Global natural gas demand is set to continue increasing Block 3, Forum 13 paper

Global natural gas demand is set to continue increasing

Per Lindberg, Statoil
Abstract: High gas prices over long periods of time will of course affect interfuel competition to the benefit of coal, nuclear and alternative energies. But environmental concerns and the superior economics of combined cycle gas turbines in power generation will for the foreseeable future keep the competition to gas at bay. Though certain emerging markets will see the highest gas consumption growth rates, North America and Europe will likely see the biggest increments in gas use. Indigenous North American and European gas supply will hardly grow at commensurate rates, judging by the signs that US L48 production is leveling off and that UKCS production is heading for decline. This will cause rapid growth in international gas trade in general and intercontinental gas trade in particular. The international oil and gas companies are prepared for the challenge, and with gas reserves in ample supply and LNG costs coming down, gas shortages, price spikes and long term demand destruction do not need to occur. Considering the distribution or world gas reserves, importing countries will likely become increasingly dependent on the same small group of exporting countries for their gas supply as they now rely on for their oil supply. This outlook raises certain supply security issues. In response, IOCs must be enabled and incentivised to reinforce E&R in the world's remaining underexplored areas. Statoil has in this respect a particular interest in the Arctic waters off North Norway. Moreover, the emphasis on cooperation at all levels, transparent regulation and supply risk management through, for instance, supply route diversification need to be further strengthened. Finally the remaining tensions between the merits of gas market liberalization and the importance of secured long term offtake for the realization of increasingly long and complex supply chains, need to be worked out. Introduction The global demand for energy is increasing and is expected to increase at a considerable pace over the next 25 years. The International Energy Agency, IEA forecasts an increase from 10350 million tonnes of oil equivalents in 2002 to 16490 by 2030, (Figure 1). The price developments we have seen over the last few years are clear signals to that effect. Looking back in time, we can conclude that natural gas has been a winning fuel in terms of relative growth. The general consensus in most predictions today is that gas also represents an important growth component in the future. It might outpace coal over the next decade.

Global natural gas demand is set to continue increasing Block 3, Forum 13 paper

Figure 1: World Energy Demand in 2002 and Forecast for 2030, International Energy Agency In the Year Book of 2004, the IEA summarises the expected implication for natural gas in the following way: Consumption of natural gas world wide will double between now and 2030 Gas resources can easily meet the projected increase in global demand Inter-regional gas trade will triple over the period from now until 2030 Gas-to-liquids plants will emerge as a major new outlet for natural gas Cumulative investment needs for gas-supply infrastructure in the period will amount to $2.7 trillion or $100 billion per year

The numbers are staggering, but nevertheless in line with historical trends. This implies that the gas industry is a healthy, growing business with a bright future. However, a closer look at some of the underpinning fundamentals governing the gas industry today could lead to the following statements. Traditional gas reserves connected to the big gas markets are entering a phase of stagnation and decline. New supply will face increasingly longer distances and a considerable portion of seaborne deliveries to the markets Gas prices have experienced a dramatic increase over the last two to three years, driven by high crude oil prices, but also by a concern for cost and timely availability of additional supply Under sustained high prices, the position of natural gas as the preferred fuel for future power generation is challenged by alternatives based on coal and nuclear

At the outset, these statements could lead to quite different conclusions about the future. In the following, four aspects will be reviewed with the objective to analyse the challenge ahead for the gas industry related to meeting the demand: Price developments in Europe and the United States (US) Perspectives on demand for power generation Security of supply Industry response

Global natural gas demand is set to continue increasing Block 3, Forum 13 paper

Price Developments The formation of prices for natural gas differs between markets due to different market philosophies and regulative frameworks for the gas industry. In North America de-regulated the gas industry early and prices have been determined by supply and demand in a liquid market over many years The United Kingdom (UK) de-regulated its gas market in the 1990s and a liquid spot market has been in function since mid 1990s governed by supply and demand of gas In Continental Europe, gas prices have been and still are directly linked to oil products. In Asia, import prices for Liquefied Natural Gas (LNG) have been linked to oil or oil products.

