K u rzfassu n g sb an d - Graz University of Technology

Energieinnovation 2006 63
3.2.3 „Economics of the LNG Value Chain and Corporate Strategies
– Determinants of Vertical Integration“
Sophia Rüster, Anne Neumann (Dresden University of Technology/Chair
of Energy Economics) 1
World primary energy demand is expected to rise by 52% until the end of 2030 under the current
situation with natural gas accounting for 30% of the increase (IEA, 2005). European natural gas import
dependency will strongly depend on Middle East and North African countries. Transporting liquefied
natural gas (LNG) from (remote) producing to consuming regions in Europe, North America and Asia
is a viable option to diversify the portfolio of energy sources as well as suppliers and thus increase the
security of supply. Therefore, bulky investments in asset specific infrastructure remain a crucial issue.
During the last five years 46 billion cubic meters (bcm) regasification capacity started operation
worldwide (11.3% of today’s capacity), until 2010 another 140 bcm will come on stream (35% of
today’s capacity). The ongoing process of liberalization in Continental Europe requires fundamental
changes in organizational behavior of market participants. Increasing competition within Europe as
well as with other consuming regions for the homogeneous product natural gas puts traditional players
in the business under pressure. Global oil producing companies heavily engage in the production,
liquefaction, transport, and regasification of LNG. Former European monopolists of natural gas are
facing their traditional markets at stake by the intrusion of oil companies. Additionally, functioning
short-term trade with an increasing traded volume at a number of places enhances truly competitive
market patterns. The largest part of the LNG value chain margin migrates downstream. Several case
studies (e.g. Iniss, 2004) focusing on the Atlantic Basin indicate that the coexistence of long- and
short-term trading activities is increasingly accompanied by vertical integration in the LNG industry.
In earlier work, Neumann and Hirschhausen (2004) have shown that liberalization leads to shorter
contract duration and more short term trading. Dailami and Hauswald (2005) show that the financing
structure for LNG liquefaction projects is closely related to the downstream contract structure. We
place ourselves in the continuation of this literature by analyzing the determinants of vertical
integration in the LNG industry from the perspective of transaction cost economics (see Coase, 1937;
Williamson, 1975; Klein, Crawford, Alchian, 1978). Transaction characteristics (asset specificity,
uncertainty, complexity and frequency) are exogenously defined. Our hypothesis is that increasing
transaction costs along the chain lead to a higher degree of vertical integration. We derive proxy
variables - the independent variables - by using explicit project data on several LNG projects – both
importing and exporting – in the Atlantic Basin. The data set has been collected from various sources
and includes detailed information on investment costs, capacities, ownership structure, etc. for more
than 35 projects. Vertical integration - the dependent variable - is defined in the form of a continuous
measure as the share of value added in stages over which market participants have control, and total
value added (see Barrera-Rey, 1995; Burattoni, et al. 2005). We test the hypotheses of higher
transaction costs having a positive impact on the degree of vertical integration using standard Tobit
regressions.
Our preliminary findings suggest that vertical integration in exporting projects exceeds vertical
integration in importing projects. This is due to higher investment costs and resulting higher asset
specificity on the one hand, and the larger degree of uncertainty in exporting countries (in a lot of
cases developing countries) on the other hand. We expect that exporting players control the midstream
stage transportation in more cases than importing players. This leaves the following points for
discussion: Is vertical integration necessary to secure LNG infrastructure investments in liberalized
European markets What should be the strategy of European natural gas and electricity companies
Keywords: liquefied natural gas, vertical integration, LNG value chain, corporate strategies,
liberalization
1 Dresden University of Technology, Department of Business Management and Economics,
Chair of Energy Economics; D – 01069 Dresden, Germany;
Tel: +49-(0)351-463-39771, Fax: +49-(0)351-463-39763;
e-mail: sophia.ruester@mailbox.tu-dresden.de, Url: www.ee2.biz;