OGPSS - future natural gas supplies and Cyprus

This post began as a view on the developments in Cyprus, and I am grateful to Gail for the suggestion, and it is my fault that it morphed a little from that simple original objective.

One of the problems that one faces in marketing natural gas is that there is so much of it coming onto the market that it makes it difficult to set a price for future production. Even when the fields and reserves are estimated to be large, having some confidence in the price that the gas will bring helps provide confidence, in turn, with investors that there will be a positive return on the cost of bring that gas to the market. However, once that initial commitment is made to invest the money, then the need for a return often drives an expeditious program to bring in revenue, even if the market is already reasonably well supplied. Prices may then fall, and the investment becomes a losing one.

The current cold weather in the United Kingdom, and the threat of gas rationing has raised the price some 30% this month and the market appears lucrative. But the UK market, in the short term, can be rescued by 3 tankers of LNG from Qatar with more available if needed. (Provided it is ordered soon.) And then, though there remains a need to refill storage, the crisis will be over for now, and the price will likely fall back. (Although likely not completely since the UK is in process of shutting down coal-fired power stations to comply with EU edicts and natural gas is the replacement fuel of the moment.) Looking further down the road Centrica, a major energy supplier in the UK, has agreed to a 20-year agreement with a US supplier to buy LNG from the US (out of the Sabine Pass terminal). This would take a fifth LNG train, at a facility where the first train is expected to come on line in 2015, and the second in 2016. Each train has a liquefaction capacity of 4.5 million tons pa or 220 bcf of NG, and customers have already been found for the first four trains – again for a 20-year period. The UK supply is therefore not anticipated to start until 2018.

In the meantime Qatar has no plans to increase production in the face of the overall growing glut in supply, although it potentially could. And this availability of alternate supply is not good news for the Big Daddy of natural gas exporters, those in Russia. Russia has already seen Turkmenistan sell its natural gas to China directly, rather than through Russian middlemen. To date this has reached 1.7 tcf with further expansion in the works.

To make the situation more volatile the natural gas discoveries in the eastern end of the Mediterranean over the course of the last five years have been found to be of increasing size, as exploration continues.


Figure 1. Relative location of the gas fields (the green region) being explored in the Eastern Mediterranean (Google Earth)

Three of these fields, Leviathan, Tamar and Dalit are in Israeli waters, while the fourth, Cyprus A, belongs to Cyprus.


Figure 2. The location of the different fields that are being developed by Noble Energy in the Eastern Mediterranean.

In terms of relative size, Cyprus A is at 7 tcf, Leviathan was initially projected at 17 tcf, Tamar at 9 tcf and Dalit is at 0.6 tcf. Since the original projection Leviathan has now been increased to 15 to 21 tcf, with a likely value of 18 tcf.

The Russian natural gas heavyweight, Gazprom has not been neglectful of these developments, occurring as they do in a region where it would not be difficult to challenge their supplies into Southern Europe. Thus Gazprom has been the high bidder in a project to float an LNG plant over the Tamar field and to liquefy that gas so that it can be sold into Asia. The goal for the start of that project is in 2017.

Turning to Leviathan, which is expected to come on line in 2016, with 750 mcfd being supplied to Israel. The interesting question is what to do with the rest. There is talk of a pipeline to run up into Turkey and thence on into Europe. This would have the advantage of further diminishing the European dependence on Gazprom and Russian gas, but there are some political problems. One is that the pipeline would run through the Greek controlled waters off Cyprus, another is that Turkey gets most of its natural gas from Russia and Iran, and they would be displeased. (Though it would help Turkey over the difficult problem of Iranian sanctions).


Figure 3. A pipeline to send the natural gas to Turkey (Mining.com)

When one looks at the Cyprus field, with these ramifications going on in the rest of the global gas market, it becomes a little more evident why Russia has not been willing to dash into the financial scene and bail the Cyprus economy out by buying a future stake in the Cyprus natural gas.

