Iran’s Future in Regional and Global Gas Markets

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P5+1 Meeting by Dept of State

Iran’s Future in Regional and Global Gas Markets

The anticipated return of Iran to world energy markets has marked consequences for oil and gas. While Iranian oil exports easily influence the global spot market, the potential for gas exports, despite Iran’s prolific reserves, are much more muted. Iran’s prospects for becoming a major regional or LNG exporter capable of impacting global prices in the short term are low. Iranian gas production must outpace consumption, requiring extensive upstream investment and a decrease in consumption growth, while risk and uncertainty in the country discourage the foreign investment that could rapidly develop new production and LNG capacity.

Risk in Energy Sector Organization

The Iranian energy sector is restrictive even by Gulf standards, leading to underinvestment and a struggle to produce enough gas to meet domestic consumption. The constitutional prohibition on foreign investment and ownership of energy resources has created an environment of buyback contracts. Essentially service contracts, these limited offerings, though expanded in recent years, have discouraged foreign investment amid high risks for the return. Coupled with American and international sanctions, the sector suffers from chronic underinvestment and mismanagement.

Production

Iranian gas production centers on the South Pars field, which holds 40% of its reserves.[1] An ambitious expansion plan to develop the field in 24 phases, of which half are currently complete, is expected to bring online new production, though much of it only after 2020. Previously, European energy firms were developing the field, however, they mostly pulled out of Iran in 2010, leaving the work to domestic firms. Developing the field is critical for new export plans as, over the past few years, Iran has only maintained a marginal level of net exports, amounting to 2.7 bcm in 2014 out of its total production of 172.6 bcm.[2]

Consumption Growth

Eroding the volumes of gas available for export, Iranian energy subsidies have encouraged profligacy while gas reinjection into aging oil fields adds further strains on production. Subsidies doubly impact natural gas as they have incentivized consumption of both gas and electricity, most of which is generated in gas plants.[3] Subsidies amounted to 27% of GDP in 2007/2008,[4] representing a substantial incentive for consumption and a drain on public finances. As a result of these circumstances, Iran uses energy inefficiently.[5] Aside from subsidies, gas reinjection to improve recovery rates from aging oil fields consumes about 12% of production.[6]

Beginning in 2010, Iran began to eliminate subsidies in two phases ending in 2015, using the savings to implement a cash transfer program to offset the impact. Domestic prices are set to increase to 90% of international market values, although this requires a constant reevaluation of prices in terms of rials as the price increases themselves fuel inflation. The impact of the subsidy reform is as yet unclear, though it will likely reduce growth in residential, commercial, and industrial gas consumption.

Regional Export Potential

Even if Iran were to produce sufficient quantities for export, its regional options remain limited, even though several of its neighbors are growing gas consumers.

A 14 bcm capacity pipeline already exists to supply Turkey with 10 bcm annually,[7] though Turkey is reported to have ended the take or pay relationship[8] with Iran in 2014. The pipeline crosses Turkish Kurdistan and has been bombed in the past, making its future particularly uncertain as Turkey intensifies its campaign against ISIS and the PKK. Moreover, Turkey has alternatives to Iranian imports, the most expensive among its import partners, with Russian, Azeri, and Algerian gas.

In the Gulf itself, Iran and Iraq signed an agreement in 2013 to supply Baghdad with up to 25 mcm per day,[9] equating to annual exports of 9.13 bcm, within 6 years. The pipeline is currently under construction and nearing completion. In 2014, Iran and Oman signed a $60 billion deal to build a pipeline financed by Oman to deliver Iranian gas. However, disagreements over the project, particularly the route and price of gas,[10] have made realization more difficult.

The long awaited Iran-Pakistan pipeline, reportedly built on the Iranian side but undeveloped on the Pakistani side,[11] is receiving Chinese backing and financing amid the thaw in relations between Iran and the US. The pipeline was intended to extend to India, however, a multitude of geopolitical factors have hindered the extension.

Although Iran is entering into export agreements, it remains doubtful whether the requisite infrastructure and sustained export volumes would be available in the short run or whether the parties can strike and maintain pricing arrangements, even if sanctions were lifted.

EIA Map of regional pipelines (2012)

Global Gas Markets and LNG

Three conditions must be met for Iran to leverage its gas reserves and become a major global gas exporter capable of influencing prices: the global gas market must mature into a fungible global spot market, Iran must develop its nonexistent LNG export infrastructure, and gas production growth would have to outpace consumption enough to capture a significant percentage of the growing 333 bcm LNG market. None of these is a short-term possibility, and although LNG markets have begun to transition from long term oil-indexed contracts, they are still predominant for the time being.

Iran has sought LNG capacity for decades and has come close to construction several times. Iran lacks the financing and technology to build the liquefaction plants domestically and thus contracted Western firms to build them during the 2000s. Amid US pressure, Iranian contracts to build liquefaction facilities with a host of European energy firms were cancelled in 2008.[12] Similar contracts with Chinese firms were also cancelled in 2010 following the imposition of sanctions. With potential of easing sanctions in 2015 and beyond, European firms are once again trying to resume work on previous projects.[13] Construction times for such projects are measured in years, even in stable and secure markets. Accounting for the uncertainty over the nuclear agreement and the risk of deals with the Iranian government or state-owned companies ensures that such projects would only be further drawn out into the medium-term.

Iran and the Gas Markets

A confluence of factors of varying likelihood must come together for Iran to enter regional and global markets and begin to impact gas prices. Iran must slow down consumption while increasing production in order to provide volumes for export. Subsidy reform will help slow consumption, especially once the cash transfer program ends. Iran will need to foster a stable, less uncertain environment with more attractive terms for international energy firms in order to encourage upstream investment and increase production. Such trust will take time to establish before development can begin, especially given Iran’s rocky history of contract dealings. These same firms will also be necessary to provide the expertise and financing to build both pipeline and LNG export infrastructure. In the short-term, these factors are unlikely to come together, though some work may begin on a number of projects. Over the longer term, especially if sanctions are lifted and Iran faithfully reforms its contract structure for foreign firms, Iran may well become a major gas exporter, but this development is far from certain.

