Online Readings

Return(t) = ln(Price(t)/Price(t-1))

The netback price to the upstream shows the value per unit of gas produced left for sharing between the
producer and the state after distribution, transmission, storage and in the event of LNG regasification,
shipping and liquefaction costs have been deducted from the end user price, and is as such a key indicator
of project feasibility.
Marginal cost curves are by definition sloping upwards and are normally becoming steeper as more supply
is brought into the picture. However, new gas discoveries and technological progress can flatten
them and allow demand to shift out for much longer before hitting the steep portion.
Gas-on-gas competition is the dominant pricing mechanisms in the US and the UK. It means that the gas
price is determined by the interplay of gas supply and demand over a variety of different periods (daily,
weekly, monthly, quarterly, seasonally, annually or longer). Trading takes place at physical hubs, e.g.
Henry Hub, or notional hubs such as the NBP in the UK. Trading is likely to be supported by developed
futures markets
Oil price escalation is the dominant pricing mechanism in Continental Europe and Asia. It means that the gas price is contractually
linked, usually through a base price and an 16 International Gas Union | June 2011
escalation clause, to the prices of one or more competing fuels, in Europe typically gas oil and/or fuel oil, in
Asia typically crude oil

Regulated gas pricing may mean cost of service based pricing as well as political pricing where costs may be considered but generally
play second fiddle to political and social concerns.
Cost based pricing shifts the rent in the affected links of the value chain to the consumers and may as
such boost gas market growth at least for a while. But cost based pricing tends to discourage efficiency
improvements along the supply chain,

Chapter 4: Contracts and Project Development (Gas Sales and Transportation

Contracts Sections only)

Concession contract. The tax/royalty concession contract is the conventional type of contract
system in North America, Argentina, Australia, the countries bordering the North Sea, and
occasionally in parts of other regions such as the Middle East. Under the concession contract,
the oil or gas company owns the buyback contracts, the company usually has no claim to the
reserves or the production. Service contracts and buybacks are generally unpopular with oil
and gas companies, which would prefer to be able to book reserves, including them in
their financial and operational statements.

In the case of LNG or international pipelines, sales price is often determined by market forces
in the importing country. It may be net-back calculated (by deducting transportation,
terminal, and regas costs) back to the producing company to determine income for the
producing company or government.

LDC tariffs tend to be two or three times higher than long-distance tariffs due to smaller
volumes, smaller-diameter pipelines, and higher costs of laying and maintaining urban
pipeline networks
Transmission tariffs may be based on distance transmitted or on a postage- stamp basis,
where all consumers pay the same tariffs regardless of distance transmitted, similar to a
domestic mail postage rate.

gas is sold by unit of energy, not by volume. Prices are usually stated in price per unit of
energy, such as dollars per million British thermal units, rather than price per unit volume,
such as dollars per thousand cubic feet.
Transportation tariffs, on the other hand, are often priced per unit volume, not per unit
energy. This can be a source of confusion and mistakes if not correctly handled.

The pipeline gas sales agreement (GSA) is also known as a gas purchase agreement (GPA) or
a gas sales and purchase agreement (GSPA). These agreements between a producing
company or sales agent (seller) and a consuming company (buyer) usually cover a number
of provisions.

Spot markets, especially in active markets such as North America and Europe, generally
have terms under one month. Internationally, especially where a gas development project
will have a limited number of potential customers, the terms could reach 20 or 30 years.

there are two distinct types of volume commitments contracts: depletion contracts and the
more common supply contracts. Under depletion contracts, also called output contracts, the
producing company dedicates the entire production from a particular field or reserve to a
buyer. supply contracts commit the seller to supply a fixed volume of gas to the buyer for
fixed term, typically 20 to 25 years.

Quantities can be defined as total contract quantity, equal to the total amount of gas (in
energy units) to be delivered over the term of the contract, and the daily quantity, which is
the total quantity to be delivered over a 24- hour period. These quantities may also be
specified as annual contract quantity (ACQ), or the amount of gas to be supplied over one
year, and daily contract quantity (DCQ), amount of gas to be supplied in any given day. ACQ
is equal to either the sum of all DCQs

Pricing may be fixed, fixed with escalators, or floating. A fixed price is a set negotiated price
over the term of the contract and is usually found in shorter- term contracts. A fixed price
with an escalator is a fixed price that changes by a certain percentage every year or other
specified time frame to reflect an inflator or an index of a known variable. The index may be
linked to: (1) inflation, such as a 2% annual increase or government price index; (2) a
published price, such as widely published price in the New York Mercantile Exchange
(NYMEX). a floating price varies according to prices reported by unbiased sources, such as
newspapers and NYMEX quotations. Prices, both fixed and floating, may also be limited to a
maximum ceiling price or a minimum floor price for the term of the contract.

The basic premise of take-or-pay (TOP) is that the buyer is obliged to pay for a percentage of
the contracted quantity, usually 60%95% of the ACQ. This is true even if the buyer is unable
or fails to take the gas supplied by the seller, other than due to fault of the seller or force
majeure incidents. The seller usually imposes this obligation on the buyer to guarantee a
predictable minimum cash flow,

he GSA clearly states the quality of gas, including its maximum and minimum heating values
(in Btu/MMcf units); maximum level of impurities like oxygen, CO2, SOx, and NOx; the
delivery pressure; and water vapor content. If the seller delivers off-specification gas, buyers
may be able to demand a discount, a reduction in TOP obligations for the period, or other
remedies as specified in the GSA.

During the nomination procedure, the buyer communicates its weekly (or other specified
period) gas volume requirements to the seller.

