International Market Integration for Natural Gas A Cointegration Analysis of Gas Prices in Europe, N

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International Market Integration for Natural
Gas?A Co-integration Analysis of Gas Prices in
Europe, North America, and Japan

• Guillaume L'Hégaret, Boriss Siliverstovs
• Christian von Hirschhausen, Anne Neumann
• DIW Berlin
• 6th IAEE European Conference
• Zurich, September 2004

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Agenda
1. The Issue Internationalization of Natural Gas
Markets 2. Theory and Data 3. Model 1
Cointegration of International Gas Prices 4.
Model 2 Convergence of Trans-Atlantic Gas
Prices 5. Conclusions
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1. The IssueIncreasing Integration of Natural
Gas Markets

• At the European level
• EU-Acceleration Directive 2003/55 increasing
  competition within and between countries
• Decreasing weight of oil price indexation, e.g.
  long-term gas contracts in the UK
• At the international level
• Trend towards LNG in the three large gas
  consuming regions (North America, Europe, Asia)
• Internationalization of LNG markets, in
  particular
• Intensification of transatlantic LNG-trade and
  ... competition
• gt This presentation analyzes the relation
  between international marker prices for gas and
  oil, with a view of quantifying long-term links
  between them
• gt Our working hypothesis is that the split
  between the European and the North American gas
  markets did prevail in the 1990s, but that one
  might increasingly see signs of market integration

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Net Inter-Regional Natural Gas Trade Flow,
2000(bcm, source IEA, 2002)
1.7
6.7
1.7
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Net Inter-Regional Natural Gas Trade Flow,
2030(bcm, source IEA, 2002)
79
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104
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Agenda
1. The Issue Internationalization of Natural Gas
Markets 2. Theory and Data 3. Model 1
Cointegration of International Gas Prices 4.
Model 2 Convergence of Trans-Atlantic Gas
Prices 5. Conclusions
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2. TheoryCointegration, the Law of One Price
(LOP), and Convergence

• Cointegration
• xt, a N-dimensional process, is co-integrated if
  each component of the process is I(1) but there
  exists v, a N-dimensional vector, such that vxt
  is I(0) ?Johansen Test Model 1
• Law of one price
• LOP is equivalent to having every relative price
  in the system constant in the long term
• a transportation costs, quality, risk
  premium, etc.
• ß relationship between the prices
• ß 0 no market integration
• ß 1 LOP holds markets are
  fully integrated
  proportionate prices
• Convergence
• A dynamic structural change, time-varying
  coefficient models ? Kalman Filter Model 2
• ß(t) relationship between the prices
• ß 0 no market integration
• ß 1 LOP holds markets are fully
  integrated
• ß ? 1 increasing market
  integration over time

lnp1 a ßlnp2 et
lnp1t a(t) ß(t)lnp2t et
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Literature Integration of regional gas markets

• North America- De Vany and Walls (1995) Gas
  spot prices in several locations (hubs) are
  increasingly cointegrated with open access to the
  pipelines (post FERC Order 436)
• - King and Cuc (1996) price convergence in
  regional markets, but also a split between
  Eastern and Western region
• - Serletis (1997) Bi- and multivariate tests
  for co-integration, indicating that North
  American natural gas spot markets are integrated
  (no split)
• Europe (Asche, Osmundsen, Tveteras, 2001, 2002)
• - Cointegration of European gas import prices
  (from Russia, Norway, Netherlands)
• - Cointegration of domestic gas prices, e.g.
  Belgium, France, Germany

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Prices Used in this Study
Brent
Pipe Europe
Pipe USA
LNG USA
LNG Japan
LNG Europe
Henry Hub
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Monthly DataSummary Statistics (until mid-2002)
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Unit Root TestsAll variables are I(1)
Tests for prices in level use a constant but not
a time trend. Tests for first differences are
performed with neither intercept nor linear
trend. One / two / three asterisks indicate
significance at the 10 / 5 / 1 level,
respectively.
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Agenda
1. The Issue Internationalization of Natural Gas
Markets 2. Theory and Data 3. Model 1
Cointegration of International Gas Prices 4.
Model 2 Convergence of Trans-Atlantic Gas
Prices 5. Conclusions
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European LNG, European Pipeline and Japanese LNG
(logged) are largely cointegrated
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and so are American LNG, American Pipeline and
Henry Hub (logged), at least since 1999
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But European and North American Prices?
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Bivariate Johansen Test ResultsSupport for the
regional divide

• First Line VECM1 (neither intercept nor trend)
  in CE
• Second Line VECM 2 (without trend) in CE
• Third Line LR trace statistic to restrict VECM
  2 to VECM 1