[1] EIA. “Iran: International Energy Data and Analysis.” 19 June, 2015

[2] Unless otherwise noted, all figures are derived from BP Statistical Review of World Energy June 2015. (London: BP, 2015).

[3] EIA. “Iran: International Energy Data and Analysis.” 19 June, 2015

[4] World Bank. “Iran: Overview.” 1 March, 2015

[5] Using World Bank GDP data and BP Consumption statistics, Iran produced $225 of GDP per BOE of primary energy consumed in 2014. This compares unfavorably with its neighbors – Saudi Arabia – $425, UAE – $531, Qatar – $573 – and with other countries – Russia – $372, Norway – $1460, USA – $1034.

[6] Derived from EIA. “Iran: International Energy Data and Analysis.” 19 June, 2015

[7] Olgu Okumuş, “Why is Turkey buying more gas than it needs from Iran?” Al-Monitor. 28 February, 2014.

[8] Natural Gas Europe. “Turkey to Abandon ‘Take-or-Pay’ Clause for Azeri Gas in 2015.” 21 October, 2014.

[9] Natural Gas Asia. “Iran Commences South Pars Link to Pipe Gas to Iraq.” 10 August, 2015.

[10] Alexander Cornwell, “Oman-Iran gas pipeline faces obstacles.” Gulf News. 13 April, 2015.

[11] Saeed Shah, “China to Build Pipeline From Iran to Pakistan.” The Wall Street Journal. 9 April, 2015.

[12] Natural Gas Europe. “Iran Eyes Resuming Huge LNG Project with Germany.” 7 May, 2015.

[13] Christopher Adams, et. al, “Iran: The oil and gas multibillion-dollar ‘candy store’.” 16 July, 2015.

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US Crude Oil Exports

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In February 2017, crude oil exports from the US hit the highest level in the country’s history with 1,116 kb/d of oil leaving the US border. While Congress liberalized crude exports about a year and half ago, exports have really only bounded up in 2017 from their 2014-2016 averages. Following the surge in tight oil production, most exports moved to Canada, effectively the only legally accessible export market prior to 2016. However, throughout 2016 and going into 2017, the destinations of American crude exports began to vary, with non-Canadian volumes primarily heading for Atlantic basin markets but also several locations in Asia. In February, about a third of crude exports were headed for China.

With such buoyant February export numbers, the US has actually surpassed several members of OPEC in terms of crude oil exports. Although February data is missing for the UAE, Venezuela, and Libya, American crude exports trailed those of Saudi Arabia, Iraq, Iran, Kuwait, Nigeria, and Angola.

Crude Exports

US exports surpassed those of OPEC members Algeria, Ecuador, Qatar and other exporters such as Azerbaijan, Colombia, and Oman.

As US crude oil production rebounds in 2017 and going forward, exports are likely to climb even higher through the year and into 2018, especially as requisite infrastructure comes into place and per barrel transportation costs are driven lower.

The Impact of Pricing Regulations on Argentina’s Energy Sector

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Introduction

Since 2001, Argentina has tried to achieve the goals of promoting domestic production and supporting consumption of energy simultaneously. In a departure from the deregulation of the 1990s, Argentina’s government imposed a pricing regime to maintain the stability and affordability of consumer energy prices in order to stimulate economic growth and preempt the possibility of hyperinflation. Exports of energy were curtailed through a system of capital controls and export duties. As consumption rebounded following the 2001 economic crisis, producer prices remained below the prices for energy imports, thereby discouraging investment and volume growth. In response, the government instituted a system of producer price controls and subsidies to encourage investment, making up the difference between producer prices and controlled prices through federal budget outlays. Argentina’s regulatory system accomplished its goal of stimulating demand and limiting exports, however, in doing so it introduced distortions in the market that prevented the market from balancing with domestic production. The Argentina case study provides a lesson for countries seeking to accomplish contradictory goals through regulation, establishing a need for professional technocratic regulation, rather than regulation by decree, and flexibility in overcoming the interaction effects caused by intervention in the markets.

Energy Regulation between 1989 and 2015

            Following a period of liberalization and deregulation in the 1990s, Argentina’s energy sector has been increasingly regulated since the 2001 economic crisis. The energy sector operates under the basic 1967 Ley de Hidrocarburos (Law No. 17.319),[1] which establishes hydrocarbon reserves as the patrimony of the nation and grants the Executive wide powers to grant concessions and regulate energy. The energy sector became heavily regulated until the Menem administration (1989-1999) pursued a vast liberalization of the economy. During this time, the Congress promulgated the Ley de Reforma del Estado (Law No. 23.696)[2] in 1989 with the aim of privatization and deregulating industry. The Menem reforms enabled private participation in oil and gas, deregulated prices, and culminated in the full privatization of YPF, a process that started with Law No. 24.145 of 1992.[3] During this time, Argentina’s economy and energy sector underwent rapid growth. Despite the oversupply in the international oil markets and the weakness of Brent prices, Argentine oil production increased 76% between 1990 and 2001, while gas production more than doubled as presented in Figure 1.

Figure 1

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Following the 2000-2001 economic crisis, the Argentine government took a much more interventionist role in the energy sector and economy in general. Seeking to stimulate economic growth and prevent a return to hyperinflation, the short-lived Duhalde administration (2002-2003) issued Decrees 310/2002 and 809/2002, which established export restrictions on oil and oil products, including a 20% export duty.[4] Export duties were extended to gas in 2004. The administration further began controlling energy prices, particularly freezing rates in the electricity sector.[5] Law 25.561, passed in 2002, established emergency control measures over the exchange rate and prices.[6] Further clarifying its role through Resolution 1104/2004, the Ministry of Energy and Mines established formulaic pricing for energy.[7] Both the Nestor Kirchner (2003-2008) and Cristina Fernandez de Kirchner (CFK, 2008-2015) administrations maintained the price controls. Although export duties were introduced as temporary emergency measures, they were effectively made permanent in 2007 through Law 26.217.

