NATURAL GAS: INTERNATIONAL TRADE AND PRICING ISSUES

• Document Type: CREST
• Collection: General CIA Records
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• Original Classification: S
• Document Page Count: 16
• Document Creation Date: December 22, 2016
• Document Release Date: March 7, 2012
• Sequence Number: 1
• Publication Date: May 1, 1981
• Content Type: REPORT

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gig
As g Assessment
I "'1" I 1- '
Natural Gas:
International Trade
and Pricing Issues
Secret
ER 81-10177
May 1981
Copy 28 ]
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National Secret
Foreign 25X1
Assessment
Center
Natural Gas:
International Trade
and Pricing Issues
Information available as of 1 April 1981
has been used in the preparation of this report.
This assessment was prepared by
International Energy Branch, International Materials
Division, Office of Economic Research. Comments
and queries are welcome and should be directed to
the Chief, International Energy Branch, OER, on
This paper was coordinated with the Office of
Political Analysis.
Secret
ER 81-10177
May 1981
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Natural Gas:
International Trade
and Pricing Issues
Key Judgments International shipments of natural gas have more than doubled since 1973 to
about 7.1 trillion cubic feet, representing 12 percent of marketable gas
production and the equivalent of 3.4 million barrels of crude oil per day. The
rapid expansion in trade largely reflects two factors: the favorable price of
gas relative to oil, although gas prices have increased sharply in the past two
years; and the growth of the liquefied natural gas (LNG) industry, which has
enabled supplies to be transported greater distances.F_~
Natural gas trade will continue to expand during the 1980s, as several more
large export projects come on stream and consumers seek to reduce further
their dependence on oil. If all pending and proposed projects are completed,
the volume of trade could double again by 1990. More likely, however, the
rate of growth will be slowed some by a continued escalation in prices and a
growing reluctance on the part of some importers to become overly depend-
ent on external gas supplies.F__-]
Completion of the proposed Western Europe-USSR gas pipeline would
place the Soviet Union by the mid-1980s far ahead of the Netherlands as the
world's largest gas exporter, with shipments of about 3.5 trillion cubic feet
per year. Exports from Algeria and Indonesia, presently the two largest
LNG exporters, will also grow considerably in the coming decade, as these
two countries seek to offset declining oil exports. Nigeria, Malaysia, Austra-
lia, and possibly Cameroon and Qatar are also likely to begin exporting
LNG in the next several years
Natural gas traditionally has been priced below crude oil. While the
difference was relatively narrow in the 1960s, the runup of crude prices in
1973 widened the gap considerably in most countries. Different use patterns
for gas, the timing of contract negotiations, and varying degrees of market
leverage existing between individual producer and consumer have caused
variations in gas prices even within the same country. Producers are
attempting to tie gas prices directly to crude oil and oil-product prices, and
we expect this linkage to become well established, although with variations
reflecting differences in the market and in the volume of alternative sources.
I 25X1
The highly segmented structure of the natural gas market, with relatively
few exporters servicing selected customers, will hinder producer efforts to
effect unified pricing policies in the short term. Instead, most producers will
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Secret
continue to rely on bilateral negotiations to establish secure long-term
markets and, at the same time, gain the most favorable price. Some
producers have already resorted to gas cutoffs and the use of oil leverage
against individual customers in an attempt to extract price concessions.[
Declining availability of domestic gas supplies will make most West Eu-
ropean countries increasingly dependent on imported gas. Several West
European countries-faced with declining Dutch and domestic supplies-
may be willing to pay premiums to encourage development of North Sea gas
supplies to avoid becoming overly dependent on Soviet or Algerian gas.
Japan will have to rely exclusively on imports to expand future gas supplies.
The United States may also have to rely more heavily on imported gas later
in the decade if efforts to boost or stabilize domestic production fail.
