What Makes a Natural Gas Marketplace Work? February 5-9, 2007 Abuja

1. What Makes a Natural Gas Marketplace Work?February 5-9, 2007Abuja Organized by the Resource Center for Energy Economics and Regulation and supported by

2. Overview of natural gas marketplaces Resource Center for Energy Economics and Regulation

3. Resource Center for Energy Economics and Regulation

4. Building the Natural Gas Factory UPSTREAM Exploration and Production (E&P) MIDSTREAM Processing Storage Pipeline Transportation LNG Liquefaction Shipping Re-gasification DOWNSTREAM Distribution and End Use Residential Commercial Industrial Power Generation Transmission Distribution to End Use • Investor Goals • Commercialize “stranded” natural gas production by: • Increasing the diversity of midstream options • Gaining access to downstream participation where supported by markets (“power the world with gas”) • Export (pipelines or LNG) Resource Center for Energy Economics and Regulation

5. Worldwide Natural Gas Business System Dynamics: Framework Issues Benefits of Competitive Supply Resource Center for Energy Economics and Regulation

6. TOPIC I:Resource & Infrastructure Investment for DeliveryKey value chain components Resource Center for Energy Economics and Regulation

7. Physical Infrastructure Resource Center for Energy Economics and Regulation

8. Gathering • Removal of basic sediment & water • Collection through field and gathering lines for removal of free liquids and extraneous materials • Gas may also be sweetened with chemical agents to neutralize sulfur compounds and carbon dioxide • From 2 inches to 24 inches in diameter • Higher pressures than transmission lines—up to 2160 psi (≈150 bar) • Generally, feed gas processing facilities Resource Center for Energy Economics and Regulation

9. Processing • Liquefy the heavier molecules that occur in the gas stream in order • to make the gas production marketable and safe for pipelines, and • to increase profits from the lease (non-methane molecules are marketable) • “Wet” gas contains a higher proportion of larger molecules as well as oil condensate as opposed to ”dry” gas. Resource Center for Energy Economics and Regulation

10. Natural Gas Products Resource Center for Energy Economics and Regulation

11. Pipeline Transportation • Line pipe—high strength carbon steel—seamless or welded (>24-inch) ~$25,000 per inch-km • Strict metallurgical standards (dictated by API in the US) • Pipe joints are welded together • Pipe Coating—Fusion Bond Expoxy (FBE)--Used to prevent external corrosion Resource Center for Energy Economics and Regulation

12. Compressor Stations • The compressor or pumping station is the “engine” that boosts pressure and moves gas (1,300 psi ≈ 90 bar) • Typically installed every 40 to 100 miles - depending on number of compressors & HP, and diameter of pipe and volume to be moved • Stations also typically have liquid separators in the form of scrubbers, strainers or filter separators. Resource Center for Energy Economics and Regulation

13. Metering & Regulation • Metering Stations are the “cash register” of the industry --Orifice meters --Turbine meters --Ultrasonic meters --Positive displacement meters • Regulation serves to reduce pipeline pressure to an acceptable level for distribution and end use Resource Center for Energy Economics and Regulation

14. Operations • Mainline valves spaced 5 to 20 miles apart depending on population density and safety codes • Allow isolation of pipeline segments for maintenance and emergencies Resource Center for Energy Economics and Regulation

15. Operations • Supervisory Control and Data Acquisition (SCADA) is a communication system to monitor and control certain equipment on the pipeline • Transmits operating status, flow volumes, pressure and temperature data from compressor stations, M&R facilities and valves to a gas control facility • Facilitates nominations, scheduling procedures, allocations & billing Resource Center for Energy Economics and Regulation

16. Operations • Integrity Assurance --Aerial Patrols --Pipeline Markers --Damage Prevention Program --Cathodic Protection --Pipeline Pigging --Leak Detection Surveys Resource Center for Energy Economics and Regulation

17. Distribution • From citygate to customers via small-diameter pipe (<12-inch) • Traditionally steel, but increasingly polyethylene (PE) or high density PE (HDPE) • $370 per 100 ft for 4-inch, $760 per 100ft for 6-inch • ~3 psi of pressurization • Mercaptan (NG is odorless) • Metering & billing • ~50% of end-user price (U.S.) Resource Center for Energy Economics and Regulation

18. Distribution metering • Residential & small commercial meters (~5 psig) cost about $125-175 • Remote sensor another $160 • Industrial meters (~175 psig) cost anywhere from $1,000 to $6,000 • Additional cost of $1-2,000 on related items Resource Center for Energy Economics and Regulation

