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					        An Integrated Asian Natural Gas Market: Potentials and Welfare Implications

                                           Youngho Chang1 and Yanfei Li

An Overview

For the coming decades, globally the consumption of natural gas is predicted to increase 38% by 2035, and
regionally in Asia to increase as high as 94% by 2035 (IEA, 2010). Such is driven both by the growing demand in
energy and the decreasing relative price of natural gas against crude oil. According to BP Statistical Review of
World Energy 2010, the price of liquefied natural gas (LNG) for Japan gets lower than that of crude oil from 2002
onwards. The growing environmental concern also pushes many Asian economies to switch to natural gas.
Altogether natural gas trade in the region is predicted to boom.

While strong demand for natural gas is forecast in the region, the current natural gas market in the region is not well
developed yet. First of all, the market in the region is dominated by long-term contracts, with prices of natural gas
and LNG pegged to that of crude oil. Second, natural gas market in the region is, to a large extent, not connected by
pipeline. Both hinder the formation of a competitive natural gas market in the region, and attribute the “Asian
Premium” to be imposed on importing natural gas, especially in the form of LNG.

As European and U.S. natural gas markets have shown, an integrated regional natural gas market generates enough
“gas-to-gas” competition and hence eliminates any premium paid to imported natural gas. Apart from thwarting the
monopolistic pricing behavior, an integrated natural gas market could drive the prices of natural gas to be
independent of that of crude oil, adding to the price advantage of natural gas (Davoust, 2008; Rogers, 2010).

There are numerous studies and models of natural gas market either for the U.S. market or the European market.
These models include Canadian Natural Gas Allocation Model (CGAM), Strategic Model of European Gas Supply
(GASMOD), Gas Market System for Trade Analysis in a Liberalizing Europe (GASTALE), North American Gas
Trade Model (GTM), EIA Short-Term Integrated Forecasting model (STIFS) among others (Rowse, 1986; Holz et al,
2005; Boots et al, 2003; Beltramo, 1985; Costello, 1999). In spite of the different findings, the common conclusion
from these studies that stands firm is that regional gas markets have progressively become more integrated with
increasing LNG utilization and pipeline extensions. The natural gas markets around the world are expected to
become increasingly more liberalized and competitive as greater linkages would enable natural gas consumers to
have more options insofar as the choice of vendors is concerned. With greater supply alternatives in which
competitive pricing would prevail, producers might not able to exercise market power for the fear of consumers
reverting to other suppliers.

The study builds a natural gas trade model for an integrated natural gas market in Asia. With the model, it assesses
the welfare implications of an integrated and competitive natural gas market in the region. It also envisions an
optimized trade pattern of natural gas in the region, from which policy makers and industrial practitioners can derive
implications on the relevant infrastructure to be developed, i.e. pipelines and LNG terminals.

Methods

A model for the Asian natural gas market is to be built by following the body of literature, mainly Beltramo et al
(1986). It computes a competitive equilibrium among natural gas trading Asian countries. It fully reflects the
potential of the Asian natural gas market and the trend of regional liberalization in natural gas markets in a non-
linear programming (NLP) approach.

The natural gas markets in the model are interconnected at a single point in time. It is assumed that economic growth
and prices of alternative energy sources are exogenously determined and fixed. It provides a static competitive
framework in which wellhead and consumer prices are analyzed, as well as the flows of natural gas between the
regions in question. Prices adjust so as to equilibrate demand and supply among importing and exporting countries,
respectively. As fixed demand can be imposed on countries that are involved in ‘take-or-pay’ (TOP) contracts with


1Lead Author, Division of Economics, Nanyang Technological University, HSS-04-65, 14 Nanyang Drive,
Singapore 637332; email address: isyhchang@ntu.edu.sg; Telephone: +65-6513-8107
suppliers, it would serve as lower bounds on the quantity demanded. Likewise, capacity constraints can also be
imposed on gas producing countries so that they would incorporate reproducibility limits. Overall, market
equilibriums are derived by solving the maximization problem of the sum of consumers’ benefits less the costs of
production and transportation costs associated with trade flows, subject to constraints on quantities traded and prices
such as upper and lower bounds.

In sum, this study builds up a competitive partial equilibrium model to analyze the Pan-Asian natural gas market.
Unlike Beltramo et al (1986), total transportation costs have been treated differently to reflect the possible and
potential role of liquefied natural gas (LNG) in the Asian natural gas market. The model is solved by GAMS
(General Algebraic Modeling System), nonlinear programming software.

Results and Conclusions

Following the assumption of an integrated natural gas market in the region, the model is capable of giving an
optimized trade pattern in the region, which maximizes welfare of all parties and meanwhile minimizes the cost of
natural gas. The following figure shows the simplified illustrations of possible outcomes of the model. As can be
observed by comparing outcomes of the model, only certain trade links remain after optimization. For policy makers,
the results clearly indicate that, in an integrated regional natural gas market, what infrastructure facilities in terms of
either pipelines or LNG terminals are needed, as well as where they are needed.

Figure 1: The Optimized Trade Pattern in the Region

                                                  Russia
               Existing Pipeline
               Proposed Pipeline
               Potential LNG
               Links
                                                      LNG
                                                                LNG             Philipines
  Middle-EastLNG                                LNG
                                   Thailand                 VietnamLNG
                      LNG            Pipeline

                                             Malaysia             Pipeline
                                            Pipeline

                                                 Singapore Pipeline
                                                                              Indonesia


References:

Beltramo, M., Manne A. and Weyant J. (1986): “A North American Gas Trade Model (GTM),” Energy Journal, Vol.
7, No. 3, pp. 15 – 32.
Beltramo, M.A. (1985): PhD. Dissertation. Interfuel Substitution and Natural Gas Trade in North America, Stanford
University.
Boots, M.G., Rijkers F.A.M., and Hobbs B.F. (2003): GASTALE: An oligopolistic model of production and trade in
the European gas market, ECN.
Costello, D. (1999): Short-Term Integrated Forecasting (STIFS) Model, Energy Information Administration,
Department of Energy, USA.
Davoust, Romain. (2008): Gas Price Formation, Structure & Dynamics, Gouvernance Europeenne et Geopolitique
de L’energie.
Holz, F., Hirschhausen C. and Kemfert C. (2005): “A Strategic Model of European Gas Supply (GASMOD),” 4th
Conference of Applied Infrastructure Research, Technical University Berlin, Germany.
IEA (2010): World Energy Outlook 2010.
Rogers, H.V. (2010): LNG Trade-flows in the Atlantic Basin: Trends and Discontinuities, Oxford Institute for
Energy Studies.
Rowse, J. (1986): “Allocation of Canadian Natural Gas to Domestic and Export Markets,” Canadian Journal of
Economics. Vol. 19, No. 3, pp. 417 – 442.

				
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