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The price of natural gas

A.M. Samsam Bakhtiari

Abstract

Natural gas used to be a relatively cheap primary energy source,


always at a discount to crude oil (on a comparative British thermal
unit basis). It gradually evolved into a major resource during the
20th century reaching a 24 per cent share of global primary en-
ergy in 1999.
In the year 2000, natural gas prices in the USA rose to
unheard-of highs of $10/million Btu, ushering in a new era, with
natural gas at a 120 per cent premium to crude oil. This clearly was
a watershed for gas, somehow similar to the 197374 watershed for
oil prices. And similarly, any return to the status quo-ante looks rather
improbable, although a number of experts (alongside the Interna-
tional Energy Agency) still believe the 2000 price spike to have
been only transitory.
The consequences of higher gas prices (at a level equal to
crude oil prices on a Btu basis) will be multifaceted and momentous,
altering habits and uses in downstream industries and economic sec-
tors, as well as providing added income for major gas-exporters,
such as Russia, Canada and Algeria.
Another potential consequence of the 2000 watershed might
be to propel US standard prices (such as the Henry Hub spot) to
international status and gas price-setter, as the WTI spot became
an international benchmark for crude oils in the post-1993 era.
(continued overleaf)

December 2001 2001 Organization of the Petroleum Exporting Countries 357


The author is from the National Iranian Oil Company, Tehran, Islamic
Republic of Iran.

Abstract continued

For the time being, the equality of gas and oil prices has
become the new norm; but, in the longer term, a discount of crude
oil relative to natural gas might be envisaged, as the latter is a cleaner
fuel and emits less carbon dioxide when used.

358 2001 Organization of the Petroleum Exporting Countries OPEC Review


U
NLIKE THE PRICE of crude oil, which has become ubiquitous due to
the importance of its impact on the world economy,1 the price of natural
gas is not widely published and rather difficult to come by. Even in our
age of cheap information, daily quotes for gas prices in major markets are far
from easy to find.
The main reason behind this state of affairs is that natural gas was always
treated as second fiddle to the dominating crude oil in energy markets. Gas was
not only saddled with transport problems, but was also (unlike oil) only trans-
ferable between two parties: the producer and the consumer. Thus, it remained
in the shadow of oil. Even at the close of the 20th century, natural gas still
stood third among fossil fuels with a 24 per cent share of global primary en-
ergy, just a single percentage point behind coal (25 per cent) but with both still
lagging well behind crude oil (39 per cent).2

Historical background
During the first half of the 20th century, natural gas was treated as an undesirable
by-product of oil production and, wherever a wildcat would yield gas, it was usually
sealed off without further ado. And, if some of the associated gas was eventually sold
off as fuel, it was at negligible prices (sometimes barely enough to cover its transfer costs).
The first natural gas market developed gradually in the United States. In 1938,
by way of the Natural Gas Act, the US Congress placed the natural gas industry
under the aegis of the Federal Power Comission (FPC) and, in 1954, the US Supreme
Court ruled that the prices of interstate natural gas were subject to FPC control at the
wellhead.3 As late as 1975 and notwithstanding the explosive consumption growth of
natural gas in the USA to a record 555 billion cubic metres that year (representing a
whopping 46 per cent of worldwide gas consumption and also a 29 per cent share of
US primary energy4), the FPC set a new national ceiling price of 52 cents (per million
Brtitish thermal units) on natural gas.5 With the posted price of West Texas Light
Intermediate(WTI) crude oil barrel at an average of $12.23 (equivalent to $2.11 per
mBtu) in 1976, the ratio of the maximal gas price to WTI (on a Btu-basis) stood at
around 25 per cent. With time, however, this ratio rose towards 50 per cent and then,
during the 1990s, even to around 75 per cent (figure 1). Still, natural gas was always
sold at a discount to crude oil.
Towards the close of the 20th century, US gas prices began their very slow pro-
gression to reach the $23/mBtu bracket in the mid-1980s and late 1990s (figure 2).
The average price of imported gas to the European Union (EU) did stabilise in the
same bracket beginning to gradually align on the US market. In the third important
market of Japan (LNG), prices were always higher, settling during the 1990s between
$3/mBtu and $4/mBtu.

Natural gas markets


Based on these relatively low gas prices, the share of natural gas in the global
primary energy basket grew steadily from two per cent in 1920 to just over 24 per cent
in 1999 (figure 3).

