LARGE VARIATIONS IN DEMAND; A CERTAIN RIGIDITY IN SUPPLY

Natural gas plays a growing role as an OECD energy source. OECD gas consumption reached 1,369 bcm in 2000 which represented 22% of total primary energy supply, up from 19% in 1980. Within twenty years, gas

consumption has increased by almost 50%. This can be explained by the intrinsic properties of natural gas (clean combustion, easy handling, efficiency, flexibility), and by its abundant reserves (178 tcm of global proven reserves as of 1 January 2002, representing 60 years of production at current rates). Gas meets some environmental concerns, as the effects of its use on the air and climate are less than those of other fossil fuels. Gas is price competitive and its attraction has been enhanced by the development of high-performance technologies, in particular gas turbines and combined-cycle gas turbine power plants.

Unlike oil, which is primarily used in the transportation sector, gas is mainly used for stationary purposes at a fixed site, such as space heating in residential and commercial buildings, as a feedstock for the petrochemical industry, as process gas, to produce steam for industrial purposes and for power generation. Residential and commercial sectors absorb 35% of OECD gas consumption, the figure reaching 40% in OECD Europe, 34% in OECD North America and 23% in OECD Pacific. Natural gas has been increasingly used to generate electricity although the share of power generation based on gas varies largely among IEA countries from zero in Norway to 55% in the Netherlands. There are important differences in gas-consumption patterns in the three OECD regions, as illustrated in the following table.

Table 1: Breakdown of Gas Consumption by Sector (2000 data)

OECD Total North America Pacific Europe

bcm % bcm % bcm % bcm % Residential/ 483.85 35 263.70 34 28.28 23 191.87 40 Commercial (1) Industry, 347.29 25 182.24 24 24.85 20 140.19 30 including Raw Material Power 391.78 29 210.81 27 66.86 53 114.11 24 Generation (2) Others (3) 145.80 11 113.38 15 5.53 4 28.91 6 Total 1,368.72 100 768.13 100 125.52 100 475.08 100 (1) Including agriculture.

(2) Including combined heat and power generation.

(3) Energy sector, district heating (accounting for 7 bcm in 2000 for the OECD as a whole), transportation sector and distribution losses.

Where gas is heavily used for space heating, total gas demand varies strongly with outside temperatures. In France, for example, consumption between the annual peak-load days and those with the lowest demand can vary by an order of magnitude. The French industry’s maximum daily dispatch of 2.42 TWh or 210 mcm, was recorded on 2 January 1997. On that day, storage facilities supplied 52% of the demand.

Two aspects of variability on the demand side need to be distinguished: (1) Variations due to demand patterns, which repeat themselves at regular

intervals. The leading example is seasonality, but there are also patterns induced by social habits, such as vacation periods or weekly work schedules. These resulting demand variations are to a large extent foreseeable. (2) Variations due to exogenous forces, mainly from fluctuations in temperature,

which trigger a corresponding fluctuation in the demand for heating or cooling. While it is predictable that winter days are colder than summer days, each winter day may vary in temperature in an unforeseeable way. The flexibility required to meet repetitive demand variation is foreseeable, so that economic decisions can be taken with some certainty. But the flexibility required to meet unexpected fluctuations takes on the character of a physical- risk insurance. It requires economic decisions to be taken in the face of greater uncertainty. Residential and commercial customers rightly expect that gas will be supplied even on the coldest winter day. Back-up systems are too expensive for these customers and an interruption of gas supplies on such a day would cause unacceptable discomfort, and possibly real damage. In addition, if gas distributors were unable to guarantee supply in extreme conditions, alternative fuels such as heating oil would gain tremendous competitive advantage, which could probably not be offset by lower gas prices. Therefore, the gas industry is required to take precautions to be able to meet the coldest day of winter demand by non-interruptible customers, without knowing when or how often that case will occur. Data on past temperatures are usually available for several decades as well as models reflecting consumers’ reactions to different weather conditions. But the investment required to meet such cases may only be recovered by charging a risk premium to customers requiring such security of supply.

Gas suppliers must cover a seasonally-determined and temperature-dependent demand, which is price inelastic and which must be covered as it arises. There are additional flexibility requirements on the supply side to anticipate

interruption due to technical, contractual or political reasons, or even because of labour-management friction.

In this study, the term “flexibility” refers to the capability to change gas volumes over defined time-periods. Flexibility may be used to adapt supply to variations and fluctuations in demand or to adapt elements of demand in the case of insufficient supply.

In the past, the provision of flexibility did not affect the price of the gas, as the flexibility was included in the service offered by the supplier to its customer and its cost was rolled into the price of the gas.

In the new liberalised gas markets, marketplaces for gas (hubs) develop, where gas supply and demand is balanced by price. The various elements of flexibility are becoming distinct services to adapt supply or demand and as such have a distinct value or price of their own, determined by the market. These costs of flexibility may not be automatically rolled into the price of the gas delivered. To provide flexibility, gas suppliers resort to flexibility tools designed to meet the varying and fluctuating volumes demanded hourly, daily, monthly and annually. Three main categories of flexibility tools are available:

■ Providing large enough supply capacity to meet the highest possible demand. That can be done by own investment into production and transportation capacity or by contracting the respective production and transportation capacity;

■ Providing of storage capacity in underground storage or LNG tanks to balance variations in demand;

■ Arrange for customers to reduce or stop their offtake of gas at the request of the supplier according to a contractual scheme. In return the customer gets a more favourable gas price.

Gas suppliers will optimise their portfolio of flexibility instruments to meet the variations and peaks in demand. The objective is to guarantee gas supply under extreme weather conditions notwithstanding the failure of a major supply source or another system component. As neither production nor transportation capacity can be increased at short notice, surge or excess capacity needed must be anticipated at the time of the investment decision. The cost of providing such capacity is largely independent of its usage, i.e., whether used or not the same costs will be incurred.

Rising gas demand in most OECD countries has brought greater reliance on more remote supplies and reduced flexibility in supply capacity. Whereas imports from external suppliers represented 8% of OECD gas demand in 1980, they reached 20% in 2000 and are expected to reach 26% by 2010 and 32% by 2030. In view of the small share of transportation costs in the value of the gas, short-haul gas easily provides supply flexibility able to match variations in demand. In the case of long-haul gas, however, as transportation costs of long-distance pipelines constitute a large share of the value of gas, infrastructure utilisation close to the maximum is extremely desirable. This limits supply flexibility. Thus, with an increased share of long-haul gas, more storage capacity and more truly interruptible customers are needed to allow meeting variations in gas demand.