Simulating Norwegian troll gas prospects in a competitive spatial model

Abstract

The 1986 Troll gas agreement between Statoil and a European consortium of gas buyers is the largest ever signed in Europe. Uncertainty surrounds this most expensive North Sea gas to date with its long lead time and dependence on an unstable oil market. Uncertain contract profitability is a key concern extending to both sides of the market. Importing and exporting governments as well as those more directly involved have a keen interest in deriving the bounds such profits might have. We provide quantitative evidence on profitability for these decision makers by simulating this infusion of gas into the European gas market using a spatial model that includes both gas and oil explicitly. The model simultaneously solves for equilibrium gas prices at demand and supply regions, given transportation costs as well as supply and demand assumptions in the oil and gas markets. The model generates gas prices under alternative assumptions about oil prices; own and cross price elasticities for gas and oil; income growth and elasticities; as well as the behavior of Norway's major competitors. Combining these prices with cost information, we compute a range of rates of return for the project that vary from 7.4% to 24.8%. We find these rates of return to be highly dependent on oil prices, income growth, income elasticities, and alternative supplies of gas, but much less dependent on own and cross price elasticities for gas. Using a probability distribution derived from oil price forecasts, we find expected real rates of return to be 15.9% to 21.9%. We conclude that under our model assumptions, if contract prices are adjusted to market forces, the Troll contract appears to be quite promising.