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Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 8 th Russian Petroleum & Gas Congress/ RPGC 2010.

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Presentation on theme: "Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 8 th Russian Petroleum & Gas Congress/ RPGC 2010."— Presentation transcript:

1 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 8 th Russian Petroleum & Gas Congress/ RPGC 2010 Moscow Gas Day 24 June 2010 Ralf Dickel Director Trade and Transit Energy Charter Secretariat Dickel@encharter.org Tel: + 32 2 775 9840 Gas Price Formation on Spot Markets and under Long-term Contracts

2 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 2 The 1991 Energy Charter Declaration: Title I Objectives: “Within the framework of State sovereignty and sovereign rights over energy resources and in a spirit of political and economic co-operation, (the signatories) undertake to promote the development of an efficient energy market throughout Europe and a better functioning global market, in both cases based on the principle of non- discrimination and on market- oriented price formation, taking due account of environmental concerns.”

3 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 3 Publications by the ECS Free download at www.encharter.orgwww.encharter.org

4 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 4 Structure 1. Elements / explanations of gas price formation 2. Regional differences 3. Recent developments

5 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 5 What are we talking about? Avoiding misunderstandings What do we mean by a market? A system where transactions along the chain are determined by the commercial decisions of the partners in the chain? or in a more narrow sense: A market place where supply physically meets demand (inclusive of facilities for storage, unimpeded transport to and from the market place) and a transparent price discovery mechanism Primary supply and demand or including secondary supply/demand What kind of transaction? On a market place? A bilateral transaction (single or longer term)? An internal transaction (crossing a border), price for taxation purposes What transaction point / reference point for the price? Where in the chain?

6 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 6 Standard Textbook Price Formation (Capacity limit) Volume Price Demand curve Supply curve (cost of supply) PC1

7 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 7 Non-standard Theoretical Aspects Resource (and energy) economics are often different from standard economics of manufacturing,e.g.: Risk and High Specificity of Oil and Gas Investment: Transaction Cost Theory The Character of a Natural Resource: Ricardian Rent Finiteness of Resources: Hotelling’s Theorem Producing Companies and Resource Owners: Principal-Agent Theory Inelastic Demand Combined with Supply Restrictions: Cournot-Nash-Formula Market Imperfections/Externalities: Pigou Taxes and Coase Theorem

8 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 8 Pricing of Non-Renewable Energy Resources: RICARDIAN VS. HOTELLING RENT (Capacity limit) Hotelling rent Ricardian rent Volume Price Demand curve Supply curve (cost of supply) Cost-oriented price Replacement value-oriented price PC1 PC2

9 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 9 Futures Market Derivatives markets have existed for a long time. In the US, Chicago Board of Trade was created in 1848, trading agricultural derivatives. Developed as an instrument to hedge price risk. Modern energy futures trading starting in the late 1970s. A futures contract is an agreement between two parties to buy, or, sell an asset at a certain future time for a certain price.

10 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 10 Comparison of Spot/Forward/ Futures/Options/Swaps ContractSpotForwardFutures Options Swaps TradingOTC Exchange OTC/ Exchange OTC Financial Derivatives NoYes Physical Delivery Yes(Yes)(No) (Yes)

11 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 11 Range of Demand Perception Range of Capacity Perception Capacity (million bbl/d) Perception of low demand, high capacity “real” case Perception of high demand, low capacity Pr ic e ($/ bb l) Speculation: The Influence of “Perception”

12 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 12 Structure 1. Elements / explanations of gas price formation 2. Regional differences 3. Recent developments

13 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 13 Domestic Supply or Gas Import Matter for Price Formation

14 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 14 Regional Differences from the Customer’s Point of View Different sector models: US: –gas on gas competition (dto UK) –Henry Hub passed on to Residential/Commercial (customers with inelastic demand) –Supply by individual players into the market place –LNG: under self contracting and flexibility with claw back clauses –Even captive customers can rely on reaction by production side on price signals (security of supply and demand reaction) Continental market West –Demand aggregation for imports, via LTCs –Working of LTCs based on sales to residential/ commercial, small industry with gas oil and fuel oil as alternatives (if only contestability) Continental market East -Increase to EU netted back level - Subsidies on gas and oil Japan, Korea –Chain passing on the import price, complete import dependence

15 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 15 Structure 1. Elements / explanations of gas price formation 2. Regional differences US / UK Continental EU (West / East) LNG 3.Recent developments

16 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 16 North America / UK US, UK: market places / spot prices: - The market place: Henry hub / UK NBP - Spot, forward, futures, derivatives - Churn of about 100 / 15 - Speculative influence - Coinciding with US, UK as banking places!! - Link with (crude / fuel) oil price? - Impact on import price - Implications for customers -Large industry / power: benefits of playing the market -Res + com: suffer from inelastic demand/ no benefit from oversupply

17 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 17 Structure 1. Elements / explanations of gas price formation 2. Regional differences US / UK Continental EU (West / East) LNG 3.Recent developments