There was an alternative proposal (H/t Gail) for the pipeline to run instead through Cypriot waters and then on up into Europe directly.


Figure 4. An alternate route for the natural gas to reach Europe. (John Galt )

With Cyprus in a financial mess they offered their natural gas to Russia, as part of the security for immediate help. In the end Russia did not bail out the Cypriots. At the same time that Cyprus was talking to the Russians they were also talking with the European Union, and it appears that perhaps the threat of Russian control of Cypriot gas helped expedite an EU rescue move.

There is, I believe, more in this for the EU than for Russia. The benefit to Russia would come more from controlling a relatively small amount of competitive natural gas, at a time when they are trying to maintain the market for their own. And while they likely did not anticipate the hit that Russian bank deposits are taking, the overall cost to them does not translate into an adequate return on the investment that they would have had to make to keep Cyprus stable.

On the other hand this has benefits for the EU if it can further expand the availability of an alternate source of supply to that from Gazprom, then they can possibly lower future projected prices for natural gas. Set against which is the history of Gazprom sitting on the sidelines waiting for an investment opportunity later in the game, and then stepping in and gaining control for a lower price. It will be interesting to see how this one plays out.

A new Massachusetts Senator and energy policy changes

The fate of coal fired power plants is one of those questions that continues to have answers hidden in the fog of their political future. And the election tonight of a Republican Senator from Massachusetts raises some interesting questions about that future. Not the least of these will be the fate of cap and trade legislation, which was already in some trouble in the Senate. And one wonders if it will have any impact in the ongoing debate about the Cape Wind project. This project, to raise a wind farm in the area off the coast of Massachusetts that the late Senator Kennedy and his family apparently sailed in, has been stalled for some nine years since it was first conceived. The process recently ran into another bump with the National Park Service agreeing that the area is eligible for listing as a historic site.

The 560-square-mile area is the first swath of ocean to be determined eligible for listing on the National Register of Historic Places. That decision Monday, based on the sound’s cultural and spiritual significance for two Wampanoag tribes, means the 130-turbine Cape Wind project and all future activities in the Sound that require a federal permit will now have to consult with the Native Americans and try to minimize the impact of projects on the protected area. That consultation will be required even if the sound is never actually formally listed on the register.

The Secretary of the Interior has now met with the Indian tribes, and the proponents of the plan and has promised that there will be a decision before the end of April. The eligibility ruling is apparently somewhat unusual, and has additional consequences relating to fishing and the use of ferries that go well beyond the wind farm issue, and no doubt tonight’s result may also have some impact. But we should find out before the end of April what that might be.

Not all political futures are as quickly resolved. One of those that has been dragging on is the one I started with, that of cap and trade, and Foreign Policy in a major review of the accomplishments of the Obama Administration in the energy field have not been overly kind in their review. And while the election may move cap and trade even further from a Senate vote, the article goes into considerable more depth in considering some of the other perceived failures of the past year.

Here is the back story of how the Obama administration dramatically raised and then dashed America's -- and the world's -- hopes that 2009 would be a pivotal year for remaking our collective energy future.

It has a much more realistic view of the consequences of actions to date, and while it considers that Secretary Chu is a voice of reason in the debate on the energy future, considers that he is a lone voice, and a largely unsuccessful one against the “partisans of the past.”

Virtually every other key policy role was filled by environmental regulators -- former Environmental Protection Agency (EPA) head Carol Browner as climate czar, former Browner aide Lisa Jackson as EPA administrator, and Nancy Sutley as chair of the White House Council on Environmental Quality.

The authors feel that the emphasis on energy conservation – a major plank in the immediate future – is part of “magical thinking” of the future where desired outcomes will occur almost at the cost of merely wishing them so.

