North Sea natural gas industry enters new era of change

Impacted by market and infrastructure development, European Union policy and Russian moves, the North Sea natural gas industry is set for profound changes. This will lead to a more integrated market and affect all North Sea producers. Most importantly, the United Kingdom’s position as a self-sufficient "island" in natural gas is history. Since the ending of Norwegian Frigg gas exports due to field depletion, the UK has not imported natural gas. The Interconnector gas pipeline between the UK and Belgium, which opened in 1998, was essentially constructed to export gas to the Continent, but it can be reversed to import at a lower capacity.

UK gas role to reverse. The situation in Britain has evolved to the point that the UK will need to import increasing volumes of gas. During the 1990s, consumption rose by more than 6% per year, so that demand in 2000 was about 80% above 1990’s level. Production has risen at an even faster pace, more than doubling during the 1990s, making the UK a net exporter in 1999 and 2000, but at the expense of a quickly depleting resource base. Exploration for gas in UK waters has not been highly successful in recent years. Therefore, the outlook is for continued demand growth, although not at historical rates, and an output that will peak and then decline.

This prospect could be modified, but not substantially, by new discoveries in waters west of the Shetlands or offshore the Faeroe Islands. In this context, the Interconnector will be useful for importing gas from the Zeebrugge hub in Belgium, originating in either Norway or Russia, or even perhaps Algeria. In addition, the new link under construction from Norway’s Heimdal field to the UK-Norwegian Frigg field – which straddles the maritime border – will open a new export outlet, the "Western Lead," for natural gas from Norway.

Opportunities for Norway. Some analysts believe the UK is set to become the largest market for Norwegian gas, competing with France and Germany. In recent years, Norway has been reasonably successful in gas exploration, and there are huge prospective areas. This indicates a potential for new discoveries and rising output, but in deeper waters and farther north, leading to higher development and transportation costs.

The diversification of gas outlets nevertheless creates some euphoria in Norway’s oil and gas industry. Historically, Norwegian gas exports were essentially confined to a small number of Continental buyers that had strong bargaining power through local monopolies. Opening up the deregulated and fragmented UK gas market would give Norway and other sellers a much stronger bargaining position, not only in relation to prospective UK buyers, but also in relation to those on the Continent. Norway is also planning a new offshore pipeline from the North Sea into the Baltic, to serve the Polish market, and possibly Finland and Sweden. Even Ukraine has asked to buy Norwegian gas through Poland, to reduce dependence on Russian supplies. The Netherlands will have a better choice of serving UK or Continental peak demand, and thereby make more money on the strategic location of Groningen field, used as a modulator.

Russian supplies re-emerge. This is where Russia has a role. Gas demand is also growing on the Continent but not at the UK rate of the 1990s. Everywhere, gas is needed for new power generation. France is unlikely to fully renew its roster of nuclear power stations as expirations occur after 2010. Furthermore, Germany has begun modest decommissioning of its nuclear power stations. The general concern is to avoid a power crunch that clashes with Europe’s growing economy.

Therefore, part of the answer is to secure gas supply contracts well in advance. Besides Norway, Russia is the obvious source for much of Europe, and Algeria and Libya fill the role for southern Europe. Russia is currently building a new pipeline through Poland to serve the German market, avoiding Ukraine. The new line will permit Russia to raise gas exports to France and Germany, or even the UK, but also to liberate capacity in the existing pipeline system to increase sales to Austria, Hungary and Italy. Additionally, Russia needs to invest in maintenance of production sites and pipelines, as well as in new capacity, which is going to be costly.

In a wider perspective, the changing British position – from being self-sufficient in gas, or even a small exporter, to becoming a major importer – triggers ripples throughout Europe. The outlook is for demand to pressure supply, gradually pushing gas prices higher in relation to oil. Higher prices should attract incremental supplies. Additionally, LNG supplies will be increasingly attractive for serving peak demand.

Ramifications for the EU. With a more integrated pipeline network, more diversified supplies and more transparent trading practices, the physical security of supplies will be less of an issue in Europe, enhancing the attractiveness of gas. The EU Commission is pushing hard to open all European energy markets by 2005. Ideally, by that time, all electricity and gas consumers should be able to choose suppliers.

Serious hurdles remain, however, as some countries hesitate to implement measures that would hurt vested interests in the power and gas industries. Belgium, France and Germany are examples. Separation of suppliers, transporters and distributors is far from complete, especially in France and Germany. Austria and Germany have no independent regulators and the intra-industry agreements on transit rights seem destined to repel newcomers and stifle competition.

The lack of uniform rules and tariffs for cross-border gas trade also hinders newcomers and limits competition. These practices – vestiges of a monopolist past – permit middlemen, transporters and merchants to capture a sizeable part of the economic rent accruing from gas. This situation is detrimental to consumers and producers, and will most probably provoke EU legislation to harmonize gas trade throughout Europe. In the meantime, the open UK market will be a more attractive outlet for Norwegian and Dutch gas, and possibly Russian and Algerian gas, providing a competitive advantage for the UK economy.

Øystein Noreng is Professor, Norwegian School of Management, and holds the TotalFinaElf chair in petroleum economics and management. He is a regular contributor to this column.