Consumer Prices and the Impact on Demand

While the price controls did appear to stimulate economic growth and promote stability in the early 2000s, the lack of political will to raise consumer prices stimulated demand beyond what would have been commensurate with economic growth. As a result of the price control legislation coming into force after 2001, energy prices were denominated in pesos and remained nearly fixed, in spite of wide fluctuations in the USD prices of commodities. Natural gas prices, as presented in Figure 2, remained close to their 2003 level until 2013, despite peso inflation averaging 17% per year between 2000 and 2014.[8] Figure 3 shows vehicle fuel prices at the official exchange rate, representing an unreactive pricing system. Faced with punitive export terms and pressure from the government to maintain prices, producers had no choice but to direct domestic production to the market at low prices.

Figure 21.png

Figure 31

Demand for controlled products, gasoline and transportation fuels, natural gas, and electricity, grew faster after 2001 than over the period 1990 – 2001. Compound annual growth rates for fuel and product demand are presented in Figure 4. As presented in Figure 5, demand for oil products, gas, and electricity grew rapidly in relation to its 2002 level, in total reaching 150% of 2002 demand by 2013. Consumers expanded structural demand for energy, leading to a large growth in residential energy demand per capita, as show in Figure 6.  The low fixed costs for products disrupted the distribution business, garnering complaints from the Argentine gas distributors trade group, citing the inability of distributors to maintain operations at current prices; GasNatural Fenosa, for example, depended on federal assistance of 515 million pesos for operation and maintenance in 2015.[9]

Figure 4

Growth in Demand by Product and Sector CAGR 1990-2013 CAGR 1990-2001 CAGR 2002-2013
Transport – Oil Products 1.5% 0.8% 3.2%
Residential – Gas 3.9% 4.1% 4.2%
Residential – Electricity 5.7% 6.4% 5.9%
Commercial – Gas -1.2% -5.0% 2.9%
Commercial – Electricity 6.5% 9.3% 4.6%
Industry – Oil Products 5.4% 12.9% -0.2%
Industry – Gas 2.3% 1.7% 2.8%
Industry – Electricity 3.7% 4.4% 3.6%

Figure 5

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Figure 6

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Regulatory Impact on Industry

            The regulation of the wider economy and energy sector in particular created large distortions in supply and demand that led to a severe decline in the upstream sector, in terms of investment, production, and wells drilled. Figure 7 presents private investment in the energy sector over the 2000s. Since consumer prices were fixed and could not react to increasing demand, prices in the upstream sector remained depressed, depriving the market of signals to raise production and seek new supply. The aforementioned export duties were introduced as a measure to maintain domestic supply for the market, yet only served to extinguish exports. Over the five year period following the 2002 introduction of export restrictions on oil, crude oil exports declined by 79%, despite production only falling by 12% over the period, as shown in Figure 8. Similarly, gas exports collapsed five years after export duties were introduced in 2004, falling 87% while production only decreased 7% (Figure 9). Imports of gas rose 36% during the period. The inability of producers to sell at realistic market prices, in either the domestic or international markets, disincentivized investment and production. Restrictions on repatriations for foreign firms, currency controls, and denomination of energy prices in pesos made Argentina even more unattractive as an upstream market.

Figure 7

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Figure 8

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Figure 9

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Regulation of Production

Seeking to address the deteriorating energy balance and decrease the outlays of foreign reserves to purchase energy in the international markets, the government sought to stimulate domestic production through a complex system of subsidies and producer pricing regulations. Wellhead prices for natural gas prices remained below $2.30/MMBtu until 2012 as a result of import competition and fixed consumer prices. Relative to international benchmarks, wellhead oil prices were also depressed as a result of an autarkic market and consumer price controls.

During the CFK administration, the Ministry of Energy and Mines declared Resolution 24/2008,[10] introducing the Gas Plus program, which enabled producers to receive prices greater than the controlled prices agreed to between the Ministry and producers. Similarly, the oil market received tax credits through the Oil Plus program, as part of Decree 2014/2008. Seeking to eliminate gas exports to keep the domestic market supplied, Resolution 127/2008 further raised the gas export tax to 100% of the highest price between Bolivian and LNG imports. Natural gas was subject to greater taxation as a result of its systemic importance to the Argentine economy, penetrating all sector including transport, and thus was deemed more important for retaining for the domestic market. This taxation stands in contrast to oil, which was taxed to a lesser degree and provided foreign currency export revenues for the government.

As the problem of domestic production became more acute by 2012, the government took more drastic steps through Decree 1277/2012, establishing the Commission for Planning and Strategic Coordination, and Law 26.741, nationalizing YPF-Repsol. The Commission gained pervasive powers to regulate the energy sector, including price-setting and approvals of private investment plans. The ultimate intention of the Commission was to ensure that firms were investing in the upstream sector in accordance with government plans for production. The expropriation of YPF similarly sought to bring greater control over the largest E&P player in the country in order to develop resources more quickly, particularly prolific unconventional reserves.

Production Subsidy Structure

The Commission, acting under a series of decrees, laws, and resolutions passed between 2012 and 2015, created a complex series of pricing regulation that sought to simultaneously subsidize both producers and consumers. In particular, Resolution 1/2013 set the wellhead price of natural gas to $7.50/MMBtu for production exceeding levels planned by the Commission. The federal budget covered the difference between the $7.50 price and the market price, which typically remained below $3/MMBtu, leading to large expenditures on energy. The remaining resolutions are summarized in Figure 10. The Commission established differential pricing for producers based on the final use of the gas, the date of operation, and the resource basin. Wells operating before 2013 may receive a price between USD $4/MMBtu and $7.5/MMBtu, depending on the production curves and whether or not the gas is reinjected. Projects streaming after 2013 sell into the market and receive the difference from the government to equal a wellhead price of $7.5/MMBtu.[11] Basins make a further difference, with the highest prices reserved for Neuquén Basin shale. Production for CNG networks receives a price of 0.89 ARS/m3.  The complexity of the subsidy structure, not only introduces uncertainty over its maintenance by political forces and added transaction costs, but also ensures that only large producers are able to meet their investment targets and field the legal expertise to capture the subsidy rents.

