CHAPTER 1 PRODUCTION AND MARKETING OF NATURAL GAS IN THE US SURVEY OF RECENT TRENDS AND DEVELOPMENTS
| Jurisdiction | United States |
(May 2005)
PRODUCTION AND MARKETING OF NATURAL GAS IN THE US SURVEY OF RECENT TRENDS AND DEVELOPMENTS
Hua Fang
John Rohrbach
Lukens Energy Group, Inc.
Houston, Texas
Jay P. Lukens is an internationally recognized expert in natural gas markets and regulation. As President and founder of Lukens Energy Group (LEG), he brings to the firm over twenty years of diverse, senior-level corporate and consulting experience within the energy and telecommunications industries. Dr. Lukens has worked with the senior management of major energy companies in evaluating mergers, acquisitions, and market entry strategies. He advises clients on issues of business strategy, energy policy, regulation, business development, and business process improvement. Dr. Lukens has provided testimony as an expert witness to state and federal courts and regulators on a wide variety of issues related to energy markets, including antitrust, analysis of market competition, and economic damages.
Prior to founding LEG in 1999, Dr. Lukens was a principal and Managing Director of The Economics Resource Group, Inc. (ERG), where he founded ERG's Houston office and led a number of major consulting engagements with energy companies. Before ERG he worked as Senior Vice President of Planning and Rates with Transcontinental Gas Pipe Line (Transco). During his eleven years with Transco he directed the company's market development, strategic planning, rates, and federal regulatory affairs. Before joining Transco, Dr. Lukens was employed by AT&T Communications in an internal consulting group called the Analytical Support Center.
Dr. Lukens earned his Ph.D. in Economics from Texas A&M University (1981) and his B.A. in Economics from Eckerd College (1977).
I. INTRODUCTION1
A. Recent Trends and Developments
1. We are living in an era that has been referred to as the "Natural Gas Age." Because of a large inventory of discovered but heretofore "stranded" gas reserves, and because of the superior environmental characteristics of gas relative to other fossil fuels, gas is projected to take an increasing share over the next 25 years of the growing world energy market. North America will remain the world's largest gas economy, but growth in North American gas demand will lag far behind growth in developing economies across the globe. On the supply side, North America is a mature region for conventional production of hydrocarbons. Although natural gas prices increased over 200% over the period 2000-2005, natural gas production increased by only 4.5% over the same period. Thus, it is reasonable to expect that virtually all of the new production to meet global demand growth will come from sources outside of North America. In certain important respects, the North American gas industry in 2005 bears resemblances to the oil industry in 1970. It appears inevitable that the US will continue to become increasingly dependent on imported energy of all forms, including liquefied natural gas (LNG) and other technologies that render gaseous hydrocarbons transportable in a liquid state.
2. While future trends in the structure and performance of the production and marketing phases of the US natural gas industry will inevitably be driven by the forces of globalization just described, the current state of the industry results from events in the recent past. The watershed event that defines the current era is the fall of Enron in late 2001 and the resulting meltdown of Merchant Energy throughout 2002-2003. The Merchant Energy era was defined by relatively low commodity prices, belief in the social value of energy sector deregulation, and the creation of large energy conglomerates that depended on mark-to-market accounting for earnings growth. The current post-Energy Merchant era is defined by high commodity prices, retrenchment in energy sector deregulation at the state and federal level, and a "back-to-basics" strategy among large midstream companies. Liquidity in natural gas spot markets and in energy derivative contracts is lower than it was during the Energy Merchant era, and most of the trading that is done is conducted by large financial houses or affiliates of major energy producers.
3. The abrupt end of the Merchant Energy era left many commercial issues in the natural gas market partially unresolved and in a state of transition. For example, during the Merchant Energy era local gas distribution companies came to rely on short-term contracts for pipeline capacity and gas supply. Shortening on the tenor of contracts was influenced by several factors, including the risk of stranded costs resulting from implementation of retail choice and availability of liquid spot markets made possible through the participation of Merchant Energy. As we look forward to a gas market increasingly reliant on imported supplies it is not clear that short-term contracts will remain the dominant form. Retail choice is waning, short-term markets are less liquid than during the Merchant Energy era, and world-standard LNG contracts call for long-term "hell or high water" purchase commitments from buyers. It will be very interesting to see how these issues are worked out in the regulatory arena and in commercial negotiations. Will state regulatory commissions eliminate risks to LDCs from holding long term contracts with pipelines and gas suppliers? Will LNG importers invest in storage and pipeline transportation assets to give LDCs assurances of delivery? Will Merchant Energy reemerge to act as a middleman between LNG importers and gas purchasers, absorbing risks from both sides in return for a fee?
4. The trends that portend increasing reliance on natural gas imports, on the one hand, and the resolution of the issues associated with the abrupt end of Merchant Energy, on the other hand, will define the strategic debates among gas market participants over the next decade or more.
B. The Value Chain for Natural Gas
The natural gas value chain is traditionally broken down into
1. Production -- Flowing gas through the well bore for disposition off the lease site.
2. Gathering -- Moving the gas by pipeline from the lease to the points downstream.
3. Treating -- Treating involves removal of water, inert gases or other contaminants from the gas stream to render it acceptable to third party pipelines. Treating can be done on the lease or at a common facility in the production field, i.e., treating can be done before or after gathering.
4. Processing -- Processing involves removal of some or all of the heavier hydrocarbons that may be entrained in natural gas production. Processing can be accomplished during the gathering phase or during the transmission phase.
5. Transmission -- Transmission involves movement of the gas downstream of gathering facilities for re-delivery to end use consumers or LDCs. Transmission pipelines typically operate at higher pressure than gathering lines, are constructed of larger diameter pipe, and move gas over greater distances than gathering lines.
6. Marketing -- Marketing involves entering into contracts to buy and sell natural gas. Gas markets exist at all points along the value chain, from the lease to the delivery points at the facilities of end users. It is common for a unit of gas to be bought and sold multiple times as it moves from the lease to the location of final consumption.
C. The Value Chain for Natural Gas Liquids ("NGLs")
1. NGLs are produced in conjunction with the production of natural gas in three ways:
a) As liquids that flow from the well head along with natural gas production. Such liquids are typically collected by the producer at the lease and transported via truck, barge or pipeline for further disposition.
b) As liquids that precipitate naturally from the gas stream in the gathering or transmission pipeline due to pressure, temperature, or elevation changes. In particular, wells with high well head pressures will keep NGLs entrained in the gas stream. Some or all of the heavier hydrocarbons will naturally fall out of the gas stream as pressures fall in the pipeline. NGLs are removed from the pipeline at slug catchers or other liquid separation equipment operated by the pipeline. The ownership of such liquids is typically addressed in the tariff of the pipeline that collects them.
c) As liquids that are made to fall from the gas stream through operation of gas processing equipment. Such equipment manipulates pressure and temperature of the gas so as to produce NGLs. Gas processing equipment may be owned by the gathering or transmission pipeline, by the producers (although it is relatively uncommon for gas processing to occur at the lease), or by third parties that operate gas processing equipment for a fee.
2. Typically producers own the NGLs in the first instance. Gas produced from the lease and tendered to the pipeline is measured based on its thermal content. NGLs have higher thermal content per unit volume than the principal component of natural gas, methane. A producer that lays claim to its NGLs at a point away from the lease must replace the thermal...
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