Natural Gas & Coal Market: US, Asia, and Asia-Pacific

Natural Gas & Coal Market

Overview

  • Natural gas is a cleaner alternative to coal.
  • Natural Gas:
    • Used for electricity generation, heating, and as industrial feedstock.
  • Coal:
    • Dominant in electricity generation, particularly in Asia and developing countries, despite environmental concerns.
  • Growing shift towards cleaner energy presents challenges globally.

Global Energy Demand

  • Rising demand driven by economic growth, urbanization, and industrialization in Asia.
  • Transition to Cleaner Energy:
    • Focus on reducing carbon emissions by shifting from coal to natural gas and renewable energy.
  • Energy Transition:
    • World is transitioning towards natural gas and renewable energy due to cleaner-burning characteristics.
  • Impact of Geopolitics:
    • Energy trade is influenced by geopolitical factors.
  • Economic Growth vs. Cleaner Energy:
    • Balancing economic growth with cleaner energy sources is important.

Measuring Natural Gas Production and Consumption

  • Two key indicators:
    • Volume Measurement: Measured in cubic meters (m³) or cubic feet (ft³).
      • Large quantities: thousand cubic feet (Mcf), million cubic feet (MMcf), or billion cubic feet (Bcf).
      • Example: 1 cubic foot = 0.0283 cubic meters.
    • Energy Measurement: Measured in British thermal units (BTUs) or joules (J).
      • Example: 1 cubic foot ≈ 1,037 BTU (varies by composition).
  • Measurements track gas extraction, conversion, and consumption.

Global Oil and Gas Pipeline Market Overview

  • Oil and Gas Pipeline Market Size was valued at USD 25.9 Billion in 2022.
  • Projected to grow from USD 27.3 Billion in 2023 to USD 41.9 Billion by 2032.
  • Compound annual growth rate (CAGR) of 5.50\% during the forecast period (2023 - 2032).
  • Increasing demand for pipelines to transport oil and gas and increased use of renewable energy are key market drivers.
  • Essential infrastructure for the global energy supply chain.
  • Moving crude oil, refined petroleum products, natural gas, and other resources from production areas to refineries, distribution points, and end-users.

Transaction Cost Economics (TCE)

  • Developed by Ronald Coase and expanded by Oliver Williamson.
  • Focuses on costs associated with economic exchanges or transactions.
  • Emphasizes real-world costs: search, bargaining, enforcement, and monitoring.
  • Corporations are the integrating force for increasing complexity and division of labor.
  • Market structure evolves to minimize transaction costs between entities.

Cost Considerations

  • Cost is crucial in optimal economic decision-making.
  • Total costs (TC):
    • TC = \sum{i=1} pi q_i
    • Where pi is the price and qi is the purchase of the i^{th} factor.
  • Includes direct and opportunity costs.
  • Price can be market price or opportunity cost.
  • Break total costs into fixed and variable costs for short- and long-run decisions.
  • Macroeconomics view:
    • Costs are payments to factors, generating income.
    • Aggregate income (Y) represents both the supply of goods and the income generated.

Keynesian Model

  • Economy divided into consumers, businesses, government, and foreign sector.
  • Aggregate purchases:
    • C = consumption, I = investment, G = government, Ex-Im = net exports
  • Equilibrium:
    • Y = C + I + G + (Ex - Im)
  • Framework aids in forecasting macro aggregates.

Transaction Costs Breakdown

  • Costs of conducting economic exchanges.
  • Go beyond the price of goods and services.
  • Include costs involved in negotiating, drafting, enforcing, and monitoring contracts.
  • Types of transaction costs:
    • Search costs
    • Information costs
    • Bargaining costs
    • Decision costs
    • Policing costs
    • Enforcement costs

Governance Structures

  • Institutional arrangements governing transactions.
  • Four models of transaction governance (least to most formal):
    • Market governance: Trading in a spot market.
    • Bilateral governance: Trading using long-term contracts.
    • Trilateral governance: Trading with long-term contracts, with a third party facilitating the transaction.
    • Unified governance: Transactions are internal to the company.
  • Chosen mode should minimize transaction costs.

Economic Realities

  • Bounded rationality: Agents cannot acquire, assimilate, and use all information.
    • Suggests limits on cognitive abilities and access to information.
  • Opportunism: Agents may take advantage of information asymmetries.
    • May make promises they do not intend to keep.

Asymmetric Information

  • Lack of symmetry or balance between parties in a transaction.
  • One party has more information than the other.
  • Can lead to moral hazard and adverse selection, affecting market efficiency.