Figure 10

Law Effect
Decree 929/2013 New E&P projects can export up to 20% of production tax-free
Resolution 60/2013 Price range for incremental volumes for small gas producers set to between USD $4.00 and $7.50/MMBtu.
Law 27.007 Amends 1967 law extending length of concessions and lowers investment requirements
Resolution 139/2014 Defines rights of acquired companies to subsidies
Resolution 123/2015 Better defines participation in subsidy program
Resolution 185/2015 More firms eligible for production subsides

The oil sector, historically offering terms similar to international oil prices, attained a large degree of support following the 2014 oil price collapse. The CFK government retained pricing support at $77.5/bbl[12] at the wellhead in order to encourage investment and prevent an increase in unemployment in sensitive provinces. The Macri administration, coming into power at the end of 2015, lowered price support to USD $67.5/bbl for light Neuquén crude and $54.90/bbl for heavier San Jorge basin crude.

The combined total of energy subsidies, for both the upstream and consumer segments, began to take up an increasing portion of the federal budget. The budgetary cost in 2015 amounted to $18.4 billion USD, primarily requiring servicing through foreign reserves. After the accession of the Macri administration, Decree 272/2015 abolished the Commission and its duties were transferred to the Ministry of Energy and Mines. The Macri government began to unwind the subsidy structure, lowering guaranteed prices at the wellhead as previously mentioned and permitting free exports and imports and repatriation of 70% of export revenues. The pro-market agenda has already attracted investment, though years are likely to pass before the investment materializes into production growth.

Argentina: A Case Study in Regulation

Argentina’s energy regulations are the result of a series of incremental regulatory measures seeking to react to the problems caused by the initial energy price controls. The primary regulations of 2001 intended to stabilize prices and stimulate economic growth were successful, while export taxes did diminish exports, providing the domestic market with stranded supply intended for export markets. However, the temporary measures became permanent in practice and began to severely distort the market. Fear of political unrest ensured that only additional regulation, rather than amendments and rollbacks of previous measures, were possible. In accordance with basic economic principles, the price ceilings on energy resulted in a supply shortage as producers found it uneconomical to continue investments. Subsequent regulations sought to spur investment through a series of command-and-control measures and subsidies. However, each incremental regulation failed to bring about a balanced energy market.

Argentina provides a case for the need of an independent, institutionalized, and professional regulator that can balance the interests of consumers, producers, and the social goals of the government. In Argentina’s centralized political system, in which the Executive retains large powers to regulate and issue emergency decrees, requiring a 2/3 vote in the Congress to overturn, regulations were easy to issue and difficult to lift without checks and balances. Regulation by decree is inherently subject to political whims and only provides broad solutions to a particular problem. As such, the Argentine system continually introduced uncertainty into the energy market, preventing firms from modeling financial performance and investing, while constant changes precluded the institutionalization of a professional regulatory body. The complex multi-tiered pricing structure also added unnecessary opacity, complicating investment decisions and leaving room for patronage and moral hazard. An independent regulator, with formulaic, rather than set prices, would serve to introduce stability, particularly through cost-plus pricing. In particular, targeting bands of prices, rather than fixed prices, would allow limited price signals to give producers, consumers, and regulators insights into market developments. The top-down Argentinian regulatory model has not brought the energy market to balance, only eroded energy security, and its failures demonstrate the need for professional regulatory capacity for other countries seeking to manage the energy market.

Beyond the regulator itself, Argentina demonstrates the interaction effects of intervention in the markets. Additional regulation, rather than simply causing its intended effect, can often interact with preexisting market distortions to cause unintended consequences. Argentina’s government consistently sought to correct problems through additional regulation, which begot further issues and regulations. Often, the impact of a particular regulation is unpredictable, especially for energy, which impacts every sector of the economy. The interaction effects call for recognition of problems and the flexibility to address them, even at political cost. Argentina’s particular form of political populism may preclude the possibility of addressing such issues quickly and early, but the lesson may be applicable elsewhere. The economic impact of additional regulation makes a strong case for a technocratic regulatory body, with the power to reverse decisions as necessary; it is not expected that all regulations are correct or achieve their desired outcome each time. Maintaining simple, transparent, and flexible regulations can better achieve social goals than crystallized controls, even if it takes some power away from politicians.

Conclusion

            Argentina’s energy regulations throughout the 2000s demonstrate that even well-intentioned regulation can be subverted by top-down political processes and interaction effects, creating the need for an independent regulator and the ability to reexamine regulations, rather than introduce new ones to correct prior measures. In response to the 2001 crisis, Argentina enacted price controls to protect consumers from rising prices and stimulate economic growth. After a return to growth, price controls became fixed and permanent as the government feared political unrest resulting from their abolition. Low and fixed consumer prices, coupled with export restrictions, translated into producer prices that were insufficient to enable investment in the country, particularly given the general volatility of economics and politics. The government turned to making the energy market more autarkic before resorting to command-and-control measures and subsidies to correct the low producer prices caused by the initial regulations. Ultimately, the Argentine government oversaw a vast increase in federal energy subsidies while the country became a net importer of hydrocarbons. The Argentine case shows the inefficacy of broad centralized regulation by decree, necessitating an independent regulator to balance the interests of the government and market participants. The interaction effects of various decrees and controls further show that flexibility in implementing regulations is necessary to correct for unintended consequences. Argentina’s energy regulations evolved into capricious decrees that only worsened problems in the energy market, rather than solving them, demonstrating the need for pragmatic flexibility and a professional regulatory apparatus that can be applied beyond Argentina.

 

[1] Government of Argentina. “Ley de Hidrocarburos.”  23 June 1967

[2] Government of Argentina. “Reforma del Estado”  17 August 1989

[3] Government of Argentina. “Federalización de Hidrocarburos” 24 September 1992

[4] Government of Argentina. “Exportaciones” 13 May 2002

[5] David Mares. Political Economy of Shale Gas in Argentina. (Cambridge, MA: Belfer Center 2013).

[6] Government of Argentina. “Emergencia Publica y Reforma del Regimen Cambiario” 6 January 2002

[7] Ministry of Energy and Mines. “Aclaraciones y recomendaciones” 10 April 2016

[8] World Development Indicators. (Washington, DC: World Bank Group, 2016).

[9] GasNatural Fenosa. Interim Report January – September 2015 Results. 4 November 2015.

[10] Government of Argentina. “Gas Natural” 3 June 2008

[11] YPF. Form 20-F 2015. December 31, 2015.

