FINAL REPORT Public Version Coordinated Marketing of Pohokura Gas - An Economic Analysis Submitted to Shell (Petroleum Mining) Limited Preussag Energie GmbH Todd (Petroleum Mining Company) Limited Prepared by: Charles River Associates (Asia Pacific) Ltd Level 11, Mobil on the Park, 157 Lambton Quay PO Box 1123, Wellington, New Zealand Tel: + 64 4 473 5080 Fax: + 64 4 473 5090 20 December 2002 Coordinated Marketing of Pohokura Gas - An Economic Analysis Charles River 20 December 2002 Associates AUTHORS The primary authors of this report were: • Professor Lewis Evans, Senior Consultant; • James Mellsop, Principal; and • Matthew Burgess, Consulting Associate. Other staff involved were: • Patrick Hughes, Principal (Toronto); • Patrick DeGraba, Senior Consultant (Washington, DC); • Robert Levinson, Principal (Washington, DC); and • Sharyn Jones, Consultant (Wellington). Final Report - Public Version Page i Coordinated Marketing of Pohokura Gas - An Economic Analysis Charles River 20 December 2002 Associates TABLE OF CONTENTS 1. INTRODUCTION, DEFINITIONS AND SUMMARY..........................................1 1.1. INTRODUCTION AND OVERVIEW OF CONCLUSIONS ................................................1 1.2. DEFINITIONS: SEPARATE AND JOINT MARKETING..................................................3 1.3. SUMMARY OF REPORT ...............................................................................................6 2. KEY CHARACTERISTICS OF THE OIL AND GAS INDUSTRY...................10 2.1. INTRODUCTION.........................................................................................................10 2.2. UNCERTAINTY AND RISK .........................................................................................10 2.2.1. Sources of Risk..........................................................................................................10 2.2.2. Mitigation of Risk......................................................................................................13 2.3. COMMON POOL RESOURCE.....................................................................................15 2.4. LACK OF A SPOT MARKET IN NEW ZEALAND ........................................................17 3. GAS SUPPLY AND DEMAND IN NEW ZEALAND ..........................................18 3.1. GAS SUPPLY ..............................................................................................................18 3.2. GAS DEMAND............................................................................................................18 3.3. IMPLICATIONS FOR POHOKURA..............................................................................20 4. MARKET DEFINITION .........................................................................................21 5. GAS MARKETING..................................................................................................23 5.1. INTRODUCTION AND SUMMARY ..............................................................................23 5.2. IMMATURITY OF THE NEW ZEALAND MARKET.....................................................24 5.3. COSTS AND BENEFITS OF SCENARIO 2 ....................................................................31 5.3.1. Intra-Joint Venture Competition and Production Externalities..................................31 5.3.2. Increased Transaction and Production Costs .............................................................34 5.3.3. Implications for Buyers of Gas..................................................................................39 5.3.4. Implications for Gas Market Competition .................................................................39 5.3.5. Statutory Constraints .................................................................................................39 5.3.6. Summary of Costs and Benefits of Scenario 2 ..........................................................40 5.4. COSTS AND BENEFITS OF SCENARIO 1 ....................................................................40 5.4.1. Lack of Demand Side Information, Flexibility Constraints and Reduced Incentives to Explore .................................................................................................................................40 5.4.2. No Competition on Pricing........................................................................................43 Final Report - Public Version Page ii Coordinated Marketing of Pohokura Gas - An Economic Analysis Charles River 20 December 2002 Associates 5.4.3. Balancing Arrangement .............................................................................................43 5.4.4. Statutory Constraints .................................................................................................43 5.4.5. Summary of Costs and Benefits of Scenario 1 ..........................................................43 5.5. COSTS AND BENEFITS OF JOINT MARKETING........................................................44 5.5.1. Timely Development and Production ........................................................................44 5.5.2. Promotion of Competition .........................................................................................44 5.5.3. Constraints on Market Power ....................................................................................44 5.5.4. Demand-Side Information .........................................................................................46 5.5.5. Summary of Costs and Benefits of Joint Marketing ..................................................46 6. COUNTERFACTUALS...........................................................................................48 7. IS THERE A SUBSTANTIAL LESSENING OF COMPETITION?..................50 7.1. INTRODUCTION.........................................................................................................50 7.2. AGAINST COUNTERFACTUAL 1................................................................................50 7.3. AGAINST COUNTERFACTUAL 2................................................................................50 7.4. AGAINST COUNTERFACTUAL 3................................................................................51 8. COUNTERVAILING BENEFITS..........................................................................52 8.1. INTRODUCTION.........................................................................................................52 8.2. PUBLIC BENEFITS .....................................................................................................52 8.2.1. Timely Development of Pohokura.............................................................................52 8.2.2. Other Public Benefits.................................................................................................68 8.3. CONCLUSION.............................................................................................................69 APPENDIX A : ECONOMIC LITERATURE SURVEY............................................71 A.1 INTRODUCTION.........................................................................................................71 A.2 RISK...........................................................................................................................72 A.2.1 Introduction ...............................................................................................................72 A.2.2 Ex Post Evaluation Bias.............................................................................................72 A.2.3 Risk Aversion ............................................................................................................73 A.2.4 Mitigating Risk ..........................................................................................................75 A.2.5 Conclusion.................................................................................................................76 A.3 ACQUIRING PROPERTY RIGHTS ..............................................................................76 A.3.1 Introduction ...............................................................................................................76 8.3.1. Sophistication and Heterogeneity of Firms................................................................77 8.3.2. Risk and Risk Sharing ...............................................................................................78 Final Report - Public Version Page iii Coordinated Marketing of Pohokura Gas - An Economic Analysis Charles River 20 December 2002 Associates A.3.2 Bidding Joint Ventures Enhance Competition...........................................................79 A.3.3 Conclusion.................................................................................................................79 A.4 RESOURCE ECONOMICS...........................................................................................79 A.4.1 Introduction ...............................................................................................................79 A.4.2 Differential Rents.......................................................................................................80 A.4.3 Optimal Depletion Rates: The Price-Time Profile.....................................................80 A.5 PRODUCTION EXTERNALITIES: COMMON POOL PROBLEMS ...............................82 A.5.1 Introduction ...............................................................................................................82 A.5.2 The Incentive Effect of Common Pool Problems: A Prisoner’s Dilemma ................83