Figure 2: Price Developments for Crude Oil, Coal and Natural Gas from 1995 Based on historical development of gas prices compared to that of crude oil, (Figure 2), it is clear that the general level of crude oil price (and oil products) have played a significant role for the prices of gas also in de-regulated market environments. Short term events such as cold winters have from time to time driven the price of gas away from the underlying longer term fundamentals related to oil as the main alternative to burning gas. With relatively comfortable absolute levels of crude oil prices throughout the 1980s and 1990s compared to today, gas has emerged as a competitive and preferred fuel for many applications given its affordability and its superior environmental characteristics. We have experienced a considerable penetration of gas in the residential, commercial, industrial and the power sector. In Europe this provided for an increase in demand of almost 200 BCM/year or almost 70% between 1985 and 2002 and in the US of more than 200 BCM/year or 35% over the same period. In most forecasts like that of the IEA, this trend is expected to continue also over the next 20 30 years. Natural gas has passed through the stages of being a bi-product from crude oil production to an affordable alternative to fuel oils with superior environmental characteristics into a preferred energy component for heating, cooking, processing and electricity generation in all the big energy markets. If we examine the price developments over the last two to three years in Europe as well as in the US, we observe significant differences compared to the 1990s, (Figure 2 and Tables 1, 2, 3). The general levels of the price of natural gas have increased in the three market places

Global natural gas demand is set to continue increasing Block 3, Forum 13 paper obviously driven by the increased crude oil and oil product prices, but also from an emerging concern for future supply. There is also a significant increase in the price of coal confirming the increasing need for energy in the world. The German border price is a reference for price development in Continental Europe, where prices in general are indexed to oil products. The National Balancing Point quotation is the UK spot price reference of a de-regulated market environment and the Henry Hub quotation is the US spot price reference in the main producing area in the de-regulated US gas market. German Border Price for Natural Gas $/MMBtu
Min. in period Max in Period Average in Period

1995- 99
1,77 3,23 2,54

2000- 05
2,00 5,60 3,63

2003 05 (April)
3,25 5,60 3,94

Table 1: Average Border Price of Gas to Germany, World Gas Intelligence

Spot Price for Natural Gas in the UK* $/MMBtu

Min. in period Max in Period Average in Period

1995- 99
1,47 2,84 1,80

2000- 05
1,75 6,98 3,53

2003 04/05
2,40 6,98 4,36

2006 - 07 (Forward)
5,86 12,05 7,86

Table 2: Spot Price for Gas in the United Kingdom, IPE NBP Nat Gas Monthly Rollover Series 1st Month Close

Spot Price for Natural Gas in the US* $/MMBtu

Min. in period Max in Period Average in Period

1995- 99
1,43 3,65 2,23

2000- 05
2,19 8,65 4,83

2003 04/05
4,67 7,61 5,98

2006 07 (Forward)
6,34 7,99 7,11

Table 3: Spot Price for Gas in the United States, NYMEX Henry Hub Nat Gas Monthly Rollover Series 1st Month Close

There is a clear development towards higher prices over time for all three markets with a stronger ascending trend for the UK and the US. On average, the price for natural gas during the first four to five years of this century compared to the period 1995 to 2000, has been more than 40% higher in Germany, more than 90% higher in the UK and almost 100% higher in the US. The latest period from 2003 to 2005 shows even higher average prices in all three markets and forward prices as quoted in May 2005 point at additional increases in the UK and the US. A likely implication from these observations is that the perception of natural gas as an affordable fuel in ample supply is subject to change. The rather spectacular rise in gas penetration into households and the power industry together with forecasts for a continued increasing demand have brought attention to the future price and supply sides of the equation to a higher degree than in the past.

Perspectives on Demand for Power Generation Considerable volumes of new gas have penetrated the power sector over the last two decades and this historical trend is expected to continue, (Table 4). Gas Demand for Power Generation BCM/year
OECD North America OECD Europe Total

1985
90 40 130

2002
207 135 342

2020 (Forecast)
405 278 683

Table 4: Gas Demand for Power Generation, International Energy Agency 2004

Global natural gas demand is set to continue increasing Block 3, Forum 13 paper Expectations for demand in Europe and the US are massive. Even relatively modest growth rates will imply big incremental volume needs given the size of these markets with 500 and 700 BCM respectively of annual demand. In particular growth for power generation needs is expected to be the main force driving future demand, (Figure 3).