December 2001 2001 Organization of the Petroleum Exporting Countries 359


Figure 1
Ratio of natural gas price (Henry Hub spot)
to crude oil price (WTI spot average) on a Btu basis6

1.0
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
1986 1988 1990 1992 1994 1996 1998 1999

Figure 2
Natural gas price (yearly average) for the three major regional markets7
$/mBtu

6
Japan
5
EU
4

3 USA

0
1975 1979 1983 1987 1991 1995 1999

360 2001 Organization of the Petroleum Exporting Countries OPEC Review


Figure 3
Share of natural gas in global primary energy consumption8
%
30

25

20

15

10

0
1920 1930 1940 1950 1960 1970 1980 1990 2000

Figure 4
Natural gas consumption growth in the three major markets9
billion cu m/yr

800

700 North America 723.9

600

500

400 443.9
Europe
300

200 268.2

Asia-Pacific
100

0
1975 1980 1985 1990 1995 1999

December 2001 2001 Organization of the Petroleum Exporting Countries 361


Figure 5
Share of major natural gas consumption markets in 200010

Rest of world 8.9%

North America 30.8%


Middle East 7.7%

Asia Pacific 11.6%

Europe 17.3%

FSU 23.7%

Global consumption in 2000: 2,484 billion cu m

Figure 6
Comparison of US crude oil and natural gas prices on relative Btu basis11
$/mBtu

11
10
9
8
7
6
5
4
3
2
1
0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr
2000 2000 2001 2001
Henry Hub spot WTI spot

362 2001 Organization of the Petroleum Exporting Countries OPEC Review


As mentioned above, it was the USA that pioneered the extensive use of natural
gas; Europe began using substantial amounts of natural gas in the 1960s and Japans
liquefied natural gas (LNG) imports took off in the 1970s. Thus three major gas mar-
kets emerged: North America, Europe and the Asia-Pacific. And, although growth in
the US market was rather muted during the 1980s and 1990s (figure 4), there was
rapid sustained expansion both in Europe and the Asia-Pacific, as these newcomers to
the gas industry warmed to the new fuel.
Another major user of natural gas was the worlds largest reserve-holder: the
Soviet Union. With around 38 per cent of global gas reserves, the Soviet Union had
begun early to use domestically this internal resource. Although not really a market,
consumption of gas in that country (and later in the former Soviet Union) was always
widespread and, in volume terms, came second only to that of the USA.
Even in the year 2000, and notwithstanding the rapid growth in both Europe and
Asia, the FSU remained the second-largest gas-consuming region with a 23.7 per cent
share of global consumption, clearly ahead of Europe (17.3 per cent) and the Asia-
Pacific (11.6 per cent) and second only to North America (30.8 per cent) as shown
in figure 5.

The year 2000


In the year 2000, not only was yet another global consumption record for natural
gas set, with 2,484 bn cu m consumed worldwide, but two far more momentous events
occurred that would make a watershed of this special year.

1.) Natural gas displaced coal in the global primary energy league, to
take the number two spot after crude oil.

2.) Natural gas prices created a revolution, as they shot up in the USA
to record highs: the Henry Hub spot price went from the normal $2.5/
mBtu in January to over $10/mBtu in late December 2000 (figure 6), while
WTI languished between $4/mBtu and $5/mBtu (on a Btu basis). At the
onset of 2001, the price of gas stood at a 120 per cent premium, compared
with WTI an extraordinary development. However, the price spike did
not last long and, by early February, gas prices had dwindled back to
$5/mBtu. Many believed things to be back on an even keel, with parity
between gas and oil prices now being seen as quite normal: the watershed
had wiped out the former discount.

Setting the price


Gas prices in the three major markets used to be set independently from one
another depending mainly upon each markets inherent energy economics and re-
gional gas industry patterns (the ratio of domestic production to imports, the share of
gas in the primary energy, the mix of pipeline gas and LNG, etc). As for transfer prices

December 2001 2001 Organization of the Petroleum Exporting Countries 363


in the FSU, they follow their own special logic: a mix of past subsidies with a touch of
hard-nosed marketing practices.
But another momentous consequence of the Y2K watershed was for natural
gas to follow in crude oils footsteps in setting new price trends worldwide. In the
world of oil, it was during the 1990s, and more precisely in the post-1993 era, as oil
consumers took over from oil producers as the dominant force in controlling the
supply/demand balance,12 that WTI became an international benchmark and, due
to its direct link to US oil imports,13 gradually turned into a market leader.
Now, in the gas industry, a somewhat similar price-setting pattern is emerging,
as US gas prices, in the post-2000 era, are bound to lead gas prices elsewhere. Its
direct impact on Canadian prices through its imports14 and also on Mexico15 are an
indisputable and irreversible fact. Furthermore, US prices indirectly influence the LNG-
dominated Asia-Pacific market through its own LNG imports and as the latter are
bound to increase in the future to balance expanding demand in the US market, so is
the indirect influence on Asia-Pacific prices. The impact on the European scene is not
as marked, but early signs of it were noted during the winter 2000/2001 as the UK
Bacton rose in parallel to Henry Hub, but only to a maximum of $5/mBtu; more-
over, Europes LNG imports are growing too (especially in France, Spain and Bel-
gium) and, in turn, these will further link prices between the two markets. And, finally,
the FSU will have to eventually align its gas prices to those of the European Union.
So, all in all, with the North American gas market dominating, the Henry Hub
spot might gradually turn out to be for natural gas what WTI spot has become for the
oil industry.