Institutional Factors

  • Three factors influencing transaction costs:
    1. Uncertainty:
      • Inability to predict volatility in future states.
      • Complexity prevents understanding.
    2. Asset specificity:
      • Investment in relationship-specific assets.
    3. Frequency of transactions.
  • Increase in uncertainty raises bargaining or noncompliance costs.

Asset Specificity

  • Investment in relationship-specific assets.
  • Types:
    • Nonspecific asset: Standard equipment with many applications.
    • Mixed asset: Customized equipment.
    • Idiosyncratic investment: Very specific to a particular transaction.
  • For idiosyncratic investment, the value in next-best use is low.

Quasi-Rent or Marshallian Rent

  • Temporary economic rent, like returns to a supplier/owner.
  • Differs from pure economic rent being a temporary phenomenon.
  • Arises from barriers to entry or entrepreneurial responses to market fluctuation.
  • In the long term, new capital competes away the quasi-rent.
  • Oliver Williamson: Joining opportunism with transaction-specific investments explains decisions to vertically integrate.

Marshallian Rent vs. Quasi-Rent

  • Marshallian rent: Extra income from limited land or resources.
    • Example: Fertile land earns more rent.
  • Quasi-rent: Extra income from machinery temporarily in high demand.
    • Example: New machine earns more initially, but rent decreases as more machines are made.

Rents and Quasi-Rents Table

  • Short Run
    • 0 < P < AVC: Shut down
    • AVC < P < ATC: Quasi-rent = P - AVC
    • ATC < P: Total rent = P - AVC
  • Long Run
    • 0 < P < ATC: Shut down
    • ATC < P: Total rent = P - ATC

Explanation of Rents and Quasi-Rents Table

  • Short run: Continue operating as long as revenue covers variable costs.
  • Long run: Must cover total costs to remain in the market.
  • Quasi-rent: Temporary survival; Total rent: Long-term sustainability.

Quasi-Rents and Holdup

  • Quasi-rents can be reduced or eliminated through strategic bargaining if assets are specific.
  • Holdup: Reduction of quasi-rents through strategic bargaining.
  • Example: Pipeline selling gas to a single power plant.
    • Fixed costs: 0.50/Mcf
    • Variable costs: 0.75/Mcf
    • Total costs: 1.25/Mcf
    • Power plant offers 0.80/Mcf. Seller accepts to cover variable costs, despite losing 0.45/Mcf.
  • In the long run, reinvestment requires covering total costs.
  • Need for formal guidelines in trading relationships.

Holdup Problem

  • Arises in transactions with highly specific investments, leading to potential exploitation.
  • Seller accepts unfavorable price due to lack of alternative buyers.
  • Highlights the necessity of formal trading agreements.

Governance Structures in Market Transactions

  1. Market Governance (Spot Market):
    • For nonspecific assets.
    • Multiple trading partners mitigate opportunism.
    • High liquidity, standardized products.
  2. Bilateral Governance:
    • Contracts between two parties.
    • Long-term contracts, e.g., natural gas.
    • Medium to high asset specificity and market uncertainty.
    • Price escalation clauses for market changes.
  3. Trilateral Governance:
    • Third party ensures fairness.
    • Costly contract enforcement, mixed asset specificity.
    • Reduces transaction costs, prevents opportunism.
    • Less needed with frequent transactions and mutual interest in fairness.
  4. Unified Governance (Vertical Integration):
    • Company fully integrates a function.
    • Highly specific assets, information asymmetries, complex custom products.
    • Example: In-house software development.
  • Governance model depends on asset specificity, transaction frequency, market uncertainty, and enforcement costs.

Spot Market

  • Public financial market for immediate delivery of financial instruments or commodities.
  • Contrasts with a futures market.

Long-Term Contract Provisions

  • Key provisions:
    • Take-or-pay clauses: Pipeline companies pay producers regardless of product taken.
    • Minimum-billing clauses: Buyers (LDCs) take or pay for agreed volume.
    • Most-favored-nation (MFN) clauses: Producers get the highest price paid within an area.
    • Price renegotiation: Allows price changes under conditions.
    • Automatic price adjustments: Adjustments at intervals or events.
    • Exclusivity or sole-source clauses: Reserves dedicated to a buyer.
  • Manage risks, ensure financial stability, and maintain pricing fairness.