Liabilities and obligations of all parties, including those resulting from negligence, must be
clearly stated in the GSA. A lengthy force majeure event may result in annulment of the
agreement.

Stabilization clauses. These clauses specify remedies in the case of changes in law or
taxation rates, keeping the seller or buyer economically whole.

he LNG equivalent of the GSA, often known as the LNG sales and purchase agreement (SPA),
is the most complex of all the agreements. Because of the long-term nature of the contracts,
flexible and trusting relationships between all parties are critical for the success of each
component of the LNG chain.

Linking the prices of oil and LNG allowed both commodities to remain competitive and
guaranteed a market for imported LNG. The linking of the prices is achieved through
mathematical formulas comprising a fixed component plus a variable component indexed, or
linked, to a JCC price. This is typically called the Japan Crude Cocktail or Japan Customs
Clearing price
he JCC price is based on a delivered price of a basket of typical crude oils imported into Japan
over a defined period plus an inflation factor. The added advantage of this formula was that
LNG prices were much less volatile than crude prices because the indexing was calculated on
a monthly or longer basis, while crude oil prices fluctuate more often
Most utilities were paid by their customers in the local currency, i.e., Japanese yen or Korean
won, but had to pay the LNG supplier in U.S. dollars.

Pipeline GSAs more frequently allow weekly or monthly nomination changes, allowing both
the buyer and the seller to modify their obligations over the short-term.
Free-on-board (FOB) basis, where the buyer takes ownership of LNG as it is loaded on ships
at the export LNG facility
Cost-insurance-freight (CIF) basis, where the buyer takes legal ownership of the LNG at some
point during the voyage from the loading port to the receiving port.
Delivered ex-ship (DES) basis, where the buyer takes ownership of the LNG at the receiving
port.

Technical specifications. The SPA details precise technical specification ranges. Buyers and
sellers must agree on the following:

heat content of LNG, related to the purity of methane versus other hydrocarbons such
as ethane, butane, and propane, etc. in British thermal units per volume. This is especially
an issue for sales to the United States, where cargoes with high heat content can cause
difficulties for regas facilities and gas pipeline operators;

maximum allowable impurities content for SOx, CO2, NOx, etc.; temperature;
chemical testing methodology;
port facilities required;


demurrage charges incurred by the seller to the buyer due to delays in loading LNG for
FOB sales, and vice versa for CIF/DES sales.

Major evolving changes to the LNG SPA

Deregulation has created a host of smaller energy suppliers, many of whom are willing to
sign LNG contracts and have access to receiving and storage facilities.
As compared to the traditional 20- to 30-year contracts, todays buyers are negotiating terms
as short as 5 to 10 years.
recent shift has been the change, in some markets, in the basic formula from fixed escalation
price to a shorter- term price basis. Today, prices are often tied to market gas prices,
especially in North America and Europe. LNG exporters are forced to accept fluctuating
prices linked to market gas prices in the buying country, with or without floor and ceiling
prices.
Pc = P0[a(Gc/G0) + b(Fc/F0)] Where:
Pc is the price of gas/LNG at current time c, P0 is the price of gas/LNG at original time 0, Gc
is the price of gas oil (diesel) at current time c, G0 is the price of gas oil (diesel) at original
time 0, Fc is the price of fuel oil at current time c, F0 is the price of fuel oil at original time 0,
and a and b are factors to be negotiated.

Buyers may demand relaxation of traditional destination clauses that limit the ability of LNG
buyers to resell their cargoes to other potential buyers. Flexible destination clauses allow
buyers to collaborate, taking advantage of varying seasonal demand, shipping capacity, or
price differentials between markets

Older contracts specified Japanese, French, and Algerian governing law. Todays contracts are
almost exclusively using English or New York law. Arbitration used to follow International
Chamber of Commerce (ICC) rules. Today, many of the contracts follow United Nations
(UNCITRAL) as well as ICC and American Arbitration rules

Chapter 10: Natural Gas Transportation and Storage

Natural gas can be transformed through chemical processes into products that are liquid in
the ambient temperatures, such as methanol or gasoline (this promising technology is known
as gas-to-liquids)

The US natural gas pipeline network is composed of large diam- eter steel pipelines
operating under high pressures, ranging typically from 600 to 1,200 psi. Transmission pipes
are usually 2442 inches in diameter and made of steel 0.25 to 0.75 thick. Smaller
branches extending from a larger pipeline and connecting to large customers or groups of
customers are known as laterals, and are made from smaller diameter pipes (616).

The pipelines follow two basic designs, known as trunk lines and grids (See Figure 10.1). A
trunk line (also known as gun barrel pipeline) is characterised by the concentration of
receipt points at one end, and of delivery points at the other end

Natural gas is propelled through the pipeline system by compres- sors located approximately
every 50 to 100 miles, typically rated from 1,00015,000 horsepower (113 MW). The
compressors operate by burning part of the natural gas flowing through the pipe, although a
new design of compressors using electric motors has been successfully tested. The
compressors, based on a centrifugal or recip- rocating design, propel natural gas along the
pipeline by increasing the local pressure and pushing natural gas towards the segments of
the pipeline where the pressure is lower

Pipeline capacity can be increased in two different ways. One solution is to increase pipeline
diameter or to use the so-called looped design, by locating several parallel pipes along the
same route, corre- sponding to the right-of-way

Pipelines often store additional gas by temporarily increasing the pressure, in anticipation of
periods of high demand, corresponding to very hot or very cold weather. The ability to adjust
the volume of gas in a pipeline, known in the industry jargon as linepack, creates a buffer
between production and demand, supplementing permanent storage facilities. Another way
of increasing capacity is the addition of compressor stations or instal- lation of more powerful
compressors. An increase in pressure reduces the space natural gas occupies, enabling the
transporter to ship more Btu per cubic foot.

