Natural Gas Pricing in West

Europe
27/09/01

- IFA Conference 13th Sept. 2001 - Romarin Maillard

European Gas Pricing - Table of contents

I. Commodities Pricing Theory

II. Gas Pricing
II.1. Gas Pricing Theory
II.2. An Example : The UK Gas Market

III. The Continental Europe Gas Market

IV. Possible Developments For Continental Europe
V. Conclusion

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I. Commodities Pricing Theory

Characteristics of the supply market

- Capital intensive
- Investment decision based on coverage of all costs (capex
and opex)
- Long time between decision to invest and start of
production
- Production decision based on coverage of variable costs
(variable opex)
- Market control via :
Investments (swing investors)
Production (swing producers)

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I. Commodities Pricing Theory

Characteristics of the demand market

- Usually growing as per Gross Domestic Production
(especially for gas)
- Low price elasticity in the short term unless substitution
commodity exists for use in existing process
- Higher price elasticity in the medium term by selection of
an alternative solution (process / commodity)
- Market control via :
short term substitution capability
medium term substitution capability

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I. Commodities Pricing Theory

Unsuitability between :
- Supply
- Demand

Prices fluctuation
Fluctuation limited either via :
- the demand market (limits : prices of competitive
commodities)
- the supply market (limits : production variable cost and
marginal producer overall cost)

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II.1. Gas Pricing Theory

Characteristics of the gas supply market

- Very capital intensive (4-5 G$ for 10 Bcm/year)
- Very long time between decision to invest and start of
production
- Low variable cost
- No swing investors
- No swing producers
No market control

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II.1. Gas Pricing Theory

Characteristics of the European gas demand market

- Growing at an expected rate of 3% per year
- Gas can be substituted :
short term : dual fuel equipments
medium term : for all its use
US market could attract European gas if price differentials high

- Market control via :

short term substitution (Heavy Fuel Oil, Coal)
long term substitution (HFO, Coal and even Gas Oil or LPG)

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II.1. Gas Pricing Theory

Consequences for European gas pricing
No market control through supply
Price may vary between low variable cost and
marginal producer cost
Market control via fuel substitution
Price will be set according to the alternatives
fuel it displaces upward and downward along price curb

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II.1. Gas Pricing Theory : Diagram

Limits of gas price fluctuation

Producer

At the end

Consumer

Price
GPL
GO
Marginal
producer cost

If demand is very high

If demand is high

HFO

If demand is not very

high

Coal
0

Variable costs

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II.2. An Example : The UK Gas Market - Introduction

Two markets :
- Spot market : daily exchanges possible
- Contracts market

Volume of the spot market is only 20% of the physical

market
Only a small part of the market is traded freely and even
this part can be linked to oil products prices.

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II.2. An Example : The UK Gas Market

Prices to industrial customers

Sales to industrial customers represent 50% of the overall
consumption
50% of industrials customers are on an interruptible basis
Industrials customers are price-makers for the spot market
Observation : Price for interruptible customers stays between coal
and HFO prices
Why ?
Interruptible customers can switch between fuels :
- stop running coal based plants to go on gas if gas is cheaper
- stop running gas based plants to go on HFO if gas is more
expensive than HFO

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II.2. An Example : The UK Gas Market

UK Energy prices for Industry

40.00

p/therm

35.00
30.00
25.00
20.00
15.00

9
Q 4
3
94
Q
1
9
Q 5
3
95
Q
1
9
Q 6
3
96
Q
1
97
Q
3
97
Q
1
9
Q 8
3
98
Q
1
9
Q 9
3
99
Q
1
00
Q
3
00

10.00

Energy Trend datas

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Gas int

HFO avg

12

Coal avg

II.2. An Example : The UK Gas Market

Spot prices
Winter level :
- Price very close to HFO at burner type of dual fuel
(Gas/HFO) industrial customer

Summer level :
Price equal to the maximum of :
- coal
- winter price - storage costs

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II.2. An Example : The UK Gas Market

P = burner tip HFO equivalence

December 2000 Future

p per therm

35.00
30.00
25.00
20.00

IPE datas

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Futures gas price

14

04/11/2000

04/10/2000

04/09/2000

04/08/2000

04/07/2000

04/06/2000

04/05/2000

04/04/2000

04/03/2000

04/02/2000

10.00

04/01/2000

15.00

II.2. An Example : The UK Gas Market

Gas Prices
30
27

p/th

25

23

20

20

19

15
12
10
8

10

16

16

13

13

17

24
21

Summer gas
price p/th
Average p/th
Winter gas price
p/th

10

5
0
10

15

20

25

Brent $/Bbl

Crude price = 26 $/Bbl

Exchange rate = 1.5$/GBP

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Winter gas price (NBP) = 24-26 p/th

Summer gas price (NBP) = 18-20 p/th
Average gas price (NBP) = 21-23 p/th

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II.2. Gas pricing

Conclusion
In an open market without "Supply price control", gas
price set by "Demand price control" itself resulting from
fuel switching capabilities
With a large capability of switching gas/HFO and
gas/coal, gas price will stay between coal price and HFO
price.
A decrease in fuel switching capability will lead to a
more tensed market with higher volatility. Loss of short
term switching flexibility may lead to very high prices