USA: Natural Gas

  • Largest producer, thanks to shale gas revolution.
  • Major areas: Texas, Pennsylvania, Louisiana.
  • Critical for electricity generation, industry, and heating.
  • Over 35% of electricity.
  • Net exporter via LNG.
  • Key export markets: Asia and Europe.
  • Price Volatility: influenced by domestic supply, weather and global LNG demand.

USA: Coal

  • Large reserves, but production declining due to natural gas and renewable energy.
  • Decreased share in energy mix.
  • Stringent environmental regulations accelerate decline.
  • Exports primarily to Asia for steel production and electricity generation.

ASIA: Natural Gas

  • Largest consumer of natural gas.
  • Increasingly reliant on LNG imports: major importers - Japan, China, and South Korea.
  • Shift from coal
  • Massive investments in LNG infrastructure.
  • Demand driven by growing middle class and industrial base.

ASIA: Coal

  • Remains dominant in energy mix.
  • China and India account for about half of the world’s coal consumption.
  • Environmental impact leads to pressure to reduce dependency.
  • China invests in renewable energy and cleaner technologies but continues to rely on coal.

Asia-Pacific: Natural Gas and Coal

  • Natural Gas: Largest importer of LNG.
  • Countries like Australia (major LNG exporter), Japan, and South Korea are central to the LNG market.
  • Coal: significant coal exporter is Australia, while countries like Indonesia, Vietnam, and India continue to consume large amounts of coal.
    Energy Mix Diversification: Ensuring energy security while transitioning to cleaner energy sources.

US vs. Asia

  • US decreasing coal dependence, shifting to natural gas; Asia heavily depends on both.
  • US has a clearer path to greener energy; Asia balances coal for energy security with cleaner energy push.
  • The price of natural gas is often more volatile due to supply- demand dynamics, with coal prices being more stable but linked to environmental policy changes.
  • U.S. policy is more aggressive in reducing carbon emissions, while Asian countries are gradually adopting stricter policies on emissions, but with a focus on economic growth.

Future Trends

  • Natural gas will continue to grow due to cleaner burning, especially in Asia and the U.S.
  • Coal demand will likely remain strong in Asia but decline in the U.S. and Europe.
  • Investments in carbon capture and storage (CCS) technologies, and green hydrogen may change market dynamics.

Natural Gas: Composition and Characteristics

  • Fossil fuel primarily composed of methane (CH_4).
  • Forms over millions of years from plant and animal remains.
  • Composition: Mainly methane (70-90%), with ethane, propane, butane, and carbon dioxide.
  • Cleaner energy source: lower \text{CO}_2 emissions and fewer pollutants.
  • Found in gaseous form; liquefied (LNG) for transport and storage.
  • Extracted from gas fields, shale deposits, and coal-bed methane sources.

Natural Gas: Common Uses and Advantages

  • Common Uses:
    1. Electricity Generation: Gas turbines and combined-cycle power plants.
    2. Heating: Residential, commercial, and industrial systems.
    3. Industrial Uses: Feedstock for chemicals, fertilizers, and plastics.
    4. Transportation: Compressed natural gas (CNG) in vehicles.
    5. Liquefied Natural Gas (LNG): Transported globally in liquid form.
  • Advantages:
    • Lower Emissions: About 50% less \text{CO}2 than coal and less than 30% of the \text{CO}2 produce by oil.
    • Abundant Supply: Vast reserves globally, especially in the U.S., Russia, and Qatar.
    • High energy content per unit.

Natural Gas: Environmental Impact

  • Cleaner Burning: Still contributes to greenhouse gas emissions.
  • Methane Leakage: Escapes during extraction, storage, and transportation, potent greenhouse gas.
  • Fracking: Concerns about groundwater contamination and seismic activity.
  • Plays a crucial role in the modern energy landscape due to its relatively low emissions and abundant supply.

Natural Gas Conversion

  • Transformation into more usable and transportable forms.
  • Typical conversions: liquefied natural gas (LNG), compressed natural gas (CNG), or liquid fuels/chemicals.

Liquefied Natural Gas (LNG)

  • Natural gas cooled to a liquid state ($-162°C-260°F).
  • Reduces volume by about 600 times.
  • Process of Conversion to LNG:
    • Extraction
    • Purification: impurities removal.
    • Liquefaction.
    • Transport and Storage.
  • Uses of LNG:
    • Global Energy Trade: can be shipped to distant markets that don't have pipelines.
    • Energy Security: imports to meet their energy needs.
  • Advantages of LNG:
    • Allows for transportation over long distances (international trade).
    • Cleaner burning than coal and oil.
    • Enables energy access to countries without natural gas pipelines.