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Blue gold: The political economy of natural gas
Book reviews Natural gas studies reviewed NATURAL GAS MARKETS AFTER DEREGULATION by Harw G. Broadman and W.G. Montgome~ Resources for the Future, Washington, DC, 1983, 112 pp, $18.00 THE NATURAL GASINDUSTRY by Arlon R. Tussing and Connie C. Barlow Harper & Row, London, 1984, 284 pp, £28.50 BLUE GOLD: THE POLITICAL ECONOMY OF NATURAL GAS by J.D. Davis George Allen and Unwin, London, 1984, 336 pp, £25.00 More than a decade into the 'energy crisis' and after literally thousands of books about oil, hundreds about coal and nuclear power and dozens about alternative energy technologies which will not be commercial for several decades, we are at last getting some books about that well known and widely used, but to many uninspiring fuel, natural gas. However, readers could be forgiven for not knowing of their existence since, even though all three of these volumes come warmly recommended, their publishers appear to have expended a negligible effort on publicity. The first two volumes deal exclusively with the world's biggest natural gas market in all of its complexity. Although the Resources for the Future paper is designed as a research proposal sketching out issues to be addressed in future volumes, it is enormously useful for those who are seeking a lucid explanation of the workings of the US gas industry in less than 100 pages. Tussing and Barlow deal with all the issues of regulation,
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price control, industrial structures and markets with an outlook for the future as well as a historical perspective. This is likely to become the standard work on the subject. The authors are very much in the current tradition of market worshippers who hold government intervention responsible for all the ills of the business, which would work much better if left to market forces. Nevertheless, their careful explanation of what to a foreigner appears to be the 'organised craziness' of the US gas market, and its ability to swing from shortage to glut in a comparatively short space of time, is excellent. In a key passage on the strategies for dealing with an impending shortage, they note, 'If gas prices are deregulated and thereby can hold supply and demand in balance, a shortage is avoided altogether, but consumers have to pay more. On the other hand, if prices are held below a market clearing level, some consumers pay less, but others are shut out of the market completely or live in fear of future curtailments. Moreover, if price is not allowed to balance demand, then some Governmental entity has to step in and decide who deserves to get how much of the limited supply'. (p 106) The problem for a country and a political system so totally committed to private enterprise as the USA, is how the government can protect large numbers of consumers in the supply of a vital product from monopolies who stand to make vast profits, without overly distorting the market. Tussing and Barlow never fully grasp this nettle, because they assume that consumers have or will develop the freedom to switch to another commodity if it is profitable to do so. The reality is that US citizens are more likely to be stuck with their utility and take it out on their Congress person, who, in turn, will try and devise complex legislation to protect constituents, which, in turn, will protect votes, but distort the market. Furthermore, in the description of the regulatory process, neither volume
fully brings out the very strong interests outside government which make their living from the present status quo. In a deregulated environment, large armies of law firms and consultants - not to speak of a good number of federal and state employees - would find themselves out of a job and virtually unemployable since their whole careers had been constructed around this edifice. Another disturbing feature of the US scene is the demise of contract sanctity over the recent past, with pipeline companies being the chief culprits. In a climate of declining demand and falling prices, as the pipeline companies found their take or pay obligations too onerous they simply claimed force majeure. As Tussing and Barlow note, ' . . . the pipeline companies soon realized that they were in the driver's seat: they controlled the valves that released gas from producer wells and they had the power to refrain from making payment. A producer could threaten to sell the reserves to someone else, but the pipeline companies knew that there were no oth'~r buyers in s i g h t . . . The business ot ,~_ ~gating take or pay commitments soon became an a r t . . . ' (p 174). However, although the US gas industry may be able to continue its contractual anarchy for as long as the natural gas 'bubble' lasts, at some time in the future there will be the problem that no bank will be prepared to finance a development without an ironclad guarantee that contractual terms will be adhered to. As Broadman and Mongomery note, 'It is likely to be particularly difficult to design long term contracts that transmit rapid changes in end-use demand to the upstream market to bring about rapid changes in supply. Overall, a move to other forms of transaction may be expected' (p 16). The problem is that in the natural gas business there can be no other forms of transaction in a situation where very large investments need to be amortized over a period of 10-20 years. Unless both buyer and seller have confidence that their contractual relationship can withstand a long period of time there will be the greatest difficulty in commencing any gas projects at the margin of economic
ENERGY POLICY February 1985
Book reviews