[12]Argentina Cuts Wellhead Prices” ArgusMedia. 6 January 2016.

Argentina’s Energy Future

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Problem: Argentina has destroyed its chances of not only regaining energy self-sufficiency but also of developing its significant hydrocarbon resources due to the nationalization of YPF-Repsol.

Significance:

The nationalization of YPF-Repsol offers a case study to examine the effects of discrete state interference on investment in the energy sector against a backdrop of poor investment conditions. While Argentina has been self-sufficient in energy and a net exporter of oil for much of its history, extrapolating current consumption and production trends suggests that Argentina will be a net importer in the coming years by a large margin, as presented in Figure 1.[1] Both the 2008-2016 Cristina Fernandez de Kirchner (CFK) and Macri administrations (2016 – ) have sought to reverse these trends and exploit significant oil and gas reserves, particularly in the Neuquén Basin. As Macri has confirmed that the nationalization of YPF-Repsol will not be reversed, examining developments in the country after the nationalization serves to highlight overall market reactions and policy options for returning Argentina to energy self-sufficiency.

This analysis will argue that the nationalization itself of YPF-Repsol does not preclude Argentina regaining energy self-sufficiency; systemic aboveground risk and the progress of pro-market reforms will determine whether Argentina will be able to encourage sufficient investment. The nationalization did not result in lower levels of investment as would have been expected. However, the expropriation is a manifestation of the long-running centralization of control over the energy sector that has created volatility in the market. Private actors require certainty to invest in capital-intensive energy projects with long timelines. The risk inherent in Argentina’s bond default, unreliable data, inflation, capital controls, and politicized oil and gas pricing system create uncertainty and remain the underlying causes of underinvestment. Argentina’s success in mitigating these aspects of the overall economy will determine the pace of investment in energy, and thereby the pace of production growth for self-sufficiency.

Analysis:

The nationalization of YPF-Repsol as a discrete event has not precluded Argentina’s return to energy self-sufficiency as private investment has continued to flow into the country. Thus, Argentina’s energy independence will depend on the underlying structural issues. State intervention in the energy sector and economy at large has created uncertainty over state action and poor macroeconomic conditions for investment. Examining both state interference and the corresponding impact on market conditions is critical in determining Argentina’s energy future.

The Nationalization of YPF-Repsol

The Argentinian government moved to expropriate the controlling share of Spanish Repsol in YPF through the Ley de Soberanía Hidrocarburífera, promulgated in 2012. Ostensibly, the purpose of the nationalization, as stated by CFK herself, was to secure state control over energy resources in the public interest and ensure investment in production, rather than dividends.[2] Despite the rhetoric, nationalized YPF entered into joint ventures with both Chevron and Dow Chemical, as well as Petronas, Gazprom, and Sinopec, to develop separate concessions in Neuquén.[3] Private spending in Argentina’s energy sector actually increased in 2012 and 2013 as presented in Figure 2. In total, YPF and Chevron have invested $2.5 billion USD since 2012.

Given the calls for state-led development of energy, the government may have been expected to consolidate control and eject private participants. Typical state-led development involves PSAs or service contracts, rather than outright concessions or joint ventures. The joint ventures, and the speed with which they were reached, are a tacit affirmation that the government needs private involvement in developing the resources, particularly in terms of technology transfers, human capital, and infrastructure. The opacity of the contract terms has led to federal judicial injunctions to release the terms to ascertain whether or not the contracts are in the public interest, as established in the Ley de Soberanía Hidrocarburífera.[4] The private sector’s willingness to invest suggest that it does not accept government rhetoric at prima facie, potentially encouraged by the quality and quantity of reserves. In the context of worldwide E&P, Argentina provides an attractive return to investment, relative to aboveground risk. While other factors in the country can discourage investment, the nationalization itself of YPF-Repsol has had minimal impact on investment in the energy sector and therefore has not precluded its chances at self-sufficiency.

State Interference  

The Argentinian government, both at the federal and provincial levels, has established long-running precedents for interference in the economy, and particularly in the energy sector, to promote self-sufficiency. Since the 2000-2001 economic crisis, the government has imposed price controls on domestic energy, both for producers and consumers, and tried to supply the domestic market by regulating exports. Decree 1277, issued in July 2012, further centralized power by establishing a commission to promote self-sufficiency, which retained the power amend private investment budgets and cancel contracts or fine companies for noncompliance.[5] After oil and gas licensure was devolved to the provinces in November 2006, the Neuquén province itself has abrogated contracts with YPF-Repsol and Petrobras as a result of unsatisfactory development. In such an environment, private firms found Argentina unprofitable in the 2000s and decreased investment, leading to the current low levels of production.

Despite the federal and provincial governments’ desire to promote energy self-sufficiency and encourage private investment, the constant interference in the market introduces volatility that discourages the investment necessary to attain self-sufficiency. Although companies can adapt to some economic and financial volatility, capricious political risk cannot be modelled in long-term investments. The Macri government appears to be genuinely focused on reforming and alleviating market concerns as it courts $20 billion USD of investment in the country.[6] As Macri signals stability to the market and settles the long-running dispute over Argentina’s 2002 default and permits a necessary currency devaluation, investor confidence is improving, leading to lower debt yields and capital costs. Argentina can regain self-sufficiency by maintaining these trends.

Economic Conditions for Investment

State interference in the economy, beyond the direct expropriations, has created economic conditions that are unattractive to investment. Energy price controls and regulation intended to promote self-sufficiency have discouraged upstream investment and boosted overall energy consumption. Energy exports were limited to 20% of production, exports to some neighboring countries were made illegal,[7] and remaining production was to be sold under a price regime. Taken together, investment in Argentinian E&P was unattractive. Following the 2014 oil price collapse, the CFK and Macri governments decided to retain price controls, currently at $67.5/bbl,[8] in order to encourage investment. Perversely, the subsidy to produces introduces some volatility as its retention is uncertain amid Macri’s move to cut subsidies from the federal budget. From the demand side, nominal prices for electricity and gas remain near their 2002 rates, despite high inflation, widening the gap between production and consumption.