Figure 3: Demand for Natural Gas in OECD North America and OECD Europe In 1989 a directive in the European Union that restricted the use of gas for power generation was lifted. With the new Combined Cycle Gas Turbine (CCGT) technology and de-regulating markets for both electricity and gas, the UK experienced a dash for gas in the 1990s. The same trend but on a bigger scale was experienced also in the US. Massive power generation capacity was developed based on expectation for electricity demand and reasonable gas prices. Today the UK possesses more than 20 Giga Watt (GW) of gas fired power. Spain and Italy have experienced impressive trends in the use of gas for power in recent years. In other big gas markets, Russia and Japan, gas has been an important fuel in the power sector for several decades. In the US, more than 180 GW of capacity was developed between the mid 1990s and today. Economics for base load gas fired power plants were competitive at the point of investment decision. Their efficiency, relatively small size and environmental characteristics made gas the preferred alternative for the generators. Over less than 20 years the amounts of natural gas penetrating the power sectors have more than tripled in Europe and more than doubled in the US. Even so, increased fuel prices have left a considerable portion of installed capacity idle or in peak mode due to deterioration in their economics and/or a shift up the merit curve. The economics applied during planning did not materialise after start-up when the variable (fuel) costs play a big role for the plants position in the merit order. The increasing gas prices have made gas fired capacity less competitive than expected. A look at power plants under construction and in planning in Western Europe does not necessarily underpin a dramatic increase in gas demand across the board in the short to medium term. Currently a total of 26 GW with a combined potential use of approximately 35 BCM/year of gas is under construction in Western Europe with more than 75 % of the capacity being built in two countries; Italy and Spain.

Global natural gas demand is set to continue increasing Block 3, Forum 13 paper Energy policies in Europe have continued to underpin the use of gas in the power generation due to: The EU Large Combustion Plant Directive restricting emissions of nitrogen oxides (NOX) and sulphur dioxide (SO2) emissions and thereby increased costs for coal fired capacity. CO2 emissions trading with emission caps fixed in National Allocation Plans and tradable emission permits Phase out of nuclear power in some countries like Germany, Belgium, the Netherlands and ban on nuclear power in Italy

The European countries have quite different starting points for compliance with the Kyoto Protocol and will face different consequences of prices for emission quota under the Emission Trading System. Actually, the market price for carbon quota has tripled over the first four months of 2005. The relative tax burden of gas compared to other fuels, possibility to de-mothball idle capacity, policy for renewable sources of energy and possibilities for delayed phase-out or even plans for new base load nuclear capacity are other factors that differ across European markets. The future of the Kyoto Protocol after 2012 is a common uncertainty for all. The high prices of natural gas over the last two to three years have to some degree offset the advantages attributed to gas. At this point the German utilities consider natural gas too expensive to stand the competition with coal. In Spain and Italy natural gas seems to be the fuel of choice for power generation in order to achieve compliance with the Kyoto Protocol and relevant EU directives. The emerging debates of new nuclear capacity both in the US and in Europe are other examples of an emerging challenge facing natural gas future position as a preferred fuel in the power sector. Security of Supply In 2003, the global demand for natural gas was more than 2800 BCM or approximately 2.8 TCM/year. According to the IEA forecast of last year this could rise to 4.6 TCM annually by 2030. European gas consumers have relied on indigenous reserves, Russian supply developed under a command economy and Algerian gas for southern Europe over the past 35 years. The US has built its gas industry mainly on domestic reserves and imports from Canada. Transportation by pipelines has dominated the gas trade in Europe and in the US. The Asian markets are to a much higher degree supplied by liquefied natural gas (LNG). A review of remaining proven reserves and their geographical distribution, (Table 5) is a guide to where the future supply will be produced and the pattern of trade that can be expected.