viability which require major investment commitments, such as LNG projects, SNG plants and the Alaska Gas pipeline. Overall the biggest uncertainty in the USA is what will happen in a price decontrolled market with greater deregulation of industry activities. Unknowns stretch right across the spectrum of regulation and market conditions, from the uncertainty of what future administrations and the Congress will allow - ie common carrier status for pipelines - to the degree and rapidity of gas price changes after full decontrol and the size of the gas market when fully exposed to interfuel competition. On a much broader front, Jerry Davis has taken on the awesome task of explaining 'who gets what, how, in the world of natural gas'. The first three chapters of the book lay the foundation for understanding the economics and organization of the industry. It then takes on in successive chapters: the USA, the UK, the USSR, Continental Europe, the growth of European gas trade, LNG trade and an analysis of current and future trading trends. In reviewing such an ambitious undertaking, it is easy to concentrate too much on omissions and differences of interpretation. If there is a major criticism of this book it is possibly that Davis tries too hard to make different countries conform to similar trends and, in places, one would have wished for more source material. Inevitably, readers will find a number of areas in which their interpretation of events will conflict with that of the author. My own quibbles would include the analysis of BGC's gas procurement from the UK and the Norwegian North Sea, where it seems quite clear from the benefit of hindsight that if one is going to talk about 'good' and 'bad' deals, it is essential to say whose point of view is represented and the time frame under consideration. This is something that the present protagonists in the Sleipner arguments seem incapable of understanding. On the Soviet experience, more thorough study of the structure of the industry is essential, the success of Soviet gas effort being very largely
ENERGY POLICY February 1985
attributable to the reorganization of the Ministry and its various branches in the mid-1970s. In addition, one should not try too hard to compare the Soviet effort to that of the USA or any other country. No other country has opened up an energy province in terrain as harsh as Siberia and the achievement of the Soviets has been quite remarkable in this regard. Whether it would have been done better by western methods using western technology is interesting speculation, but skirts perilously close to some judgement of which system is 'better' - the joint nightmares of American regulation or Soviet planning. LNG The chapter on LNG trade possibly lays too much stress on technical problems and not enough on commercial disagreements. However, Davis rightly redresses some of the balance of reporting on the disagreements between Algeria and its customers by reminding us of the teething problems of a new technology which are borne by an exporter: 'The liquefaction plant at Arzew never reached design performance, working at a 58 percent production factor in 1978 and a 65 percent production factor in 1979. Three of the nine ships . . . were faultily designed with defective insulation and could not be used. A fourth went aground off Gibraltar with severe damage to the hull. The reception terminal at Cove Point was devastated by an explosion that significantly reduced its capacity' (p 217). In addition, in the context of the American market, Algerian militancy has been a problem, and this factor has been complicated immensely by the American regulatory process, a process that the Algerians, perhaps with considerable justification, have felt was giving American buyers a monopsony rent' (p 218). However, a further point that needs to be made is that Algeria has sacrificed its LNG market in the USA - perhaps permanently, certainly for this decade - having made all the investments in liquefaction facilities and now seeing them lie idle. It is hard to see how this can make sense, when
price concessions, albeit of considerable proportions relative to Algerian expectations, would have enabled them to maintain their foothold on the world's biggest gas market, ready for any change in market conditions. In the West European market, Algerian ultimatums on price renegotiation have led to brief termination of some contracts, curtailment of volumes in others and a general desire on the part of importers to seek their supplies from elsewhere. In his concluding chapter, Davis notes that, 'There was a day when the active natural gas community involved in the buying and selling of natural gas in Western Europe comprised about thirty men. This group wielded incredible power over an industry that makes up 15-20 percent of West European energy consumption. The power of the industrial brokers has been curtailed by an expanding policy community interested in the international political implications of natural gas trade in general and East-West trade in particular' (p 250). This is undoubtedly true, with the Soviet gas pipeline episode having brought the trade to the attention of the public, as well as having engaged the attention of West European governments in their dealings with the USA; these developments being likely to recur in the future. Yet the degree to which a handful of people in half a dozen utilities control the business in Western Europe is still surprising and contrasts sharply with the situation in the USA where very powerful market forces have been set free, engaging dozens if not hundreds of producers, transmission companies, distribution companies and the federal and state regulatory linkages between these actors. Perhaps this is the major difference between the world's two largest natural gas markets. If you only have time and space on your shelves for one book on natural gas, this is the most complete study thus far available.
