The Price of Natural Gas

In the global exchange and in the local wholesale markets, the price of most of the natural gas is established through regional businesses, or through contracts indexed to competitive fuels (mainly oil). Another way used is regulation by government authorities. Whatever the price formation mechanism may be, its importance will be paramount in the next 30 years. Certain trends of change in the natural gas business have already begun to appear. Among them, one can mention its globalization, vertical integration (which is erasing the limits of roles in the supply chain and changing its structure), the consolidation of regional sales, the convergence between natural gas and electric power, the need of investments in infrastructure, the liberalization of markets and the maturation of local industries; In short, all these factors will affect the price formation environment.

Since natural gas became a market good with an economic value, it has attracted producers, consumers, governments and stakeholders in general. However, the price of gas has not appeared on the news as many times as the price of oil, since for many countries it has been less important than oil.

Unlike oil, natural gas has substitutes in most of its applications and these have balanced the fluctuation of its price. It has always been a topic of regional interest - not global - and the reserves of this energy were more widely distributed, which did not encourage geopolitical problems. But in recent years, these differences between natural gas and oil have become less evident, because the former increased its share in the global energy matrix, its prices rose and became more volatile. In addition, liquefied natural gas (LNG) allowed to unite intercontinental markets, with the consequent increase in its export capacity.

Thus, there is an understanding of natural gas as a commodity product and the determination of its price according to the totality of its market, with the use of a forward market or spot price modality. Natural gas prices in North America, Europe and Asian countries have been monitored closely, and are generally known references. In the case of countries belonging to the OECD (Organization for Economic Cooperation and Development), these represented the largest consumers of natural gas, so the institutions responsible for leading the search for energy options were always located there, sponsored for their governments and companies. While prices in the OECD area are driven by the market, and therefore are susceptible to economic theories and models, in the rest of the world gas prices show important exceptions, for example for political reasons, that they make them difficult to predict.

During 2007, the use of natural gas dispersed equitably among the OECD countries and since then its consumption has grown at slower rates than those that are taking place in countries that do not belong to this organization. In addition, many of these other countries are becoming key players that determine the supply of gas in world markets and only forecast that their presence will continue to grow, so that their decisions on the price will be strongly felt in the OECD. Russia is a clear example of this trend. Studies of their natural gas balances conclude that Russian natural gas will increase its participation significantly and that, therefore, they should be made big investments to avoid shortages. This situation provokes discussions about the adequacy of investment budgets. Most Russian natural gas is consumed internally and if this variable can be contained through price increases, investments would be more than sufficient. Long-term estimates of the change in the price of gas against demand change according to each country and each period of time. If the achievement of a consensus on the volatility of the price of natural gas in OECD countries is difficult, it is even more difficult to achieve it in other countries.

In competitive markets, with many sellers and many buyers, prices are governed by supply and demand, balancing. But some changes in the environment of these markets can cause an increase or decrease in the price, without responding to the logic of stability. Given the new characteristics of commodity that LNG has taken, added to the characteristics of the markets and national industries, their prices do not necessarily accommodate themselves under competitive conditions. Some markets have been liberalized, but others remain regulated. There are factors of short, medium and long term that influence in diverse ways directly on the prices.

There are many examples in which the peaks of natural gas demand led to spikes in their price, which could occur due to changes in climate, legal regulations or policies. A raw winter or a summer of unusual heat will shake the normal demand, causing a rapid increase in price. This type of medium / short term factor could be observed when hurricanes Katrina and Rita hit the United States and resulted in a 13% drop in natural gas production and a consequent increase in its price by 26%. As an example of the long-term factors, the results of the exploration for new reserves and the discoveries that increase the volumes of available gas, which lower their price according to the regions, can be taken.

There are also other factors that affect demand, such as economic growth, which brings with it an improvement in the quality of life of the population and that requires an increase in energy intensity and in the structure of the market (as new suppliers , new companies and changes in the networks). In OECD countries, a large part of the supply does not accommodate supply and demand. In Continental Europe and in the developed part of Asia there is a small number of importers and wholesalers who have been negotiating with a small group of exporting countries, represented by their national oil companies.

In Europe this structure is breaking down, as there are new entrants: traditional LNG sellers decrease and new suppliers await their entry through long-distance pipelines. Outside the OECD, there are many countries that consume natural gas, which fix their prices through methods that are not always transparent. Political and social considerations are probably the culprits of this system. Regulators aim to fix prices without affecting the competitiveness of industrial consumers, overloading residential consumers and causing potential political unrest. This criterion is ambiguous, because it reflects that consumers have grown accustomed to preferences over objective thresholds.

There are different ways in the world to form the prices of natural gas, influenced by economic and political issues specific to each country. In this sense, the following existing main mechanisms can be enumerated:

• Gas gas competition

• Oil price escalation

• Bilateral monopoly

• Netback value

• Regulation based on the cost of the service

• Regulation based on political or social issues

• Regulation below cost

A comparative analysis with the mechanisms scenario presented since 2005 offers conclusions about its variations over time. Not only did the share of gas increase by gas, but price allocations below cost also increased, as a result of national regulations in the face of increases in consumption. In general, the markets that use the mechanism related to the escalation of the price of crude, present the biggest drops in their global presence. Globally, since 2007, a third of natural gas sold and purchased regulated its pricing mechanism through the gas-for-gas competition system.

The mechanism based on regulation through social or political issues decreased, mainly due to changes in Brazil and Argentina. It is commonly accepted that the gas gas competition: means that the price of natural gas is the result of the interaction of supply and demand and its variation of certain periods (daily, weekly or monthly, by seasons or by annual periods). The exchange takes place in physical centers, such as Henry Hub or NBP and is supported by future developed markets and by the online exchange of commodities.

This does not mean that oil prices do not play a determining role in the price of natural gas, since key groups of consumers of natural gas can switch between petroleum products or natural gas, or coal and natural gas, according to the economic convenience. However, the connection of this market with the prices of different fuels, contrary to the contractual one, does not remain stable over time nor prevents gas prices from moving outside their boundaries for long periods of time.

The prices of natural gas, scaled by the price of oil, identifies the dominant mechanism in Continental Europe and Asia. Thus, the price of natural gas is bound in a contractual manner, usually through base prices and adjustment clauses, to one or more of the competitive fuels. In Europe it is normally related to fuel oil and in Asia it is related to crude oil. Adjustment clauses state that if a value of the adjustment fuel changes, the price of natural gas will change proportionally, depending on the factor that has been modified. Of course, this does not mean that prices remain unrelated to demand.

Regarding bilateral monopolies, this modality occurs when the dominant price mechanisms are based on agreements between countries. This was the case of the "Eastern Bloc", which included the former Soviet Union, Eastern and Central Europe. The price of gas Natural was set for a period of time, usually a year, and negotiations took place only at the political level. Consumers paid part of the cost through the realization of projects, such as the improvement of gas pipelines. This type of bilateral arrangements can still be seen in undeveloped countries where a strong supplier stands out, for example, national oil companies, which faces one or a few dominant buyers.

The Netback valuation includes the price that arises from the final price of the product, less the cost of manufacturing the product (including a profit margin), less the cost of transporting natural gas from the deposit to the point of consumption. The payment received by the seller depends on the final price offered by the buyer on the product. A typical example of the application of this mechanism is the price offered to the seller of natural gas by the electricity sector, which depends on the final price given to the energy product offered (thus the price of natural gas depends on the price of electricity). This is also common in the case of the sale of natural gas for the production of chemicals, such as ammonium.