolt, who reflects upon his long experience in supporting corporate decisions about large energy projects. An energy model cannot be credible and useful in a corporate setting unless it is based upon certain principles. Stibolt discusses in turn these principles, starting with a perspective that is decision-focused, embraces uncertainty, is fact-based, can navigate the complexity of systems, and recognizes the important distinction between insight and unattainable precision. Reflecting upon the most recent experience on Wall Street, he argues that the financial collapse demonstrated not so much a failure of models as a failure of thought. Models provide useful insights, but they do not replace thought nor can they be used indiscriminatingly for establishing precise forecasts. The danger lies not with using models but rather in using them without careful attention to their limitations.
The second article by Dale Nesbitt and Jill Scotcher follows this same theme by demonstrating how a simple spatial framework can generate powerful conclusions about integrated energy markets. They initially show the fallacy of applying network pricing to any pair of supply and demand regions in an energy market. Network pricing requires that the particular supply-demand flow is within the realm of being economically competitive. Next they show that local supply or demand perturbations in one region will have global effects and permeate throughout all regions if the market is well integrated. Transportation costs also significantly influence the outcomes, but perhaps in unexpected ways. A global reduction in transportation costs may raise prices in many production areas and reduce prices in many demand centers. If the story stopped there, it would be interesting but hardly surprising. The Nesbitt-Scotcher analysis shows that lower transportation costs shifts the relative advantage of different transportation links. Links that were previously high cost now gain a relative advantage with a uniform percent reduction in transportation costs. And finally, the analysis shows how specific constraints alter the conclusion relative to a workably competitive market. A congested transmission system or a monopolist controlling a segment of the transmission line can push prices up well above competitive levels. This paper unfolds some of the mystery behind spatial models, which the other papers in this special issue use to explore a range of pressing industry problems.
3. COMPETITIVE WORLD MARKETS
The next four papers explore a range of interesting results from world natural gas models. The first three models represent regional supplies and demands in workably competitive markets. The various nodes are linked by explicit pipeline and LNG infrastructure. Natural gas trade and regional prices are inextricably linked in these systems. Increased trades along certain corridors cause supply and demand conditions to rebalance. More trade causes a realignment of regional prices. Gas on gas competition emerges as a driving factor in world natural gas markets.
Finn Aune, Knut Rosendahl and Eirik Sagen use a numerical model of international energy markets (coal, oil and electricity as well as natural gas) to explore key features of the growing natural gas trade. These authors expect lower LNG costs to continue expanding LNG trade and spot purchases into demand regions like the United States and Europe with growing import requirements. Their framework contains considerable detail on regional natural gas production and international gas transport. A key finding in their analysis is the critical role of Middle Eastern natural gas supplies. Unconstrained by political factors, regional natural gas prices around the world may not experience much upward movement from current levels. If policies and other factors restrict the development of these Middle Eastern supplies, however, consumers around the world will see substantially higher prices.
Justine Barden, William Pepper and Vineet Aggarwal analyze the effects of higher oil prices on world natural gas markets. Higher oil prices lead to higher production and consumption of natural gas regardless of constraints on future gas-to-liquid (GTL) capacity additions. When GTL capacity can be easily built, however, higher oil prices cause more natural gas production to be shifted towards the production of diesel fuels. Natural gas prices rise under these conditions, causing reductions in natural gas consumption by powerplants and industrial users, who instead shift to less expensive fuels. Oil and natural gas prices will be more closely linked in the long run when the development of the GTL infrastructure is relatively less constrained.
Russia currently supplies large volumes of natural gas to Europe, is well-situated to satisfy rapidly expanding demand in Northeast Asia, and has extraordinary potential for developing new resources in the future. Peter Hartley and Kenneth Medlock explore the likelihood that Russia will dominate this industry's future with a large model of the world natural gas market with considerable detail on competing supply and demand regions. They conclude that Russia's advantageous position does allow them to influence natural gas trade flows and gain excess rents in the near term. The difficulty will be that these efforts will be offset by significant and sustained losses in the longer term. The developing global market for natural gas implies that disturbances in one location are spread across the globe in the same way as articulated in the article by Nesbitt and Scotcher. Interregional competition will become intense if Russia exerts its market power too aggressively. Additionally, producers will delay their investment strategies to extract resources more fully in later periods. They also highlight the Middle East as a possible counterweight to Russia. Coordinated action by Russia and the Middle East could therefore be a much more significant threat to the energy security of the rest of the world. These conditions emphasize that the countries of Western Europe, Northeast Asia and North America have a common interest in promoting the development of an efficient worldwide market with multiple natural gas supply options.
In contrast to the competitive markets represented in other world modeling systems, Ruud Egging, Franziska Holz, Christian von Hirschhausen and Steven Gabriel discuss the results of simulating a more collusive behavior by some natural gas producing and exporting countries. This possibility is widely discussed in the popular press by reference to a country grouping called the gas producing and export countries (GASPEC). These authors employ a dynamic, strategic representation of world gas production, trade, and consumption between 2005 and 2030 that allows capacity investments to be determined endogenously by market conditions. Their results suggest a much stronger impact on European and North American delivered natural gas prices (15-20%) than in the workably competitive frameworks. Their analysis reveals that much of the consumer surplus transferred away from these major demand centers flows to natural gas producers outside of the cartel. These producers receive higher natural gas prices that result from the strategic behavior of cartel members.
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