Cointegration
No evidence of cointegration
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Estimated Cointegration Vector and the Law of
One Price(selected statistics)
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Results from Model 1Regional Market
Integration, but not Trans-Atlantic
Brent
Pipe Europe
Pipe USA
LNG USA
LNG Japan
LNG Europe
Henry Hub
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Agenda
1. The Issue Internationalization of Natural Gas
Markets 2. Theory and Data 3. Model 1
Cointegration of International Gas Prices 4.
Model 2 Convergence of Trans-Atlantic Gas
Prices 5. Conclusions
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Towards Cointegration of Spot Gas Pricesin
Europe and North America?
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Kalman Filter (NBP Henry Hub)

• Two periods of convergence, stronger relations
  in winter periods
• Some linkage between North American and European
  gas prices, but by far not
• systematic

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Agenda
1. The Issue Internationalization of Natural Gas
Markets 2. Theory and Data 3. Model 1
Cointegration of International Gas Prices 4.
Model 2 Convergence of Trans-Atlantic Gas
Prices 5. Conclusions
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5. Conclusions

• The European/Japanese natural gas markets and the
  North American markets seem to be highly
  integrated within themselves
• Even so, the law of one price does not hold in
  any of the regional price relations
• - For the period under observation, there seems
  to be no integration between the gas markets in
  Europe/Japan and North America
• - However, analysis of recent data indicates at
  least some convergence between European and North
  American gas prices
• ? The dynamic evolution of the trans-atlantic
  market, with increasing spot-trading and
  arbitrage, might lead to a further integration of
  European and North American gas markets and prices

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Hypothesis for Further ResearchTrans-Atlantic
Market Integration
Brent
Pipe Europe
Pipe USA
LNG USA
LNG Japan
LNG Europe
Henry Hub
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Literature

• Asche, Frank, Petter Osmundsen, and Ragnar
  Tveteras (2001) Market Integration for Natural
  Gas in Europe. International Journal of Global
  Energy Issues, Vol. 16, No. 4, 300-312.
• Asche, Frank, Petter Osmundsen, and Ragnar
  Tveteras (2002) European Market Integration for
  Gas ? Volume Flexibility and Political Risk.
  Energy Economics, Vol. 24, 249-265.
• De Vany, Arthur and David Walls (1993) Pipeline
  Access and Market Integration in the Natural Gas
  Industry Evidence from Cointegration Tests. The
  Energy Journal, Vol. 14, No. 4, 1-19.
• De Vany, Arthur and David Walls (1993) The
  Emerging New Order in Natural Gas Market versus
  Regulation. Querum Books, Westport.
• Deutsche Bank (2003) LNG going going Gone
  Global. Global Equity Research.
• Engle, Robert F. and Clive W.J. Granger (1987)
  Cointegration and Error Correction
  Repreentation, Estimation and Testing.
  Econometrica, Vol. 55, 251-276.
• European Commission (2001) Green Paper Towards
  a European Strategy for the Security of Energy
  Supply. Luxembourg, Commission Document
  COM(2000)769final.
• Hartley, Peter R., and Dagobert L. Brito (2001)
  New Energy Technologies in the Natural Gas
  Sectors. Houston, Texas, The James A. Baker III
  Institute for Public Policy.
• Hendry, D. and K. Juselius (1999) Explaining
  Cointegation Analysis Part II. Oxford, Nuffield
  College, Lecture Notes.
• International Energy Agency (2002) Flexibility
  in Natural Gas Supply and Demand. Paris, OECD.
• International Energy Agency (2004) Security of
  Gas Supply in Open Markets LNG and Power at a
  Turning Point. Paris, OECD.
• Jensen, James (2003) The LNG Revolution. The
  Energy Journal, Vol. 24, 1-45.
• Johansen, S. (1988) Statistical Analyis of
  Cointegration Vectors. Journal of Economic
  Dynamics and Control, Vol. 12, 231-254
• King, Martin and Milan Cuc (1996) Price
  Convergence in North American Natural Gas Spot
  Markets. The Energy Journal, Vol. 17, No.2,
  17-42.
• Meinhold, Richard and Nozer Singpurwalla (1983)
  Understanding the Kalman Filter. The American
  Statistician, Vol. 37, No. 2, 123-127
• Serletis, Apostoles (1997) Is there an East-West
  Split in North American Natural Gas Markets? The
  Energy Journal Vol. 1, 47-62.
• Serletis, Apostoles and J. Herbert (1999) The
  Message in North American Energy Prices. Energy
  Economics Vol. 21, 471-483.

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BACKUP
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Data (USD/Mbtu)
Henry Hub
Brent
Pipeline Europe
Sources IEA Energy Prices and Taxes (several
issues) Oil and Gas Journal Database (Henry Hub)
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Multivariate Johansen Test Results