The Economics of LNG Export Contract Flexibility: a quantitative approach By Yichi Zhang, 29 October 2012, EPRG weekly seminar Supervisors: Pierre Noel, Chi Kong Chyong shebazhang@gmail.com
Introduction Methodology Results Discussion Golden Age for Natural Gas? IEA: Gas consumption could rise more than 50% over the next 25 years, becoming second largest primary energy source only next to oil Massively expanding unconventional gas in North America Uncertainty about nuclear power after Fukushima Surging gas demand, especially in China
Introduction Methodology Results Discussion LNG (liquefied natural gas) Natural gas in the liquid form, transported efficiently by ship or truck to all over the world Price divergence in the different regional markets Large price spread provide arbitrage opportunities Trends in the Spot Price of Global Market (US$/Mbtu)
Introduction Methodology Results Discussion Long-term Contracts (LTC) - little flexibility Length of 15-20 years The price of LTC gas is linked to the price of oil. Take-or-pay (ToP) term Customers should take at least a minimum ratio (e.g 80%) volume of gas in the contract and not exceed a maximum amount (e.g. 120%) Spot Markets fully flexible Price decoupled from the oil price Liberalisation of the gas markets Henry Hub in the US, National Balancing Point (NBP) in UK, Title Transfer Facility (TTF) in Netherlands, Japan/ Korea Maker in Pacific Asia Japanese LNG buyers push for more flexible contracts
Introduction Methodology Results Discussion Literature review Debate about continuing LTC vs. liberalisation of gas market Quantitative analysis of gas arbitrage value Rodriguez, Holleaux (2008, Real option valuation ) Neuhoff and Hirschhausen (2005, Long-term and short-term elasticity) Panagiotidis and Rutledge; Villar (2007, 2008, Co-integration analysis) Large-scale equilibrium gas simulation models Gabriel, (2005, 2010, North American market) Holz (2008, GASMOD) Chyong and Hobbs (2011, very detailed representation of the European gas market, economic analysis of the Nord Stream gas pipeline project) Gap literature research: Only qualitative analysis using economic theory or small-scale quantitative estimation about the economic value brought by the gas market liberalisation
Introduction Methodology Results Discussion research questions With more flexible LNG contracts, will producers gain more profits? will consumers have more surplus? will the whole market efficiency increase? Explanation of flexibility 100% flexibility=0% ToP (free diversion of gas) 0% flexibility=100% ToP (no diversion allowed)
Introduction Methodology Results Discussion Model of Arbitrage (a) No arbitrage in the market (b) Arbitrage is allowed in the market Buyer: Country B Buyer: Country B Buyer: Country C Contracted Spot market Contracted Spot market Spot market Contracted Seller: Country A Seller: Country A
Methodology: Global gas market equilibrium model Concept: Example: Maximization of the profit of each market player: producers, suppliers, pipeline transmitters, LNG operators under a series of constraints.
Methodology: Global gas equilibrium model Changing this value Assumption of Market Power Scenarios Other Producers Traders Cournot player ++ -- Competitive players -- ++
Methodology: Global gas equilibrium model Extend the market in the model from Europe to worldwide Combine nearby markets into blocs of consumption regions Red: net importers Green: net exporters Blue: exporters and importers
Methodology: Newly Established International Connections Importer: Exporter: Japan/ Korea China India France Belgium Spain & Portugal Italy UK North America South America Australia ++ ++ ++ ++ Malaysia ++ ++ Indonesia ++ ++ Trinidad Tobago ++ ++ ++ Oman ++ ++ North America ++ Qatar ++ ++ ++ ++ ++ ++ ++ ++ ++ ++ Egypt ++ ++ ++ Netherlands ++ ++ Nigeria ++ ++ ++ Norway ++ ++ ++
Methodology: Data source.. Data Production Capacities Liquefaction/Regasification capacities Transportation cost Source IEA World Energy Outlook 2011, BP Statistic Review 2011 and 2012 IGU 2010, 2011 EIA 2003 and online distance voyage distance calculator Production cost Golombek 1995, Chyong 2011, Consumption Long-term contract volumes Price BP statistic Review, 2011, 2012, IEA WEO 2011, IEA WEO Policies Scenario Bloomberg LNG contract database Platt (Japan JKM), Bloomberg (NBP, TTF, Oil),
Methodology: Mean Reversion Method for Price Simulation Simulating future prices Future prices are unknown But simple assumptions can be made from past data (e.g. trend)
Methodology: Mean Reversion Method for Price Simulation Original formula Expected change in price from t to t+1 Mean reversion term Random walk term Updated formula:
Results: Spot Price Simulation Spot Price series used for estimating mean reversion parameters Reference Price (US$/kcm) Estimated Mean Reversion Parameters US Henry Hub UK NBP EU TTF Pacific Asia JKM 165.28 246.9 262.2 -- a 0.611 0.429 1.227 0.3212 5.345 5.390 5.649 6.87 0.316 0.370 0.354 0.1834 a : Hidden for confidential contract with the data supplier
