Southern African Natural Gas Advisory Service Service

The natural gas value chain

The concept of value chains is applied widely today in many industries. It is important for companies to understand the contribution that each step in a production and supply process makes to the final value of the product in the market place. Natural gas value chain analysis and optimisation is a complex mathematical activity that aims for greater efficiency in the use of assets, the achievement of desired rates of financial return on investments, fair and reasonable margins at each step in the chain, profitability and the financial sustainability of the gas industry.

In the natural gas supply industry there are a number of value chains involved depending on the manner in which the gas is produced, stored, transported and marketed that draw on the same fundamental value chain analytical concepts. In simple terms the natural gas value chain consists of the following steps:

             EXPLORATION               PRODUCTION               PROCESSING             TRANSPORTATION               MARKETING

A natural gas value chain involves linking specific functions from input through to delivery, enhancing the economic value of the final product. Other related concepts include  supply chains  and  business systems .  Within each of the major natural gas supply chain steps described above there are relevant value chains or  sub-sets . The production, transportation and marketing of LNG are one such gas value chain as are those involving pipeline networks and CNG.

When considering major gas value chains in which gas is produced from various reservoirs, subjected to various production processes, produced as LNG, pipeline gas and CNG, stored, transported in various ways and marketed to a range of end users in different locations, complex computer assisted mathematical programs have to be deployed.  Three of the major reasons for applying these analytical methods is firstly to ascertain the  value added  at each stage in the overall complex value chain; secondly to optimise the whole chain to enhance the final value of the product in the market place; and, thirdly to ensure that the cost of each stage is properly recovered together with an appropriate financial margin.  The challenge in the natural gas industry is to build value chains from various dynamic market demands that require fixed supply infrastructure for physical delivery but with liquidity for price risk management.

Each step in the supply chain deploys assets and these have to be paid for so value chain analysis is also used to ensure that capital is prudently deployed and that investors and owners of the various components of these  complex gas supply chains are properly compensated. All these costs (and risks) must be reflected in the final  value  or cost of the product to the end user or buyer. The international natural gas supply industry generally operates on the basis of reflective costs, in other words the cost of the natural gas plus the associated cost of producing, processing, transporting and delivering it to consumers are all reflected in the final price charged to the customer.

In addition to the cost of the actual natural gas, the associated costs depend greatly on the distance from gas fields, method of supply, transportation, volume of gas and contractual terms governing the supply  arrangements.

Users of natural gas produced from nearby production wells will pay less than those remote from the gas fields because they do not have to contribute to the transportation of the gas across oceans or through continental pipelines. Very large users of  natural gas who can be supplied directly from bulk transmission pipelines will also be charged significantly lower prices than smaller customers who take their gas from a local distribution network. Large customers who require a guaranteed permanent supply of gas will pay more than customers who are able to have their supply interrupted by prior arrangement. The smaller customers must also make a contribution to the cost of constructing and maintaining the local gas distribution pipeline network and these costs will be reflected in the price they pay for  their natural gas service. It is for this reason that smaller users of natural gas may be paying up to 300% more for their gas than a very large bulk user or wholesale customer. In identifying, managing and optimising these many inter relationships in the various supply steps, natural gas value chains play a crucial role in ensuring fair and reflective pricing.

There is one further reason why value chains  play such an important role in the international natural gas supply industry. In most cases several different bodies, some private others public, are involved in various stages in the natural gas supply and usage chain. These various players are often located in various places around the world, they also provide different activities such as extraction or processing or transportation or even generation of electricity using natural gas. In some cases they are vertically integrated meaning that several steps in the process are under the control of a single entity. In other cases they are not integrated in this way and many different companies and investors are involved throughout the whole supply chain. So in many instances consortia are involved with many different players involved in bringing natural gas to the end user. Each company  and investor in such a complex supply chain must be able to obtain an equitable return on their investment and expertise.

Risk has to be managed and a fair rent must be extracted for all the supply activities from within the final price paid by consumers to cover these costs and liabilities. Natural gas value chain analysis therefore provides a basis to negotiate large complex natural gas supply developments and to agree mutually acceptable commercial terms for all the investors and players who may be involved.