19. Storage • Gas storage supplements pipeline deliverability in peak demand winter periods • Generally, storage fields are depleted reservoirs, aquifers or salt caverns • In distribution regions, there are smaller LNG storage facilities used for “peak shaving” Resource Center for Energy Economics and Regulation

20. Depleted reservoirs • 50% base gas • Advantages: • Typically near existing regional pipeline infrastructure. • Already a number of useable wells and field gathering facilities. • Low risk of reservoir “leaks”. • Disadvantages: • Working gas volumes are usually cycled only once per season. • Substantial amount of well maintenance & monitoring to limit wellbore leaks. Resource Center for Energy Economics and Regulation

21. Aquifer • Advantages: • Typically, close to end user market. • High deliverability high quality reservoirs + water drive. • The ability to cycle the working gas volumes more than once per season. • Disadvantages include: • A high level of geological risk - risk for substantial reservoir leaks. • Water production is often experienced during the withdrawal cycle, increasing operating costs. • Due to the water drive mechanism, the base gas requirements are high (80%). A large percentage of base gas is not recoverable after site abandonment. (increases the initial capital cost). Resource Center for Energy Economics and Regulation

22. Salt cavern • Advantages: • Low base gas requirements of 25% or less. • Ultra-high deliverability. • Operational flexibility - can cycle working gas 4-5 times a year. • Salt caverns provide excellent seals - risk of reservoir gas leaks is small. • Disadvantages: • Costly initial startup (disposal of the saturated salt water generated during the solution mining process can be costly and environmentally problematic). Resource Center for Energy Economics and Regulation

23. Resource Center for Energy Economics and Regulation

24. TOPIC I:Resource & Infrastructure Investment for DeliveryInvestment considerations Resource Center for Energy Economics and Regulation

25. Where is Natural Gas Used? • Residential uses: cooking, water heating, space heating and/or cooling. • Commercial uses: space heating, water heating, and cooling. • Transportation uses: CNG, LNG as fuel (~2.5 million vehicles worldwide) • Power generation: Steam, simple cycle, combined cycle, micro turbines, fuel cells Resource Center for Energy Economics and Regulation

26. Where is Natural Gas Used? • Industrial uses: • base ingredients for such varied products as plastic, fertilizer, anti-freeze, pharmaceuticals and fabrics • pulp and paper, metals, chemicals, petroleum refining, stone, clay and glass, plastic, and food processing • waste treatment and incineration, metals preheating (particularly for iron and steel), drying and dehumidification, glass melting, food processing, and fueling industrial boilers Resource Center for Energy Economics and Regulation

27. Pipeline Economics • Costs associated with pipeline construction depend on many factors. • the cost per mile increases with the pipe size. • construction on land using a 12-inch pipeline costs about $300,000 per mile while using a 42-inch pipeline costs almost $1.5 million per mile. • costs increases if the pipeline goes through residential areas, or there are roads, highways and rivers on the way. • costs are dependent on location, terrain, population density, or other factors (for instance, different labor and tax laws in different countries). Resource Center for Energy Economics and Regulation

28. Pipeline Costs • The most important are material and labor costs - 70 to 80% of the total construction cost both onshore and offshore. • Surveying, engineering, supervision, administration and overhead, telecommunications equipment, freight, taxes, regulatory filing fees, interest, contingencies (all covered under Miscellaneous). • Right-of-way (R.O.W.) and damages Resource Center for Energy Economics and Regulation

29. U.S. average: $1 million/mile, $6-8 million/mile in urban areas Resource Center for Energy Economics and Regulation

30. Resource Center for Energy Economics and Regulation

31. CEE High, Mean and Low Construction Cost Estimates Resource Center for Energy Economics and Regulation

32. CEE pipeline cost estimates for natural gas Resource Center for Energy Economics and Regulation

33. TOPIC I:Resource & Infrastructure Investment for DeliveryKey concepts & issues for natural gas system investment Resource Center for Energy Economics and Regulation

34. U.S. (Canada) Natural Gas Value Chains Physical Bypass “LDC” Industrial Commercial Residential, Small Commercial Interstate Pipelines Production Gathering Processing Intrastate Pipelines (Often serve industrial customers directly) Electric (fuel; bulk market for power) “City Gate” “Unbundling” involves the separation of transportation from sales to allow third party marketing with pipelines providing “open access” and comparable service to all shippers. Transportation (pipe) Sales (commodity) Most Competitive Competitive Least Competitive Resource Center for Energy Economics and Regulation