In this view, energy efficiency pays for itself, solar and wind power are already nearly cost competitive with fossil fuels, and both can quickly and cheaply reduce emissions. This Pollyanna view of fossil fuel alternatives and efficiency, which makes going green seem cheap and easy -- little more than the cost of "a postage stamp a day" -- has provided the justification for green-policy advocacy that has overwhelmingly focused on pollution regulations and carbon pricing while ignoring serious investment in energy research and development.

Some of the roadblocks to the anticipated “magical change” in the energy supply of the country are already evident. The resistance to a wind farm in Massachusetts from the Democratic Establishment there; the blocking of sites in the Mohave Desert that would contain solar and wind farms by Senator Feinstein - to give examples on both coasts – illustrate some of the problems that the reality of renewable energy provision must get through in order to continue to increase the percentage power that it provides to the nation. (And it is still not nearly as much as the public perception of its impact has been, I suspect).

Unfortunately that is not the sum of the national woes. For in reading the Foreign Policy piece, what struck me was the lack of understanding on the part of the authors of the potential future problems of overall energy supply.

The grip of the “greens” on short-term energy policy will likely make it increasingly difficult to build new coal-fired power stations. Secretary Chu, driven in part I suspect by his own view of Climate Change, is focusing on finding long-term solutions to the provision of electric power, with the benefit that dealing funds to that aim helps his constituency in the National Labs. But in the process neither side pays much attention to the possibility of nearer term problems of energy supply.

But there are some warning signs (apart from the ones that I write about in most posts relating to the coming difficulty in producing enough oil to meet global demand – which Goldman Sachs now expects to happen next year). And these concerns are illustrated by example. For in the United Kingdom the power companies are requesting that some of the coal-fired and nuclear power stations be kept around after the European Union regulations require that they be closed.

"Given that the issue we are trying to grapple with is climate change, there is a question mark over keeping one or two of these oil or coal fired plants mothballed to secure supplies for a few days per year when we get these conditions," Golby (chief executive for E.ON UK) said.

"It might be a small economic and carbon premium worth paying for security of supply and getting us through this transition to a low-carbon energy system. It's something we have talked to the government about."

Golby's view is privately supported by many UK power station operators who fear a looming energy gap in a few years when old coal and nuclear plants have been closed but new reactors, clean coal plants and wind farms have not been built.

So the new Senator enters an arena where the debates, actions, and inactions of the next year or so may have a very significant impact on whether or not there is sufficient power in this country after 2015. Let us hope that he understands that.

The OFGEM Report - bad news which may be optimistic

As the year starts its move towards a close, there are an increasing reams of reports coming out that review aspects of the global energy supply. One of these came out in the UK last week. It is the report from the UK’s Office of Gas and Electricity Markets (OFGEM) on Project Discovery – which looks at four future energy scenarios for the UK.

The report recognizes that the UK has a growing problem. This is because there are two directives from the European Union, the Large Combustion Plant Directive and the Industrial Emissions Directive (pdf) that increasingly restrict the use of coal and oil-fired power plants, when, at the same time, some nuclear plants will also be closing which will lead to a reduced number of major power plants being available. New power plants take time to plan, permit and construct and the postponement of construction of the new power plant at Kingsnorth this past week merely underlines the coming problems.

And so OFGEM set out to see what the challenges and risks to the UK would be over the next twenty years. The report is the result of that investigation.

It looked at four scenarios based on two levels of economic recovery and two levels of investment in green technologies, which combine to the four scenarios examined.

The four scenarios OFGEM examined.

The scenarios had some underlying assumptions to allow dealing with the conditions that were imposed in the models. There is, for example, the assumption that investment for each scenario (which reaches 200 billion British Pounds (BP) for The Green Transition scenario) will be available and will allow the timely investment in power generating systems that meet the targets set. (As a source of reference the UK spent $8 billion BP in 2008 on utility capital investment for the green scenarios this will have to rise to 30 billion BP in 2019).

