Long-term Contracts in the Natural

Gas Sector: An International Survey

Add picture on

dark green area

(see slide 9 for

an example)

29 May 2015

BELEC

Anne Neumann, Sophia Ruester, and Christian von Hirschhausen

With research assistance by Julia Rechlitz and Astrid Cullmann

DIW Berlin (German Institute for Economic Research)

And Berlin University of Technology, Workgroup for Infrastructure Policy (WIP)

- 2 - Kennedy-School, Lunchtime Seminar Energy Policy

05 November, 2012 Christian von Hirschhausen

Agenda

1) Intro: Natural Gas as a Key to the Energy Transformation (in

Europe)?

2) A Long-Term Issue of Long-Term Contracts (LTCs)

3) Data and Simple Estimations

4) A Closer Look

5) Conclusions

- 3 -

Natural Gas in the World - Consumption

Source: Own depiction based on IEA (2013)

Increasing global demand for natural gas.

- 4 - Prof. Dr. Christian von Hirschhausen

January 2013

Share of Gas in Electricity Production in the EU scenarios

Source: EU Energy Roadmap

0%

5%

10%

15%

20%

25%

2010 2015 2020 2025 2030 2035 2040 2045 2050

Reference Scenario Diversified Supply Technologies High RES Scenario

- 5 - Prof. Dr. Christian von Hirschhausen

January 2013

The Fuel of the Future? Egging, Holz, Richter (2012)

- 6 - Berlin Lunchtime Seminar “Natural Gas”

15 May 2012

Agenda

1) Intro: Natural Gas as a Key to the Energy Transformation (in

Europe)?

2) A Long-Term Issue of Long-Term Contracts (LTCs)

3) Data and Simple Estimations

4) A Closer Look

5) Conclusions

- 7 -

onshore

offshore

Processing Im

port

s

Export

s

Inje

ction

Withdra

wal or

Production Transmission Distribution

Compressor

stations

Small consumers

(residential,

commercial)

Industrial

consumers

Electricity

Generation

The Industry

Storage

Source: Own depiction

- 8 -

Take-or-Pay Contracts

Producer Importer

Contract

Deliveries according to

negotiated price

Price risk

Payment of ex ante

defined quantity

Quantitiy risk

- Take-or-pay quantitiy

- price fixing to substitutes

- Swing-option

- price adjustment clause

Quasirents, Hold-up problem

- 9 -

Globalization of Natural Gas Markets – Just a „Dream“?

- 10 -

Structural Changes in the Industry

Mature industry

- Significant cost reductions in transport, in particular LNG

- Decreasing asset specificity of infrastructure investments

Regulatory framework

- Development of spot markets and short-term trade

- Market entry

- Flexible pricing mechanisms

Simplified value added chain:

Production Transport Trade Distribution Sales

Reduced reliance on long-term contracts.

- 11 -

Literature

• Long-term contracts as solution to „hold-up“ problem without vertical integration

(Klein, Crawford, and Alchian, 1978, Williamson, 1979)

• Asset specificity, uncertainty, opportunistic behavior, bounded rationality

(Williamson, 1975, 1985)

• Joskow (1987): contract duration in North American coal mining industry

• Masten and Crocker (1985), Crocker and Masten (1988): inverse relation of

contracted volumes and contract duration in US natural gas industry; Mulherin

(1986), Hubbard and Weiner (1986), Doane and Spulber (1994): impact of

sector specific regulation on long-term contracts in US natural gas industry

• Neumann and von Hirschhausen (2004, 2008)

• More recently: Polo and Scarpa (2013), Hartley (2015)

Hypothesis: shortening contract duration due to changes in

market structures, à la Joskow

- 12 -

Agenda

1) Intro: Natural Gas as a Key to the Energy Transformation (in

Europe)?

2) A Long-Term Issue of Long-Term Contracts (LTCs)

3) Data and Simple Estimations

4) A Closer Look

5) Conclusions

- 13 -

Decreasing Contract Duration over Time?