Pipeline transportation contracts

firm service, which can be denied only under conditions of force majeure (ie, acts of God,
natural disasters and, in many cases, equipment failure); and
an interruptible service offers a lower level of reliability (offset by a lower cost). It is not
guaranteed and can be cancelled at short notice, or without notice at all, if pipeline capacity
is required to serve higher priority customers

In the case of a firm contract, a shipper pays the so-called demand (or reservation) charge,
which is comparable to an option premium and gives the right, but not the obligation, to use
the service, and a commodity charge that is related to the actual volume of natural gas that
flows. In the case of interruptible service, only a commodity charge is paid by the shipper.
The logic behind this tariff design is that reservation charges related to the firm contracts
should pay for the capital costs of building the facility, and the commodity charges should
cover the operating costs

No-notice. This service can be defined as a premium or platinum firm transportation

contract. The shipper can receive gas (both nominated and un-nominated) on a daily basis
up to the maximum contract level, without incurring daily balancing and scheduling
penalties.
Other primary firm. This type of service has a somewhat lower degree of firmness than goldplated firm service. A shipper has a reasonable expectation of an uninterrupted service.
Secondary firm. Many contracts specify secondary delivery/ receipt points in addition to the
primary points. The rights asso- ciated with such delivery points have typically a lower
priority service than primary delivery points, but higher priority than interruptible
transportation.
Authorised overrun (AO). The AO service can be acquired in conjunction with firm or
interruptible service and provides a licence to exceed daily (or weekly, monthly volumes) up
to a limit and at a price.

the charges paid by shippers of natural gas are broken into two tiers. Fixed charges (also
called demand charges or reservation fees) are paid irrespective of whether the pipeline
capacity is actually used. Variable costs (also called commodity charges) are paid only if the
service is actually used and depend on the level of throughput.

The breakdown between the fixed and variable charges varies from pipeline to pipeline, with
pipelines shifting most of the cost to the fixed (SFV) charges (as the overriding objective is
faster amortisation of the capital cost). SFV stands for the straight fixedvariable rate design
approach. Under SFV, a pipeline recovers all of its fixed costs through a demand charge and
all of its variable costs through a commodity charge.

Many natural gas buyers, like average shoppers, are willing to pay extra for guaranteed and
immediate supply. The end users who have other options (for example, local gas storage
access or dual burner capacity and propane or resid tanks) may take the risk of relying on
interruptible contracts and lower the overall cost of acquisition of natural gas. The local
distribution companies, expected to provide reliable uninterrupted supply, do not have this
luxury. Another advantage of holding firm capacity is that the holder can resell/release
unused capacity at a price higher than the maximum tariff regulated rate for pipelines.

The nomination process can be broken up into several stages. During the timely cycle,
occurring during the day ahead, with the nomination deadline of 11.30 CST and results being
posted by 4.30 CST, shippers get guaranteed service as long as the scheduled amounts do
not exceed contract quantities.16 The capacity that remains unscheduled can be offered to a
customer with lower priority. During the gas day, capacity is scheduled only if previously
scheduled firm shippers do not use capacity

A special service, called backhaul (and, sometimes, paper flow) delivers natural gas to a
delivery point upstream of the receipt point. This happens not through reversing the physical
flow (although some pipelines have this ability) but through displacement. This service is
offered under a special rate schedule or service, which recognises that no compressor fuel is
used in the process.

The differences between daily and hourly takes and contractual volumes (imbalances) are
settled through a process called balancing, which takes place under the conditions specified
in the tariffs.

Many pipelines either invest in their own storage capacity or acquire storage space in order
to protect themselves against imbalances. If the pipeline gas inventory is significantly out of
step with demand, the pipeline can declare in such case what is known as an operational
flow order (OFO) notice which imposes, in addition to strict requirements to balance gas
volumes daily within tolerance bands, heavy penalties for short-term imbalances. The
penalties may be quite severe (in some cases, exceeding US$50/MMBtu), leading to a hectic
race to acquire or sell natural gas

An OFO will only be called if inventory is forecast to fall outside the established pipeline
inventory limits (the pipeline inventory limits are 600 MMcf apart). The OFO typically states:
the OFO stage; the system inventory level (high or low); the noncompliance charge; the
tolerance band (percent of allowable variance between scheduled volume and actual
volume)
As one can see, the penalties may be quite severe in the case of Stage 3 or 4 OFO. This
explains why an OFO may lead to a spike in prices (to the downside or, more often, to the
upside). A physical trader will be willing to pay a very high price (or accept a very low price)
to avoid penalties.

A cost of service includes the following components:

operation and maintenance expenses; depreciation, depletion and amortisation; taxes;
return on investment.

Rates expected volumes = Reasonable expenses + (Rate base Permitted rate of return)

The construction of new pipelines often results in the discrete and sudden realignment of
prices, as previously stranded gas can be taken to more lucrative markets, and existing
markets are flooded with cheap supply from alternative sources. The price changes can be
quite dramatic. This explains why monitoring pipeline projects and analysing their potential
market impact is critical to any trading operation. This is equally important to equity stock
analysts.

