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International Monetary Fund
Published Date:
February 2011
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I. Developments in Global Gas Markets: Challenges for Algeria1

A. Introduction

1. Recent developments in global natural gas markets point to important structural changes. The United States (US), one of the world’s top producers and the largest producer of nonconventional gas, became self-sufficient in terms of natural gas needs in 2009 largely due to a sharp increase in nonconventional gas production. In the last two decades, unconventional US production has more than quadrupled, currently amounting to about half of US production.2 Moreover, the growing trade of liquefied natural gas (LNG), market liberalization in several countries, changes in the supply chain, and falling transportation costs, have eroded barriers between regionally segmented markets in the largest gas consuming markets (North America, Asia, and Europe).3 In select markets spot gas price indexation has appeared as an alternative to traditional pricing based on long-term and oil-price indexed contracts. Finally, new emerging markets have increased global supply and eroded the market share of traditional gas producers.

2. The 2009 recession has depressed European gas demand at levels of 2004, the steepest contraction since 1970. The slow recovery has left gas buyers in Italy and Spain, Algeria’s biggest export markets, significantly over-contracted in volume terms in 2010 (Schels (2010)). Moreover, the International Energy Agency (IEA) expects that the development of shale production on the European continent might further depress the demand for non-EU gas imports in the next years.4

3. The changes in global gas markets could have lasting consequences for Algeria. Around 49 percent of Algeria’s total exports are natural gas exports. The significant contraction of hydrocarbon prices in late 2008 and early 2009 showed Algeria’s macroeconomic vulnerability to a prolonged period of low hydrocarbon prices. In 2009, the fiscal balance registered the first deficit in a decade and the current account surplus dwindled to just 0.3 percent of GDP. A recovery encompassing higher oil prices but a modest recovery in gas prices and demand would still have a sizable impact on Algeria’s fiscal and external balances. Algeria’s recent efforts to coordinate prices between major gas exporters reflects increasing concerns on gas demand and pricing in its main export markets (MEES (2010)).

4. This paper assesses recent developments in gas markets and the implications for Algerian gas demand and prices. We document the changing relationship between oil and gas prices in the US over the past decade. We then examine the drivers of Algerian gas exports and prices before evaluating the country’s fiscal and external accounts in a medium-term scenario with lower gas demand and prices.

B. Global Environment

Increase in production and producers

5. Global gas output increased substantially in the past two decades (Figure 1). With the exception of 2009, production increased every year since 1990. Producers in emerging markets outside the former Soviet Union have driven the expansion of global gas production. These producers have doubled their share in global gas production from 19 percent in 1990 to 39 percent in 2009. European producers and non-EU OECD (mostly the US and Canada) have seen their share in total production decline.

Figure 1.Algeria: Global Gas Production

Source: British Petroleum Statistical Review of World Energy, June 2010.

6. During the last five years, the share of non-EU OECD producers has recovered. The main reason is the production of significant amounts of nonconventional gas in the US. This gas is mostly produced from shale deposits, and its production has increased more than four fold since 1990.

7. The production of shale gas started over 100 years ago but became economically profitable only in recent years. Higher natural gas prices and technological advances in drilling have led to increased investments in shale gas exploration. In turn, lower well risks pushed up production and profit margins. The economic success in North American shale gas production has stimulated the exploration of shale gas in Europe (Austria, Germany, Hungary, Poland, Sweden, and the U.K), China, Canada, and India.5

8. Algeria’s gas production is stable but its share in global gas production has been on a downward trend since the early 2000s (Figure 1). Nonetheless Algeria remains the world’s 8th largest producer and is a key supplier for European gas markets. Natural gas represents nearly 49 percent of total exports, oil exports cover another 49 percent and nonhydrocarbon exports amount to less than 2 percent. Hydrocarbon exports are the key source of fiscal revenues and foreign exchange. The importance of natural gas for its economy has made Algeria an active player in the Gas Exporters Countries Forum (GECF) which attempts to create an OPEC-like organization for the gas market.6