25X1
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Natural Gas:
International Trade
and Pricing IssuesF
The Resource Base
Proved reserves of natural gas have been estimated at
about 2.64 quadrillion cubic feet, the Btu equivalent of
455 billion barrels of crude oil, and reserve additions
continue to outpace consumption. In comparison,
proved world crude reserves total about 650 billion
barrels, but are being depleted rapidly.F_~
More than one-third of world natural gas reserves are
located in the Soviet Union; slightly more than one-
fourth are in the Middle East. Huge reserve additions
in the USSR and Middle East and sharp reductions in
reserve additions in North America have shifted the
distribution of reserves in recent years. Only one-tenth
of world natural gas reserves are in North America,
which accounts for more than 40 percent of world
natural gas consumption. Western Europe, with 6
percent of world reserves, accounts for about 14
percent of natural gas consumption.F_~
Gross production of natural gas totaled an estimated
67 trillion cubic feet in 1980-the oil equivalent of
nearly 32 million barrels per day. Large quantities of
gas have to be vented or flared if an appropriate
collection and distribution system is not available. An
estimated 7 trillion cubic feet were vented or flared in
1978-the last year for which data are currently avail-
able-with OPEC producers alone flaring about 4.7
trillion cubic feet. About 30 percent of natural gas
production occurs in association with oil production.
Development of Natural Gas Industry and Trade
Since most of the initial production of gas occurred as a
byproduct of oil production, the production cost of gas
was virtually zero. Still, even local trade in natural gas
was nonexistent for many years because of the large
capital expenditures required to move gas from the
wellhead to markets. Transport costs are two to five
times as much for gas as for crude oil on a heat
equivalent basis, with the relative disadvantage greater
for small-scale movements. Thus associated gas was
simply vented or flared, and nonassociated gas wells
were shut in.l
The United States was the first country to develop a
major internal market for gas. Lack of alternative uses
for gas enabled pipeline companies to obtain gas from
producers at relatively low prices. With relatively low
pipeline construction costs, and the need to amortize
pipeline investments, the pipeline companies were able 25X1
to offer gas at attractive prices with the added security
of long-term contracts. The low prices in turn encour-
aged gas consumption as a substitute for coal, manu-
factured gases, and residual fuel oil in the industrial
and utility sectors. Gas also became a favorite sub-
stitute for heating oil in the residential and commercial
sector as a result of lower prices, and the cleaner
burning characteristic of the fuel. Rapid growth led to
government regulation of pipeline companies as a pub-
lic utility, also helping to keep prices down.F_~ 25X1
The first major international shipments were from 25X1
Canada to the United States. In 1952, Canadian pro-
ducers, taking advantage of the spreading US distribu-
tion network, began exporting to the northwestern
United States. The volume of trade expanded rapidly
during the 1960s.F__1 25X1
Several West European countries began to supplement
their limited domestic output with imports of small
amounts of Libyan and Algerian LNG in the 1960s,
but development of the Groningen field in the Nether-
lands led to the first major international gas trade in
Western Europe in the late 1960s. The Dutch pursued 25X1
export sales in order to recoup some of the investment
costs in developing the field. They offered long-term
contracts at extremely low prices to encourage gas
substitution and to head off expansion of nuclear
power. At about the same time, the discovery of North
Sea gas and construction of pipeline facilities enabled
the United Kingdom to develop a large internal gas
market. In the early 1970s, the USSR began piping gas
into Western Europe at prices even below those for
Dutch gas
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Natural Gas Exports, by Country, 1980
Japan also began LNG imports in the early 1970s,
with deliveries from Alaska and Brunei. By the latter
part of the decade, Tokyo was also receiving shipments
from Indonesia and Abu Dhabi. The Japanese have no
significant natural gas resourcesF I
Among LDCs, only Saudi Arabia, Mexico, Iran, Ven-
ezuela, Kuwait, and Pakistan-all of which produce
for their own needs-are substantial consumers of gas.
Programs to expand the use of gas domestically are
also well under way in Saudi Arabia and Mexico.
Other LDCs also possess gas reserves, but lack of
financial resources or political will has limited develop-
ment of gas resources for either internal use or export.
Only Argentina has imported significant quantities of
natural gas from Bolivia and Chile.F__1
International trade in natural gas has grown rapidly in
recent years from about 3.4 trillion cubic feet in 1973
to about 7.1 trillion cubic feet in 1980. Nevertheless,
only about 12 percent of marketable gas flows in
international trade
Market Structure
The bulk of internationally traded gas moves via pipe-
line. Pipeline gas exports totaled about 5.9 trillion
cubic feet in 1980 or roughly 80 percent of total gas
exports. The Netherlands, USSR, Norway, and
Canada accounted for 95 percent of pipeline exports.