A critical step in any pipeline project is obtaining a certificate of public convenience and
necessity from the FERC pursuant to Section 7c of the NGA and a number of FERC policy
statements. The FERC seeks to determine whether a new project is in the public interest and,
if this is the case, how it should be paid for (on an incremental or a rolled-in basis).

The consumption of natural gas is characterised by seasonal patterns, with consumption

peaking in winter, dropping in spring and then increasing to a smaller seasonal peak in
summer, due to demand for air-conditioning.

Demand shocks are due to periods of unseasonably warm or cold weather, or disruptions in
other parts of the energy complex.

A constraint in the pipeline grid may suppress prices in the producing region and create
shortages and higher prices in the market region.
Successful traders, armed with reliable weather forecasts, information about current pipeline
operational capabilities and up-to-date information covering the levels of production and
demand, are able to anticipate constraints in the pipeline grid and profit from them.

the USCanadian gas grid comes very close to being a closed system (ignoring, for the
moment, LNG flows and flows through the Mexican border). certain receipt/delivery points
can be associated, uniquely and exclusively, with natural gas storage facilities. By observing
the flows at these points, it is possible to assess injections and withdrawals into and out of
storage and thus estimate the level of storage inventories. using flow data from specific
receipt/delivery points, it is possible to estimate the impact of changes in pipeline line fill.
The line fill or line pack can be consid- ered an extension of the natural gas storage facilities,
a natural buffer between the producers and consumers of natural gas.
This information is provided by a number of data vendors, including LCI Energy Insight (LCI),
Genscape and BENTEK Energy.
Many energy trading organisations invest heavily in data processing, concentrating on the
visualisation of the data (to allow traders to identify quickly any emerging patterns). This is
important, as the data arrives when physical natural gas trading gets under way

LNG is made by cooling methane to about 260F (about 160C). This results in the
condensation of gas into liquid form under normal atmospheric pressure. This process
shrinks the volume of natural gas to about 1/600 of the original level in gaseous form,
making trans- portation over long distances economically viable.
The breakeven points between pipelines and LNG tankers range between 1,500 and 3,000
miles.

LNG supply chain consists of three main links:

liquefaction facilities; transport by LNG tanker; regasification.

natural gas may have to be treated to satisfy the requirements of the liquefaction process in
the producing area and/or the processes at the regasification terminal required to meet the
pipeline gas quality specifications.

The process of liquefaction may be carried out under pressure and, once gas is liquefied, its
temperature has to be further lowered as normal pressure is being restored. A unit for the

liquefaction of natural gas is called a train. Trains range in capacity from three to eight
million tons per year.

LNG carriers can carry loads typically around 125,000 m3. As in the case of trains, the trend
is towards building bigger carriers with some tankers under construction reaching the size of
215,000 m3. By the end of 2010, the worlds LNG fleet consisted of 360 ships with a
combined capacity of 53 million m3

The heat loss that happens during transporta- tion yields natural gas known as boil-off, which
is used for the tankers propulsion system, amounts to about 0.2% of the LNG cargo per day.
New technological developments reduced the boil-off to 0.1% of the cargo per day.

Q-max is a category of LNG membrane tankers that were introduced in 2007, with a capacity
of between five and six Bcf. The Q-max ships have a re-liquefaction system that reduces
natural gas losses due to boil-off. This improves energy effi- ciency and reduces methane
emissions (ie, the emission of a potent green house gas (GHG)). The Q-flex tankers range
from 210 to 216,000 m3 in capacity (smaller than Q-max tankers reaching 266,000 cubic
metres) and use slow diesel engines (unlike traditional LNG tankers burning boil-off), that
help to improve energy efficiency. The use of larger, more efficient tankers reduces the unit
cost of trans- porting LNG.

table 10.5 LNG liquefaction by country (MMtpa, 2010)

Country

mmtpa

Qatar 69.2 Indonesia

34.1 Malaysia
23.9 Nigeria 21.9 Algeria 19.9 Australia
Trinidad
15.5 Egypt 12.2 Oman 10.8 Russia 9.6 Brunei 7.2 Yemen 6.7 UAE

19.3
5.8

Norway
capacity

4.5 Equatorial Guinea

271.0

4.5 Peru

3.7 US

1.5 Libya

0.7 Total

Energy Bridge is the proprietary offshore liquefied natural gas (LNG) regasification and
delivery system developed by Excelerate Energy. [...]Energy Bridge Regasification Vessels, or
EBRVs, are purpose built LNG tankers that incorporate onboard equipment for the
vaporisation of LNG and delivery of high pressure natural gas. This solution addresses two
critical issues related to LNG. In many potential destinations there is a strong grassroots
opposition to the construction of LNG plants, given safety concerns. In many locations, there
are no regasification plants and construction of the offshore collection system is a cheaper,
time- efficient alternative.

Regasification is carried out in vertical tubes or coils submerged in heated water or exposed
to water running outside the tube. Vapourised gas may be further treated, especially if it
originates from reservoirs rich in heavier hydrocarbons that have to be removed from the
stream before it enters the pipeline system. Most of the capacity is concentrated in Japan
(31.5%) and the US (19%), followed by Korea (14.6%), Spain (6.8%) and the UK (5.8%).

the unit cost of bringing one MMBtu of natural gas to a specific market. In the case of the US
market, many estimates revolve around the magic number of US$3.50 per MMBtu, creating
an impression that as long as the domestic prices at Henry Hub exceed this threshold, flows
of LNG will materialise.

