Natural Gas Pipeline Regulation: Natural Gas Pipeline Regulation: Costs and Benefits of the Costs and Benefits of the Canadian Approach Canadian Approach Glenn Booth Chief Economist National Energy Board Gold Coast, July 2004 1(title)
Outline Outline 1. Mandate and Goals of the NEB 2. Canadian natural gas market 3. Economic objectives of pipeline regulation: framework for assessing costs and benefits 4. An assessment of the Canadian experience 5. Conclusions Note: All views expressed in this talk are mine and do not necessarily express those of NEB Board Members 2
Mandate of the National Energy Board Mandate of the National Energy Board � Regulate interprovincial and international pipelines: construction, tolls, terms of service, environmental & safety considerations � Regulation of gas, oil & electricity exports � Monitoring of Canadian energy markets � Created in 1959 � Located in Calgary, Alberta 3
Rocky Mountains from Calgary Rocky Mountains from Calgary 4
National Energy Board Goals National Energy Board Goals NEB-regulated pipeline facilities are safe and 1) perceived to be safe NEB-regulated pipelines are built and operated in a 2) manner that protects the environment and respects the rights of those affected Canadians derive the benefits of economic efficiency 3) (from pipeline regulation) The NEB meets the needs of the public to engage in 4) NEB matters 5
2001 Worldwide Natural Gas Reserves 2001 Worldwide Natural Gas Reserves 1000 900 800 700 Tcf 600 500 400 300 200 100 0 . e a a n t a a a r a S s a p i i n d a i i . r r l a s t U a a o e e r i a h E y I r n r g g Q a t C u a l i r s A N l E a a C u F M A . W 6
2001 Worldwide Gas Production 2001 Worldwide Gas Production 60 25 Percent of Total World Production 50 20 40 15 Bcf/d 30 10 20 5 10 0 0 Saudi Arabia Argentina Netherlands Other FSU Algeria Australia Indonesia Malaysia Canada Mexico U.S. Norway U.K. Russia Iran China 7
Top Gas Producers, 2001 Top Gas Producers, 2001 2500 16 Percent of Total Canadian 14 2000 12 Production 10 1500 MMcf/d 8 1000 6 4 500 2 0 0 l o n P n l n l o a n L y o t e t n y s a i l s n b t n o a a e k k h h u o R B i c o l e u r o h s A r a t m C o c p l v N r e W p g a o u e M S a v C - n r p C s o d n m u r o H p e D n o n e i n m i a i r h M l A l R n a n E a C o t n r I C e r u e E T x A a P P B x P E 8
Major Natural Gas Pipelines in Canada 9
Early Development of the Gas Industry Early Development of the Gas Industry � Large finds of oil in western Canada in 1947 and 1950s: gas found in solution � Natural gas was largely a by-product of oil production or an accident of oil exploration � With no pipeline out of Alberta, gas was “trapped” � Producers were willing to sell gas very cheaply 10
Challenge: Bring Gas to the Market! Challenge: Bring Gas to the Market! � All you need is a pipeline � So what’s the problem? Where’s the market failure? � It’s the “hold-up” problem � Once a specific large capital investment is made, each party has an incentive to renegotiate the terms of the contract � Shippers can threaten by-pass, search for alternatives � Pipeline can try to extract monopoly profits � Result: high risk and uncertainty 11
Primary Purpose of Regulation Primary Purpose of Regulation � Regulation reduces the uncertainty and risk associated with a huge capital outlay: � Restricts entry and thereby protects the original investor � Reduces costs associated with contract negotiation � Reduces risk and thereby reduces overall cost of financing � Creates an incentive to invest and provide the desired service 12
Secondary Purpose of Regulation Secondary Purpose of Regulation � Granting monopoly franchise creates need to: � Protect shippers against monopoly abuses � Ensure right to be served � Regulate prices � All of these activities will result in “second best” outcomes (but are they also second level objectives?) 13
NEB Economic Regulation Objectives NEB Economic Regulation Objectives Ensure adequate pipeline capacity is in place 1) Ensure that pipeline system provides shippers 2) with desired services at reasonable cost Ensure that pipelines are financially viable 3) (are able to raise adequate capital to maintain system and finance expansion) 14
