PUTTING A PRICE ON ENERGY International Pricing Mechanisms for Oil and Gas ENERGY CHARTER SECRETARIAT
Table of Contents Foreword 3 Acknowledgements 5 The Energy Charter Treaty 7 Executive Summary 19 Chapter 1 Introduction 33 1.1 Issues 33 1.2 Approach 33 1.3 Questions Investigated in Detail 33 Chapter 2 Explaining Oil and Gas Pricing Mechanisms: Theoretical and Historical Aspects 41 2.1 Theoretical Aspects 41 2.2 Historical Aspects 52 2.3 Market Structure and Pricing Mechanisms 61 Chapter 3 Oil Pricing 65 3.1 Summary 65 3.2 Introduction 67 3.2.1 Oil - a Commodity Like No Other 67 3.2.2 Crude Oil and Petroleum Products 68 3.2.3 Benchmark Crude 69 3.2.4 Crude Transactions 72 3.2.5 Price Formula 73 3.2.6 Netback Pricing 73 3.2.7 Refining Margins 74 3.3 Development of Oil Pricing Mechanism 76 3.3.1 Early Days 76 3.3.2 Majors 76 3.3.3 OPEC 77 3.3.4 Spot and Futures Markets 77 3.4 Spot/Forward/Futures/Options 79 3.4.1 Spot Market 79 3.4.2 Forward Market 80 3.4.3 Futures Market 81 3.4.4 Options Market 85
3.5 Hedging and Speculation 86 3.5.1 Hedging " 86 3.5.2 Long Hedge and Short Hedge 86 3.5.3 Hedgers, Speculators and Arbitrageurs 87 3.5.4 Regulatory Authority 88 3.6 Current Oil Market Fundamentals 90 3.6.1 Recent Price Developments 90 3.6.2 Demand 91 3.6.3 Supply 91 3.6.4 Refining 93 3.6.5 Stocks 95 3.7 Conclusions 96 Chapter 4 Gas Pricing 99 4.1 Will Gas Follow Oil to Become a Global Commodity? 99 4.2 North America 103 4.2.1 Summary 103 4.2.2 Introduction 103 4.2.2.1 The Integrated North American Natural Gas Transmission System 103 4.2.2.2 North American LNG Import Terminals 105 4.2.2.3 US Natural Gas Demand 106 4.2.2.4 US Natural Gas Supply 108 4.2.2.5 Canadian Supply and Demand 109 4.2.3 The Development of US Natural Gas Regulation 110 4.2.3.1 The Historic Basis of US Gas Regulation 110 4.2.3.2 The Natural Gas Act of 1938 111 4.2.3.3 The Supreme Court's Phillips Decision 111 4.2.3.4 The Natural Gas Policy Act of 1978 112 4.2.3.5 Industry Response to the NGPA 112 4.2.3.6 FERC Order 380 114 4.2.3.7 FERC Order 436 115 4.2.3.8 The Pipeline Take-or-pay Problem 115 4.2.4 Canadian Gas Regulation 115 4.2.5 The Evolution of North American Gas Prices 116 4.2.5.1 Pre-NGPA US Gas Pricing 116 4.2.5.2 The NGPA and Partial De-regulation of Gas Prices 116 4.2.5.3 The Effect of US Regulatory Policies on Canadian Prices 118 4.2.6 The Current North American Pricing System 119 4.2.6.1 The Emergence of Henry Hub as the Centrepiece of North American Pricing 119 4.2.6.2 The Operation of the North American System 119 4.2.6.3 Gas Price Formation in North America 120 10
4.2.6.4 Current North American Price Relationships 123 4.2.7 Conclusions '. 125 4.3 The United Kingdom 126 4.3.1 Summary 126 4.3.2 Introduction 127 4.3.2.1 The History of UK Gas Regulation 127 4.3.2.2 The UKTax Regime 128 4.3.2.3 The Natural Gas Transmission System 129 4.3.3 UK Supply and Demand 131 4.3.3.1 Gas Demand 131 4.3.3.2 Gas Supply and Trade 132 4.3.3.3 Future UK Gas Supply 134 4.3.3.4 The LNG Terminal Third-party Access Issue 136 4.3.4 Natural Gas Pricing 137 4.3.4.1 Pricing before Industry Restructuring 137 4.3.4.2 Pricing in the Restructured Gas Market 138 4.3.4.3 How Do Prices in the UK Interact with Continental Prices? 140 4.3.4.4 The Experience of the 2005/2006 Winter 141 4.3.5 Conclusions 142 4.4 Continental Europe 143 4.4.1 Summary 143 4.4.2 Development of Market Structure and Imports 144 4.4.3 The Groningen Concept of Replacement Value and of Long-term Minimum-pay Export Contracts 146 4.4.4 Gas Import Contracts Following Groningen 152 4.4.5 Price Review Rounds 163 4.4.6 Regulatory Change 164 4.4.7 Cross-border Gas Deliveries in Former COMECON States 166 4.4.8 Conclusions 173 4.5 LNG 175 4.5.1 Summary 175 4.5.2 Introduction 176 4.5.2.1 The History of World LNG Trade 176 4.5.2.2 The Role of Long-term Contracting in Traditional LNG Trade 179 4.5.2.3 LNG Costs 180 4.5.2.4 The Emergence of More Flexible LNG Markets 181 4.5.2.5 Arbitrage 185 4.5.3 LNG Pricing 187 4.5.3.1 Regional Differences in the Logic of LNG Pricing 187 4.5.3.2 Early Atlantic Basin LNG Pricing 188 4.5.3.3 Early Pacific Basin LNG Pricing 189 4.5.3.4 Mounting Pressures for Change in Pricing Formulas in the 1990s 191
4.5.4 New Approaches to LNG Contracting in the 1990s 191 4.5.4.1 New Patterns of Asian LNG Contracting 191 4.5.4.2 China and India Enter the Asian Market /. 192 4.5.4.3 Oil Price Escalation and its Impact on Northeast Asian Prices 193 4.5.4.4 Recent Asian Market Developments 195 4.5.4.5 The Emerging North American West Coast Market 196 4.5.4.6 New Patterns of Atlantic Basin LNG Contracting 196 4.5.4.7 Middle East Contracting 198 4.5.4 Contracting for Restructured Gas Markets 199 4.5.5.1 North America 199 4.5.5.2 The UK 199 4.5.6 Conclusions 200 Chapter 5 Overall Conclusions 203 Bibliography 213 Abbreviations and Acronyms 219 Glossary of Terms 227 12