On the macroeconomic side, high inflation and exchange rate fluctuations, as well as capital controls, have undermined the rationale for investment as firms cannot be assured of USD cash flows. Figure 3 portrays inflation figures for Argentina, which average 17% between 2000 and 2014. During the CFK years, capital controls and a currency peg were implemented to prevent a devaluation, despite inflation, as shown in Figure 4. The Macri government is seeking to return macroeconomic stability to the country to encourage investment. The administration devalued the currency to control inflation and improve business sentiment, in addition to overhauling statistical agencies and returning the country to the capital markets. Private and foreign investors presently view the reforms as genuine, and Macri’s ability to maintain the momentum of reforms will determine the pace of investment and growth in production to achieve self-sufficiency.

Conclusion

The nationalization of YPF-Repsol, by itself, has not precluded Argentina’s chances of regaining energy self-sufficiency. Following the nationalization, foreign investment in the country continued to flow in and major joint ventures were reached to exploit resources in the Neuquén Basin. The reforms of Argentina’s volatile and capricious investment environment will determine whether or not the country can achieve energy independence. The CFK administration has overseen conditions that eroded investment, leading to production declines, turning Argentina into a net importer. Despite the uncertainty, the resource base has still been attractive enough to draw foreign investment. Reforms addressing the volatile conditions will be critical in bringing the necessary capital to enable production growth in the attractive Vaca Muerta play.

Appendix

Figure 1

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Source: BP Statistical Review 2015 Data – Forecasts extrapolated using 2010-2014 CAGRs

Figure 2

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Source: World Bank Development Indicators

 

Figure 3

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Source: World Bank Development Indicators

Figure 4

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Source: Yahoo Finance ARS/USD 2001-2016

 

[1] BP Statistical Review of World Energy June 2015. (London: BP, 2015).

[2] Cristina Fernandez de Kirchner “Discurso del Proyecto de Ley de Expropriacion de YPF.” 17 April 2012.

“Ahí están exactamente, en la distribución de dividendos y en la no inversión, las claves de por qué hoy tenemos que estar haciendo esta importación que también va a ser muy fuerte este año”

[3] Scott Weeden. “Argentina Goes Against the Grain by Increasing Spending.” E&P. August 2015.

[4]La jueza ordenó que YPF entregue el contrato completo con Chevron.” Infobae. March 2016

[5] David Mares. Political Economy of Shale Gas in Argentina. (Cambridge, MA: Belfer Center 2013).

[6] Mauricio Macri. Interview with Bloomberg. 22 January 2016

[7] David Mares. Political Economy of Shale Gas in Argentina. (Cambridge, MA: Belfer Center 2013).

[8]Argentina Cuts Wellhead Prices” ArgusMedia. 6 January 2016.

Colombia’s Hydrocarbon Boom

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Problem: Colombia’s exploration and production boom since the late 2000s is just a product of improved security after decades of lawlessness on the ground.

Significance

The conditions underlying and enabling Colombia’s hydrocarbon boom can provide an indicator of the necessary conditions to reproduce a similar boom elsewhere in Latin America. In direct contrast to neighboring Venezuela, hydrocarbon reserves are only a prerequisite, but insufficient, condition for a boom in hydrocarbon production. Colombia’s improving security environment merits examination as one of the enabling factors in the country’s hydrocarbon boom.

This analysis will argue that improved security is but one of the factors that influenced Colombia’s hydrocarbon boom, but not the primary driver. Hydrocarbon extraction by private actors requires the minimization of risk through general stability, ease of investment, sufficiently high prices sufficient to justify the risk, and proven reserves. Hydrocarbon commerciality – the discoveries and market prices that make extraction economical – as well as the overall regulatory and rule of law environment could have all contributed to Colombia’s hydrocarbon boom in the late 2000s. As such, they are significant in determining the conditions necessary to replicate the boom elsewhere.

Analysis:

The confluence of several factors, within and without Colombia, created the conditions for the boom and each merits a separate hypothesis to be tested. Thus, the analysis examines three hypotheses with oil production as the dependent variable.

  • H1: Decreasing violence in Colombia is associated with an increase in oil production.
  • H2: Improving hydrocarbon commerciality conditions are associated with an increase in oil production.
  • H3: Legal and regulatory reforms in Colombia are associated with an increase in oil production.

Each subsection provides the context for each hypothesis and examines the quantitative results arising from the analysis.

Violence and Lawlessness

The decline in violence and improvement in security in Colombia helped provide the environment and stability for investment in multi-year E&P projects. Using World Bank data[1] on homicides per 100,000 as a proxy for the level of security, violence in Colombia did materially decrease between 2000 and 2013, the last year for which data is available. Homicides declined from a high of 68 in 2002 to 31 in 2013, during which period oil production grew by 74%.[2] As programs dedicated to weakening armed groups through demobilization and an overall tougher stance to retain government control over territory proved effective, lawlessness and the general security environment improved. These developments are reflected in the World Bank metrics on rule of law, which include control of corruption, government effectiveness, political stability and absence of violence, regulatory quality, and general rule of law. Colombia has seen marked improvements from the 1990s to 2011, the last year of data availability. These data, transformed into a 0-10 scale where 10 presents the greatest level of rule of law, are available in Table 1.

While homicides declined and rule of law improved throughout the 2000s, the relationship with oil production is tenuous. Plotting the available data points against oil production yields a weak association as presented in Figures 1 and 2. Figure 3 presents a more rigorous statistical analysis in which statistical significance, the beta coefficients of the regression, and R2 are all presented. In this analysis neither the homicides variable nor the average of each of the rule of law metrics yields any statistical significance or meaningful R2. Admittedly, the analysis is flawed in that it only contains 16 data points, thereby skewing the results, and homicides serves as an imperfect proxy for guerrilla violence in the country. However, based on this specific analysis, the lack of statistical significance suggests that there is no association between the improved security environment and oil production in Colombia. Indeed, international oil companies often operate in hostile environments and are able to produce oil.

International Markets and Colombian Hydrocarbons

The increase in price of international crude benchmarks throughout the 2000s pushed certain projects into positive net present value and encouraged E&P activity in riskier markets, yielding a production boom around the world. Thereby, price and reserves are plausible drivers of Colombian production. Colombia’s production figures and reserves are presented in Figure 4, as indexed to the year 2000. After falling for years, Colombian reserves recovered from 2010 onward, though primarily as a result of smaller fields becoming economical and more productive, rather than major new discoveries[3].