Jonathan P Stern Joint Energy Programme Royal Institute of International Affairs
105
104
price control, industrial structures and markets with an outlook for the future as well as a historical perspective. This is likely to become the standard work on the subject. The authors are very much in the current tradition of market worshippers who hold government intervention responsible for all the ills of the business, which would work much better if left to market forces. Nevertheless, their careful explanation of what to a foreigner appears to be the 'organised craziness' of the US gas market, and its ability to swing from shortage to glut in a comparatively short space of time, is excellent. In a key passage on the strategies for dealing with an impending shortage, they note, 'If gas prices are deregulated and thereby can hold supply and demand in balance, a shortage is avoided altogether, but consumers have to pay more. On the other hand, if prices are held below a market clearing level, some consumers pay less, but others are shut out of the market completely or live in fear of future curtailments. Moreover, if price is not allowed to balance demand, then some Governmental entity has to step in and decide who deserves to get how much of the limited supply'. (p 106) The problem for a country and a political system so totally committed to private enterprise as the USA, is how the government can protect large numbers of consumers in the supply of a vital product from monopolies who stand to make vast profits, without overly distorting the market. Tussing and Barlow never fully grasp this nettle, because they assume that consumers have or will develop the freedom to switch to another commodity if it is profitable to do so. The reality is that US citizens are more likely to be stuck with their utility and take it out on their Congress person, who, in turn, will try and devise complex legislation to protect constituents, which, in turn, will protect votes, but distort the market. Furthermore, in the description of the regulatory process, neither volume
fully brings out the very strong interests outside government which make their living from the present status quo. In a deregulated environment, large armies of law firms and consultants - not to speak of a good number of federal and state employees - would find themselves out of a job and virtually unemployable since their whole careers had been constructed around this edifice. Another disturbing feature of the US scene is the demise of contract sanctity over the recent past, with pipeline companies being the chief culprits. In a climate of declining demand and falling prices, as the pipeline companies found their take or pay obligations too onerous they simply claimed force majeure. As Tussing and Barlow note, ' . . . the pipeline companies soon realized that they were in the driver's seat: they controlled the valves that released gas from producer wells and they had the power to refrain from making payment. A producer could threaten to sell the reserves to someone else, but the pipeline companies knew that there were no oth'~r buyers in s i g h t . . . The business ot ,~_ ~gating take or pay commitments soon became an a r t . . . ' (p 174). However, although the US gas industry may be able to continue its contractual anarchy for as long as the natural gas 'bubble' lasts, at some time in the future there will be the problem that no bank will be prepared to finance a development without an ironclad guarantee that contractual terms will be adhered to. As Broadman and Mongomery note, 'It is likely to be particularly difficult to design long term contracts that transmit rapid changes in end-use demand to the upstream market to bring about rapid changes in supply. Overall, a move to other forms of transaction may be expected' (p 16). The problem is that in the natural gas business there can be no other forms of transaction in a situation where very large investments need to be amortized over a period of 10-20 years. Unless both buyer and seller have confidence that their contractual relationship can withstand a long period of time there will be the greatest difficulty in commencing any gas projects at the margin of economic
ENERGY POLICY February 1985
Book reviews
viability which require major investment commitments, such as LNG projects, SNG plants and the Alaska Gas pipeline. Overall the biggest uncertainty in the USA is what will happen in a price decontrolled market with greater deregulation of industry activities. Unknowns stretch right across the spectrum of regulation and market conditions, from the uncertainty of what future administrations and the Congress will allow - ie common carrier status for pipelines - to the degree and rapidity of gas price changes after full decontrol and the size of the gas market when fully exposed to interfuel competition. On a much broader front, Jerry Davis has taken on the awesome task of explaining 'who gets what, how, in the world of natural gas'. The first three chapters of the book lay the foundation for understanding the economics and organization of the industry. It then takes on in successive