35. Unbundling Pricing Supply Pricing Transport, Distribution Capacity • COMPETITIVE SALES • Commodity • Wellhead producers • Third party wholesalers for gas • RESERVATION (DEMAND) • Fixed cost of investment • Return on equity, taxes, long term debt, A&G, DA, O&M • COMMODITY (USAGE) • Variable cost of operation • O&M • CONGESTION MANAGEMENT “Mean reversion” is a reality if market-clearing participants exist, but is often not captured in capacity pricing Resource Center for Energy Economics and Regulation

36. Achieving Competitive Supply • The challenges: • Entry of new suppliers • Managing common pools • Developing liquidity to establish locational basis • Protecting market transparency • Dealing with third party wholesalers that are affiliated with regulated infrastructure • Access for new supplies • Balancing short term cycles and long term capital requirements for resource development (field optimization) Pricing Supply • COMPETITIVE SALES • Commodity: Molecules • Wellhead producers • Third party wholesalers Resource Center for Energy Economics and Regulation

37. Role of regulators • Certification • Transmission and distribution tariffs • Service quality standards (in the US, North American Energy Standards Board sets quality, safety and operational standards) • Customer protection • Dispute resolution • Safety inspections • Penalties for infringements Resource Center for Energy Economics and Regulation

38. US Cost of Service Ratemaking Model Balance Sheet Cost of Service Income Statement = Gross plant Depreciation rate Depreciation Regulated revenues X - - + Accumulated DD&A Other revenues Other revenues - - + Deferred income tax O&M/A&G O&M/A&G - + + Taxes Depreciation Working capital - + = Rate of return = Return Taxes X Rate base = = Return (net income) Cost of service Resource Center for Energy Economics and Regulation

39. TOPIC II:Standards for Gas Market Operations Resource Center for Energy Economics and Regulation

40. TOPIC III:Access to Natural Gas Equipment & Services Resource Center for Energy Economics and Regulation

41. Awarding LDC franchises – Turkish approach Resource Center for Energy Economics and Regulation

42. Resource Center for Energy Economics and Regulation

43. General Requirements • Qualified companies bid on distribution tariff • 3 lowest offer further discounts • Lowest distribution tariff wins bid (fixed for the first 8 years) • Must start construction in 6 months • Must start gas delivery in 18 months • Must connect everyone in 5 years • 30-year exclusive franchise to distribute • Customers consuming >15 million cm per year are free to chose supplier during first 5 years; amount to decline per EU regulations in later years Resource Center for Energy Economics and Regulation

44. Prequalification of Bidders • financial viability - equity, balance sheets and income statements and documents and letters of intent showing how the investment shall be financed • experience of the bidder or the firms which will provide design, construction and operation services to the bidder, in the natural gas sector and other sectors. Resource Center for Energy Economics and Regulation

45. Licensing rounds • 43 out of 53 franchises have been bid out • 40 received their licenses • 10 more to be put on the auction block soon • In early 2006, for 3 regions, more than one company bid “0” cent/kWh; they started bidding down connection fees  in 2 of the regions, the winners bid $5 per customer (the third one bid $163 per customer) Resource Center for Energy Economics and Regulation

46. Case study – City of Erzurum • ~375,000 residents • Average January temperature -11°C • 81 active industrial plants • mostly small to medium enterprises • 40 non-operational • New industrial park • Mining opportunities • $1.2 billion of GDP Resource Center for Energy Economics and Regulation

47. Case study – City of Erzurum • Five qualified bidders • Eventual winner’s first bid was 0.0078 cent/kWh, or 0.242 $/MMBtu • After further discounting, 0.0046 cent/kWh, or 0.137 $/MMBtu • $180 fee per connection • ~$700 per certificate to equipment installers; ~$70 renewal fee per year; ~$10 installation inspection and approval Resource Center for Energy Economics and Regulation

48. Case study – City of Erzurum • Investment • $4.8 million in 2004 for 122 km of pipe + other facilities • 2005-33: $11.2 million for 261 km of pipe + other facilities • 40,000 residential customers by 2005, consuming ~80 MMcm/year • 42 MMcm/year C&I load • 6.4 bcm cumulative 2004-2033 Resource Center for Energy Economics and Regulation

49. Awarding LDC franchises – Northern Ireland case studybased on Regulation in New Natural Gas Markets – The Northern Ireland Experience by Peter Lehmann, Note No. 179 Public Policy for the Private Sector, The World Bank Group http://www.phoenix-natural-gas.co.uk/ Resource Center for Energy Economics and Regulation

50. General Characteristics • Drivers • Environmental reasons • Desire to attract investors • Conversion of a power plant to NG • 600,000 households • 250,000 in greater Belfast • Small C&I market • Combined license for distribution & supply Resource Center for Energy Economics and Regulation