The growth of the liquefied natural gas industry in
recent years has increased supply flexibility in the gas
industry, but there are still only a small number of
countries that have the facilities to receive and distrib-
ute the fuel. Many countries have been dissuaded from
importing LNG by the high capital costs associated
with constructing regasification facilities (up to $370
million each), LNG tankers ($150 million each), and
internal gas distribution networks. At present there are
only 16 LNG import terminals in operation-seven in
Japan, six in Western Europe, and three in the United
States; 70 LNG tankers are in service. LNG shipments
totaled about 1.2 trillion cubic feet in 1980.1
25X1
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World Trade in Liquefied Natural Gas (LNG)
South
Pacific
Ocean
Export terminal
A current
p proposed
Import terminal
A current
o proposed
S
Libya
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North
Pacific
Ocean
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Natural Gas Movement in 1980
Arrows are proportional to the total annual volume of gas
transferred. Scaling is constant for both main map and inset.
The inflexibility and high cost of gas transport has
resulted in the development of three geographically
segmented markets-United States (pipeline and
LNG), Europe (pipeline and LNG), and Japan (LNG
only)-each serviced by a small number of suppliers:
? Gas is supplied to the US import market via pipeline
from Canada and Mexico and by LNG tankers from
Algeria. US gas imports totaled about I trillion cubic
feet in 1980, the bulk from Canada. LNG shipments
amounted to only 86 billion cubic feet-down from
252 billion cubic feet in 1979-because of a pricing
dispute with Algeria. Both Canada and Mexico have
no alternative export outlets at present.
? The European market-West and East-is the larg-
est gas trading market. The Netherlands, the USSR,
and Norway are the major suppliers by pipeline. The
Netherlands exported about 1.8 trillion cubic feet to
West European countries in 1980; the USSR shipped
about 2.1 trillion cubic feet, divided between Eastern
Europe (57 percent) and Western Europe (41
percent). LNG imports into Western Europe from
Libya and Algeria totaled about 260 billion cubic
feet in 1980.
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 Table I
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Total
Imports
Canada
Mexico
United
States
Bolivia
Chile
Nether-
lands
Norway
USSR
Algeria
Libya
Afghani- Brunei
stan
Indonesia UAE
Argentina
0
0
0
70
15
0
0
0
0
0
0
0
0
0 85
United States
806
102
0
0
0
0
0
0
86
0
0
0
0
0 994
Europe
Austria
0
0
0
0
0
0
0
85
0
0
0
0
0
0 85
Belgium, Luxembourg
0
0
0
0
0
350
70
0
0
0
0
0
0
0 420
Finland
0
0
0
0
0
0
0
36
0
0
0
0
0
0 36
France
0
0
0
0
0
390
90
170
78
0
0
0
0
0 728
Italy
0
0
0
0
0
240
0
240
0
50
0
0
0
0 530
Netherlands
0
0
0
0
0
0
110
0
0
0
0
0
0
0 110
Spain
0
0
0
0
0
0
0
0
70
30
0
0
0
0 100
United Kingdom
0
0
0
0
0
0
350
0
32
0
0
0
0
0 382
West Germany
0
0
0
0
0
800
330
380
0
0
0
0
0
0 1,510
Eastern Europe
0
0
0
0
0
0
0
1,200
0
0
0
0
0
0 1,200
USSR
0
0
0
0
0
0
0
0
0
0
85
0
0
0 85
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? Japan imported about 850 billion cubic feet of LNG
in 1980 from Indonesia, Brunei, the United States
(Alaska), and the United Arab Emirates. Japan has
no external pipeline sources of natural gas.F__1
Pricing Trends and Policies
Low initial prices for natural gas reflected low produc-
tion costs, pipeline company desires to penetrate and
establish long-term markets, the lack of alternative
uses of gas, and the relatively low price of alternative
fuels that natural gas replaced. The long-term contract
prices, in turn, set an effective ceiling on prices for new
supplies. In the US market, for example, domestic gas
prices initially put an upper limit on the prices the
Canadians could demand. Similarly, Dutch pricing
policy held down gas prices in Europe well into the
1970s. The price of Soviet gas in Western Europe in
1974, for example, ranged from $0.30 to $0.50 per
million Btu delivered and reflected almost a zero
wellhead price. Heavy fuel oil, a major competing fuel,
was selling for $1.86 per million Btu in Western Eu-
rope at the same time. Gas prices from different pro-
ducers have varied widely even within the same coun-
try in Europe, reflecting different degrees of leverage
between buyer and seller and different periods of con-
tract negotiations. In 1980, for example, Italy was
paying three different prices for delivered gas from the
USSR, Libya, and the Netherlands.
