Thursday, 19 January 2012

Natural gas, markets, politics and other bores

After the WWII,  US made a major commitment to natural gas as a source of energy. From a very small and local business (i.e. no long-distance pipe network), natural gas became a major energy source covering 25% of the US energy demand by the beginning of the 1970’ies. By that time, gas companies built an intricate network of pipes connecting high demand urban sprawls to remote gas fields. This economic and engineering development had not been matched by a similarly progressive policy, and the gas prices stayed highly regulated. As always, this means low prices to keep voters happy, but set arbitrarily and in a complex way. Politicians have generally shied away from the difficult task of convincing their voters to trade today’s low prices for a much larger but less clear multi-generational benefit. Economics suggests this is a disastrous choice that it discourages long-term investment, ultimately leading to supply constraints. As bad things come, such a bottleneck came in the exceptionally cold winter of ’76-77 and brought large scale industrial shut downs, closing of schools and major disruptions to other public services . Even the politicians found such a disaster hard to ignore and started the exceptionally difficult process of liberalising the prices, a process finalised with the Natural Gas Policy Act of 1978. Deregularisation brought predictability to a large and growing market, which in turn attracted the large, long-term investments required; gas supply never became a problem in the US, while overall reserves were fairly continuously augmented by new discoveries. Prices dropped and kept voters and businessmen alike content – there was even talk of a gas bubble at some point. The so-called bubble (oversupply) was, as it is in most cases, linked at least partially to the half-measures produced by the US legislators. Price deregulation did not mean full market liberalisation; politicians decided to ban the use of natural gas in the production of electricity as this was too valuable to just be burned away, so a growing economy resorted mainly to coal to satisfy its power needs, leaving natural gas mainly for domestic and industrial consumption. One can speculate on the long-term impact on the environment.
When this ban was removed in the 90ies to help sustain the booming economy of the Clinton era, gas prices increased rapidly but were soon tamed by alternative supplies, principally LNG, which Japan had been using for years to power its manufacturing-focus boom.  By 2000, the US energy market had two large alternative and complementary supply sources for the natural gas – multiple North American fields (plus the required pipelines) and multisource LNG supplies (Middle East, Trinidad). Shale gas becomes now the third, owing to very large, economically viable fields in North America. This is what energy security and a stable and predictable market really rely on – diversified supply sources.
As many other governments do, the Romanian one decided to ignore the lessons learned from past experiences of other countries and went on to make the same mistakes, mostly from incompetence and a natural desire to avoid political heat. Lucky to have domestic reserves of natural gas, the government decided to keep a tight grip on the prices for the domestically produced gas as well as on the other aspect of the markets – regulation, control, ownership of the national gas company (Romgaz), etc. Predictably, this determined a certain level of underinvestment resulting in decreasing natural gas reserves . As the domestic production is insufficient, there is a certain dependence of a single source of gas imports, Russia, for which Romania pays a high market price. In this case, what “market” really means is the result of some form of negotiation with the Gazprom mammoth, with no realistic alternative in short and medium term. Gas storage alternatives(large empty holes in the ground where gas can be pumped in during the summer and used to smooth the supply/ demand balance during the winter) have been feasible from an economic and technical standpoint, but these initiatives have suffered enormous delays.
However, some things have changed. The privatisation of Petrom, Romania’s national integrated oil company in 2004 brought both investments and a more business-like approach. Petrom is now Romania’s premier natural gas producer having taken over Romgaz years ago. Some liberalisation of the natural gas prices is being pursued, half-heartedly and only due to the pressure of the EU. Regulation has been maintained complex, with all sorts of rules on what kind of gas (imported or local production) various domestic and industrial consumers can use and when. Such a complicated and regulated market is, as almost everywhere, the perfect recipe for inefficiency, market disturbance, fraud.  In the meantime, the blanket subsidy of low prices continues to benefit everybody, the poor as well as the wealthy and inefficient – particularly some gas-intensive industries. When the next step of liberalisation comes through, a hard political act that most politicians will try to exploit one way or another particularly in an election year, the correct economic measure (liberalise the prices and direct financial help to some categories of poor private consumers) will be swamped by a torrent of populism and incriminations. Some say that this has already started and refer to recent events, particularly a large scale prosecution of some 40+ people connected to the market (executive management and Board members of Romgaz, officials from the relevant Ministry, the owner of Romania’s largest industrial consumer of natural gas, etc.).
In a nice symmetry to the American story above, the Romanian government took a keen interest in Petrom’s plans to bypass the over-regulation of the gas market by building its own gas-fired power plant, as the electricity market is indeed liberalised. Romania’s most modern power plant, the only facility of this sort built in the country in 40 or so years, was finalised last year. However, the government decided that Petrom’s own natural gas is far too valuable to be just burned and decided that the power plant can only burn a combination of domestic and imported gas. Petrom needs to buy the imported gas (expensive) while gas from its own domestic production (cheap) will still go to the over-regulated market. This issue may not be finally settled, but it is another example of market manipulation that goes against economic efficiency.
One can only hope that years from now all this would look as childish as the American experience of 30 years ago, and Romania will have a stable, secure and  well supplied market from domestic natural gas (Romgaz, Petrom and international companies), imported (Russia and Caucaz), LNG (Qatar)and off-shore shale gas.

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