Beware of bargains

Short-term trading on the spot markets is playing an increasingly important role in the natural gas sector. That is a good thing. But those who think that long-term supply agreements linked to the oil price are no longer necessary as a result are mistaken. As GASWINNER shows, it’s all in the mix.

For natural gas customers in Germany, the World Energy Outlook issued by the International Energy Agency (IEA) in November appeared to bring good news. It stated that the supply of natural gas was increasing worldwide at a greater rate than demand and that the prices would remain under pressure for years. The capacity utilization of the existing pipelines as well as the transport capacities for liquefied natural gas (LNG) will fall substantially by the year 2015, according to the annual statistics on the development of the international energy markets.

The media and energy traders pounced on the story: the energy market was experiencing a “flood of gas”, and the “gas bubble” was bursting, they said. The fact that the Leipzig-based EEX, the leading energy exchange in Continental Europe, reported the highest spot trading figures for natural gas in the month of October in its almost ten-year history seemed to be an accurate reflection of the current analysis of the IEA. The EEX registered around 700 trading transactions, compared to 310 in September. In Leipzig and other European energy exchanges, at times natural gas was traded well under the prices of the gas volumes agreed in long-term supply agreements. Is natural gas becoming a bargain price form of energy?

There were three key factors that put pressure on the natural gas prices in 2009. The global financial crisis had put a serious dent in industrial production round the globe. As a result, the consumption of all three fossil fuels, crude oil, coal and natural gas, fell. But at the same time, trade in LNG continued to grow. This gas, which is cooled and then transported in special ships from exporting countries round the world to the importers, supplements the pipeline gas supply in Europe, albeit in small quantities in Germany so far. In the USA,on the other hand, the world’s largest natural gas market, production from domestic natural gas fields increased recently. This had an impact on the LNG prices round the world. Norway, which is Europe’s most important supplier of natural gas alongside Russia, responded to the general decline in demand and increased its trading of uncommitted natural gas volumes on the energy markets and exchanges.

The development of natural gas prices on the spot market has fuelled the debate on the link between gas and oil prices, especially in Germany. Germany imports more than 80 percent of its annual natural gas requirements. The large majority is transported through pipelines and is guaranteed by long-term supply agreements. Since the 1970’s there has been strong growth on the import market in continental Europe. In order to protect their investments in the development of new natural gas fields and the construction of pipelines, some stretching thousands of kilometers, from the very beginning exporters and importers linked the gas price to the development of the crude oil price, which serves as a reference marker worldwide . Today this link is still a key feature of this market.

The price signals on the spot market encourage critics in their belief that the link to the oil price in the import agreements is an anachronism and should be abandoned. “Since the IEA anticipates that there will be a growing surplus on the natural gas market, abandoning the link between the gas price and the oil price could certainly make sense,” Dagmar Ginzel, from the consumer portal Verivox, said. The IEA recently made a similar case: “Should the major importers capitulate and change the conditions in the long-term supply agreements, in other words, release more gas onto the spot markets, the result would be lower prices,” it said in November. “That would stimulate demand and help to ensure that gas plays a stronger role in power generation in future.”

However, the debate surrounding indexing gas prices to the oil price could prove to be short-sighted. Many developments in recent years, such as the transit dispute between Russia and the Ukraine, have highlighted the importance of stable general market conditions, particularly on the energy markets. Long-term supply agreements, linked to an indicator like the oil price, create reliability. “If the gas price is governed by supply and demand alone, gas can become very expensive in winter, for example,” Thorsten Kasper, from the Federal Association of Consumer Protection Centers, says. “Hence, abandoning the gas-oil price link could lead to massive price hikes.”

In the case of natural gas, the market participants, especially in the USA and the UK – countries with very active spot markets – clocked up some unpleasant experiences. The supply crises and the black-outs in California at the beginning of the decade were in part triggered by the fact that the electricity companies had not signed sufficient long-term purchase agreements for the required quantities of gas. The British market, on the other hand, which for a long time was fed by its own stocks in the North Sea, came under pressure as domestic production began to fall. “The fact that the British gas prices are strongly aligned to the spot market there, the NBP, creates a great deal of price volatility, which confronts gas consumers with major challenges, particularly in economically difficult times, and which has impacts on the natural gas market in Continental Europe,” Gerhard König, Chairman of WINGAS, says. “In terms of supply security, the British system is certainly not a suitable role model.”

An important difference between the German natural gas market and the British – the largest in Europe – is that the construction of a system of natural gas storage facilities in the UK is still in its infancy. The storage facilities there can only cover the country’s requirements for 15 days at present. In contrast, the German natural gas suppliers have much larger capacities. WINGAS, for example, operates Germany’s largest natural gas storage facility in Rehden in Lower Saxony, amongst others, and is currently building another facility in Jemgum in East Frisia. Germany’s natural gas storage facilities can store about a quarter of the entire annual natural gas requirements. But it is the system of long-term supply agreements, some of which span over decades, combined with natural gas storage facilities that offers gas suppliers the possibility of taking advantage of the benefits of spot markets and passing them on to their customers.

“We use all the spot markets in Europe, such as the spot market in Zeebrügge in Belgium, in order to optimize our portfolio,” Gerhard König says. “At the same time, most of our gas procurement will continue to be based on long-term supply agreements linked to the oil price. That not only provides investment security for our billion-euro investments, it also ensures a reliable supply of the required quantities.”

One thing the global financial crisis has taught us is how fragile long-term economic forecasts are, including for the energy markets. The growth of the global population, however, leaves no doubt that the demand for energy will continue to grow long term. This was made clear again in the most recent World Energy Outlook of the IEA in November 2009. The International Energy Agency is predicting that by the year 2030, additional natural gas capacities of 2.7 trillion cubic meters a year will be needed to replace older natural gas fields and to cover rising global demand. That is equivalent, according to the IEA, to around four times the current capacity of the world’s largest producer of natural gas, Russia.

That means major investments, but also increasing competition for energy among the world’s different regions. Spot market gas is particularly flexible in this regard. LNG tankers with cargo that is not contractually bound simply head ad hoc to the place offering the best price for the natural gas. Perhaps the next time the economy booms people will view the oil-gas price link entirely differently again.

The Author: Olaf Preuß

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Philip Detharding, Head of Trading at WINGAS, talks about the possibilities of trading on the spot markets for utilities. more

Glossary: Spot market, OTC & Co.

Spot market (day-ahead-market): the term, which originally comes from the crude oil trading sector, describes the trading of raw materials, commodities or securities between the provider and the consumer for immediate delivery – in Germany generally within two days. Transactions for delivery at a later date are handled on the futures market.

Over-the-counter, also called OTC trade, describes the trading of finance instruments, energy or raw materials directly between the provider and the consumer or via a broker but without the use of an exchange.

Physical delivery: in short the delivery of the described goods instead of a mere contract. In gas trading the contracts agreed on the exchanges are usually actually “physically” delivered. However, until the contract matures, the quantities can in general be traded as often as desired in order to take advantage of price fluctuations.

Control energy is needed in order to maintain the supply voltage in the electricity or natural gas networks. That means control energy is purchased in order to cover shortfalls and sold when there are capacity surpluses. The energy exchanges are one of the suitable platforms for the short-term trading of control energy.

eeX in Leipzig – Energy exchanges plays an increasing role

The European Energy Exchange (EE X) in Leipzig trades in electricity, natural gas and coal as well as emissions rights for carbon dioxide (CO2). Nordpol in Oslo and APX in Amsterdam are also important energy exchanges in Europe. more