On the other hand, because the Japanese market had
no competing sources of gas via pipeline and only
limited domestic production, delivered LNG prices
soon became closely tied to crude oil prices as an
alternative fuel supply. LNG prices charged by various
sources in Japan have remained fairly closely linked to
crude prices and to each other.F__-]
The delivered price of natural gas was roughly half
that of crude oil on an energy-equivalent basis during
the 1960s. The gap widened sharply following the oil
price runup in 1973, with prices realized by some gas
producers equating to only 10 to 20 percent of the price
obtained for oil in the same market.)
In response to these disparities, the Dutch enacted the
Natural Gas Act of 1974 giving the government
authority to raise prices unilaterally for exported gas,
regardless of the provisions of existing contracts. Until
then, even those contracts that called for automatic
price increases based on increases in fuel oil prices
allowed only for a percentage of the oil price increase
and lagged by several months the change in oil prices.
Other producers such as the USSR soon followed th25X1
Dutch precedent in raising prices. 25X1
Several other factors have also influenced the upward
trend in gas prices:
? Natural gas use has grown. Besides its use as a fuel,
it is a raw material for petrochemical production and
can be reinjected into many oil reservoirs to enhance
oil recovery.
? The inability to substantially boost supplies of low-
priced traditional sources of gas in the United States
and the Netherlands has eliminated the effective
ceiling that these gases placed on imported prices.
? New gas sources, particularly LNG projects and
offshore gasfields now being developed, are costlier.
25X1
Several gas exporters have sought and, in some cases,
received substantial increases in prices during the past
year:
? Canada and Mexico received increases of 30 and 25
percent, respectively, in their export prices to the
United States in 1980. The Canadian price increase,
however, resulted in a sharp cut in US demand. 25X1
? The Netherlands renegotiated prices with its West
European clients last year, linking the price of gas to
the price of low sulfur fuel oil. Under the new for-
mula, gas prices at the Dutch border would now
equate to about $4.40 per million Btu but are being
phased in at a lower level. Dutch gas prices for
domestic users have traditionally been considerabl.25X1
higher than export prices.
? Norway concluded a deal with a West German firm
that has the delivered gas price linked to a basket of
crude oils at essentially heat-equivalent prices. Oslo
is expected to receive close to thermal parity on all
future sales of its North Sea gas. 25X1
? Abu Dhabi and Brunei boosted prices for their LNG
exports to Japan by having them indexed to crude oil
prices on a delivered basis.
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Average Prices for Oil and Natural Gas
Average retail price
No. 2 fuel oil
Canadian gas
Border price
I I I I I I I I I
1972 73 74 75 76 77 78 79 80
Brunei LNG
delivered
2
I I I I I I I I I I V I I I I I I I
1972 73 74 75 76 77 78 79 80a 1972 73 74 75 76 77 78 79 80a
aAverage price 4th quarter 1980, aAverage price 4th quarter 1980. No Libyan LNG was delivered.
Average retail price
No. 6 fuel oil
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JGL L V L
? Algeria has sought to have f.o.b. prices for its LNG
exports based on the thermal equivalent of high-
quality Algerian crude-about $6.90 per million Btu
at present crude prices. The United States and
France refused these demands and deliveries were
cut off last April. An agreement with the El Paso
Company and the United States Government has
failed to materialize and deliveries remain sus-
pended. French deliveries were resumed on an in-
terim basis although the price issue remains
unsettled.
? Iran demanded a severalfold increase in prices from
the USSR. The Soviets did not agree, and gas deliv-
eries have been cut off since early 1980.
