Measuring and valuing Guyana’s potential for gas security of supply

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Bobby Gossai, Jr.
Bobby Gossai, Jr. is currently pursuing the Degree of Doctor of Philosophy in Economics at the University of Aberdeen with a research focus on Fiscal Policies and Regulations for an Emerging Petroleum Producing Country. He completed his MSc (Econ) in Petroleum, Energy Economics and Finance from the same institution, and also holds an MSC in Economics from the University of the West Indies. Mr. Gossai, Jr.’s professional experiences include being the head of the Guyana Oil and Gas Association and senior policy analyst and advisor at the Ministry of Natural Resources and Environment.

Energy is a vital part of every aspect of modern life in Guyana and for our continued economic prosperity. There is at present no universally accepted definition of security of supply and how this should be measured. Factors such as the reliability of production, transportation, import and storage capacity and the flexibility and responsiveness of the gas market to price signals each drive security of supply. None of these in isolation, however, serves on its own as a measure of whether or not gas supply will be able to meet demand.

It is clear, however, that no system can provide 100% certainty that there will always be enough supply to meet demand under any conceivable circumstance. Also, the costs of increasing security, when security is already at a very high level, may be greater than the benefits. There is a balance to be struck, requiring judgments on various factors: potential hazards, related costs and probabilities, and the costs of the possible means of mitigating or avoiding them (e.g. additional storage capacity).

Measuring Security of Supply

Most measures of security of supply are based on one or a combination of three of the drivers discussed above: capacity, reliability and diversity. Given the different forms ‘spare’ capacity can take, assessing security of supply simply through comparisons of our existing gas storage capacity with that in other countries can be misleading. The flexibility and diversity of gas supplies can also limit the need for large gas storage facilities. Higher levels of storage capacity in other countries reflect in part their greater dependence on imported gas originating from a narrower range of sources and related exposure to geopolitical risk. The fact that there is less storage capacity may not mean that there is less security of supply than these countries, as the diversity of the import sources helps limit these risks.

An alternative might be to look at the level of interruptions in the local electricity market (i.e. whether the system was robust or not). It will help to determine the level of security of supply going forward, as demand and supply change.

A better measure of security of supply might be the gas margin (the difference between the maximum gas supply capacity and the maximum gas demand, say on a particularly warm day or throughout a heatwave period). However, this does not tell us the extent to which maximum demand is likely to coincide with maximum supply, or whether, for example, we might expect some capacity to be unavailable when demand is at its maximum. In other words, while a useful indicator, the gas margin does not measure the likelihood of a gas supply interruption.

An alternative measure that can account for more drivers of security of supply, such as reliability and diversity of capacity, is ‘expected energy unserved’, defined as the expected gap between demand and supply. On most days this gap will be zero (because supply is expected to exceed demand), whereas on a small number of days demand might exceed supply (for example, if it is very hot, or if a storage facility is out); expected energy unserved averages across these different types of days.

Estimating energy unserved requires judgments to be made on a range of uncertain factors that underpin demand and supply (for example, the weather, capacity, availability and reliability of facilities, etc.). Making these judgments can be difficult, particularly when assessing expected energy unserved 5 or 10 years into the future. To account for these uncertainties, it is possible to consider different future scenarios and look at a range of estimates of ‘expected energy unserved’. Using this quantitative approach, allows for the comparison of different conditions that the market might be in over time or for the comparison of different policies.

Valuing the Economic Impact of Security of Supply

Being able to quantify the value of security of supply is important in assessing the costs and benefits of policies to support this. The inputs into valuing security of supply are estimated levels of expected energy unserved and the value of a unit of energy unserved. The cost of energy unserved (i.e., the negative consequences to society of facing gas shortages) is calculated multiplying:

  • Expected energy unserved by
  • Value of lost load ($)

The concept of ‘value of lost load’ is widely used in energy (especially electricity) economics and refers to the economic value lost if a certain amount of energy is not delivered to a consumer. In other words, it relates to consumers’ willingness to pay to avoid interruptions in energy supplies.

It is not straightforward to calculate as the costs of energy interruptions depend on a number of factors, such as time of day/week/year, whether the interruption is known about in advance, what the duration of it is, which customer groups are impacted, and how frequent interruptions are in general. This, inevitably, leads to controversy as to the best way to estimate value of lost load, and a wide range of estimates have been proposed by various academics, consultants and market participants. However, these estimates tend to be within the same order of magnitude.

Given the number of factors that affect the ‘value of lost load’ calculation, in specific circumstances, it may not be appropriate to use the average figures, but rather to use estimates of the direct and indirect economic loss resulting from companies in specific sectors ceasing production due to interruptions to their gas supplies.

Such an approach, has for example, will give an estimate for the average cost of ‘unserved gas’ to energy-intensive industrial users. However, it should be noted that even within this estimate, different sectors and sub-sectors within sectors face very different costs, depending on their circumstances (e.g., type of process they use gas in). Hence, in practice, it is possible to use a range of estimates and still come up with meaningful valuations of security of supply (or lack of it).

Measuring the Costs and Benefits of Policies

The methodology for measuring and valuing security of supply described above can be used to carry out cost-benefit analysis of possible investments and policies to support investments. Take for example the case of a policy that will increase import capacity. Clearly additional capacity is good for security of supply, and this would be reflected in reduced expected energy unserved, all other things being equal. There would be the risk, however, that the capacity might be unavailable, and this would need to be reflected in expected energy unserved. Multiplying the reduction in expected energy unserved with an estimate of value of lost load would provide an estimate of the economic benefits of the investment. This composite measure could be compared against the cost of providing new capacity. If the former were to exceed the latter, subject to unintended consequences, then the policy might be a good thing from an economic point of view.

The Price Mechanism

In Guyana, we must establish a regulatory and commercial framework that provides incentives for market participants to ensure adequate security of supply in the most efficient and effective way. The framework will have to rely on the price mechanism to balance demand and supply and to provide signals to market participants, as it regards consumption and investment decisions and contracting strategy of shippers. For example:

  • A price spike in the short term may help bring the system into balance. This would signal to all participants in the market that the system is short of energy, and would incentivise a response from consumers (e.g. participants in the balancing market who would rather not consume than pay the high price) or from suppliers (who might import more or use gas from storage).
  • In the long term, persistently high prices or high price volatility signal the need for greater capacity or market flexibility. In these circumstances, market participants who invest in improving the diversity of their supply sources or improved demand or supply side responsiveness stand to gain a competitive advantage. Different types of assets and technologies such as Liquefied Natural Gas (LNG), storage or pipeline imports of gas have different characteristics, and depending on the circumstances determining price peaks different solutions may be appropriate.
Cash-out Arrangements

In addition to the signals provided by market prices, if suppliers/ shippers do not have sufficient gas to deliver on their contracts they must pay an imbalance charge or cash-out price, which reflects the marginal cost of buying gas on the system that day, exposing themselves to potentially very high costs. This is intended to provide shippers with an incentive to acquire a portfolio of contracts and assets which will enable them to provide a sufficient, flexible, competitively priced source of gas when needed, even when demand is high, for example due to extreme hot weather.

Supplier Obligations

Do not rely solely on prices to provide incentives for investment in gas infrastructure. One additional mechanism is a supplier obligation. The government should implement the relevant legislation in this context through the various licence conditions. These licence conditions should require gas suppliers to ensure availability of supplies to domestic customers even in the event of severe conditions.

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