Gas versus oil prices in the US market

9. The behavior of US gas prices relative to oil prices reflects the latest developments in energy markets. Figure 2 presents the US$ evolution of the US Wellhead gas price reported by the Energy Information Administration (EIA) versus the Western Texas Intermediate oil price (WTI) in energy equivalent Million British Thermal Units (MMBTU).7 In general gas prices co-move strongly with oil prices. However, as oil prices recovered after the 2008 crisis, there has been a marked decoupling with gas prices. Oil prices doubled from $6.7 per MMBTU in February 2009 to $13.7 in August 2010. Wellhead gas prices, on the other hand, registered a more modest increase of 44 percent from $2.9 per MMBTU in September 2009 to $4.2 in August 2010.

Figure 2.Algeria: US Oil and Gas Prices Jan. 1990-Aug. 2010

(In US$ per MBTU)

Sources: Haver Analytics database and IMF staff estimates.

10. Additional supply of noncoventional gas, the weak economic recovery and high storage levels, are the main reasons behind the relative weakness of US gas prices. Pydrol and Baron (2003) also argue that direct fuel switching capabilities between natural gas and residential fuel have become relatively limited.

11. The expansion of nonconventional gas production has cut almost all the needs of LNG imports. It has also put downward pressure on gas prices in other regions (EIA (2009) and IEA (2010)) and leaves Asia and Europe as key destinations for the growing supply of LNG. In the case of Europe, pipeline suppliers such as Norway’s Statoil and Russia’s Gazprom have been forced to renegotiate contracts (Barysch (2010)).

Relationship in a state of flux

12. The impact of a change in the spot oil price (WTI) on gas prices can be statically examined with a Vector Auto-Regression (VAR).8 The variables included in the VAR are Zt = [ln(Wellheadt), ln(WTIt)]. For both oil and gas prices, we cannot reject the hypothesis that this period’s value equals last period’s value plus a random error. Each series could contain a so-called “unit root”. However, statistical tests indicate that a combination of the two series moves in tandem along a trend, i.e., they are co-integrated. The reduced-form VAR is then:

where c is a constant, Trend a time trend and Zt is the matrix with variables. The inverse of the Choleski factor of the variance-covariance matrix V can be used to identify structural shocks that are orthogonal to each other. Given the ordering of the variables in Zt this corresponds to the assumption that on impact an innovation in the spot oil price has a zero effect on gas prices.

13. To assess if there was a structural shift in the impact of oil prices on gas prices, we estimate the VAR for two sub-samples: (1) 1990m1-2004m12 and (2) 2005m1-2010m9.9 For the first period, the Impulse Response Function (IRF) in panel 3A shows a persistent and long-lived response of gas prices to an oil price shock. Panel 3B displays a less long-lived response in the later period.

Figure 3.Algeria: IRF of US Gas Prices after an Oil Price Shock

Source: IMF Staff Estimates.

14. Forecast error variance (FEV) decompositions suggest that oil price shocks are becoming a less important driver of gas prices. In the earlier sample period, the FEV of natural gas prices at lower frequencies is primarily driven by oil prices (Panel 4A). In recent years, own shocks have explained most of the FEV of gas prices (Panel 4B). The results are consistent with a weakening impact of spot oil prices on US natural gas prices.

Figure 4.Algeria: FEV Decompositions of US Gas Prices

Source: IMF Staff Estimates.

C. Algerian Gas Exports

Composition and destination

15. Compared to the US, Algeria’s gas prices have tracked spot oil prices more closely. Figure 5 shows that contracted export prices for Algerian gas and spot oil (Brent in US$ per MMBTU) co-move strongly, even in recent years.10 Contrary to the US gas market there is no apparent decoupling between gas and oil prices. This is in line with anecdotic evidence that most of Algeria’s gas is purchased under oil-indexed contracts.