The cost of a five MMtpa integrated LNG project is estimated to be between 11 and 16 billion
USD (four to six billion upstream, four to six billion for the liquefaction plant, one billion for
transportation and two to three billion for regasification)

Table 10.6), which has the unit cost of LNG for a relatively large liquefaction plant at 7.5
million metric tons of LNG, 1 Bcf/d regasification unit and a 6,500 nautical miles distance.
The breakeven cost is calculated assuming an 8% return on different operations, except for
the upstream, where higher risk of exploration and production requires a higher return (15%
was assumed)

Two basic types of storage are cryogenic storage and under- ground storage. Cryogenic
storage is used for peak shaving, the delivery of natural gas to satisfy local needs during the

conditions of excessive stress, and when demand spikes or interruptions of supply occur due
to accidents and/or pipeline outages

Depleted oil and natural gas fields have rock formations charac- terised by high porosity and
permeability. They are typically operated as seasonal storage, with the injection season
extending typically from March/April into October/November. They are emptied during the
winter months between December and February, although the withdrawal season may start
in November and extend into March
Salt dome storage facilities are created as underground caverns by dissolving salt formations
capped by impermeable rock. The salt dome storage is characterised by high deliverability
natural gas can be injected and removed quickly.
Depleted reservoirs and aquifers are used primarily to satisfy demand during winter and,
given their characteristics, it usually takes the entire spring and summer season to fill them.
They may sometimes be used to satisfy summer peak load during periods of unusually hot
weather when more natural gas is used as fuel in power plants, or during supply outages
caused primarily by hurri- canes.
The energy trading floors are the only place in the US where people sometimes pray for
hurricanes

Natural gas storage inventory statistics are among the most important data points followed
by the energy traders. The data is collected by EIA through the survey of big storage operators. Respondents provide estimates for working gas in storage as of 9 am Friday each
week. The estimates are released on Thursday between 10:30 and 10:40 am (Eastern Time)
on EIAs website.
It is important to emphasize that the EIA-reported data show the level of inventories, not the
level of injections and withdrawals. This distinction is important because the industry
participants often refer to this report as injection/withdrawal data.

Form EIA-912, Weekly Underground Natural Gas Storage Report is supplemented by

information collected on Form EIA-191, Monthly Underground Gas Storage Report.
The monthly data does not receive the same level of attention as the weekly reports. This is
true of all economic data. The first release, which often contains a large error, moves the
market. Few analysts pay attention to subsequent revisions.

High levels of natural gas in inventory close to the end of winter send a strong bearish
signal. This is because many natural gas storage facilities have to be emptied towards the
end of winter for technological or accounting reasons.

The operators may take risks and inject natural gas beyond rated capacity levels.
Construction of new storage facilities and a demonstrable ability to squeeze more gas into
existing fields has increased available capacity beyond 4,000 Bcf.

In the commodity markets, it is necessary to always evaluate the fundamental trading

strategy through the lens of existing trading positions. When almost everybody marches to
the same tune the trading positions may become dangerously skewed and vulnerable to
bear or bull raids.

Production + Imports Exports + Storage withdrawals Storage injections = Consumption

Natural gas consumption can be estimated using an econometric model that ties natural gas
consumption to certain explanatory variables, related primarily to weather. Most models use
actual temperatures or temperatures transformed into heating and cooling degree days.
Consumption (realised demand) data is available, with a considerable time lag, from the EIA,
by state and by consumer class. The regression model explaining consumption is run at the
aggregate US level, at regional level or state by state and by end-user class. The model can
be cali- brated by using the estimated demand, in conjunction with reported storage data, to
calculate the implied production. The implied production is calculated from equation 10.1,
under the assumption that all the other items are known or are estimated correctly. After a
few weeks of collecting implied production numbers, one has a fairly good guess of
production levels and is ready to produce injection/withdrawal forecasts. This approach relies
critically on the assumption that production changes very slowly from week to week. This is
true in general, but such an approach may break down during periods of supply disruptions
for example, due to hurricanes.

This method, used across the industry, has some obvious short- comings. First, EIA
consumption data is fairly aged and usage levels may evolve quickly. Demand destruction
due to high prices or slowing macroeconomic activity, especially in the case of industrial and
commercial loads, can be very rapid. Second, some types of demand are not weathersensitive. For example, industrial demand in states with a high concentration of chemical
industries (Texas, Louisiana) that use natural gas as feedstock or fuel is not weatherdependent. Third, this approach misses additional storage capacity associated with line
pack, the volume of natural gas in the pipeline system. The pipelines often take advantage
of the ability to adjust internal pressure in order to store natural gas short term in anticipation of higher demand.

An alternative approach is based on monitoring the natural gas flows through specific meters
associated with natural gas storage facilities. One can obtain very precise information about
injec- tions and withdrawals by monitoring nominations on the meters associated with these
facilities and use econometric techniques to extrapolate the injections/withdrawals for the
monitored facilities to the rest of the industry.

Storage contracts include a number of standard terms that restrict a customers freedom of
action, such as:

maximum storage quantity (MSQ); maximum daily injection quantity (MDIQ); maximum daily
withdrawal quantity (MDWQ); maximum daily transportation quantity (MDTQ).
hourly injection quantity (HIQ); hourly withdrawal quantity (HWQ); hourly transportation
quantity (HTQ).

The contracts or tariffs specify the deadlines for nominations (typi- cally by 10.30 am CST on
the day preceding gas flow or an hour before the deadline for intraday nominations).

The fees that are charged under a storage agreement include:

J reservation fee (applied to the maximum storage quantity); J injection fee; J withdrawal fee;
J fuel charge; J hub services fee; J parking services fees; J loaning services fee; and J
authorised overrun charge.

