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THE GAS MARKET IS IMPORTANT. It is comparable in size with the global oil market. It is a
major determinant of wholesale electricity prices, therefore impacts revenues and earnings for
most European power and gas utilities. Given its significance, we will publish a series of
reports on the gas industry. This first one concentrates on the global market and LNG.
There are four main geographical markets (EU, UK, US and Asia Pacific), each of which has a
different pricing mechanism.
• Continental Europe is linked contractually to oil products.
• Asia Pacific is linked contractually to oil, but with caps, floors and S curves.
• The US is set by a competitive supply/demand market, capped by oil product prices, and
floored by coal, because of market substitution, rather than contractual clauses.
• The UK is set by a competitive supply/demand market, but linked to the EU market.
Arbitrage between these markets is currently limited because most deliveries in the Atlantic
Basin market (97%) are made by pipelines, which have fixed delivery points. However, we
forecast a rapid growth in deliveries by Liquefied Natural Gas shipping to 2010, which will
have variable delivery points. This growth will be driven largely by Qatar’s development of the
world’s biggest gas field (with 15% of the world’s reserves in one field) during this period.
Gas to bring pressure on wholesale electricity prices We forecast this rapid growth in LNG
will result in supply curves being impacted (as LNG has such a low Short Run Marginal Cost).
The marginal unit of gas in the Atlantic Basin will decrease in price, putting downward
pressure on wholesale electricity prices – this will be negative for most European utility
companies.
UNDERWEIGHT 12m rating on utilities We prefer regulated stocks and those short in
generation (Centrica) to those long in generation (British Energy, Drax, RWE).
4 Investment summary
9 The European gas market to 2010
9 Introduction
11 Gas report 1- the global gas market and LNG trade
11 Summary
14 The global gas market
14 Introduction
14 The global gas market is big
14 There are four distinct traded markets
15 The four markets in more detail
16 Continental Europe – Troll and Gazprom contracts escalated through oil products
19 UK – competitive supply/demand set price, with linkage to Continental market
21 US – competitive supply/demand set price
27 Asia Pacific – the Japanese crude cocktail
28 The increasing importance of LNG trade in the global gas market
28 Introduction
29 Pipeline delivery vs LNG delivery
30 The engineering characteristics of LNG
31 The economic characteristics of LNG
36 History of the LNG market
39 Development of the LNG market to 2010 and impact on stocks
39 Introduction
39 Rapid acceleration of LNG trade about to happen
41 Large amounts of additional upstream liquefaction capacity
42 We do not expect shipping to be a constraint for projects under construction
43 Where will the increased flow of LNG go?
47 Dynamics of LNG trade over the coming years
51 Impact to 2010 of pricing mechanisms, demand developments, and regasification-liquefaction capacity balance
52 1. Winter 2007/08
56 2. Winter 2008/09
59 Conclusions, investment themes and stock ideas
61 Appendices: SG methodology and restatements
61 Appendix 1 – Gas production is a complex process
63 Appendix 2 – Global gas reserves (BP 2006)
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