There is no "intrinsic reason" why Europe can't develop into a natural gas commodity market like the US, instead of remaining tied to long-term contracts and pricing formulas linked to oil, said authorities at the Centre for Global Energy Studies (CGES), London, in a recent report.
"Although short-term gas trading is now well-established in the UK and at a number of embryonic gas trading 'hubs' on the [European] continent, around 90% of Europe's gas supplies are purchased under long-term take-or-pay contracts-most of which are still priced using formulas linked to the oil market," they said.
Consequently, for example, the July natural gas contract closed at the equivalent of $1.81/Mcf May 31 on the International Petroleum Exchange in London, while in the US, where the natural gas market has disconnected from oil, the July natural gas contract closed at $3.22/Mcf on the New York Mercantile Exchange (OGJ Online, June 3, 2002).
Prices for near-month gas contracts on the two markets sometimes came within pennies of each other in late 2001 and early 2002 when the US gas market was languishing. But most of the time since the mid-1990s, near-month gas futures contracts on NYMEX exceeded those on the IPE, usually by several dollars per thousand cubic feet (OGJ Online, Jan. 31, 2002).
Competitive market hurdles
Members of the European commission have said that fully developed gas trading hubs with transparent gas reference prices are necessary "to secure the full benefits of competition" in Europe's natural gas market that the US market enjoys.
However, CGES officials said, "The major gas producers and key pipeline system operators argue that such a development could undermine long-term security of supply, since significant investments in new capacity-required to meet growing gas demand in Europe-could be jeopardized." Therefore, it "seems unlikely" that the gas producers and pipeline operators will voluntarily make the switch away from oil-indexed long-term contracts.
Unless the European Commission can persuade national regulators to force gas market "incumbents" to renegotiate long-term contracts with suppliers on a "more competitive" basis, CGES said, "...a fully fledged commodity market for gas in Europe will remain a distant prospect."
Meanwhile, officials reported, "Natural gas displays all the necessary characteristics that encourage the development of commodity trading. Gas prices are highly volatile, especially in the short term, because demand is not only strongly seasonal but also unpredictable, while supply is relatively inflexible, creating the need for an effective storage market to iron out the imbalances that arise both geographically and between different time periods.
"However, this will be hard to achieve while long-term contracts linked to oil prices remain the predominant source of gas supplies."
Because the oil-indexed formulas used for those long-term gas contracts have a built-in lag of 6-9 months, they said, traders are able both to gauge the general trend of gas prices and to use the oil market to hedge their longer-term exposure to the gas market.
"As a result, market liquidity is highly concentrated in the near future, and there is only limited arbitrage along the forward curve, creating an unusual and distinctive pattern of price behavior in the IPE natural gas futures market," said CGES officials.