Examining the impact of price and reserves on oil production statistically, as presented in Figure 5, there is a clear and statistically significant association between both price and reserves and oil production. When using both reserves and price as dependent variables, both are statistically significant and R2 reaches 0.5. One should note some multicollinearity issues as reserves are also a function of price, not just in-situ resources. Interpreting these results, a $1 increase in the Brent price translates into an increase in oil production of 2,500 b/d on average, while a 1,000,000 barrel increase in reserves translates into an increase in oil production of 200 b/d on average. Figure 6 presents the substantive effects of price on oil production, with reserves at the median.

Colombian Reforms

The reforms to the overall economy and the hydrocarbon sector in particular under the Uribe administration are difficult to quantify, but nevertheless enabled the environment in which production could grow quickly in the late 2000s. Beginning its mandate in 2002, the Uribe administration’s platform focused combating armed groups, encouraging foreign investment, and improving regulatory stability. In 2003, the Uribe administration enacted liberalization reforms in the hydrocarbon sector, deemphasizing the role of Ecopetrol and partially privatizing the company in 2007. The fiscal terms were amended in favor of producers to encourage investment and lowered the state’s share of revenues to 50% from 70%.[4] An independent regulator, Agencia Nacional de Hidrocarburos (ANH), was also established to impartially auction licenses and administer bid rounds. After the reforms, private partners could retain 100% ownership of fields with fewer than 60 million barrels of reserves. Foreign investment increased tenfold between the time of the reforms and 2010 as a result.[5]

The reforms were found to be statistically significant in each of the models examined in Figure 7. The reforms were coded as a binary variable, where 1 indicates a year in which the reforms were promulgated and in force. The reforms are strongly associated with oil production, even when controlling for price or reserves. On average, a year in which reforms were in force registered an increase in oil production of 377,000 b/d. Interestingly, when controlling for price, reforms remain statistically significant while price falls from statistical significance. The quantitative analysis suggests that the reforms were successful in increasing oil production. When coupled with a supportive price environment and discoveries in Colombia, they were successful in attracting investment and stimulating production.

Conclusion

While price increases, discoveries, and reforms of the regulatory structure and fiscal terms were found to be associated with the late 2000s oil boom, declines in violence and improvements in rule of law were found to lack statistical significance. Certainly, a diminishment of violence has not hindered oil production. However, improved security is not correlated with oil production despite citations of violence as one of the limiting factors to oil and gas E&P. Admittedly, the analysis is limited by the lack of data points and the availability of data to serve as a proxy for overall security environment and violence. As such, further analysis is required to ascertain the link between improved security the hydrocarbon boom.

The lessons of Colombia’s hydrocarbon boom provide a framework for increasing hydrocarbon production elsewhere in Latin America. A confluence of factors created the conditions necessary for Colombia’s hydrocarbon boom. Given that Colombia is not particularly well endowed with reserves and the quality of its oil remains low, it suggests that other countries with suboptimal conditions can also replicate a boom. In particular, Colombia’s government has been stable, supportive towards the sector, and has offered attractive fiscal terms. Moreover, its focus on improving fiscal terms and providing an impartial regulatory regime has sustained the necessary capital flows. Underlying reserves and global prices were necessary to support the risk-taking in the country yet are ultimately exogenous factors. Although global benchmark oil prices are currently depressed, a government that provides investors with a regulatory framework and the stability necessary to create certainty over projects will set the foundation for expanding production once cyclical prices rebound.

Appendix

Table 1

Year Control of Corruption Government Effectiveness Political Stability and Absence of Violence/Terrorism Regulatory Quality Rule of Law Voice and Accountability Composite Score
1996 4.02 4.61 1.80 5.15 3.22 3.69 3.75
1997 4.14 4.66 1.47 5.10 3.43 4.06 3.81
1998 4.19 4.43 1.78 5.28 3.04 3.88 3.77
1999 4.53 4.18 1.04 5.05 3.38 4.00 3.70
2000 4.66 4.73 0.22 4.84 3.48 4.08 3.67
2001 4.80 4.72 0.62 4.95 3.60 4.38 3.85
2002 4.77 4.67 0.93 5.11 3.67 4.40 3.92
2003 4.79 4.76 1.29 5.25 3.96 4.64 4.12
2004 4.62 4.90 1.42 5.47 4.06 4.64 4.19
2005 4.56 4.94 1.32 5.52 4.13 4.65 4.18
2006 4.39 4.54 1.34 5.31 4.15 4.68 4.07
2007 4.18 4.91 1.94 5.52 4.31 4.69 4.26
2008 4.40 5.13 2.47 5.74 4.43 4.82 4.50
2009 4.13 5.02 2.21 5.78 4.22 4.80 4.36
2010 4.12 5.09 2.43 5.78 4.10 4.77 4.38
2011 4.21 4.78 2.76 6.01 4.32 4.81 4.48
Change 4.7% 3.7% 53.3% 16.6% 34.2% 30.2% 19.5%

Figure 1

1

Figure 2

2

Figure 3

Lawlessness and Oil Production
Dependent variable:
Oil Production (‘000 b/d)
(1) (2) (3)
Homicides

per 100,000

-2.5 -0.7
(2.2) (5.2)
Rule of Law

Composite Score

-20.8 -57.7
(113.9) (285.4)
Constant 806.6*** 734.5 921.9
(113.8) (463.9) (1,403.4)
Observations 19 16 16
R2 0.1 0.002 0.004
Adjusted R2 0.02 -0.1 -0.1
Residual Std. Error 151.5 (df = 17) 126.3 (df = 14) 131.0 (df = 13)
F Statistic 1.3 (df = 1; 17) 0.03 (df = 1; 14) 0.03 (df = 2; 13)
Note: *p<0.1; **p<0.05; ***p<0.01

 