? Libya cut deliveries of LNG to Spain and Italy in an
effort to extract sharply higher prices. While ship-
ments to Spain have been resumed after reaching a
pricing agreement, deliveries to Italy remain
suspended.
? Indonesia recently concluded an agreement with Ja-
pan on future LNG deliveries which effectively links
f.o.b. gas prices to crude prices on a heat-equivalent
basis. The agreement is the first of its kind in the
industry.F-7
The relationship of current natural gas prices to the
price of substitute fuels varies widely among countries
depending upon the use of gas. In Japan, for example,
delivered prices for LNG currently are close to the
price of imported crude oil on a heat-equivalent basis
and 5 to 15 percent more than the delivered price of
residual fuel oil. Nevertheless, most natural gas is used
as a substitute for residual fuel oil in electricity genera-
tion and industry because of its cleaner burning nature
and the utilities' desire to cut oil use. Natural gas is
also substituted, to a much smaller extent, for direct
crude burning in electricity generation. It does not
substitute for higher valued oil products such as heat-
ing oil in the Japanese residential sector.F_~
In France, about 45 percent of natural gas is used in
the residential/commercial sector where it substitutes
for heating oil, a product with a current f.o.b. price
about 15 percent higher than average crude prices and
85 percent higher than natural gas prices. Similar use
patterns and price differences occur in the United
States, the Netherlands, and the United Kingdom.
Indeed, the price of natural gas in these countries
remains well below equivalent crude oil prices because
of the availability of lower priced competing fuels,
including domestic gas, in each of these markets.L125X1
Outlook
Although leadtimes are such that large-scale expan-
sion will take several years, supplies and trade of
natural gas are likely to grow over the longer term as
real price growth encourages the development of new
distribution systems. Moreover, as prices rise, trans-
portation costs will become less of a constraint on gas
trade and pricing issues.F_~ 25X1
The USSR is in the best position to expand its gas
trade.' It is negotiating with several West European
countries to build a large new gas pipeline from West
Siberia to Western Europe which would more than
double its current gas exports to that region. Under the
proposed project, a European consortium would pro-
vide the engineering, equipment, and financing for the
pipeline. In terms of capacity and length, it would push
the state of the art to new levels. An agreement by the
participants to go ahead with this multibillion-dollar25Xl
project would greatly improve the gas supply situation
in Western Europe, but probably not before the late
1980s at the earliest.) 25X1
Algeria, Nigeria, and Indonesia, all of which have
abundant reserves, are likely to rely on gas export
projects for a considerable portion of future revenue
needs. These producers will not be as constrained by
revenue surpluses and conservationist tendencies as the
Persian Gulf oil producers and are likely to expand gas
output noticeably over the next decade.0 25X1
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Table 2
Gas Contract Pricing
Exporter
Importer
Price a
(US $ Per Million Btu)
Abu Dhabi
Japan
5.57
Delivered price at heat equivalency with
Abu Dhabi crude oil (f.o.b.)
Afghanistan
USSR
1.98
At Soviet border
Alaska
Japan
5.93 b
Delivered price tied to average crude im-
port prices in Japan
Algeria
Spain
United Kingdom
US (Distrigas)
US (El Paso)
France
Belgium
4.50
Base price ($3.50) indexed to 80 percent of
crude price change
Escalates to $4.80 on 1 July
Shipments suspended
Start 1982; escalation linked to crude
prices
Delivered price tied to average crude im-
port prices in Japan
Canada
United States
4.94 b
Tied to basket of Canadian crude imports
Indonesia
Japan
5.42
90 percent crude oil equivalent 10-percent
inflation index
Libya
Spain
Italy
4.50
3.45
Escalates at 83 percent of crude price
change
Shipments suspended August 1980 over
price dispute
Mexico
United States
4.94 b
Tied to five key export crudes
Netherlands
France, Italy,
Belgium,
West Germany
3.90-4.10 c
95 percent of low-sulfur fuel oil price
change with a five-month lag
United Kingdom
West Germany
France
Belgium
Netherlands
4.00 b
4.60 b
4.60 b
4.60 b
4.60 b
Italy
France
West Germany
3.81
3.90
4.00
a Prices are f.o.b. the exporting country, unless otherwise noted.
b Prices are c.i.f.
c At the Netherlands border.
