The economics of natural gas storage

Within the context of an evolving global market for natural gas and restructuring efforts in the European market, natural gas storage is an important element. Providing additional flexibility, promoting competition, and enhancing supply security are crucial elements for natural gas sector liberalization. The objective of this research project has been to provide an in-depth investigation of storage activities and their regulation by taking into account both economic and technical aspects. Four topics have been analyzed (i.e. commercial storage, storage and market power, optimal regulation of access to storage with capacity constraints, and storage for security of supply) and models have been carried out to provide either theoretical and/or empirical support to our assessments. First we have analyzed the role of storage for economies facing the risk of a gas supply disruption. We have characterized the optimal/competitive transitory dynamics (accumulation, drainage and target stock). We have partially relaxed the irreversibility hypothesis, by extending the model in two directions: first, we have considered a long but finite duration of the crisis, and second, we have studied the impact of "alerts". The policy analysis has shown that the lack of protection of property rights, e.g. antispeculation measures, is likely to discourage storage completely. Responsible policy involves a series of measures taken ex ante that limit market failure. We have provided a method to calculate the social value of a policy. Finally, the model has been extended to encompass specific characteristics of the gas industry (injection and release costs, limited storage capacity). Second we have studied how competition on downstream gas markets is influenced by sourcing decisions in the supply chain. We have analyzed the sequential relationships between storage decisions and intermediate pricing in spot markets. We have shown that an upstream leadership in the access to storage facilities leads a dominant firm to adopt strategic storage decision. This strategy consists in stockpiling more than supplied in the downstream market. This behavior is a part of a raising rivals cost strategy for the leader. Furthermore in some cases, optimal regulation of gas storage access may not prevent such a behavior. Third we have claimed that regulated access should be introduced until storage plants are essential facilities and competition is not feasible. However storage is not a natural monopoly and storage services may be partially substituted by alternative flexibility inputs. Moreover, access to storage is at present expected by capacity constraints. We have firstly analyzed the effects of storage rationing on the productive efficiency of gas suppliers and characterize an efficient allocation rule for storage. As the latter may be hard to implement, because of suppliers adverse incentives due to asymmetric information, we have considered storage allocation through market and non-market (administrative) mechanisms. In particular, we have compared an administrative and an auction mechanism in a two stage model where firms firstly obtain access to storage capacity and then compete in the gas market. Due to the strategic behavior of the dominant gas supplier, even a market mechanism could be characterized by capacity hoarding. However, this mechanism welfare dominates the administrative distribution of storage capacity, unless the latter assigns more capacity to the competitive follower. Fourth we have focused on the assessment of the optimal precautionary gas stocks that should be accumulated, knowing the potential minimum and maximum prices, the carrying costs and the probability of crisis. Most importantly, since the understanding of potential market failures or imperfections is of crucial importance in the perspective of the European Directive aimed at improving the security of gas supply, we have analyzed the effects of public interventions. We have suggested coordination rules to efficiently use storage together with other flexibility instruments that prove useful in managing gas crises: interruptible contracts, line packing (that is, using transport capacities to ensure some additional gas supply), LNG as an alternative to storage in salt caverns or other specific facilities.