Figure 5.Algeria oil and gas prices Jan. 1994-Aug. 2010

(in US$ per MBTU)

Sources: Haver Analytics database and IMF staff estimates.

16. The recent recovery in Algerian gas prices has not been matched by volumes. Figure 6 shows that annual production has remained more or less stable during the last decade but exports have been declining while domestic consumption has been growing. In turn, Figure 7 shows that neither type of gas exports (LNG or natural gas) has increased during the last decade and export volumes have decreased in the past years.

Figure 6.Algeria’s Natural Gas Production, 2001-09

(In billions of cm3)

Sources: Authorities; and IMF staff estimates.

Figure 7.Algeria’s Monthly Exports of Gas Jan. 2001-Aug. 2010

(In billions cm3)

Sources: Authorities; and IMF staff estimates.

17. While exports have declined in recent years, export markets have become more concentrated. The gazoducs linking Algeria with Spain and Italy have made these two countries the largest export destinations (Figure 8). The pipelines ensure very stable export destinations with long-term contracts indexed to oil prices and guaranteed minimum purchases. On the other hand LNG exports to the US and Belgium, which represented 10 percent of Algeria’s total gas exports in 2005, have stopped in the last years. In the case of the US, the lack of demand reflects higher nonconventional gas production.

Figure 8.Algeria’s Main Natural Gas Export Markets, 2001-09

(In percent)

Sources: IEA database and IMF staff estimates.

Cyclical links with gas buyers

18. Although long-term contracts and pipelines ensure stable export markets, Algerian gas export are highly dependent on the economic performance of its gas buyers. Figure 9 plots the 3-month moving average of Algeria’s natural gas exports and the buyers’ export-weighted average headline industrial production (IP). The crisis of 2008 and the collapse of industrial gas demand in Europe sharply reduced Algeria’s gas exports. Following an unusually cold winter in 2010, the modest industrial recovery, especially in Spain and Italy, has kept natural gas export at relatively low levels. Another indication is that natural gas buyers have recently been purchasing only the minimum volume required by long-term gas supply contracts.

Figure 9.Algeria’s Exports and Industrial Production of Main Gas Importers, Jan. 2001-Aug. 2010

(3-month moving average)

Sources: Authorities; and IMF staff estimates.

Drivers of Algeria’s gas demand and prices

19. The interrelations between Algeria’s natural gas exports, prices, spot oil prices, and economic activity in partner countries can be examined with a VAR. The monthly variables included in this multivariate VAR are (in natural logs over 2000m1-2010m8):

The variable QGast is Algeria’s monthly volume exports, PtGas/CPIUS is the real gas price (Algeria’s export price deflated by US CPI), Brentt/CPIUS the real oil price and IPt is export-weighted headline IP in Algeria’s gas buyers. As before, statistical tests fail to reject the hypothesis that these variables contain a unit root but indicate co-integration along a trend. The reduced-form VAR is:

where c is a constant, Trend a time trend and Zt is the matrix with variables. The inverse of the Choleski factor of the variance-covariance matrix V can be used to identify structural shocks that are orthogonal to each other.

20. The IRFs in Figure 10 show that there is a positive short-run effect of oil prices on gas exports, which subsequently turns negative at lower frequencies. This suggests that high oil-indexed contract prices can depress demand and is in line with recent industry analyses of the European gas markets (Schels (2010)). One of the reasons is that oil-indexed gas prices make gas-intensive manufacturing less competitive. In addition, renewable energy and nuclear output offer reliable alternatives for gas-fired power generation. Following the recession and the subsequent recovery in spot oil prices, utilization rates in gas-fired power generation have remained low. On the other hand, there is a general positive effect of a pickup in importers’ industrial production on Algerian gas exports (Panel 10B).

Figure 10.Algeria: IRF of Algerian Gas Exports after an Oil price and an IP Shock

Source: IMF staff estimates.

21. Turning to gas prices, we find that there is a positive effect of oil prices and IP in importing countries on natural gas prices (Figure 11). The response of contracted gas prices to spot oil is quantitatively similar to what we observed in the US.