Year Contract signed

Con

tract D

ura

tio

n

- 14 -

Data Documentation Long-Term Supply Contracts (DD-LTCs):

An Overview

0

5

10

15

20

25

30

0

20

40

60

80

100

120

140

160

1963-1972 1973-1982 1983-1992 1993-2002 2003-2013

Pipeline LNG Durchschnittliche Laufzeit (Pipeline) Durchschnittliche Laufzeit (LNG)

- 15 -

DD-LTCs: by Start-up Delivery Year and Type

70

57

99

200

Pipeline - Start of deliveries before 2000

Pipeline - Start of deliveries 2000 or later

LNG - Start of deliveries before 2000

LNG - Start of deliveries 2000 or later

- 16 -

Long-Term Supply Contracts

- 17 -

Estimation Equation

CD = F (Total Volume, DummyLNG, Dummy2000, DummyExp_Asia,

DummyExp_Europe, DummyExp_Africa,…,

DummyImp_Europe, …,

DummyExp, DummyComp, DummyPubl, DummyExt)

- 18 -

Data on Long-term Import Contracts OLD VERSION (updating Hirschhausen and Neumann, 2008, RIO)

Variable Description Mean Min Max Std.Dev.

CD Contract Duration 18.84 2 39 6.51

TVol Total contracted volume (bcm) 52.03 0.32 360 75.08

Project Contract signed to dedicated project D=1: 206 observations

Entrant Contract signed by new market player D=1: 96 observations

D00 Contract signed since 2000 D=1: 229 observations

Reneg. Extended/renegotiated contract D=1: 51 observations

C_Europe Deliveries for European market D=1: 220 observations

C_Asia Deliveries for Asian market D=1: 191 observations

P_Oceania Production Oceania D=1: 138 observations

P_Africa Production in Africa D=1: 77 observations

P_Eurasia Production in Eurasia (Russia) D=1: 48 observations

P_Europe Production in Europe D=1: 88 observations

P_ME Production in Middle East D=1: 58 observations

Observations 454

-

- - +

- 19 -

Estimation Results OLS OLD VERSION

Reported are estimated coefficients and p-values.

***, **,* indicate significance at 1%, 5%, and 10% level

Variable Variable

C 17.92***

(0.000) EU_post2000

-3.86*** (0.000)

TVOL 0.03*** (0.000)

C_Asia -1.56* (0.086)

Project 2.23*** (0.000)

Entrant -2.11***

(0.002) R2 0.314

Renegotiation -4.35***

(0.000) Adjusted R2 0.297

P_Africa 0.85

(0.427)

P_Eurasia 0.85

(0.465)

P_Europe 0.78

(0.462)

P_ME 2.01*

(0.067)

P_Oceania 3.40

(0.705)

Contr

act part

ners

E

xport

regio

ns

Imp

ort

regio

ns

-> positive relation of asset specificity

and contract duration

-> changes in European institutional

framework ‚successful‘

- 20 -

Variable Description Mean Min Max Std.Dev.

CD Contract Duration 20.00 5 42 6.61

Yearly Volume Yearly contracted volume (bcm) 2.47 0.03 30 3.17

Dummy 2000 Contract signed since 2000 D=1: 235 observations

Dummy LNG Contract with LNG D=1 :299 observations

Dummy

EX_Europe

Production in Europe D=1: 75 observations

Dummy EX_Asia Production in Asia D=1: 96 observations

Dummy

EX_Oceania

Production Oceania D=1: 61 observations

Dummy EX_Africa Production in Africa D=1: 79 observations

Dummy

EX_Russia

Production in Russia D=1: 45 observations

Dummy

IM_Europe

Consumption in Europe D=1: 188 observations

Dummy IM_Asia Consumption in Asia D=1: 201 observations

Observations 426

Data on Long-term Import Contracts UPDATE

- 21 -

Variable Estimate

Intercept 20.49***

Yearly Volume 0.46***

Dummy LNG 0.44

Dummy 2000 -4.72***

Dummy Export Asia -2.97**

Dummy Export Europe -1.05

Dummy Export Africa -1.25

Dummy Export Oceania -1.66

Dummy Export Russia 0.26

Dummy Import Asia 1.67

Dummy Import Europe -0.26

Estimation Results OLS UPDATE

Reported are estimated coefficients and p-values.

