This article is part of our special report European gas markets.
Almost ten years after the implementation of the Third Energy Package, the risk of backtracking on liberalisation looks very real as policymakers seem increasingly frustrated at having “given away” power to the market, writes Luca Franza.
Luca Franza is a researcher on international gas markets at the Clingendael International Energy Programme (CIEP) in The Hague.
Almost a decade after the Third Energy Package has come into force, time is ripe to draw conclusions on gas market liberalisation. This assessment is timely as the temptation of bringing politics back into gas seems to have reached an all-time high.
To be sure, breaking up incumbents has not been a painless undertaking, but the industry has now adapted to the “new normal” in most EU countries. New ways of doing business, commercial opportunities and professional profiles have emerged. Young executives operate with a post-liberalisation mindset. Alongside traditional players, new ones have come to the scene, such as trading companies, TSOs and DSOs.
The number of active players on the NBP (National Balancing Point, the British hub) and TTF (Title Transfer Facility, the Dutch hub) is now approaching 200 and annual traded volumes in each of them exceed 1.8 Tcm – three times the amount of gas consumed in entire Europe.
The British and Dutch hubs have in fact become fully fledged liquid hubs, serving as benchmarks for Europe. Gas-to-gas competition has risen and gas prices are increasingly set by supply and demand.
Importantly, liquidity has also reached satisfactory levels in the NBP’s and TTF’s far-curves. Apart from enabling supply hedging and price risk management, this is also a key condition for hub prices to be used as markers in long-term contracts.
Moreover, the borders of liberalised Europe are expanding. Liquidity in other Western hubs – particularly in Germany and Italy – has risen substantially in the last three years. The hubs of France, Belgium, Germany, Italy, Austria and Czechia are now all classified as “advanced” by the Agency for the Cooperation of European Regulators (ACER).
They display a good correlation with NBP and TTF and, with some exceptions, also increasing convergence with the leading hubs. This is in line with liberalisation’s ambition of allowing gas volumes to move freely across European borders, reacting to price signals. It shows that many physical and regulatory barriers to cross-border trade have been lifted.
As a result, a number of short-term security of supply challenges have been successfully met by markets in Western Europe. This has been proven by market responses to nuclear shortages in France; to British gas shortages provoked by outages at the Rough UK gas storage site, maintenance in Norwegian pipelines and cold snaps; and to the December 2017 Baumgarten explosion that threatened a vital supply line to Italy.
On these occasions, prices skyrocketed for short periods to signal scarcity, triggering market reactions (storage withdrawals, increased reverse flows) that soon brought prices back to normal.
Lower import bills in a globalised market
Finally, liberalisation has allowed Europe to cut its gas import bill after last decade’s economic crisis. European hub prices have started to decline in 2008-2009, first reflecting oversupply (rooted in the rise of US shale production and Qatari LNG) and the decline in demand due to the economic crisis and then Norway’s and the Netherland’s choice to sell gas on hub terms.
Oil-indexed prices did not follow this trend for a number of years, and a substantial gap between hub prices and oil-indexed prices remained until 2014-2015. As end-users were finally allowed to switch suppliers and source gas directly at the hub, EU midstreamers found themselves in a difficult position and asked suppliers to renegotiate long-term contracts.
Gas exporters were forced to change pricing mechanisms and introduced hub indexation.
In the old world of long-term oil-indexed contracts, vertical integration and captive end-users, it would not have been possible to translate oversupply into low prices. Prices would have remained artificially high, anchored to a high oil price.
But thanks to liberalisation (and not-always-private investment in redundant infrastructure), oversupply delivered competitively priced gas and plenty of optionality. Even if Russian gas imports soared in the last three years, European buyers have had the possibility to call on alternative gas in case of disruptions or price spikes. Russian market power is thus limited and head-to-head competition between LNG and Russian gas is proving a blessing for the EU.
Besides, a global LNG market is taking shape, with greater flexible volumes that arbitrage between a rising number of buyers across the globe and sizeable portfolio aggregation dynamics that are jolting the point-to-point nature of gas trade.
The Energy Union has indicated the establishment of a global liquid market for LNG as a strategic objective: this is rooted in the realisation that the “new model” will more easily work for Europe if it is exported to other importing markets.
Indeed, if Asian buyers lock large volumes in long-term contracts, the global LNG market will risk losing its flexibility and Europe will thus risk losing the optionality that is so essential to let the “new model” work.
What if markets tighten?
This leads to the unveiling of the weakest point of this whole architecture: its reliance on oversupply. The truth is that the resilience of the new model has never been tested in a tight market.
European gas demand has been subdued for a decade: even when global gas markets were tight in the wake of Fukushima, Europe has never got close to experiencing real tightness.
In spite of its claim of neutrality, liberalisation does have a bias towards consumers: Europe has stopped feeling concerned about whether gas producers have the instruments to plan investments on new supply.
Indeed, as gas prices have fallen in 2014, final investment decisions on new capacity have been stalling. Nobody is excited to sign long-term contracts at the moment and, although some people don’t like to admit it, long-term contracts are still required to underpin the development of new fields (as Shah Deniz-2 and TAP reminded us).
Experts foresee a tightening market towards 2022-2025: how will “liberal Europe” fare then? Will it be exposed to very high hub prices? And with the Asians potentially locking in LNG, will dependence on Russian gas grow?
Liberalisation has broken the old consensus on long-term oil-indexed contracts and weakened the midstreamers’ leverage vis-à-vis export monopolists. It is legitimate to raise the preoccupation that in a tight market, swing suppliers may have the key to influence hub prices.
At the end of the day, sources of gas remain limited and diversification is complicated by the lack of appetite for long-term contracts. While Europe has been quite effective in obstructing unwanted pipelines, it has not been equally effective in attracting investments on the pipelines it wanted.
Backtracking in sight?
This feeling of having “given away” power to the market is met with frustration by some policymakers. As a result, already before 2014, the liberal regime has been profligate in derogations to general principles, socialised costs, targeted financing and selective use of regulation. This included for example Exemptions to third-party access (TPA) rules and other derogations granted on the grounds of “security of supply”.
As a result, the long-announced deregulation never came. Instead, regulation has proliferated – with corrections to market and regulatory failures piling up. After the 2014 Ukraine crisis, the temptation of bringing back politics has hit an all-time high, as proven by the Nord Stream-2 saga.
Almost ten years after the implementation of the Third Energy Package, the possibility of a backtracking on liberalisation looks very real.