Adequate Capacity Adequate Capacity � Belief that a little too much capacity is much better than too little � Key measures of adequate capacity: � Basis differential between markets � Capacity utilization factors 15
Upstream Gas Spending and Export Revenues Upstream Gas Spending and Export Revenues vs. Transmission Expenditures vs. Transmission Expenditures $C Billions 20 10 0 1999 2000 2001 2002 Upstream Gas Drilling & Equip. Spending Canadian Gas Export Sales Revenues Transmission Facilities Spending 16
Gas Cost Components 1 1 ($/GJ) ($/GJ) Gas Cost Components 0 1 2 3 4 5 6 7 Field Gate Price Intra-Alberta Transportation TCPL Transportation to Dawn Distribution 1 Average cost components to Toronto industrial consumer in 2003 17
North American North American Gas Pipeline Grid Gas Pipeline Grid TransCanada Alberta Westcoast (NGTL) Alliance ANG/ Foothills Sumas TransCanada Transmission AECO-C Mainline Foothills TQ&M M&NE Northwest St. Stephen PGT Great Lakes Northern IroquoisPNGTS Dawn Northwest Border Algonquin PG&E CNG Kern Trailblazer River ANR NGPL Panhandle Texas Eastern Transwestern SoCal ANR NGPL Transcontinent El Paso al El Paso NYMEX Key Pricing Point for Canadian Gas
Importance of Adequate Capacity Importance of Adequate Capacity Basis Differential (Daw n- HH) 0.60 1200 Intra-AB Sales Volum e (Bcf) 0.50 1000 0.40 800 ($US/M cf) 0.30 600 0.20 400 0.10 200 0.00 0 1995 1996 1997 1998 1999 2000 Basis Differential (Dawn - Henry Hub) Intra-AB Sales Volume (Bcf) 19
Example: Benefits of Adequate Capacity Example: Benefits of Adequate Capacity Difference in basis differential = roughly $0.40 Minimum: 800 Bcf (intra-Alberta sales) x $0.40 = $320 million Maximum: 5.8 Tcf (all sales) x $0.40 = $2.3 billion/year $2.3 billion better estimate of “deadweight” losses 20
Competition and Canadian Gas Pipeline Tolls Competition and Canadian Gas Pipeline Tolls ($/Mcf Mcf) ) ($/ 1.6 Start up of Alliance 1.4 from Alberta to Ontario Cost of Transportation 1.2 1 TransCanada 0.8 Alliance 0.6 0.4 0.2 0 1997 1998 1999 2000 2001 2002 2003 2004 Year 21
Cost of Competition and Excess Capacity Cost of Competition and Excess Capacity � Cost = extra cost of capacity as reflected in higher tolls � Approximately $0.20/Mcf � Cost = 5.0 Tcf (ex-Alberta sales) x $0.20 = $1 billion/year 22
Costs of Too Much Capacity Costs of Too Much Capacity vs. Inadequate Capacity vs. Inadequate Capacity Annual Cost of Inadequate Capacity: $320 million to $2.3 billion/yr Annual Cost of Excess Capacity: 5.0 Tcf (ex-Alberta sales) x $0.20 = $1 billion/yr Is it a wash?? We don’t think so! 23
Full Costs & Benefits of Full Costs & Benefits of Inadequate vs. Adequate Capacity Inadequate vs. Adequate Capacity Costs Benefits � Foregone sales revenue � All gas/oil receives full � Foregone royalties market value � Inefficient allocation of � Maximization of royalties supply � Efficient allocation of � Negative signal to supply upstream investors � Positive signal to upstream and downstream investors 24
Implicit Alberta to Ontario T- -Value Value Implicit Alberta to Ontario T 1.6 1.4 1.2 1.0 $US/Mcf 0.8 0.6 Jan 2002 - June 2004 (July daily) 0.4 (by month) 0.2 0.0 1 3 5 7 9 1 - - - - - 1 7 7 7 7 7 - 7 TCPL FT & Fuel Monthly Basis Daily Transport + Fuel Daily Basis 25
Gas Pipeline Tolls and the CPI Gas Pipeline Tolls and the CPI (Normalized to the Year 1991) (Normalized to the Year 1991) 1.800 1.700 1.600 1.500 Normalized level 1.400 1.300 1.200 1.100 1.000 0.900 0.800 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Year TransCanada PipeLines Westcoast Energy Inc. Consumer Price Index 26
Are Services Meeting Shippers’ Needs? Are Services Meeting Shippers’ Needs? � Services on TransCanada: � Long-term firm, short-term firm � Biddable interruptible � Parking and loans � Multiple delivery points, multiple “handshakes” � Firm and interruptible backhaul � Active secondary market – efficient allocation � Services on Alliance � NGL transportation in gas stream � Authorized overrun service (free overrun) 27
What do Shippers Think? What do Shippers Think? � NEB is requiring pipelines to survey their shippers � NEB has designed questions on: � Satisfaction with service � Satisfaction with value for service � Satisfaction with NEB’s role � First results to be received for 2004 � We also informally meet with shippers 28
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