i.d) £1 valor de la diversidad -

Gas prices in a competitive market with non-discriminatory third-party access to the pipeline network are determined by the interplay of supply and demand. At any given moment, the market price for gas, whether it be the base price in a long-term contract or the spot price (for a fixed volume supply over a short period), is determined by the marginal consumer and the marginal supplier.

The key implication of free-market pricing for gas is that, in principle, there is only one prevailing market price for the commodity at a given location. This contrasts

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with a monopoly, which may set the gas price for each end-use customer on a discriminatory basis. Where there are no pipeline capacity constraints, differences in market prices across regions in a truly competitive market must reflect the actual cost of moving gas between locations. Where gas flows from A to B, the price at B must be equal to that at A plus the cost of transportation: if the price at A were to move out of line with that at B, traders would arbitrage gas between the two points until prices came back into equilibrium. The cost of transportation is determined either by the regulated tariff or by the secondary market rate where secondary trading of released capacity is allowed. When pipeline capacity between two points in the network is fully utilised, the market becomes disconnected and the supply/demand balance in one market can no longer influence the price in the other. This has been the case at times over the last few years in North America, where pipeline capacity constraints between the East, West and South have led to considerable divergence in spot prices during periods of high winter demand.

Where competition through third-party access is confined to the high-pressure transmission system, as in the United States, the market sets the bulk gas price delivered to large end users supplied directly off the transmission system, as well as the price to LDCs at the city gate. The pricing policy of the LDC and the price controls imposed by regulators will determine the mark-up on the city-gate price and the structure of prices to LDC retail customers. Where competition is extended to all retail customers, as in Britain, end-user prices will reflect the bulk-market price at the wellhead, beach or border, plus the cost of transportation and distribution including any customer service costs to each end-user location.

In the short run, the demand curve for gas in a given market will be determined by the following factors:

■ The importance of seasonal heating load, which in turn is largely a function of residential and small commercial short-term demand. The position of the demand curve is generally driven by the weather.

■ The seasonality of demand for gas in power generation and the degree to which seasonal gas and electricity demand peaks coincide, depending on the use of electricity for heating and cooling.

■ Demand from shippers for gas to put into storage (which is in turn a function of storage capacity), prevailing storage levels, actual price levels and expectations concerning future price levels.

■ Capability of end users to switch at short notice between different fuels and the prices of those competing fuels. Most end users are essentially captive in the short term. In most countries, almost all residential customers and the majority of commercial and small industrial customers do not maintain dual-firing equipment to enable rapid switching away from or to gas. Any demand response by these customers to a price change usually lags by several years. Some large customers, however, may be able to switch fuels at very short notice thanks to dual-firing or, in the case of power generators, by switching to alternative non-gas

fired plant. The extent to which end users as a whole are able to switch fuels quickly helps to determine the slope of the demand curve; the price of competing fuels affects the position of the curve.

The shape of the supply curve, on the other hand, is determined by the production policy of producers (notably their willingness to shut in production and bring forward or delay maintenance programmes for economic reasons) and the willingness of holders of gas in storage to release it to the market at different price levels. Generally, the supply curve will be steep, since production becomes insensitive to price as output reaches the maximum sustainable level; at low levels of output, the curve will tend to become flat as producers shut wells rather than sell at very low prices. The willingness to sell at different prices is largely a function of expected price movements and storage levels. The position of the gas curve may change according to total short-term productive capacity. The commissioning of a new gas field or the stocking of gas through the low demand season shifts the supply curve downwards.

Figure 4 illustrates the impact on price of a sudden change in supply and demand fundamentals. A sudden decrease in supply as represented by an upward shift in the supply curve from S₁to S₂(resulting for example from the shutting down of a gas field) causes the gas price to rise from P₁ to P₂ but reduces the equilibrium demand for gas from Q₁to Q₂. Given the supply curve S₁, a shift upwards in the gas demand curve from D₁ to D₂, caused by a sudden increase in the prices of competing fuels, causes the price to rise from P₁to P₃. Similarly, a shift upward in both demand and supply curves (to D₂and S₂) results in an increase in both supply (to Q₄) and price (to P₄).

Figure 4

Short-Run Gas Price Determination

S₁

Q₁

D₂ P₂

P₁

S₂

Q₂

D₁

Q₃ P₃

Price

Quantity P₄

Q₄

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In practice, the shapes of the demand and supply curves vary considerably across countries according to short-run fuel switching capability and storage availability, which in turn depends partly on geological factors. Interfuel competition and gas-stocking behaviour both play significant roles in short-run price determination in North America because of extensive fuel-switching capability in industry and power generation and the existence of a sizable storage capacity. By contrast, interfuel competition plays virtually no role in price determination in Britain because of over-capacity (see the case studies in Part II for a detailed analysis of price setting in these markets). Figure 5 illustrates in an indicative manner this key difference:

■ In North America, market conditions in the low demand season are such that a sudden shift in the demand curve from D_L1 to D_L2caused by an increase in competing fuel prices normally results in a slight increase in the volume of gas supplied (from Q₁to Q₂) and a proportionately larger increase in the gas price (from P₁to P₂). In winter, the demand and supply curves shift outwards (to D_P and S_P) as captive heating demand increases with colder weather and available supplies from storage increase. In the example shown in Figure 5, the equilibrium price is higher in the winter; in practice, lower winter demand levels due to mild weather and higher availability of gas from storage could, and sometimes does, result in lower winter prices than in the peak demand seasons.

■ In Britain, the shape and interaction of the demand and supply curves are at present somewhat different. In the summer, deliverability is well in excess of maximum potential demand, so that the demand curve (D_L) effectively cuts the supply curve (S_L) at a price (P₁) below which fuel switching to gas or any other increase in use is possible. At that price, supply is more or less perfectly elastic; no producer or holder of gas in storage is prepared to sell at a price lower than P₁. In winter, the demand curve shifts up to D_P1. The supply curve also shifts up but less than in North America, because storage withdrawal capacity is more limited. The equilibrium price and supply in the winter are higher at P₂and Q₂. However, at that price there is still no upside demand flexibility because all dual-fired capacity is already using gas. In this illustration, a shift upwards in the demand curve from D_P1to D_P2caused, for example, by higher oil prices, has no impact on price or demand; the supply curve would have to fall back to summer levels (S_L), causing prices to rise to P₃, before any consumers with dual-firing would switch from gas to alternative fuels. Thus, gas-to-gas competition rather than interfuel competition determines gas prices in the summer and winter.

This simplified analysis demonstrates that fuel switching potential and storage capacity in North America tends to temper seasonal and temporal fluctuations in market prices. Excess summer production capacity and a relative lack of storage (which limits the ability of suppliers to meet sudden short-term demand surges) explain why prices fluctuate over much larger ranges in Britain.

Figure 5

Indicative Short-Run Demand and Supply Curves

Note: Low demand season is denoted by L(early and late summer in North America, summer in Britain), peak season by P(winter in both markets).

A further major difference between the two markets concerns the price responsiveness of supply. Incremental onshore production capacity in the United States can be brought onstream at two to three months-notice if drilling rigs are available, so that production may respond quickly to changes in price expectations through changes in drilling activity. In Britain, the lead times of offshore projects tend to be several years, so that installed production capacity responds to price movements with very long lags (see below).

Despite these differences, the most important factor in determining short-term price movements in both the North American and British markets is the weather, especially temperatures which have a direct and predictable impact on winter heating. In the United States, weather also influences summer cooling demand.

The importance of residential and commercial heating in total load in both markets, especially Britain, contributes to short-term demand volatility and unpredictability, which has a direct and pronounced effect on spot prices.