The cost-based method typically uses the equitable approach under which the fixed costs
(such as capital costs, interest on debt, taxes) are recovered through rates: 50% based on
storage deliverability; and J 50% based on storage capacity.
while variable costs are recovered through injection and withdrawal charges.

According to the FERC Staff Report, a two-cycle per year facility costs US$56 million per Bcf
of working gas capacity. This compares with US$1012 million for a salt dome cavern with 6
12 cycles per year. The median cost-of-service per one Dth of working natural gas per year
was estimated at US$0.64 (based on the 20 tariffs on file). The corresponding number for
salt caverns is close to US$2.93 per Mcf. This is based on the following assumptions: a 5 Bcf
salt dome facility, 13% targeted return-on-equity, 8% cost of debt, 100% debt to equity ratio,
34% tax rate, 3% state ad valorem tax rate, annual cost of service of US$14.53 million, a 20year life and a 10-year useful life for the purpose of tax calculations.

The potential for exercise of market power is measured by analysing the size and
concentration of the market. The market power screen is based on the HerfindahlHirschman
Index (HHI). The threshold level for the HHI adopted by the FERC is equal to 1,800. The HHI is
calculated by squaring the percentage market share of different participants in the relevant
market (as described above), and calcu- lating the sum of the squares. The maximum value
of the index is 10,000 (corresponding to one firm representing 100% of the market), and the
minimum is 0% (corresponding to an infinite number of equally small firms).
if the HHI is above 1,800 the Commission will give the applicant closer scrutiny because the
index indicates that the market is more concentrated and the applicant may have significant
market power

The heating and cooling degree days are calculated by using a threshold temperature level
(typically 65F), corresponding to weather conditions seen as comfortable. If the average
daily temperature is equal to 73F, it translates into eight cooling degree days and zero
heating degree days. If the average daily temperature is equal to 40F, it translates into 25
heating degree days and zero cooling degree days.
Chapter 26: Coal Markets

Anthracite is the coal of the highest degree of maturation and carbon content (over 85%),
and is used for space heating, power generation and as a metallurgical fuel. Bituminous coal
is less mature than anthracite, and contains 4585% carbon. Bituminous coal of a high
quality (to be defined below) is used for the production of coke,2 a fuel used in iron smelters.
Sub-bituminous coal has carbon content of 3545% and a higher moisture content than
bituminous coal. Lignite (known as brown coal in Europe) has low-carbon content (2535%)
and high-moisture content
The main physical and chemical properties of coal include: coal rank; sulphur content;
mercury content

Coal rank is a classification based on a combination of the two factors: calorific value and
moisture content. Lignite coals through to high-volatile bituminous coals are classified based
on a moist, mineral-matter-free basis, whereas medium-volatile bituminous through to
anthracite coals are classified based on a dry mineral- matter-free basis
Transportation of high-rank coal (lower moisture level) is less expensive.
Thermal coals (also called steam coals) range from lignite coal through to bitumi- nous coals.
They are used primarily for power generation, in industrial boilers installed in many industrial
plants
According to the EIA 1993 classification, low-sulphur coal has less than 0.6 pounds of sulphur
per million Btus, whereas medium-sulphur has between 0.61 and 1.67, while high-sulphur
has over 1.68.
Sulphur content is also an in important factor in the selection of coals for the production of
coke: low- sulphur content is required for this.
a low of 2.04 pounds of mercury per trillion Btu for low-sulphur subbituminous coal originating from mines in the Rocky Mountain supply region, to a high of 63.90 pounds of
mercury per trillion Btu for waste coal.
Ash content refers to the non-combustible residue left after coal is burned. Ash content
varies for anthracite coals from 9.720.2% of weight, 3.311% for bituminous coals and
around 4.2% for lignite.
Ash produced during burning of coal is classified either as fly ash or bottom ash (ie, ash that
is not emitted into the air with flue gases but remains at the bottom of the furnace).
Environmental regulations require that fly ash be trapped using electrostatic devices and
removed, together with bottom ash, to landfills

The main price benchmarks used for coal are available from Argus/McCloskey11 and Platts.
API 2 index is the price for coal imported into Western Europe. This index represents an
average of the Argus CIF Rotterdam assessment and McCloskeys northwest European steam
coal marker.

Bituminous material from all origins is included in the NW Europe marker as long as the
materials specification reaches the general European standard, established by McCloskey in
1991, of under 1% sulphur, with prices c.v.12 adjusted to a 6,000kc NAR13 basis.

API 4 index14 is the price benchmark for all coal exported out of Richards Bay, South Africa.
The API 4 index is calculated as an average of the Argus FOB Richards Bay assessment and
McCloskeys FOB Richards Bay marker.
API 5 index is the price benchmark used for exports of 5,500 kcal/kg net as received (NAR),
high-ash coal from Australia.
API 6 index represents 6,000 kcal/kg NAR coal exported from Australia. The API 6 index is
calculated as an average of the Argus FOB Newcastle 6,000 kcal/kg assessment and the
equivalent from IHS McCloskey.
API 8 index is the benchmark for 5,500 kcal/kg NAR coal delivered to south China. It is
calculated as an average of the Argus 5,500 kcal/kg CFR south China price assessment, and
the IHS McCloskey/Xinhua Infolink South China marker.

The OTC Broker Index has been published by Platts since 2003. It is based on the market-onclose approach and covers the following contracts:
J CAPP, barge, 12,000 BTU/lb; J CAPP, rail (CSX),16 12,500 Btu/lb; J Powder River Basin, rail,
8,800 Btu/lb; and J Powder River Basin, rail, 8,400 Btu/lb

The ICI (Indonesian Coal Index) is a spot price of four grades of Indonesian coal 6,500,
5,800, 5,000 and 4,200 kcal/kg gross as received (GAR) calculated by Argus.