The future
Global consumption of natural gas is set to continue its ascending course with
or without the implementation of the Kyoto Protocol and notwithstanding the higher
price bands. The International Energy Agency predicts global consumption of 4,315
bn cu m in 2020 from 2,484 bn cu m in 2000 (for an increase of 73.7 per cent over two
decades or an annual compounded average growth rate of 2.8 per cent).16
Another indication of things to come is underlined by the fact that global natural
gas reserves (in oil equivalent) will soon come to surpass crude oil reserves. Accord-
ing to BP, worldwide oil and gas reserves stood at, respectively, 140 and 134 billion
tonnes (oil equivalent) at end of 1999: a small advantage to oil. But, as crude output
annually averages around 3.5 bn t and that of natural gas only 2.1 bn t (oil equivalent),
by 2005 natural gas reserves should come to surpass crude reserves for the first time in
history: another advantage for natural gas in its bid to rival crude oil in the future.
As for gas prices, it would seem that, in the post-2000 era, the times of cheap
natural gas are a thing of the past, even though some diehard experts like John C.
Cochener advance that the relatively high gas price levels of 1999 and 2000 are con-
sidered to be transitory and supported by temporary factors17 and goes on to predict
that US nominal prices would rise only marginally from $2.32/mBtu in 2000 to $3.06/
mBtu in 202018 (supported in this by the IEAs vision of $3.5 mBtu in 202019). All

364 2001 Organization of the Petroleum Exporting Countries OPEC Review


those who still believe that the winter 2000/2001 price spike was transitory might be
in for a surprise as early as late 2001.
It would seem that, as crude oil prices never looked back after the first price
increases of 1973/1974, natural gas prices will never return to the pre-2000 discount
prices relative to crude oil. The era of high gas prices seems to be here to stay. This is
even though, some day, it is crude oil that might drop to a discount to natural gas, the
discount being rational due to gas being a cleaner fuel that emits less carbon dioxide
than refined crude products.

Consequences of higher gas prices


It is inevitable that high gas prices (that is, anything over the price of crude oil on
a Btu basis) will have a score of long-ranging consequences, echoing throughout the
whole energy world, the gas industry and its major downstream activities (e.g. petro-
chemicals and power generation), bringing to an abrupt end many deeply ingrained
industrial habits. Some of the main consequences of higher gas prices that are bound
to materialise are outlined hereunder.

* They will certainly lead to higher fertilizer production costs and sales
prices,20 sending inflationary waves throughout the agricultural world and
the food chain.

* They will trigger revisions in the choice of petrochemical feedstocks


(especially in the USA) and rewrite the rules of economic competitiveness
in the global petrochemical industry.

* They will cause parallel increases in electricity costs, because of the ever-
higher share of natural gas in power generation, worldwide in general and
in the USA in particular, where 97 per cent of new power plants announced
since 1998 will rely substantially or entirely on natural gas as their primary
fuel.21

* They will mean higher income for all natural gas exporters, and espe-
cially for the major ones, such as Russia, Canada and Algeria (table 1). For
example, a rise of $1/mBtu in the gas price would yield an extra profit of
$4.6 bn to Russia.

* They will facilitate the implementation of future major gas-exporting


projects, as, for example, the Qatar/Iran gas pipeline to Western Europe
which was not feasible at prices under $3/mBtu but could yield dividends
at over $5/mBtu. Morever, even grassroots LNG plants become viable at
such prices and the more so the expansion of existing plants (like the
record-breaking train of 4.7 million tonnes per year planned for Qatars
RasGas).

December 2001 2001 Organization of the Petroleum Exporting Countries 365


* They will tend to disfavour gas transformation technologies, such as gas-
to-liquids, which become uneconomic at gas prices equivalent to oil prices
(all production costs translating into direct losses).

* They will further disadvantage the use of natural gas as fuel, for example,
flagging down that of compressed natural gas (as against LPG).

Conclusion
For natural gas prices, the year 2000 was the watershed, as 1973/74 was for
crude oil pricing. In 2000, for the first time in history, the price of natural gas not only
rose significantly over that of crude oil (on a relative Btu basis), but even reached a
premium of 120 per cent in the USA, at its peak in late December 2000.
Natural gas prices used to be set independently in the three major markets, but
the 2000 crisis might have triggered the emergence of an American price-setter, and
gas prices worldwide could eventually come to follow the US Henry Hub, especially
if (as widely predicted) the USA steps up its LNG imports to readjust its gas supply/
demand imbalance.
With natural gas prices coming to the fore, it will soon be much easier to get
major market benchmarks: among others, Henry Hub in the USA, Bacton in the
UK and LNG cif prices for Japan.
The main beneficiaries of these higher prices will naturally be the main gas-
exporters: Russia, Canada, and Algeria. And they will also encourage potential
gas-exporters to jump into the fray.

