The Economics of Natural Gas Infrastructure Investments Theory and Model-based Analysis for Europe Inauguraldissertation zur Erlangung des Doktorgrades der Wirtschafts- und Sozialwissenschaftlichen Fakultät der Universität zu Köln 2011 vorgelegt von Dipl.-Volksw. Stefan Lochner aus Riesa . Referent: Prof. Dr. Marc-Oliver Bettzüge Korreferent: Prof. Dr. Christian von Hirschhausen Tag der Promotion: 16.12.2011 Contents List of Figures iii List of Tablesv Abbreviations vii Summary1 1 Introduction5 1.1 Motivation................................5 1.2 Structure.................................6 1.3 Contributions and acknowledgments..................6 2 Background and Theoretical Considerations9 2.1 Literature survey.............................9 2.2 Analytical analysis: Infrastructure valuation and efficient investments. 14 2.2.1 The value of transmission and storage services........ 17 2.2.2 Optimal investment level..................... 21 2.3 Selected studies on European infrastructure investments....... 26 2.4 Institutional framework for European natural gas infrastructure invest- ments................................... 27 3 European Gas Infrastructure Dispatch and Investment Model 31 3.1 Overview................................. 31 3.2 Mathematical model formulation..................... 34 3.2.1 Objective function........................ 34 3.2.2 Optimization constraints..................... 35 3.3 Model implementation.......................... 40 3.4 Modeling of gas supply......................... 41 3.5 Stochastic demand modeling...................... 43 3.5.1 Temperature modeling...................... 45 3.5.2 Estimating temperature-demand curves............. 47 3.5.3 Household demand frequency distributions........... 51 3.5.4 Household demand scenarios.................. 54 3.5.5 Industry and power generation natural gas demand...... 56 3.5.6 Demand and demand regions.................. 57 3.6 Model validation............................. 58 i Contents 4 Numerical Assumptions of the Model Simulations 63 4.1 Natural gas supply assumptions..................... 63 4.1.1 Pipeline gas imports....................... 63 4.1.2 LNG imports........................... 67 4.1.3 European gas production.................... 68 4.1.4 Supply flexibility......................... 71 4.1.5 Supply costs and value of lost load............... 72 4.2 European natural gas gemand assumptions.............. 74 4.3 Excursus: Effect of temperature-related stochasticity.......... 77 4.4 Infrastructure endowments and expansion options........... 80 4.4.1 Long-distance transmission network............... 81 4.4.2 Storage.............................. 84 4.4.3 LNG import terminals...................... 85 4.5 Infrastructure cost parameterization................... 87 4.5.1 Capital cost of pipelines..................... 87 4.5.2 Capital cost of natural gas storage............... 89 4.5.3 Capital cost of LNG import terminals.............. 92 4.5.4 Model discount rate....................... 93 4.5.5 Operating costs......................... 94 4.6 Scenarios................................ 96 5 Results 101 5.1 Congestion, efficient investments and natural gas flows........ 102 5.1.1 Identification and valuation of congestions........... 102 5.1.2 Efficient investments in European natural gas infrastructure.. 105 5.1.3 Natural gas flows, marginal supply costs and import mix.... 109 5.2 The value of the modeling approach and infrastructure cost sensitivity 115 5.2.1 Stochastic versus deterministic modeling............ 115 5.2.2 Mixed-integer versus linear programing............. 118 5.2.3 Sensitivity on infrastructure investment costs.......... 118 5.3 Scenario analysis............................ 121 5.3.1 Scenario simulations on LNG price and flexibility........ 121 5.3.2 Scenario simulation on additional Southern corridor supplies. 123 5.3.3 Scenario simulation on unconventional gas production in Europe 125 5.3.4 Summary on natural gas market scenarios........... 127 5.4 Investments to increase security of gas supply............. 130 5.4.1 Resilience against transit disruptions in Eastern Europe.... 131 5.4.2 Resilience against supply disruptions from North Africa.... 139 5.4.3 Summary on security of supply investments.......... 143 6 Conclusion 147 Bibliography 149 Appendix 157 ii List of Figures 2.1 Three node grid with storage...................... 15 2.2 Marginal investment optimality condition................ 24 2.3 Discrete investments between two markets............... 25 3.1 Modeled infrastructure elements in Europe............... 32 3.2 Storage injection and withdrawal rates as function of storage level... 39 3.3 Production flexibility factor........................ 42 3.4 Paris average daily temperature and modeled temperature example.. 