Figure 11.Algeria: IRF Algerian Gas Prices after Oil Price and IP Shock

Source: IMF staff estimates.

22. The FEV analysis also indicates that the level of oil prices matters for gas export volumes though own shocks dominate (Figure 12). In the case of gas prices, Panel 12B shows that oil price shocks explain most of the FEV of gas prices at frequencies lower than six months.

Figure 12.Algeria: FEV Decompositions of Algeria’s Gas Exports and Prices

Source: IMF staff estimates.

23. The estimates give rise to a long-run relationship for gas exports. The following relationship between gas exports, gas prices, oil prices and industrial production in export markets (t-stats between parentheses):

In line with the IRF analysis, there is a positive link between export volumes and real gas prices whereas higher oil prices tend to depress gas demand in the long run and growth in industrial production tends to boost it. All coefficients are significantly different from zero.

Subsample analysis

24. We carry out two subsamples estimates for (1) 2000ml—2004ml2 and (2) 2005ml—20l0m8. The subsample analysis hints at a changing role for oil prices and IP as drivers for Algerian gas demand. Figure 13 shows that the negative effect of oil prices on gas exports at certain frequencies only arises in the second subsample. IP has a positive effect in both subsamples. The FEV decompositions in Figure 14 show that at lower frequencies oil price shocks explain most of the FEV of gas exports in the later period.

Figure 13.Algeria: Accumulated IRF of Algerian Gas Exports to Oil Price and IP Shocks

Source: IMF staff estimates.

Figure 14.Algeria: Subsample FEV Decomposition of Algeria’s Gas Exports

Source: IMF Staff Estimates.

25. The positive effects of oil price shocks on gas prices became less long-lived in Algeria (accumulated IRFs in Figure 15). However, the FEVs in Figure 16 show that, in contrast to the US, oil price shocks still dominate.

Figure 15.Algeria: Accumulated IRF of Algerian Gas Price to Oil Price and IP Shocks

Source: IMF staff estimates.

Figure 16.Algeria: Subsample FEV Decomposition of Gas Prices

Source: IMF staff estimates.

D. Scenario Analysis

26. The previous section examined the interrelationships between Algerian gas demand, gas prices, spot oil prices, and industrial production in gas buyers. The link between the price for Algerian gas and spot oil remains strong even after the global crisis of 2008 and the increase in production of nonconventional gas in North America. However, some of the evidence hints at a slower recovery in gas prices for Algeria. Efforts to turn the Gas Exporters Countries Forum (GECF) into an OPEC for natural gas, is another indication of this potential trend. Moreover, in the case of Algeria the threat of lower gas prices is coupled with declining export volumes and growing domestic demand, making the issue all the more pressing for Algerian authorities.

27. To assess the potential impact of a fall in natural gas exports and prices, we evaluate a medium-term macroeconomic scenario which assumes that gas prices would fall to US levels and export volumes would decline. This scenario could be overly pessimistic due to the current long-term structure of Algerian gas contracts and the hitherto absence of substantial nonconventional gas production in Europe. However, it offers a good illustration of what could happen if nonconventional gas production would take off in Europe and across the world in five to ten years.

28. Figure 17 presents the current scenario together with two alternative scenarios. The first alternative scenario assumes an average gas price kept real at current US levels (the 2010 nominal price increasing with inflation in advanced economies) and constant export volumes. The second alternative scenario makes the same price assumption but incorporates an annual fall in natural gas export volumes of 5 percent per year.11 The data show an important deterioration of the fiscal balance (-0.9 of GDP and -2.0 of GDP in alternative scenarios 1 and 2 versus 3.2 of GDP in the base scenario in 2015), the current account surplus (4.0 and 2.5 percent of GDP in alternative scenarios 1 and 2 versus 10.1 percent of GDP in the base scenario in 2015), the oil stabilization fund (Fonds de Regulation de Recettes, FRR) (14.5 percent and 11.4 percent of GDP in alternative scenarios 1 and 2 versus 30.1 percent of GDP in the base scenario in 2015) and international reserves (US$191 billion and US$182 billion in alternative scenarios 1 and 2 versus US$247 billion in the base scenario in 2015).