Figure 4

4.png

Figure 5

Price, Reserves, and Oil Production
Dependent variable:
Oil Production (‘000 b/d)
(1) (2) (3)
Brent Price (2014 USD) 2.5** 4.2***
(1.1) (1.1)
Reserves (Millions Barrels) 0.2*** 0.3***
(0.05) (0.05)
Constant 300.7*** 187.2* -213.1
(66.5) (99.0) (133.0)
Observations 50 35 35
R2 0.1 0.3 0.5
Adjusted R2 0.1 0.3 0.5
Residual Std. Error 251.2 (df = 48) 209.4 (df = 33) 175.7 (df = 32)
F Statistic 5.0** (df = 1; 48) 13.8*** (df = 1; 33) 17.2*** (df = 2; 32)
Note: *p<0.1; **p<0.05; ***p<0.01

 

Figure 6

 6

 Figure 7

Reforms and Oil Production
Dependent variable:
Production (‘000 b/d)
(1) (2) (3) (4)
Reforms 377.2*** 419.1*** 310.8*** 266.1***
(68.4) (86.4) (52.8) (69.9)
Brent Price

(2014 USD)

-0.9 1.2
(1.2) (1.2)
Reserves

(Million Barrels)

0.2*** 0.2***
(0.04) (0.04)
Constant 335.7*** 372.3*** 38.8 -52.4
(33.5) (56.8) (74.0) (119.3)
Observations 50 50 35 35
R2 0.4 0.4 0.7 0.7
Adjusted R2 0.4 0.4 0.6 0.6
Residual Std. Error 206.5 (df = 48) 207.2 (df = 47) 147.3 (df = 32) 147.4 (df = 31)
F Statistic 30.4*** (df = 1; 48) 15.4*** (df = 2; 47) 31.3*** (df = 2; 32) 21.2*** (df = 3; 31)

 

 

[1] World Development Indicators. (Washington, DC: World Bank Group, 2016).

[2] BP Statistical Review of World Energy June 2015. (London: BP, 2015).

[3] Robert Perkins, “Colombia’s Oil Boom Stalls.Platts. December 2014.

[4] Lisa Viscidi. “Colombia’s Energy Renaissance.” Americas Society and Council of the Americas. December, 2010

[5] Lisa Viscidi. “Colombia’s Energy Renaissance.” Americas Society and Council of the Americas. December, 2010

US Gasoline Exports

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The 1975 EPCA, as described in more detail previously, gave the executive large discretionary power to shape American energy exports. During most of the Act’s existence, US crude oil exports have been prohibited on energy security grounds, with minor exceptions. However, the EPCA does not prohibit the export of petroleum products. Even in the depths of the 1970s energy crisis, the US exported small quantities of finished gasoline. Exports continued to increase throughout the 1980s and 1990s to reach a peak of 161 million barrels in 2014. 2015 will likely supersede this number.

Gasoline Exports

Concurrently, imports of gasoline have continued to decline since reaching a peak of 219 million barrels in 2005, down to 17 million in 2014. Despite the calls for increased energy security throughout the last decade, the US became a net exporter of gasoline in 2010.

Gasoline Net Exports Historical

Gasoline Net Exports since 2000.png

Several factors contribute the rise of gasoline exports. In recent years, in which WTI has traded at a discount to Brent, refining of crude domestically and exporting it to worldwide markets becomes lucrative. Overall demand for gasoline in the US has stagnated throughout the 2000s and 2010s as vehicles became more efficient and drivers more conscious of their driving patterns amid high gasoline prices.

More importantly, the level of gasoline exports serves to highlight the impact of the EPCA and the rent-seeking it has enabled in the refining sector. With the recent repeal of provisions prohibiting crude oil exports, the pricing dynamic of the refinery sector will change and gasoline exports may decline. In any case, the energy security that the EPCA sought to provide did not materialize throughout the 2000s. Refiners were able to take advantage of arbitrage conditions and export finished products to countries where they would receive the highest price, hence the high levels of gasoline exports throughout the decade.

 

All graphs derived from Energy Information Administration data.

Comparison of GDP Produced for Energy Consumed

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GDP Produced

Using World Bank GDP data and BP primary energy consumption statistics, this chart shows the energy efficiency of select countries, in terms of GDP produced for each barrel of oil equivalent consumed. Among all Gulf countries, Iran performs the worst on this metric, largely a result of inefficient industries, partly a result of the sanctions regime, and heavy subsidization of energy consumption up to 2010 and the slow phase out of subsidies until 2015. In contrast, the low energy consumption, relative to GDP, of the US, Germany, and Norway portray lowering energy intensity as economies shift towards service industries.

Shale Rig Counts, Productivity, and WTI Price

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Rigs Productivity WTI

Rig counts, rig productivity, and WTI price normalized to January 2011. This graph shows the lagged relationship and responsiveness of the rig count and WTI price. However, more importantly, the productivity per rig is four times its level in January 2014, thereby making tight oil production less sensitive to decreases in rig counts. This helps explain the resilience of US oil production. The productivity is an average of all shale plays, not just the most productive oil plays.

Source: EIA data on rig counts, productivity, and nominal monthly WTI spot price per barrel

Oil Multiplier

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Multiplier

A quick post, this graph shows the oil multiplier, or how much each barrel of oil contributes to GDP as a multiple of the oil price. To create this graph, the real GDP was divided by yearly consumption to get the contribution of each barrel to GDP. The contribution to GDP was then divided by the real price of oil in 2014 USD to figure out how much each barrel contributes to GDP as a multiple of its price.

The chart shows how the US economy has shifted from industry to services, thus bringing down its oil intensity, while the wide variations reflect the volatility of the price of oil. The peak multiplier of 91.17 is a function of the oil price crash after the Asian financial crisis combined with a quickly growing US economy, especially given the low oil intensity 1990s tech boom.

The 1979 nadir multiple of 9.40 results from the oil price spike following the Iranian Revolution.

Data Sources: St. Louis Fed Real GDP and GDP deflator. Oil consumption statistics from BP Statistical Review 2015.

Oil and Gas Prices Since 2000

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A short post – normalized oil and gas prices where the year 2000 is the baseline. It shows the divergence between US and European gas prices in addition to oil price indexation for natural gas in most of continental Europe and Asia.

All statistics derived from BP’s Statistical Review.

Oil prices reflect Brent spot prices. US gas prices are Henry Hub, while the remaining prices reflect costs plus freight and insurance.