A significant portion of the coal price represented transportation costs over which both the
producers and the buyers had limited control, an additional reason for the perpetuation of
long-term contractual arrangements

The most important contracts offered by the CME include Central Appalachian coal futures
(Globex, ClearPort) and Powder River Basin Coal (Platts OTC Broker Index) swap futures and
Coal (API 2) CIF ARA (Argus/McCloskey) swap futures offered on ClearPort. The Central
Appalachian contract quality specification includes: heat content (minimum 12,000 Btu/lb
gross calorific value, with a tolerance of 250 Btu/lb below), ash content (maximum 13.50%),
sulphur content (maximum 1.00%, with a tolerance of 0.050% above), moisture (maximum
10.00%), volatile matter (minimum 30.00%), grindability (minimum 41 Hardgrove Index, HGI,
with three-point analysis tolerance below) and sizing (three inches top size). Deliveries are
made to the buyers barge at the sellers delivery facility on the Ohio River between
Mileposts 306 and 317 or on the Big Sandy River. The contract size is 1,550 tons (a typical
barge). The ClearPort contracts mentioned above are cash- settled.
Discrepancies with respect to weight and quality would be smoothed over time and resolved
in an amicable way.
The QVA defines a deadband (typically +/2%) around the contrac- tual quantity. The
volumes outside the band would be priced at current market prices, and not at the contract
price.

reasons why the industry could increase the production of electricity from natural gas. The
first was the development of mature energy markets and energy trading that made possible
the physical substitution of one fuel for another. The second reason is the availability of costefficient spare gas- fired generation capacity.

Grindability is a coal property measuring the difficulty of grinding coal to a specific size
for boiler combustion. HGI was developed in the 1930 to measure empirically this property.

Chapter 9: Liquefied Natural Gas (LNG)

The gas reserves identified for LNG develop- ment must meet three fundamental criteria:
composition, size, and sustainability.

Natural gas is often found with a combination of associated components, like associated
liquids (liquefied petroleum gases [LPGs] and condensates), are of considerable commercial
value and add significantly to the revenues earned from gas development. Impurities in the
gas such as hydrogen sulfide, carbon dioxide, or mercury must be removed before
liquefaction and add cost to gas processing.
The size of the gas field for development (i.e., the proven gas reserve base) must be large
enough to support at least 1 million tons of LNG production per annum (mtpa) for 20 years (1
Tcf or 28 Bcm). The size of the reserve base must also consider the 10% to 15% of the gas
lost/used in the LNG chain. The field must possess a sufficiently large reserve base left in the
field at the end of the project life span in order to maintain the fields production over time

(plateau level). This may mean a capacity of at least 8 million tons per annum, which could
support two large LNG trainsa minimum proven gas reserve of 10 Tcf (280 Bcm).

There are three business structures typically used in LNG production and transportation:
integrated projects, transfer pricing agreements, and throughput agreements.
In an integrated project, the ownership structure is the same for both upstream development
and liquefaction. This struc- ture allows a high degree of alignment and the business
agreements may be simpler than for the other structures.
A transfer pricing agreement is often used when ownership of gas reserves is separate from
the LNG project sponsors. This is frequently the case in countries using production sharing
agree- ments (PSAs) or production sharing contracts (PSCs) and the government retains
ownership of the gas.
A throughput agreement is a contractual structure in which the owner of the upstream
reserves pays a contractual toll for transportation and liquefaction, retaining ownership of
the gas for post liquefaction marketing and sale

High transportation costs to liquefaction can easily doom an LNG projects prospects.
Once gas feedstock reaches a liquefaction facility, it enters a series of processing and
storage steps called the LNG train.

The first step in liquefaction is the removal of any remaining condensates and impurities
from the natural gas feedstock. The gas is then liquefied when it passes through a heat
exchange where it is cooled to 161oC.
There are two primary liquefaction processes used globally: the multi- component refrigerant
(MCR) process and the Phillips Cascade process. The MCR process, in use since 1970, uses
propane to precool the gas to 35oC before passing it to a second stage for final liquefaction.
The Phillips Cascade process is a three-stage process using different refrigerant gases for
sequential cooling. Once in liquid form, LNG is stored in insulated tanks where it rests at
atmospheric pressure until loaded on LNG ships for transport.

industry has seen real capital cost reduction over time, falling from more than $500 per ton
per year in the 1970s to under $240 per ton per year in 2004. Much of this capital cost
reduction has been achieved by expanding the scale of trains from under 2.0 mtpa in 1970
to nearly 8.0 mtpa in 2008.
A 390 bcf per year facility (8.2 million tons per year) may cost between $1.5 and $2.0 billion.
This cost is roughly 50% construction, 30% equipment, and 20% bulk material costs. Once
under operation, ongoing liquefaction operating costs are roughly 50% operation of the train,
24% storage and loading costs, 16% utilities, and 11% other.