18 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 18 LTCs: The Groningen Concept Developed by Nota de Pous (Note to Parliament in 1962) For exports: Pricing: Replacement value principle (no cost-related approach) Net-back value, netted back from replacement value Regular price review, if no joint solution => arbitration Price risk and reward for seller, marketing risk for buyer Protection against arbitrage by buyer Volumes and risks: Long term supply vs. off take obligation based on minimum pay: dedication of certain volumes of reserves vs. commitment to market defined volumes Secure supply at marketable prices against reliable sales volumes at maximum highest marketable price

19 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 19 Pricing After Groningen Pricing developed by new contracts and by price reviews based on Groningen concept: NL as “trendsetter”, later also Troll Heavy fuel oil share decreased, the share of light fuel oil increased (now about 60-65%) Algerian exports partly pegged to crude oil (Algerian crude oil parity campaign early 80s) More recent: a small share of coal or electricity indicators, gas-to-gas price indicators (at the expense of HFO). Arbitration was seldom invoked => comparable price levels and similar pegging

20 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 20 LTC: Indexation by Producer

21 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 21 Gas pricing in Ukraine 2005-2010 Until 2005 the bulk of Russian gas supplied to Ukraine was delivered as barter payment for transit services for Russian gas. In 2005, Ukraine paid a notional $50/1000m3 for Russian natural gas, Russia paid 1.09$/1000m3/100km. 2006 – “First gas crisis”; transportation and supply deal split: agreement between Naftogaz, Gazprom and RosUkrEnergo; price set at $95/1000m3 for 2006 and $130/1000m3 for 2007; 2009 – After “Second gas crisis”;10-years agreement between Gazprom and Naftogaz, gas imports priced at “European netback level”, special reduction by 20% for 2009; April 2010 – “Gas for Fleet” agreement between Presidents Medvedev and Yanukovych; Ukraine received $100/1000m3 discount (by cancelling custom duties in Russia) if the price according to the formula is above $333/1000m3 or 30% if the price is lower in return for an extension of the stay of the Russian Black Sea Fleet.

22 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 22 Structure 1. Elements / explanations of gas price formation 2. Regional differences US / UK Continental EU (West / East) LNG 3. Recent developments

23 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 23 Long-term Contracts in LNG Trade Sale and Purchase Agreement (SPA) Long term contracts – traditional pattern - 20 years or longer Risk sharing – buyers take volume risk (take- or-pay), sellers – price risk (price escalation clause) Flexibility through swapping cargoes: “global” exchanges of LNG cargoes accelerated, esp. from Atlantic to Pacific Early indexation clauses used crude oil

24 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 24 New Trends in LNG Activities Traditionally high take-or-pay threshold Buyers insist on more “take” flexibility => Emergence of new LNG suppliers outside Asia Pacific plus short reemergence of US market Flexibility in new contracts: - disappearing of floor price - shorter term - smaller off-take - destination flexibility (FOB instead of CIF) Important flexibility through self- contracting: upstream stakeholders purchase output + equity acquisition downstream While LTC remain, they become more flexible

25 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 25 Structure 1. Elements / explanations of gas price formation 2. Regional differences 3. Recent developments

26 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 26 Recent Developments Affecting on Gas Price Formation 1. Recent development of supply and demand -new perspectives of shale gas 2. Development of new market places - global pricing for LNG? 3.Impacts on LTCs replacement value / net back value pricing Fuel oil indexation heavy fuel oil indexation

27 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 27 Issues LTCs and replacement pricing need under supply / capacity restrictions Are we facing a situation of oversupply? Due to shale gas High potential but so far limited contribution to US Duration of recovery, major structural changes, e.g. due to renewables? LNG entry point control? Q max, Q flex into existing harbours?

28 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 28 Production of Unconventional Gas in the United States (Source: WEO 2009) US unconventional output has expanded nearly 4-fold since 1990 to almost 300 bcm in 2008 – equal to more than half of total US gas output and ¾ of global unconventional output

29 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 29 Why LNG will not Develop a Spot Quotation LNG not like oil: Unlike for oil: No extraterritorial storage faculties for LNG (high specific costs of storage) Bilateral deals Relative high transparency: Follow ships Import statistics (but also transparency by commercial actors, e.g. Spain)

30 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 30 Gas Trading Hubs in Continental Europe Source: WEO 2009

31 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 31 Recent Developments Affecting Gas Price Formation 1. Recent development of supply and demand (may last several years) -new perspectives of shale gas (too early to tell) 2. Development of new market places (difference between resource driven and contract driven market places) - global pricing for LNG (not likely because there are no off border market places) 3.Impacts on LTCs (basic logic for cross border LTCs in Continental Europe unchanged, but modifications to match competition downstream) replacement value / net back value pricing (in principle based on under supply /capacity restricitons) Fuel oil indexation (still reflecting competitive situation for small costumers, especially gas oil) heavy fuel oil indexation (since long not based on competition with but on contestability by Heavy Fuel Oil; HFO indexed part of gas sales a multiple of HFO consumption; for large positions increasingly access to gas to gas in UK or secondary markets)

32 Putting a Price on ENERGY International Pricing Mechanisms for Oil and Gas Energy Charter Secretariat 32 Thank you !


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