Reaching a Fully Liberalised and Single EU Gas Market - Interview with Patrick Heather

“There is still a long way to go for the EU to reach a fully liberalised and single gas market”

Natural Gas Europe was pleased to interview Patrick Heather, Senior Research Fellow at the Oxford Institute for Energy Studies about his coming academic paper in April on European natural gas hubs development.

According to him, reaching the single gas market targeted by the EU regulators is a long process, considering the EU gas hubs’ different paces of development and disparate stages of maturity.

You are about to publish a paper at the Oxford Institute for Energy Studies on the Evolution of European Gas Hubs: What is the main message of your paper? And have you seen some significant changes in the last couple of years?

I am in the process of writing a paper called the Evolution of European gas hubs. It originally was going to be a follow up to my 2012 paper on the EU gas hubs, but in actual fact, it is going to be much broader and it is going to answer different questions.

In 2012 it really was about the Northern European hubs, there were no hubs elsewhere. It was also in the context of the change in price formation in the European long term gas contracts (indexed to oil prices). In order for them to change price formation, from oil indexation to gas on gas pricing, there needs to be a reliable reference price in the gas market that participants can use to price their contracts. And that was really what I was addressing in 2012, with the question: will the hubs provide a true reference point? In my analysis, I then discovered that at that time there was only one hub, the British NBP, which could fulfil that task. The Dutch TTF was still growing at that time and it was not far off becoming a mature hub. The other hubs in North West Europe were a long way behind.

Now in 2014-2015, looking at this again, rather than being just a simple update on the 2012 paper, I am looking at all of Europe. The reason is that the context is different. We have now seen a change in price formation across the European long term gas contracts. Above 50% of the contracts are now priced against gas. The British NBP is still the reference gas marker and the Dutch TTF is a very close second now, and may even overtake NBP this year.

But the situation with the other trading hubs is very similar to 2 years ago, they are still a long way behind. I am now looking at it within the context on the European union vision of a single market and in particular the Gas Target Model, which sets out a plan for all of the community’s member states to be part of the same formation of wholesale liberalised gas market (according to the EU third energy package requirement). Therefore I am now looking at all member states development of their wholesale gas market in order to achieve the Gas Target Model and the EU vision.

In your view, is the Gas Target Model reachable for 2017?

I am not in the position to answer whether the Gas Target Model is reachable in the sense that this is not a commercial target. But there are many hurdles.

What I am trying to determine is the level of development in each member state towards achieving what the Gas Target Model says. I have the view that it is a far more complicated route in order to achieve that than the politicians probably thought it would be. I’ve got the impression that the politicians felt that you just have to write a few laws, a few directives, get the member states to ratify them, and within a year or two, you would have created a different market place in Europe for energy. Unfortunately, that is not the case, and it is certainly not the way it has been happening.

So what are the hurdles, why isn’t it happening at the speed that the EU first thought it would?

I look at it through two different standpoints:

One is the political willingness to actually enact and effect the change. The other one is the cultural attitudes of the countries, which let’s face it, are very different from country to country across Europe. It is what makes the beauty of Europe, we are all different, but we are all in one big union. 

Can you develop on these differences?

Let’s say in a very generalist way, that as you go from North West Europe, including the Anglo-Saxon, the Scandinavian and the Dutch view on trading, it is very proactive towards trading. It is a very logical approach to commercialisation. As you go from there towards Eastern and South East Europe, or Southern Europe, you progressively get different attitudes to trading, different attitudes also in the political willingness. It is not necessarily the case that these countries do not want to move towards liberalisation, it is just that they want to do it in a different way, at a different speed. Even though they may have ratified the European directives, the result _ and it is what I am analysing in my paper _ shows that there is a very disparate range of achievement across Europe.

So in your view, NBP and TTF are the ideal hubs in term of liquidity and are the models to achieve everywhere Europe? Is that correct? 

From a commercial point of view, it does not make sense to have trading hubs fully liquid, tradable, liberalised, across every country in Europe. There are just not enough volumes.

If you look at other commodity markets in the world, if you look at oil, there are two, maybe three reference markets. The largest is Brent (Crude oil), the second largest is WTI and then maybe Dubai. But actually most of the other grades of quality of oil are traded on a basis, on a differential to Brent!

If you look at soft commodities, at sugar or coffee or cacao, there are also one or two or maybe three reference markets in the world.

And here we are in Europe, where the EU’s vision originally was to have one energy market, but with every country having its hub and every hub being active. There is just not enough volume for that to happen.

Do you think it would be a good idea to merge some markets or to merge some balancing systems as the Gas Target Model would suggest in certain specific cases in Central Eastern Europe?

