Natural gas markets Jan Osička Natural gas and oil Production: complements Consumptions: substitutes End use consumption:  Industry (heat + feedstock)  Residential and commercial (heating)  Electricity generation IEA 2009: End use consumption IEA 2009: End use consumption in CZ 2007 Transport 1 % Industry 55% Households 44% Gas Transport 68% Industr y 32% Households 0% Oil Actors and structure • Dodělat principy liberalizace (schéma trhu) Pricing Regulated: end user prices set by national authority (domestic markets of major producers) Fuel indexation: pegging the price to competing fuel reflects fuel substitutability (oil, oil product basket, fuel basket) Market based pricing: price equilibrium in gas-to-gas competition and fuel-to-fuel competition Fuel indexation Fuel indexation Gas-to-gas competition Fuel-to-fuel competition (USA) Fuel-to-fuel competition (USA) Contracting Duration • Long-term contracts (LTCs) • Spot Trading mechanism • Bilateral negotiations • Over the counter (OTC) • Exchange Pricing • Marginal costs • Netback Hubs/exchanges Exchanges • Trading places (physical, financial) • Exchange = central counterparty • Necessary conditions • Liquidity • Interest • Regulation Hubs • Infrastructure crossroads, natural development of physical trading • Conditions • Infrastructure • Market fundaments – liquidity, demand • Storage capacity • Regulation: TPA Hubs Physical • Transit hub: infrastructure crossroad + OTC trading • Trading hub: infrastructure crossroad + Exchange • Transition hub: in between Virtual hubs • Regulated emergence • Geographical delimitation (regional or national market) Kontrakty OTC • Short term bilateral agreement • Standardized products, balancing • Direct or via a broker • 16 – 40% of European market Bilateral negotiations • Two parties, direct negotiations, details kept in secret (Russia – China gas deal of 2014) • Long term, strategic contracts • Content • Duration • Pricing formula • Additional clauses Duration 15-35 years, recently up to 20 years Example: RWE contract portfolio Pricing formula: oil indexation P(m) = P(o) + 0.60 × 0.80 × 0.0078 × (LFO(m) − LFO(o)) + 0.40 × 0.90 × 0.0076 × (HFO(m) − HFO(o)) ... o = current month ... m = target month ... LFO = light fuel oil ... HFO = Heavy fuel oil ... 0.60, 0.40 = market shares of competing fuels ... 0.80, 0.90 = pass through factors ... 0.0078, 0.0076 = FO/gas energy parity Energy content parity Oil parity is achieved at a = 0.172 (1 MMBtu = 0.172 barrels) • Brent = $120 => NG = 0.172*120 = 20.64 $/MMBtu (Brent parity) • Brent = $20 => NG = 0.172*20 = 3.44 $/MMBtu (Brent parity) »Producers (Qatar, Russia) usually prefer oil indexation »Consumers (North America, Europe) usually prefer hub/spot indexation Pricing formula: Netback pricing Netback price = replacement value What is the maximum competitive price? Netback to natural gas Netback to other fuels Kontrakty Russian import price in 2012 Additional clauses • Flexibility (take-or-pay): (70-) 85 - 90% • Destination clause (reexport) • Delivery point Compromising oil and hub indexation: mixed formula (Gazprom – E.ON, RWE 2010) • Price formula = 85% oil indexed + 15% hub indexed Compromising oil and hub indexation: „Indirect spot pricing“ (Gazprom – ENI, PGNiG, 2013) LNG Oil, Gas, Coal 2010 (milion MMBtu) Oil Gas Coal Reserves 8 021 000 6 657 200 16 441 176 Production 169 456 113 670 150 794 Traded 107 512 34 710 24 520 Seaborne trade 59 096 10 573 13 631 Oil, Gas, Coal 2010 Oil Gas Coal Trade/Production (%) 63.4 30.5 16.3 Seaborne trade/Trade (%) 55.0 30.5 55.6 Seaborne trade/Production (%) 34.9 9.3 9.0 Development of LNG trade •Before 2000: strictly bilateral LTCs supplying premium markets (Spain, France, Japan, South Korea) •After 2000: the rise of Qatar • 1997: 0.16 bcm of LNG exported • 2012: 105.4 bcm of LNG exported 0 50 100 150 200 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Qatari NG production (bcmy) Global Situation before 2010 • Two main production areas: • Atlantic basin • Pacific basin • Three main consumption areas: • North American market • SE Asia • Europe • Growing share of LNG on the overall traded volume. • The rise of Qatar (and possibly Australia). Since 2010 • North America out of the picture • Rapid rise of flexible trading • More LNG contracts with destination flexibility • New exporters and importers • Balancing needs in traditional markets • The continued disparity between prices in different basins which has made arbitrage an important and lucrative monetization strategy. • The large growth in the LNG fleet • The decline in competitiveness of LNG relative to coal and shale gas • The large increase in demand in Asia and in emerging markets Flexible LNG trading Global LNG Fleet by Year of Delivery European supply dynamics European supply dynamics Demand Domestics production Pipeline imports LNG imports Case study: Russia‘s pipeline strategy Case study: Russia‘s pipeline strategy US storage level as a volatility factor Case study: Russia‘s pipeline strategy Case study: Russia‘s pipeline strategy Case study: Russia‘s pipeline strategy EU LNG imports Retail market CustomerTrader Retail price (CZ) Price components • Non-regulated: 50-81% • Supplier/trader price (wholesale price) • Storage price • Regulated: 19-50% • Transmission (high-pressure network) • Distribution (low-pressure network) • Market operator services (balancing, clearing) • Gas tax (legal entities) • VAT Customers Up to 1.89 MWh/y – just cooking 1.89-7.56 – cooking and hot water More than 7.56 – heating 20-25 MWh/y – typical household Below 630 MWh/y – „small customer“ by law (protected customer) Trader-customer relations Competition and retentive programs • 24/7 assistance services • Energy consultancy (efficiency, furnaces, insulation, lighting) • Price • „Personal assistant“ • Discounts on (un)related services (mobile tariffs, fitness, ...) Trader-customer relations • Customers prefer price to other benefits • Traders want them to prefer other benefits • Large customers change supplier every year • Households: • 1/3 already switched • 2/3 not incentivized Trader-customer relations At what price it makes sense to gain or maintain a customer? • Margin • Gross: margin per MWh (smaller customers bring more profits due to limited negotiation position) • Net: margin per MWh including salaries, advertising, etc. (large customers bring more profits due to tiny margin x great volumes) => Portfolio: small customers unstable in offtake (weather) and stable in contracts; large customers stable in offtake and unstable in contracts • Negotiation position: price, individual terms of service => dozens of products (tariffs) now on the market • The treshold between small and big customer is getting lower (100-200 MWh/y) At the price when gross margin > acquisition costs. Trader-customer relations Door to door contracting (D2D) Direct, or Outsourced: +Time efficient +Cost efficient +Coverage +Powerful channel - No exclusive cooperation - Whole portfolio moving - Ignoring portfolio - Faking offtake volumes for more commision In the shoes of a trader... • Searching for purchase oportunities • Fighting for customers • Fighting with customers • Regulation to follow: • National law • Original European directives (implementation risk) • European Court of Justice‘s rulings • Rulings of the Member states‘ highest courts