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West European nations that have been attempting to
reduce their dependence on oil, largely by substituting
gas, appear vulnerable to producer demands:
? The Algerians, disappointed with the resistance to
their price demands, have halted plans for construc-
tion of both the Arzew (LNG-3) and Skikda 11 facili-
ties that were to produce gas earmarked for West
Germany, France, Sweden, Belgium, and the Neth-
erlands; they are now considering expansion of pipe-
line transport. The Europeans in general, and West
Germany in particular, have expressed concern that
pipeline supplies are vulnerable to disruption by
countries through which they transit.
? European gas companies have signed agreements to
import one-half of Nigeria's output scheduled for
1985 and have indicated an interest in purchasing
the remainder. Lagos has pressured the United
States to take one-half of Nigerian gas production in
the interest of diversifying its customers and main-
taining leverage over US policy on southern Africa.
Development of Nigeria's LNG system has been
slowed pending approval of funding for the project.
Western Europe probably will be forced to bank heav-
ily on increased Soviet supplies and more rapid devel-
opment of Norwegian North Sea reserves if gas sup-
plies are to be increased during the 1980s. Recent
contract signings have shown that some West Eu-
ropean customers are willing to pay a premium for
supply security although much remains to be resolved
on pricing issues for future supplies of both Soviet and
North Sea gas.
Japan is depending on growth in Indonesian LNG
supplies and development of LNG facilities in Malay-
sia and Australia to increase its natural gas supplies.
While a joint US-USSR-Japan LNG project at
Yakutsk is unlikely to materialize, Tokyo is hoping to
begin imports of LNG from the Soviet island of
Sakhalin by 1987. Qatar and Kuwait have expressed
interest in LNG exports to Japan, but any project
would probably require a considerable investment by
the Japanese.F_~
The United States will become increasingly susceptible
to producer price demands if, as many forecasters
believe, domestic gas and oil supplies continue to
shrink. Future LNG imports from Algeria remain in
doubt because of the pricing dispute. To date the
United States has moved slowly on import projects
involving Nigerian and Indonesian LNG. Some addi-
tional supplies of pipeline gas from Canada now appear
likely by the mid-1980s following Canadian approval
of the southern section of the Alaska-Canada pipeline.
Still, considerable uncertainties remain regarding fu-
ture availability of Canadian natural gas, despite Ot-
tawa's sizable resource base. While Mexican exports to
the United States are likely to show some growth,
Mexican domestic consumption probably will limit the
amount available to the US market later in the decade.
25X1
Natural gas prices should rise faster than prices for
crude oil, approaching parity with crude prices over the
next few years as gas continues to replace higher priced
oil in residential and commercial uses. Still, crude
prices probably represent an approximate ceiling for
gas prices in most markets in the near term because gas
lacks the flexibility of oil as a fuel.F_~ 25X1
Over the longer term, gas prices may rise to the level of
high-quality crudes if recent technological develop-25X1
ments allow gas to be converted to high-value products
that would substitute for gasoline or jet fuel. Mobil Oil,
for example, has developed a process to produce syn-
thetic gasoline from natural gas. F__~ 25X1
The highly segmented structure of gas trade and lack
of supply flexibility provide little economic basis for
the formation of a gas cartel. Because few producers
are capable of competing in the same markets, there is
little need to fix price or regulate output. Industrialized
exporters such as Canada, Norway, and the Nether-
lands would have serious political reservations about
joining a cartel-like pricing arrangement with OPEC
gas exporters. Moreover, the incentive for cooperation
on prices will diminish as natural gas prices are boosted
by market forces. Consultations among gas exporters
have been held and such discussions are likely to
continue, but prospects are limited for unified pricing
policies in the short term. Most producers will continue
to rely on bilateral leverage to negotiate prices and will
doubtless threaten to cut off oil or gas supplies to 25X1
extract price concessions.0 25X1
Declassified in Part - Sanitized Copy Approved for Release 2012/03/07: CIA-RDP08S01350R000200400001-1
 Declassified in Part - Sanitized Copy Approved for Release 2012/03/07: CIA-RDP08S01350R000200400001-1
IJGGI GL
Secret
Declassified in Part - Sanitized Copy Approved for Release 2012/03/07: CIA-RDP08SO135OR000200400001-1