There is no need to do that. It is extremely costly. The larger the single entry exit zone you create, the more costly it is in order to achieve the infrastructures necessary to be able to balance on a daily basis.

What I want to try to get across, is the point that as long as you have one or two, or at the most three, reference markets in Europe, that people can price their contracts on, that people can risk manage their portfolios against, that is enough.

However, every hub in every country would be a balancing hub for physical reasons. Actually for physical reasons, you do not want the hub to be too big, because the bigger the hub, the more costly it is to balance it.

Are there still some issues with physical balancing in Europe? 

Yes there are. This is a historical problem from the days of the Cold War, when you had Western Europe and Eastern Europe. Essentially, Western Europe, in particular North West Europe, has a very well developed gas infrastructure. Unfortunately Iberia and Southern France have a less well developed infrastructure.

What was used to be called “Eastern Europe” was very much a transit to bring Russian gas to Western Europe. There was a very small distribution network off the transit pipe in each country. The issue with the Eastern part of Europe today is that there is very poor connectivity between countries, in particular a North South axis. Let’s say from the Baltics and Poland, down to Greece.

Is liquidity the only factor to improve markets efficiency, or are there other factors which could be improved?

In my paper I will be presenting two sides of the coin if you’d like.

I will be presenting an objective analysis, which I call the 5 Key Elements: they are who are the market participants and how active are they?; what products are there to trade?; how much volume is traded and over which periods?; the Tradability Index; and the churn rates. I believe that it is essential to review as a minimum these five criteria to permit a rigorous analysis but, unfortunately, not all of the elements are available in all of the hubs. Each of these elements can be measured and can be put in a nice table to compare in absolute terms, this is very important.

The other side of the coin is the subjective side, we just spoke about it: the political willingness and the cultural attitude. If the cultural attitude in a country is against trading, the liberalisation of the market is not going to happen. You can still have an efficient physical balancing market which you need for safety reasons. But this does not mean that you necessarily have a busy traded market.

Coming back to the first side of the coin: when we were preparing this interview earlier, you mentioned the importance of prices correlation between European hubs. Why is it so important that prices are correlated to make the EU gas market efficient?

First of all let me clarify what is correlation. There is a misunderstanding, notably in the trade press, that correlation means the same price. That is not correlation.

The idea of the new administration in Brussels that there could be a single pricing model for all of Europe to me seems to be a total anathema against the ideal of a single EU energy market. A single market to me means that there is a fair energy market for all European consumers; it does not mean the same price in London and Budapest. That would be dependent on transport costs and things like that.

Correlation means that prices in two or more locations move roughly at the same speed in the same direction at the same time. If you look at the hubs where there is data available on price and you compare, mostly in the North West European hubs, but also including Spain, Italy and the Czech Republic let’s say, you can see that the great majority of them, over the last two years are quite well correlated. There are some exceptions. These are the two Southern French hubs, PEG Sud and TIGF, and the Spanish AOC all of which are highly dependent on LNG. Those three hubs are not only more expensive than the other North West European hubs, but they are not correlated to them either.

Another example is the Austrian VTP and the Italian PSV. Those two hubs are most of the time slightly dearer than the Northern hubs but they are quite well correlated with them.

The fact that some markets are not correlated show that there is not a single energy market yet. It is not about having the same price but about having the same price formation. France and Spain are highly dependent on LNG while North West markets are dependent on pipeline gas; that is why there is a difference in price formation.

Talking about LNG, what is your view on further LNG infrastructure development in Europe, and the potential impact on wholesale gas prices?

Any infrastructure development should be welcomed. If you are concerned about security of supply and if you want a well-functioning market, you need to be able to move the commodity around easily. Therefore the more infrastructures you have, the better it is. So it will help security of supply if you can get supply from many more places, both pipeline and LNG. Obviously, by extrapolation, the more interconnections you have within the landmass the less risk you have of supply interruptions.

In turn this should also mean that the wholesale price of gas is the cheapest it can be without the added costs that infrastructure constraints bring.

The Northern coast of Europe is very well supplied in LNG receiving terminals, but there are no export terminals in Europe. We know that there are reloading facilities and a few but increasing number of terminals using this possibility. That is good. Maybe one day we may even see someone realise that Europe could be an exporter, a bit like in the US?

LR

Patrick is an internationally recognised expert in the development of traded gas markets in Europe. He is a Senior Research Fellow at the Oxford Institute of Energy Studies and author of several papers and presentations on this subject. Patrick’s consultancy work focuses on the gas market evolution in Europe, supply and demand dynamics, the impact of regulation on market outcomes, contracting strategy and marketing strategies to take advantage of new market opportunities.

Patrick can be reached at: patrick.heather@oxfordenergy.org