The LNG itself contributes to its own cooling, as roughly 0.10% of the LNG boils off daily,
adding to the overall cooling. Additional boil-off gas is usually used to power the ships
engines. An additional small amount of LNG is left in the ships storage tanks after unloading
at the receiving terminal to keep the storage tanks cooled on their return trip to the
liquefaction facility. This saves time and cost in recooling the ships storage tanks.

here are two basic ship designs used for LNG shipping. The Kvaerner-Moss design (shown in
figure 93) stores the LNG in large spherical tanks welded into the ships hull. The tanks
extend vertically far above the ships deck, giving the ships their unmistakable look of a
series of balls. Designs vary between four and six spherical tanks. The second structure, the
membrane design, has LNG tanks built into the insulated hull of the ship. This design also
has the ability to reliquefy the boil-off gas to reduce volume loss. This has proved important
in cost reduction, particularly in longer delivery, making distant markets competi- tively
viable.
The first LNG ships were only 27,500 m3 in capacity, but in recent years a number of the
newer ships delivered are more than 250,000 m3. The ships have proven to be long lasting,
with many still operating after nearly 40 years of service. Newer LNG ships can be fully
loaded and unloaded in 12 hours. Continuing improve- ments in transportation have resulted
in many LNG ships spending less than 24 hours for turnaround at both ends of the cycle.

The cost of receiving terminals and regasification facilities, like liquefaction facilities, are
very site-specific. A small facility may cost as little as $100 million, whereas a very large
state-of-the-art facility in Japan (one of the most stringent safety and security regulatory
environments) may cost as much as $2 billion.

An industry rule-of-thumb is that a complete receiving terminal and regasification plant cost
will run $1 billion per billion cubic feet (bcf) of gas per day capacity. If the receiving terminal
requires a variety of marine upgrades, like dredging to deepen water for tanker access, costs
can easily rise $100 million.

The roughly 50 receiving and regasification terminals around the world are all slightly
different, ranging in size from just 0.5 mt to over 8.0 mt. Storage capacity is critical, with the
Sodegaura terminal in Tokyo possessing the largest storage capacity in the world at 2.66
million m3 of LNG, or about 20 standard shiploads of LNG.

There have been several significant innovations in recent years. One is the development of
the floating regas (regasification) vessel, which is an LNG carrier with onboard LNG
vaporizers. this reduces the entry costs for LNG into many markets and countries. This allows
faster and more cost-effective switching from traditional pipeline gas or other fuel. A second
innovation is offshore regasifi- cation terminals that take advantage of limited onshore space
and not in my backyard concerns about terminals on land. A third innovation is offshore
LNG plants. Processing gas in LNG at sea could open up new opportunities for gas
developments far from shore.

To date, LNG projects have been demand/buyer driven. As a result, once a true buyer is
identified, particularly for long-term purchase agreements, the lowest delivered cost of a
sufficiently large and reliable supplier will prevail.
Regas costs are the same across all 12 given the same assumed regas and receiving facility
at Lake Charles ($0.35/mmbtu)
FOB cost differs dramatically across sources. The lowest cost source, Algeria LNG at $0.45/
mmbtu, is one-sixth of the FOB cost originating from the Norway Snohvit LNG liquefaction
facility, at $2.90/mmbtu. Second, the shipping tariff varies, with the highest from QatarGas II
(Qatar in the Persian Gulf) at $1.90/mmbtu and the lowest of the ALNG facilities (Atlantic
LNG facilities, Point Fortin, Trinidad and Tobago) at $0.50/mmbtu.

he Asia Pacific market is the larger of the two regional markets and is driven by Japan (the
worlds largest LNG buyer), Korea, and Taiwan. Pricing in this market was based primarily on
the Japan crude cocktail (JCC) in Japan and South Asia.
LNG prices have generally been the highest in the Pacific (e.g., US$4/mmbtu as opposed to
$3/mmbtu in the Atlantic) as a result of limited competing fuels and the structure of longterm contracts.

Gorgon is the first major field development in the Carnarvon Basin off the northwest coast of
western Australia. The project is a joint venture between Chevron (50% and the project
operator), ExxonMobil (25%), and Shell (25%). The project cost is estimated at more than
AUD 43 billion (USD 37 billion, JPY 3.4 trillion). Gorgon is thought to hold more than 13.8
trillion cubic feet (tcf) of hydrocarbon reserves (2.25 billion barrels of oil equivalent) and is
expected to have a production life close to 40 years.
One of the Gorgons major challenges is the design for carbon dioxide capture and storage.
Gorgon has a high carbon dioxide content at 14% or 15%. (Interest- ingly, the adjacent JanszIlo Field has less than 1% carbon dioxide content.) The project development plan is to
separate the CO2 from the hydrocarbons and then inject it into a subterranean cavern, the
Dupuy Formation, more than 2,000 meters below Barrow Island, for permanent storage. This
CO2 re-injection for permanent storage, termed CO2 geosequestration, will make Gorgon the
largest carbon capture project in the world.

gas to liquids (GTL). GTL turns natural gas into a clean- burning synthetic diesel fuel. GTL
fuels ignite more easily than conventional fuels, improving the performance of car engines.
Although GTL fuel is clean burning, the process generates significant carbon dioxide
emissions that, if regulated, could prove extremely costly. The International Energy Agency
says the cost per barrel of producing GTL is in the range of $40 to $90.
Shells Pearl GTL in the Middle East is the largest GTL project to date. Due to come onstream
in 2010, it is Shells single largest investment project globally. The Pearl GTL plant is under
construction at Ras Laffan, the industrial city 50 miles northeast of Doha, Qatar. Some
35,000 workers are employed at what is one of the worlds largest construction sites.
Shale gas developments require very little initial capital and can be shut down or suspended
when demand drops. When demand rises, drilling can restart. In contrast, LNG megaprojects
require billions in capital up front for a multi-decade expectation of production. Should
demand drop, the capital has been spent, and much of the production will be locked into
long-term sales contracts.