***, **,* indicate significance at 0.1%, 1%, and 5% level

Co

ntr

act

pa

ram

ete

rs

Exp

ort

re

gio

ns

Import

reg

ion

s

- 22 -

Agenda

1) Intro: Natural Gas as a Key to the Energy Transformation (in

Europe)?

2) A Long-Term Issue of Long-Term Contracts (LTCs)

3) Data and Simple Estimations

4) A Closer Look

5) Conclusions

- 23 -

Supply in Japan

Years

Duration of Contracts

Country Number of

Contracts

Australia 48

Brunei 9

Indonesia 30

Malaysia 19

Oman 4

Papua New Guinea 2

Qatar 9

Russia 10

USA 10

- 24 -

Supply in Europe

Duration of Contracts

Years

Country Number of

Contracts

Algeria 33

Egypt 3

Libya 7

Malaysia 1

Nigeria 16

Oman 4

Qatar 11

Russia 27

Trinidad & Tobago 5

USA 2

Yemen 2

Europe 74

- 25 -

Agenda

1) Intro: Natural Gas as a Key to the Energy Transformation (in

Europe)?

2) A Long-Term Issue of Long-Term Contracts (LTCs)

3) Data and Simple Estimations

4) A Closer Look

5) Conclusions … and one Idea

- 26 -

Decreasing Contract Duration over Time?

Year Contract signed

Con

tract D

ura

tio

n

- 27 -

Natural Gas Transmission Network:

Europe and the U.S. …

Source: Natural Gas Information (IEA, 2011)

Long-term Contracts in the Natural

Gas Sector: An International Survey

Add picture on

dark green area

(see slide 9 for

an example)

29 May 2015

BELEC

Anne Neumann, Sophia Ruester, and Christian von Hirschhausen

With research assistance by Julia Rechlitz and Astrid Cullmann

DIW Berlin (German Institute for Economic Research)

And Berlin University of Technology, Workgroup for Infrastructure Policy (WIP)

- 29 -

- 30 -

U.S. Natural Gas Infrastructure

Source: Natural Gas Information (IEA, 2011)

- 31 -

Technology of Pipeline Natural Gas Transportation

Natural gas transmission:

- High pressure (> 1 up to 80 bar)

- Diameter: 100 to 1400 mm

- Pipeline length up to some 1,000 km

- Transportation based on a pressure

gradient

Entry point Delivery point Delivery point End consumers

Natural gas distribution:

- High pressure, then curbing to

low pressure at delivery points

- Distribution to end consumers

- 32 -

Conclusion

• Alles ganz wichtig

• Empirisch: potential for improvement

- Anwendung anderer Methoden

• Use the data and feel free to contribute to our dataset

- 33 -

Data Documentation Long-Term Supply Contracts (DD-LTCs):

The Data

0

5

10

15

20

25

30

35

40

45

1960 1970 1980 1990 2000 2010 2020

Co

ntr

ac

t d

ura

tio

n (

ye

ars

)

Start of deliveries

Pipeline

LNG

- 34 -

References

Cretì, A., Villeneuve, B., 2004. Long term contracts and take-or-pay clauses in national gas markets. Energy Studies Review

13 (1), 75–94.

Crocker, K.J., Masten, S.E., 1985. Efficient adaptation in long-term contracts: take-or-pay provisions for natural gas. American

Economic Review 75, 1083–1093.

Hartley, P.R. (2015): The future of long-term LNG contracts. The Energy Journal, forthcoming.

Hubbard, G., Weiner, R., 1986. Regulation and long-term contracting in US natural gas markets. Journal of Industrial

Economics 35, 71–79.

Polo, M. and Scarpa, C. (2013) Liberalizing the gas industry: Take-or-pay contracts, retail competition and wholesale trade,

International Journal of Industrial Organization 31, 64–82.

- 35 -

Decreasing Contract Duration over Time?

- 36 -

DD-LTCs: by Start-up Delivery Year

6 17 18

89

22 17

5-9 years 10-14 years 15-19 years 20-24 years 25-29 years > 30 years

Start-up deliveries before 2000

40 33

46

105

30

3

5-9 years 10-14 years 15-19 years 20-24 years 25-29 years > 30 years

Start-up deliveries 2000 or later