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III. The Continental Europe Gas Market - Particularities

Not too many producers

Reserves far from consumption sites
High costs of transportation and development

TOP Long Term Contracts indexed on oil products

prices with important volumes and duration
Natural monopoly of gas transporters
Share of gas consumption not so important than in UK
and gas power plants not so developed
Markets just at the beginning of deregulation

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III. The Continental Europe Gas Market - Supply

Reserves and future

supply sources
North Sea
6.3 Tcm

Russia
47.7 Tcm

LNG

Caspian Sea
5.8 Tcm

North Africa
6.6 Tcm

Source : Cedigaz - Proved reserves at 01.01.2000

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III. The Continental Europe Gas Market - Gas Directive

Network Access negotiated or regulated
Eligible customers :
- Power plants
- Customers buying more than 25 Mcm/year

Accounting unbundling, transparent, objective and non

discriminatory criteria
Possible derogations for public service obligations
(recognized subsidiarity for distribution)
Possible derogations for Take or Pay contracts
Exceptions for emerging markets

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III. The Continental Europe Gas Market - Gas Directive

A progressive opening...

Electricity Directive
Minimum opening
Minimum threshold

Gas Directive
Minimum opening
Minimum threshold

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In force 19th February 1999

1999
2000
2003
26%
40 Gwh/year

28%
20 Gwh/year

33%
9 Gwh/year

In force 10th August 2000

2000
2003
2008
20%
28%
25 Mcm/year 15 Mcm/year

20

33%
5 Mcm/year

III. The Continental Europe Gas Market - Gas Directive

Third Party Access
Reg TPA
Neg TPA
Mix
Not yet decided

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III. The Continental Europe Gas Market - Conclusion

Conclusion
A market driven by oil products prices and long-term
contracts with high costs of transportation
But pressure from European Commission for
deregulation
So, what could be the future ?

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IV. Possible Developments For Continental Europe

Seasonal prices with more interruptible customers who

are price-makers during Winter, and storage capacities
regulating offer during Summer
Winter prices linked to HFO
Summer prices = Winter prices - Storage
Criteria to follow :
-

Pressure of the European Commission

Trading development and share of spot gas
LNG development
Consumption of gas
Offer of interruptible services

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V. Conclusion

A more and more complicated market with different rules

for each country
Level of risks increasing for buying gas
What are the solutions ?
- Customers grouping ??
- Relocation ??
- Oil & Gas companies with good knowledge of the market
who are risk-takers - Why not TotalFinaElf ?

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Trading - Marketing in Europe

Strategy = use expertise built in UK and take
advantage of European deregulation to develop
trading and marketing throughout Europe
The gas/electricity marketshare
open to competition in 2005
represents 30-35% of the total
market

NWE Key Indicators - 2005

Electricity demand :
Electricity open to competition :
Gas demand :
Gas open to competition :

1035 TWh
385 TWh
238 Bcm
104 Bcm

CE Key Indicators - 2005

Electricity demand :
Electricity open to competition :
Gas demand :
Gas open to competition :

NWE
CE
SWE

SWE Key Indicators - 2005

Electricity demand :
Electricity open to competition :
Gas demand :
Gas open to competition :

470 TWh
112 TWh
45 Bcm
13 Bcm

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871 TWh
244 TWh
195 Bcm
57 Bcm

South West Hub

Norvegian
Gas

Existing Hub

UK
Gas

Possible Hubs
Gaspipes
Gaspipes in project

Bacton

Neth.
Gas

Emden

LNG
Zeebrugge

LNG in project

Northern Europe Hub

Russian
Gas
Baumgarten

GSO

Sou

Central Europe Hub

th-W
est
Southern Europe Hub
Algerian
Gas

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Algerian
Gas

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TotalFinaElfs European Gas and Power Portfolio

Great-Britain
39%

Netherlands
13%

Production : 18.5 Bcm in 2000

Reserves

Onshore transportation
Storage
Marketing
Power Generation

Others
5%
Norway
43%

Offshore
transportation

Great-Britain
40%

Production
Netherlands
23%

Reserves : 210 Bcm at 31.12.00

Others
11%
Norway
26%

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11 years of production
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TOTALFINAELF Strategy :
Significant Positions in European Gas and Power
Humber Power (1260 MW)
:
40 % + tolling (510 MW)
Interconnector 10 %
(Capacity : 20 Bcm/y)
Bcm/y)

TotalFinaElf Gas & Power UK 100

% (Sales : 2.8 Bcm,
Bcm, 10 % I&C

TFE G&P North Europe

Marketshare)
Marketshare)

Bruxelles

Gaz de
Strasbourg 25 %
45 %
(Sales : 9.4 Bcm)
Bcm)

CFM
Gaz de Bordeaux 16 %
Storages 100 %
(Izaute Lussagnet)

GSO

GAZ DU SUD OUEST

Cepsa Gas Comercialidazora

50 % TFE / 50 % Cepsa

70 %
(Sales : 3.7 Bcm)
Bcm)

Pipe project
Cepsa/Sonatrach
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