Global natural gas demand is set to continue increasing Block 3, Forum 13 paper

Country and Region

Proven Remaining Reserves in (BCM)

47592 2011 55314 2086 1756 5497 26629 25779 71448 4986 4547 13499 2558 2125 10876 5355 1603 7379 4278 733 7097 171110

Gas Production 2003 (BCM/year)

608 59 768 77 73 334 78 31 256 20 87 150 80 50 286 542 182 766 24 23 120 2680

Reserves/Production Ratio (Years)

78 34 72 27 24 16 342 842 279 228 19 90 32 42 38 10 9 10 177 31 59 64

Russia Turkmenistan Total FSU Norway Netherlands Total Europe Iran Qatar Total Middle East Nigeria Algeria Total Africa Indonesia Malaysia Total Asia Pacific US Canada Total North America Venezuela Trinidad & Tobago Total South America Total Global

Table 5: Proven Remaining Reserves, Gas Production 2003 and Estimated Reserves/Production Ratio, Oil & Gas Journal 2004 Reserves; IEA Natural Gas Information, 2004 - Production

Ample reserves are available on a global basis. At the same time, the biggest markets in North America and Europe are entering a phase where traditional supplies are in decline and replacement volumes and incremental needs will have to be delivered from new and more distant sources.

Figure 4: Geographical Distribution of Proven, Remaining Gas Reserves, Oil & Gas Journal 2004

Global natural gas demand is set to continue increasing Block 3, Forum 13 paper The gas price development in the US is a reflection not only of a higher level of crude oil and product prices, but also for the future domestic production potential and associated costs. Increased import from Canada is not an obvious alternative since future Canadian needs including use of gas for heavy oil extraction must be taken into account. With a perspective of 2015 and beyond, new resources need to be taken into account on a large scale at the same time as some of the production corner-stones of Europe enter into decline. The West Siberian giants Urengoy, Yamburg and Medvedzhye with a combined production of more than 400 BCM/year are on decline and expected to yield less than 100 BCM/year by 2030. In the UK, a production of over 100 BCM/year in 2003 is expected to decline to less than half of that by 2015. Algerian and Norwegian production are still in a phase of growth, but will inevitably face a decline in existing capacity. There is still ample supply in the European hemisphere, but distance will be a factor when the European consumer must turn towards new Russian capacity from the Yamal peninsula in northern West Siberia, Middle East, Central Asia and Africa, as well as offshore resources in the Barents Sea the for their incremental demand. With a climbing import dependency that can reach 70 % by 2030, an important factor in the security of supply equation will be the overall risks and impact on costs. These observations in combination with expectation for continued increasing demand are the reasons behind the concern for future security of supply in Europe. It is the justification for the EU initiatives to encourage new infrastructure developments for natural gas that can both secure and diversify future supply. Together with the currently high prices it is also the reason behind the new nuclear debate in the UK. Price development together with concerns for the future domestic production potential are the driving forces behind the renewed focus on LNG imports to the US, for the efforts to open up the environmentally sensitive North American Arctic areas for oil and gas exploration and for the new debate on nuclear power. With a total global demand of gas of close to 3 TCM/year today and a reserve base of 170 TCM there are still ample reserves of natural gas for more than 50 years, not taking into account considerable amounts of yet to find resources. The new features going forward is not the lack of resources, but distance from reservoirs to consumer, costs associated with such distances and long term dependence between new holders of big reserves and the importing countries.

The industry response The restructuring of the major oil and gas companies in the late 1990s and during the subsequent years into the new century provided economy of scale and increased financial strength. It further created a need for adding increasingly bigger reserves to the international oil companies portfolios in order to keep reservetoproduction ratios at a comfort level. Growing gas markets in both the US, Europe and Asia as well as increasing price level have provided for previously stranded gas to be monetized on the basis of LNG.