Table 1
Major natural gas exporters with amounts exported in the year 2000
(Cedigaz estimates22) and share of total exports

Exports 2000 Share of total


Gas exporters bn cu m exports %
Russia* 130.3 24.4
Canada 101.7 19.1
Algeria** 61.6 11.6
Norway 49.0 9.2
Netherlands 36.6 6.9
Indonesia 35.7 6.7
Malaysia** 22.5 4.2
Total seven major exporters 437.4 82.1
Total world exports*** 532.9 100.0

*Not inclusive of intra-FSU gas trade (estimated at 119.0 bn cu m for 2000).


**In the special cases of Algeria and Malaysia, gas exports include both pipeline and LNG exports.
***Worldwide exports of 532.9 bn cu m subdivide into pipeline exports of 395.9 bn cu m (74
per cent) and LNG exports of 137.0 bn cu m (25.7 per cent).

366 2001 Organization of the Petroleum Exporting Countries OPEC Review


Footnotes
1. A.M. Samsam Bakhtiari, The price of crude oil, OPEC Review, March 1999, pp. 121.

2. BP Statistical Review of World Energy, June 2000 p.38.

3. See Carl Solberg, Oil Power, New York: Mentor Book, 1976, pp. 215219.

4. BP Statistical Review of World Energy, June 1985, pp. 22 and 28.

5. Carl Solberg, op. cit., p.230.

6. BP Statistical Review of World Energy, issues of June 1991 and June 2000.

7. Ibid., it should be noted, however, that, for the gas prices presented graphically in figure 2,
the following applies:

USA: for 197588, the average US wellhead price is presented and, for
198999, the Henry Hub spot price;

EU: for 197584, the average price for Western Europe is shown and, for
198599, the average price for the European Union; and

Japan: throughout, the Japanese average price of imported LNG is being used.

8. In order to compile the gas-to-primary energy ratios, the following sources were used:

M. Gratwohl, World Energy Supply, de Gruyter, 1982, pp. 1819.

G. Jenkins, Oil Economists Handbook, Elsevier, 5th ed., 1989, Vol. 1, p. 207.

BP Statistical Review of World Energy, 1960 and subsequent issues.

9. The BP gas statistics were retrieved from:

www.bp.com/downloads/387/gas_consumption_[billion_cubic_meters].xls.

10. Preliminary estimates for 2000 were published by the International Gas Report, no. 423,
27 April 2001, pp. 14, quoting from the report Natural Gas Statistics for 2000 Cedigazs
First Estimates.

11. The data for the Henry Hub spot and the WTI spot was retrieved from the Energy
Information Administrations Natural Gas Weekly Market Update and averaged either
monthly or weekly. The WTI selling price (from the Gas Daily) was converted from $/b
into $/mBtu by using a conversion factor of 5.80 mBtu per barrel (in accordance with the
EIA).

(see: www. eia.doe.gov/oil_gas/natural_gas/nat_frame.html).

December 2001 2001 Organization of the Petroleum Exporting Countries 367


12. See M.S. Memarian, How just-in-time management of crude oil stocks can affect the
markets, in Middle East Economic Survey, 12 February 2001, A5.

13. Ibid., A6.

14. The Canadian standard price of AECO C Hub (Alberta) rose in parallel with Henry
Hub during the year 2000. See various issues of the Petroleum Economist in 2000 and
the first quarter of 2001.

15. On the direct impact of US gas prices on gas-pricing in Mexico and the problems thus
created for PEMEX and Mexican customers, see George Baker, Mexicos natural gas
pricing crisis, Oil and Gas Journal, 22 January 2001, pp. 1825.

16. Gas to fore in IEA 2020 vision, in International Gas Report, no. 416, 19 January 2001,
pp. 3137.

17. US gas growth to rely heavily on Canada, Gulf of Mexico, Oil and Gas Journal, 22 Janu-
ary, 2001, p.59.

18. Ibid., p. 60.

19. International Gas Report, no. 416, 19 January 2001, p. 34.

20. See A.M. Samsam Bakhtiari and F. Shahbudaghlou, What are the consequences of high
oil and gas prices?, in Hydrocarbon Processing, February 2001, pp.2526.

21. Benjamin Schlesinger, US Natural Gas Supply, in Oxford Energy Forum, February
2001, p.5.

22. Cedigaz estimates from the quotes in International Gas Report (see note 10 above).

368 2001 Organization of the Petroleum Exporting Countries OPEC Review

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