ArrowHead Models – Natural Gas

The ArrowHead Global Gas Model (AGGM) Represents the Way Global Gas Markets Work throughout the World

Representing the Structural and Probabilistic Dimension for Every Region Globally

Natural gas is produced, transported, and consumed in located, regional markets around the world, markets interconnected by a huge existing and prospective pipeline and LNG transportation system. One must interconnect these regional markets in order to understand located gas price everywhere in the world, gas price basis between regions globally around the world, production within regions, flow within and between regions, and consumption within regions. That is precisely what the AGGM is and does. It incorporates all the geographic and structural dimensions of the gas market and even includes the probabilistic dimension of all of the regional markets worldwide. It calculates the price of gas at every located region in the world both deterministically and probabilistically, and thereby, by subtraction, gives the basis differential to every other region in the world both deterministically and probabilistically. The probabilistic dimension is unique, calculating probability distributions over prices, basis, production, and capacity addition worldwide. AGGM has extensive interregional structural detail. (In the absence of this level detail, one has no hope of understanding gas supply, transport, demand, price, basis differentials, contracting, gas-on-gas competition, etc.) An overview of the interregional structure is depicted in Figure 1.

Figure 1: AGGM Interregional Structure

Figure 1: AGGM Interregional Structure

Detailed, Comprehensive Representation of Market Components

Regional detail is necessary but not sufficient. Representing the proper structure inside every region is a must. Within each of the hundreds of existing and prospective producing basins in the world, the AGGM represents every category of gas production. See Figure 2, which occurs for every existing and prospective gas producing basin in the world. Every supply region throughout the world contains an explicit supply curve that represents geology, exploration, development, production, decline, investment, operation, and other crucial parameters of supply. To miss any prospective supply is to get the wrong answer, and we don’t miss any. There are hundreds of existing and prospective supplies around the world, and we have measured and inserted them all. Distinction by resource type is pivotally critically important now that shale gas, coalbed methane, and tight sands, which now and in the future compete and complement/displace conventional onshore and offshore gas and they are ubiquitous and competitive throughout the world. AGGM includes equal coverage for all the other critical components of the gas market (each of which is embedded region by region in Figure 1):

  1. Gas demand by region by segment (power generation, refining, residential, commercial, industrial, transportation, considering competition with electricity, fuel oil, coal/wood, etc.)
  2. Gas supply for the disparate existing and prospective supplies for each region in the world (Figure 2 below)
  3. Contracts where applicable
  4. Overland/undersea pipeline, including all existing and prospective
  5. LNG liquefaction, shipping, and regasification, including all existing and prospective
  6. Gas distribution and infrastructure
  7. Seasonal and short term storage
  8. Coproduction of liquids (with appropriate coproduct revenues.
Figure 2: AGGM Diversity of Supply in Every Region of the World

Figure 2: AGGM Diversity of Supply in Every Region of the World

AGGM Uniquely Incorporates Uncertainty and Outputs Probability Distributions over Price and Quantity

Superimposed over all the structural detail is the notion that all the agents operate under uncertainty. Probabilities are endogenous in AGGM, fully considered by agents in their investment, operation, and retirement decisions. Agent actions in the face of probabilistic states of the world hedge and avert risk. This determines price (or more formally probability distributions over price in every region of the world). AGGM uniquely calculates probability distributions of prices and quantities in a full world supply-transport-demand context with endogenous agent-by-agent probabilities. There is no other commercially available model in the industry that provides a probabilistic, multiregional, multi-technology representation of world gas supply, transportation, and demand. The AGGM output is a full probability density function over price and quantity, and also over basis, capacity additions and retirements.

Investments and commitments in LNG, pipelines, contracted gas, and upstream projects are intrinsically long term and large scale in nature, so much so that they cannot be realistically hedged through simple strategies.  Thus, it is critically important to have a solid grasp on the market fundamentals; there is no substitute. Such grasp may open the door to somewhat more sophisticated hedging strategies designed to mitigate the extremes. That simply cannot be done in the absence of a fundamental model like this.

Model Transparency and Adjustability Based on Client Need and Perspective

As with all of our models, the data used and the network structure are transparent and easily viewable by clients. All data, network structure, and assumptions can be reviewed and fully adjusted to include clients’ point of view, whether for a client base case or for any scenario.

This, coupled with our time-tested, validated methodology, is why the AGGM (and earlier versions) have helped clients clearly understand future gas markets and make correct, profitable decisions.