Global natural gas demand is set to continue increasing Block 3, Forum 13 paper

Figure 5: Development of Costs of LNG Chains and Size of Liquefaction Trains The gas industry, both operators and contractors have made considerable progress in bringing down costs for liquefied natural gas, (Figure 5). Unit costs for liquefaction have seen a cost reduction of 50% since the start of LNG trade. State of the art trains for liquefaction of gas to be put in operation by 2008 are almost two times the size of those from the turn of the century. The same is the case for the size of LNG vessels. This will provide for the Middle East, notably Qatar and other regions overseas to become key suppliers towards Europe, Asia and to the US. In general, we have seen radical cost cutting technological advances in drilling technology, subsea production and transportation of unprocessed well streams, increased efficiency in operations and capacity utilisation, new field development concepts and enhanced recovery of oil and gas. Statoil has contributed to and benefited from the technological evolution in the offshore arena. It has allowed us to increase capacity in offshore transportation, reducing costs and reaching reservoirs in deeper waters and in more remote locations from the markets. It has allowed us to connect offshore reserves over long distances directly to markets in the UK and Continental Europe. A combination of advanced subsea production and new LNG technology has provided for the development of Europes first liquefaction plant and the first development in the Barents Sea with planned deliveries to the south of Europe and to the US market from 2006, (Figure 6).

Global natural gas demand is set to continue increasing Block 3, Forum 13 paper

Figure 6: Illustration of the Snhvit LNG Project in the Barents Sea, Norway Snhvit was discovered early in the 1980s during the first exploration efforts in the Barents Sea. At 120 km from shore and thousand of kilometres from market, the Snhvit resources were characterised as stranded gas for more than 15 years. Technology and the development in the markets on both sides of the Atlantic basin after 2000 were key factors in bringing the project forward to an investment decision. This illustrates the potential for monetizing previously stranded gas resources in several parts of the world on the basis of technology and favourable market conditions.

Figure 7: Illustration of the Barents Sea In case of Snhvit, the development is also a gateway into the greater Barents Sea, (Figure 7) and a first step to unlock an expected huge resource potential of oil and gas both in the Norwegian and the Russian parts of the Arctic. We observe considerable efforts in North Africa and in Russia that will bring forward new supply to Europe by pipeline and into the Atlantic Basin as LNG. Several LNG receiving

Global natural gas demand is set to continue increasing Block 3, Forum 13 paper facilities are under construction or being planned in Continental Europe from Belgium in the north to Italy and Greece in the south In the UK, several initiatives from the industry including new pipelines and new LNG receiving facilities are in progress and might even lead to excess capacity into the UK market for some time. The US government has taken steps to facilitate the construction and utilization of new LNG receiving facilities. The industry has responded by proposing more than 40 new plants for receiving LNG. Not all will be built, but sufficient new capacity can be expected to secure the incremental supply that the US market will need. In Statoil, we look at these trends as a result of market forces put in motion based on clear signals on price and demand as well as expectations of well defined regulatory environments in both producing regions and in the markets. What we observe in the LNG business today are good examples of how the industry responds in order to secure future necessary supply. The contribution from the authorities, federal, national as well as European, must be to providing predictability in fiscal terms, transparency and regulatory regimes that facilitate development of new production, removal of infrastructure bottlenecks and development of new import capacity.

Concluding remarks The natural gas business can look back at an impressive track record. Natural gas has gained position as a preferred fuel and the future perspectives are good. At the same time, high energy prices and declining reserve/production ratios in the biggest markets have triggered understandable concerns for future energy costs and the security of supply. In the power sector where natural gas is expected to play a key role in meeting future demand for electricity, current price levels and distances to new supply have increased the attention to alternative methods for power generation. The industry having worked successfully to build the impressive market position of gas of today and is responding on a massive scale in order to continue to secure ample and timely supply to consumers across the globe. New trade patterns will emerge in the coming years. Liquefied natural gas will play an increasingly important role and provide for cost efficient supply from long distances. We will see the Atlantic basin and the Pacific more and more playing the roles for natural gas as they are for crude oil today. New countries and regions will join the traditional producers in securing supplies to the US and Europe. We will see increased competition providing for continued efficiency in the industry and to the benefit of the consumer.

References 1 2 3 4 Bjrnson Rune, Presentation to the 11th Annual Flame Conference, 2005 Amsterdam International Energy Agency, World Energy Outlook, 2004 US Department of Energy, Annual Energy Outlook, 2005 Oil & Gas Journal December, 2004