chapters: the USA, the UK, the USSR, Continental Europe, the growth of European gas trade, LNG trade and an analysis of current and future trading trends. In reviewing such an ambitious undertaking, it is easy to concentrate too much on omissions and differences of interpretation. If there is a major criticism of this book it is possibly that Davis tries too hard to make different countries conform to similar trends and, in places, one would have wished for more source material. Inevitably, readers will find a number of areas in which their interpretation of events will conflict with that of the author. My own quibbles would include the analysis of BGC's gas procurement from the UK and the Norwegian North Sea, where it seems quite clear from the benefit of hindsight that if one is going to talk about 'good' and 'bad' deals, it is essential to say whose point of view is represented and the time frame under consideration. This is something that the present protagonists in the Sleipner arguments seem incapable of understanding. On the Soviet experience, more thorough study of the structure of the industry is essential, the success of Soviet gas effort being very largely
ENERGY POLICY February 1985
attributable to the reorganization of the Ministry and its various branches in the mid-1970s. In addition, one should not try too hard to compare the Soviet effort to that of the USA or any other country. No other country has opened up an energy province in terrain as harsh as Siberia and the achievement of the Soviets has been quite remarkable in this regard. Whether it would have been done better by western methods using western technology is interesting speculation, but skirts perilously close to some judgement of which system is 'better' - the joint nightmares of American regulation or Soviet planning. LNG The chapter on LNG trade possibly lays too much stress on technical problems and not enough on commercial disagreements. However, Davis rightly redresses some of the balance of reporting on the disagreements between Algeria and its customers by reminding us of the teething problems of a new technology which are borne by an exporter: 'The liquefaction plant at Arzew never reached design performance, working at a 58 percent production factor in 1978 and a 65 percent production factor in 1979. Three of the nine ships . . . were faultily designed with defective insulation and could not be used. A fourth went aground off Gibraltar with severe damage to the hull. The reception terminal at Cove Point was devastated by an explosion that significantly reduced its capacity' (p 217). In addition, in the context of the American market, Algerian militancy has been a problem, and this factor has been complicated immensely by the American regulatory process, a process that the Algerians, perhaps with considerable justification, have felt was giving American buyers a monopsony rent' (p 218). However, a further point that needs to be made is that Algeria has sacrificed its LNG market in the USA - perhaps permanently, certainly for this decade - having made all the investments in liquefaction facilities and now seeing them lie idle. It is hard to see how this can make sense, when
price concessions, albeit of considerable proportions relative to Algerian expectations, would have enabled them to maintain their foothold on the world's biggest gas market, ready for any change in market conditions. In the West European market, Algerian ultimatums on price renegotiation have led to brief termination of some contracts, curtailment of volumes in others and a general desire on the part of importers to seek their supplies from elsewhere. In his concluding chapter, Davis notes that, 'There was a day when the active natural gas community involved in the buying and selling of natural gas in Western Europe comprised about thirty men. This group wielded incredible power over an industry that makes up 15-20 percent of West European energy consumption. The power of the industrial brokers has been curtailed by an expanding policy community interested in the international political implications of natural gas trade in general and East-West trade in particular' (p 250). This is undoubtedly true, with the Soviet gas pipeline episode having brought the trade to the attention of the public, as well as having engaged the attention of West European governments in their dealings with the USA; these developments being likely to recur in the future. Yet the degree to which a handful of people in half a dozen utilities control the business in Western Europe is still surprising and contrasts sharply with the situation in the USA where very powerful market forces have been set free, engaging dozens if not hundreds of producers, transmission companies, distribution companies and the federal and state regulatory linkages between these actors. Perhaps this is the major difference between the world's two largest natural gas markets. If you only have time and space on your shelves for one book on natural gas, this is the most complete study thus far available.
Jonathan P Stern Joint Energy Programme Royal Institute of International Affairs
105