With an increased reliance on imported natural gas, where the domestic production falls short, there is also the assumption that this will be available – an area of concern in times of high demand in a severe winter. (And this winter may be one) This will, however, become more of an issue in the UK as it responds to the EU directives and loses a significant sector of its electricity generating power after 2015. The report notes that the market and the regulatory arrangements can well undergo severe testing as the nation moves out of the comfortable position it currently holds, with large gas reserve (by normal standards) and a robust gas infrastructure.

The investigation applied a number of stress tests, under the different scenarios, and evaluated their results. The results were summarized in the following figure:

OFGEM stress tests and their perceived results (Bacton is the UK gas import facility)

The designation 1 in 20 refers to the worst condition in the past 20-years with the peak day being the highest demand for energy on the coldest day; and the severe winter being a period of 60-days of exceptionally high natural gas (NG) demand.

While the rapid response and move to green energy both tighten the NG market, when there is not this initial high demand, then the evaluation is that the market will remain oversupplied, though tightening towards the end of the study period.

Perhaps the assumption that raises the greatest doubt is the one that crude oil prices rise to $130/bbl and then fall back, as upstream investments provide the additional supplies needed, to a price of $110/bbl. They cite the IEA and the EIA models as justification for these assumptions, which apply to the rapid growth scenarios. When there is a slower rebound of the economy, then oil prices are anticipated to stabilize at $90/bbl (and they point out that the EIA is predicting that it would actually fall to $50/bbl).

The peak price that they see for NG is 100p/therm under the rapid growth scenario, while carbon dioxide prices are set at 50 BP/ton by 2025 (assuming a global agreement at the meeting in Copenhagen this winter).

In assuming that adequate NG will be available it appears that they are assuming that all the gas pipelines projected will be funded and adequately supplied at full capacity (something that is currently quite questionable for Nabucco, as but one example – though Nabucco only becomes necessary under the rapid demand scenarios), though they also assume that LNG will be available to fill any shortfalls, and that NG will appear from the Yamal fields in the time and quantities predicted (either 2013 or 2014).

OFGEM assumed European supplies of natural gas

In all scenarios they recognize that there must be an increase in the amount of NG supplied from Russia, though, as noted, there is an assumption that there will be enough LNG to make up any shortfall. (Global demand is expected to double or treble by 2020 – to somewhere between 350 bcm and 700 bcm/year – and largely the USA takes care of itself).

As with many of the models of an energy future this one includes the caveat

provided the market participants respond adequately to market signals

but with those responses governed also by perceptions of future politics, and the potential limitations of future supply, that caveat may well cover a multitude of unpleasant outcomes. Yet this is recognized also realistically (but with no real current solution being available to provide an answer).

there are security of supply risks within each scenario, but as important is to consider the implications for security of supply resulting from the huge range of uncertainty that the scenarios cover. For example, by 2020 gas demand could be as low as 77 bcm/yr or as high as 113 bcm/yr depending on the scenario, low carbon generation could make up anywhere between 21% and 52% of the mix, the levels of investment required in the GB energy market (excluding upstream investment) could range between £96bn and £200bn depending on the extent of environmental actions. Together with more traditional risk factors such as commodity prices and project risks, this means that investors face difficult decisions before committing large sums of capital to new projects.

The way in which these events unfold in the UK is that report is now open to public comment with specific questions being identified that OFGEM is interested in getting answers to.

It will be interesting to see how this plays out, though I fear that some of the assumptions that have been made as the review progressed are a little optimistic about future supplies of oil and natural gas.

Although it has the highest investment cost, it appears that the Green Transition is perceived as giving the best outcome:

The Green Transition summary

While perhaps the dash for energy scenario projecting the worst outcome:

The Dash for Energy summary of outcomes

It will be interesting to follow the story, and see how Britain reacts, given that, as the report notes, while the time for decision is here, the conditions are still pleasant, and the urgency of the situation is not yet apparent.