Figure 17.Algeria’s Economic Indicators Under the Baseline and the Alternative Scenarios

Source: IMF staff estimates.

Table 1.Current Assumptions and Alternative Scenarios for Algeria’s Gas Prices
Current assumptions2009201020112012201320142015
International oil price (US$/bbl)61.876.278.882.384.886.087.5
Gas price for Algeria’s exports (US$/MMBTU)
Algeria’s exports in volume (billion of cm3)53.753.853.853.853.853.853.8
Alternative scenario 1: fall in prices and volumes constant2009201020112012201320142015
International oil price (US$/bbl)61.876.278.882.384.886.087.5
Gas price for Algeria’s exports (US$/MMBTU)
Algeria’s exports in volume (billion of cm3)53.753.853.853.853.853.853.8
Alternative scenario 2: fall in prices and 5 percent fall in volumes2009201020112012201320142015
International oil price (US$/bbl)61.876.278.882.384.886.087.5
Gas price for Algeria’s exports (US$/MMBTU)
Algeria’s exports in volume (billion of cm3)53.753.851.148.546.143.841.6

E. Conclusion

29. This paper assesses recent developments in natural gas markets. Econometric analysis shows that the tight link between US gas and spot oil prices has weakened. This decoupling coincided with a significant increase in the production of nonconventional gas (especially shale gas) in the US. The additional supply has discontinued plans for sizable LNG imports into the US.

30. Conversely, the impact of spot oil prices on Algeria’s contracted gas price remains strong but export volumes are under pressure. Oil prices and industrial activity have a significant and important impact on Algerian natural gas prices. Although long-term contracts and pipelines to main markets ensure demand stability, recent developments in international gas markets and a slow recovery in partner countries has led to declining export volumes.

31. Even with a continued recovery of oil prices, Algerian gas priced at US levels and tepid demand would have a sizable effect on Algeria’s economy. A medium-term scenario analysis assumes an increase in nonconventional gas production on the European continent or a global glut in LNG supply. Under this constellation, natural gas prices are kept constant in real terms at current US prices and exports fall with 5 percent per year. Our current assumptions imply a significant negative impact on Algeria’s macroeconomic balances.

32. The development of alternative gas production in Europe is not imminent and would take five to ten years. However, this paper shows the dangers of relying on a limited basket of exports and the importance of boosting the diversification of the Algerian economy.


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1Prepared by Reinout De Bock (MCM) and José Gijon (MCD).
4International Energy Agency, “Presentation to the CSIS Medium term oil and gas markets 2010”\speech\2010\Cronshaw_MTOGM_CSIS.pdf
5Chapter 11 of IEA (2009) provides further information on nonconventional gas production.
7The EIA’s wellhead price is the sales price obtainable from a third party in an arm’s length transaction. It pertains to all transactions occurring in the United States and covers purchase commitments of all durations.
8Villar and Joutz (2006) and Brown and Yucel (2008) find a quantitative effect of changes in crude oil on natural gas prices. Both studies do not reproduce Impulse Response Functions or examine the effect of sample breaks.
9The analyses for 1990–2004 and 2000–04 show similar impulse response functions and forecast error variance decompositions.
10Brent prices and the Algerian export oil price behave very similarly.
11A 5 percent fall corresponds to a scenario where a boom of nonconventional gas production in Europe or a glut in global LNG supply entails a gradual fall of Algerian gas exports. We do not expect this to occur in the next five years but we wish to examine the macroeconomic impact using the current medium term macroeconomic assumptions. That said, despite increasing capacity Algeria’s average gas exports have been declining in the past years (by 6 percent with respect to 2000 levels).

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