Spot Price Insurgency

It’s no longer “just like old times” for oil-linked natural gas prices in Europe.

According to a study by Societe Generale Group, in 2011 an estimated 58% of natural gas was sold in Europe according to oil-linked contracts and 42% according to spot; this year, those figures look to be 55% oil-linked/45% spot.

“This is a major change,” said Thierry Bros, Senior Analyst for European Gas and LNG at Societe General, who explained that the increase of spot prices in Europe had to do with renegotiations and arbitrations.

“This is due to a recent renegotiations: we’ve seen GDF Suez - Gazprom and E.ON - Statoil successful renegotiations; there are also renegotiations talks between GasTerra (the Dutch gas producer) and its buyers and E.ON/Gazprom, RWE/Gazprom and PGNiG/Gazprom arbitrations.”

Mr. Bros said, “We could reach a point where we will see less than 50% of gas sold in Europe under an oil-linked formula before 2014. We think this is a major change – prior to this, oil indexation looked here to stay no matter what, and it was substantial.”

Today, however, with poor demand and natural gas being too expensive for power generation, he said European gas producers would be forced to change their formula.

“Europe is at the eve of a period where this is going to change, from mostly oil-linked to mostly spot pricing,” he added.

But what would big natural gas producers have to say about that? Thierry Bros offers his assessment.

“Gazprom has given already a bit of spot indexation for its North West European customers – 15-25% - not a majority.”

“They may not like it,” he said of Gazprom, “but they are losing market share year after year.”

According to him, Gazprom’s pre crisis worldwide share in 2007 compared to today’s showed that gas demand had dropped and the company’s production decreased. 

“They’ve seen their share being reduced, and I think they are facing a problem where they may not like it, but they will have to change, either by themselves - i.e. negotiating and being flexible – or via arbitration decisions. The fact that demand is very low and we are closer and closer to a 50/50% spot versus oil indexation scenario, gives buyers a better chance to say that a mainly oil-linked contract is not acceptable any longer,” he explained.

There are, however, minuses to having increased spot indexation.

Mr. Bros said, “We don’t have a perfect market as the US has. Europe’s market has some major producers – Russia, Norway, Algeria and Qatar – controlling big stakes in the market. So with more spot indexation, the four major producers will have the ability to make sure prices don’t fall too much.”

He agreed, in part, that long-term contracts like those from Gazprom had their place, to accompany hub pricing in Europe, in contrast to the situation in the US market.

According to him, the US would eventually become a net natural gas exporter which would change a few things.

“Will it be a major gas exporter? Perhaps not. We are talking about marginal volumes, which make the margin on prices,” he said.

“I think we are in a period where the European system starts to be less stable, and the outcome of this is difficult to predict. What I’m sure of is that it’s not going to be ‘business as usual,’ i.e. we are going to have more spot indexation, and see changes in contracts.”

But how would this influence levels of investment into energy infrastructure?

“We’re seeing the big producers – Gazprom mainly – investing a lot, while the utilities are not investing, because they are facing losses in their gas business line.

“Again, if we want more gas to be used, we need to first to operate more CCGT, gas-fired power plants,” he contended, adding that at present Europe was not making the proper efforts to pursue this path.

Mr. Bros noted: “It’s more profitable to burn coal, so this is what’s happening. Full stop.”

He said that policymakers in Europe needed to address the CO2 market.

“They decided to cap and trade greenhouse gas emissions, but it seems the price coming from this is not pushing for a greener route as the cap was set too high. That’s why policy makers are now looking at reducing the supply of permits,” concluded Thierry Bros.

Editors Note:  E.ON today announced an agreement with Gazprom to receive an undisclosed discount. RWE has said it expects to reach a deal with Gazprom in late 2012.