47 3.5 Set of modeled temperatures for France................ 48 3.6 Temperature-demand curve for France................. 49 3.7 General form of the sigmoid curve................... 50 3.8 Set of modeled demand curves for France............... 52 3.9 Demand density function for winter average and winter day (France). 53 3.10 Five stochastic demand scenarios for France.............. 55 3.11 Derived typical winter days for simulations (France).......... 56 3.12 Validation: Deviation of simulated and actual gas flows in 2008.... 60 4.1 Assumptions on pipeline imports available to the European market.. 64 4.2 Assumptions on indigenous European natural gas production..... 68 4.3 Different projections on European gas demand............. 75 4.4 Winter 2020 demand depending on temperatures........... 78 4.5 Modeled pipeline and LNG infrastructure................ 80 4.6 Pipeline and LNG infrastructure - high resolution............ 81 4.7 Location of storage and storage projects................ 84 4.8 Existing LNG import capacities..................... 87 4.9 Regression on pipeline investment costs................ 88 5.1 Gas infrastructure investments in the Reference demand case.... 106 5.2 Gas infrastructure investments in the High demand case........ 109 5.3 European import mix in Base scenario................. 110 5.4 Gas flows in the European gas market 2025 Reference demand vs. 2010................................... 111 5.5 Gas Flows in the Reference demand case............... 112 5.6 Gas Flows in the High demand case.................. 112 5.7 Locational marginal price ranges by country and year (Reference de- mand case)............................... 113 iii List of Figures 5.8 Amount of investment with different model approach (deterministic, continuous)................................ 118 5.9 Gas infrastructure investments in the High demand case in LP model. 119 5.10 Impact of investment cost increases on infrastructure capacity additions 120 5.11 Gas infrastructure investments with additional Southern corridor sup- plies (High demand)........................... 124 5.12 Pipeline investment costs per region.................. 125 5.13 Gas infrastructure investments with European unconventional gas pro- duction (Reference demand)...................... 126 5.14 Investment costs by infrastructure category and scenario....... 127 5.15 Security of supply enhancing investments regarding SoS1 disruption with 5 % probability........................... 132 5.16 Additional SoS1 infrastructure investments expenditures........ 133 5.17 Total system costs from uncertainty regarding supply disruption.... 134 5.18 Additional gas storage per country depending on emergency probability 138 5.19 Security of supply enhancing investments regarding SoS2 disruption with 5 % probability........................... 140 5.20 Additional SoS2 infrastructure investments expenditures........ 141 5.21 Security of supply enhancing investments regarding certain SoS2 dis- ruption (100 % probability)........................ 142 iv List of Tables 3.1 Model variables and element sets.................... 35 3.2 Model parameters............................ 36 3.3 Production regions in model....................... 43 3.4 Estimated parameters of the sigmoid function of selected countries.. 50 3.5 Relative sigmoid parameters Central and Eastern Europe....... 51 3.6 Number of demand regions by country................. 57 3.7 Model validation: Actual vs. simulated cross border gas flows for 2008 59 4.1 EU gas production............................ 69 4.2 Development of production flexibilities................. 72 4.3 Assumption on gas supply costs and reference supply capabilities.. 73 4.4 Reference demand case assumptions for selected countries in bcm per year.................................... 76 4.5 High demand case assumptions for selected countries in bcm per year 77 4.6 Demand variations between stochastic scenarios, winter 2020.... 79 4.7 Transmission system operators covered in model........... 82 4.8 Natural gas storage - aggregated existing capacities and proposed ad- ditions.................................. 86 4.9 Storage unit investment costs...................... 89 4.10 Selected storage project investment costs............... 91 4.11 LNG import project investment cost................... 93 4.12 Scenarios and variations simulated in Chapter 5............ 99 5.1 Congestion costs in simulation without investment........... 103 5.2 Infrastructure investment costs until 2025................ 107 5.3 Base scenario infrastructure investment by country.......... 108 5.4 LMP mean and standard deviation in 2025............... 114 5.5 Storage levels in deterministic and stochastic models in 2015..... 116 5.6 Storage WGV additions 2015 to 2025 in the High demand case...