Summary of Working Paper No. 41-1996

III.07.4 : European Gas markets and Russian LNG. Prospects for the Development of European Gas Markets and Model Simulations of Possible New LNG Supplies from Year 2000.

By Tom Eldegard, Foundation for Research in Economics and Business Administration, Bergen Norway.

This study aims at clarifying the framework for possible LNG exports from Northern Russia, starting by the turn of the century. Focus is on the European natural gas markets and the study is developed in two stages. The first stage provides general background information on the market structure and related topics.

In the second stage this information is used to develop a formal market model and subject it to simulations with various assumptions of the future gas supply. A scenario analysis is employed to evaluate the economic effects of hypothetical LNG deliveries from northern Russia. The work is carried out on a model named GAS, that is especially developed for the analysis of West European natural gas markets. The model is designed to allow users to create a structural system of interconnected producers and market regions. Every defined connection line between separate “agents” in the model is assigned a maximum transport capacity and a fixed unit tariff. Furthermore, the user may equip every producer with one or several gas fields, each with a unique cost structure. A specifically designed calibration procedure is used to establish basic demand relations from historic data on every market region. In addition the model user controls a set of growth parameters, which may also strongly influence demand at calculation time. A solving routine attached to the model looks for a general equilibrium solution that can satisfy the sum of specifications set up by the user.

According to the analysis carried out in this study the introduction of a new LNG supplier in the European gas market will inflict a substantial loss upon all the existing producers. Even though the hypothetical LNG supplier may run an isolated surplus, the combined business of FSU and Insrop will lose compared to the FSU alone. The reason is that the resulting drop in prices, more than outweighs the expansion in the combined FSU-Insrop sales. The primary keys to this result are the assumptions made for gas demand and supply capacity. Thus, the LNG alternative will find it hard to get approval for purely economic reasons as long as the Russians maintain sufficient pipeline export capacity at the current cost level. What may possibly modify this conclusion is if either LNG is selected as export solution for associated gas from isolated oil field developments, or if domestic Russian gas demand grows significantly faster than anticipated.