Results: LTC Price Simulation Estimated Parameters for Long-term contract price US LTC UK LTC EU LTC Crude Oil 0.545 0.930 0.192 0.114 5.385 5.538 5.953 2.904 0.288 0.292 0.200 0.248 Price Formula for Japan LTC Gas from Different Origins Japan from Australia Japan from Indonesia Japan from Malaysia Japan from Oman Japan from Qatar Japan from TT Japan from USA 57.8 91.23 41.604 91.453 35.978 47.38 92.973 22.62 20.01 25.688 18.995 28.182 31.38 16.658 Norm of residuals 138.23 26.47 136.62 110.18 148.6 113 190.76
Results: Impacts of Long-term Contract Flexibility Mean of Simulated Spot Price Series with ToP0% Full Flexibility and ToP 100% No Flexibility
Results: Impacts of Long-term Contract Flexibility Price and Consumption in 2015 with Full Flexibility and no Flexibility 0% ToP leads to higher consumption and lower price in the spot market Spot gas market Spot gas market North America Japan United Kingdom Italy Portugal and Spain France Germany Belgium 0 200 400 600 800 1000 Mean value of 1000 possible spot gas price in 2015, (US$/kcm) Continental Europe North America Japan Italy Portugal & Spain Belgium Australia France Germany Netherlands United Kingdom 0 200 400 600 800 1000 TOP 0% TOP 100 % TOP 0% TOP 100% Mean value of 1000 possible spot gas consumption in 2015, (bcm/year)
Results: Impacts of LTC Flexibility on Profits Profits of All Producers with 0%ToP and 100%ToP from 2010 to 2020 800 Profits of All Proucers (Billion US$) 700 600 500 400 300 TOP 0% TOP100% 200 100 0 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Profit of All Producers as ToP changes
Results: Impacts of LTC Flexibility on Market Share Market Share of Net Producers with Full and no Flexibility Ration among net producers Ration among net producers Market share vary with year Share of Australia increases remarkably, reaching 21.5% for 100% ToP and 23.1% for 0% ToP in 2020; shares of Nigeria, Norway and Libya decrease Market share adjusted with ToP, Share of Trinidad doubles when ToP is 0% than when ToP is 100%. Shares of Nigeria, Norway, and Libya decrease with 0% ToP Share of Australia increases slightly with 0% ToP
Results: Impacts of LTC Flexibility on Consumer Surplus Consumer surplus is defined as the difference between the total amount that consumers are prepared to pay and the total amount that they actually pay. Total Consumer Surplus with ToP 0% and ToP100% from 2010 to 2020 8.E+05 7.E+05 Consumer Surplus (Million US$/year) 6.E+05 5.E+05 4.E+05 3.E+05 2.E+05 TOP 0% TOP 100% Consumer Surplus as ToP changes 1.E+05 0.E+00 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Results: Impacts of LTC Flexibility on Market Efficiency Figure 3.8 Social Welfare as ToP changes
Discussion: Sensitivity Analysis Change the long-term mean for spot and LTC price +20% 0% -20% +20% -20% Social welfare change (2015) 14.3% 13.1% 10.4% Social welfare change (2020) 16.5% 14.3% 11.9% Producer profit Change (2015) -0.34% -1.9% -4.7% Producer profit Change (2020) 3.6% 1.1% -1.8% Consumer surplus (2015) 35.8% 35.3% 33.3% Consumer surplus (2020) 33.0% 31.4% 30.4% +20% 0% -20% +20% -20% Social welfare change (2015) 14.3% 13.1% 10.4% Social welfare change (2020) 16.5% 14.3% 11.9% Producer profit Change (2015) -0.34% -1.9% -4.7% Producer profit Change (2020) 3.6% 1.1% -1.8% Red indicates positive change Blue indicates negative change
Discussion: Sensitivity Analysis Change in Key Economic Indicators as Total Production Capacity Changes, ToP=0% 2.E+6 1.E+6 1.E+6 Million US$/year 1.E+6 8.E+5 6.E+5 4.E+5 +50% +20% 0% -20% -50% 2.E+5 0.E+0 Social welfare (2015) Social welfare (2020) Producer profit (2015) Producer profit (2020) Consumer surplus (2015) Consumer surplus (2020)
Discussion: Monte Carlo Simulation 100 times 200 times 500 times 1000 times
Conclusion With more flexible LNG contracts, will producers gain more profits? Uncertain will consumers have more surplus? Yes will the whole market efficiency increase? Yes Open questions: The flexibility of each regional market is different The validity of mean-reversion methods to simulate gas price, limited length of past data Oversimplified assumptions such as regarding Malaysia and Australia have the same marginal production costs, due to lack of data Further sensitivity analysis about elasticity of gas Traders are considered perfectly competitive The liquefaction and regasifcation capacities are considered but not the LNG shipping capacities. Consumer surplus,
Many Thanks
Discussion: Market Power Assumption of Market Power Scenarios Cournot player: ++, Price taker :-- Market Power Scenario Producer Trader Upstream Oligopoly ++ -- Perfect Competiton -- -- Composition of Social Welfare in Different Market Power Scenario In 2015, ToP100% Perfect Competition Social Welfare Oligopoly Upstream Social Welfare 43.5% 96.4 Billion US$/year 56.5% 40.3% 96.5 Billion US$/year 59.7% Producer profit Consumer surplus