Gas markets Europe 2010 – 2011

The past month has been a bit low in blogging activity, due to my being busy creating a report on the European gas market. Research of supply and demand figures brought me some surprising insights. You can read an extract of the report by clicking on the link below. Please read the executive summary of the report below. Contact me at benedict@eecc.eu if you want to receive a full copy of the report.

Executive summary

• ‘Energy can only get more expensive’, is a common belief among energy buyers. However, we have recently seen that natural gas prices remained relatively low, even when the economic activity picked up. Oil prices rose, so the gas prices on the Hubs became structurally lower than oil-indexed gas prices.

 

• The biggest natural gas reserves in the world are to be found in the Middle-East and not in Russia. However, the Middle-East are currently only the world’s fourth largest producer of natural gas, meaning that huge reserves are untapped. Gas production in gas reserves giants Qatar and Iran has started to rise exponentially in recent years. This explains the presence of excess gas volumes in the world markets.

 

• The US has increased its production of natural gas by 16% due to the development of shale gas. In 2009 they were the world’s biggest producer of natural gas, bigger than Russia. We have always known that beyond conventional gas reserves, a lot of gas was trapped in this shale layer. Only, it was always thought that it was impossible to produce gas from these layers without excessive costs. Recently production techniques have been improved, and the energy companies claim that it is now possible to produce shale gas at a cost that is lower than the production of conventional gas. The possibility to economically produce shale gas boosts the gas reserves of the world.

 

• Shale gas production has already had an impact on gas prices, as it made more LNG available to the European market as less was needed in the US. If the US continues to expand its gas production, it might even start exporting LNG. There is also potential for shale gas production in Europe and in China. If all this shale gas production is developed, the world’s gas supply situation will look completely different. However, this whole shale gas development could be turned back due to environmental impact of the shale gas production. It is too early to decide what the further development will be.

 

• As of 2011, the Nord Stream gas pipeline will bring additional gas from Russia to Germany, 22,5 billion m³ of capacity in 2011 and 45 billion m³ in 2012.

 

• Natural gas demand in Western-Europe peaked in 2004 and then started to fall. This is contrary to popular belief that energy consumption is continuously growing.

 

• Although the growth rate of power consumption is slowing down, it is still growing. Deployment of electric cars would speed up this growth of electricity demand. Most of these extra MWh’s of electricity are now produced from renewable energy sources. But the growth of demand is faster than the growth of renewable. This means that extra power plants will need to be built. Plans to shut down nuclear power plants in countries like Germany, Belgium, the Netherlands and UK have been turned back, meaning that fewer power plants will need to be built. How much of the new power plants will be gas-fired will depend on whether new nuclear and (clean) coal-fired power plants can be developed. Which plants will be built is subject to political decisions. It is therefore madness to try to predict how much extra gas will be needed for new gas-fired power plants.

 

• A multitude of factors will determine whether gas supply will continue to grow and/or gas demand will continue to fall. Therefore, it is impossible to predict whether the current situation of over-supply will continue or not. The important news is that it is not unthinkable that we might see some decades ahead with abundant natural gas available to our markets, resulting in lower gas and electricity prices. Therefore, corporate energy strategies based on the adagio that energy can only become more expensive, should be adapted. Guidance on how to do this can be found in the conclusion of this report.

Filed under: Belgium, Energy demand, France, Germany, Market analysis, Natural gas, UK

Transparency & the European gas market

Europe’s continental gas markets are slowly making the transition to a different market model. The Hub market model, known in the UK and the US for decades, is to replace the system of oil-indexed gas deals. Historically, gas in Europe has been sold in long term deals. These deals were between on the one side companies in producing countries, companies that we now know under the names of Statoil from Norway, Gazprom from Russia, Gasterra from the Netherlands or Sonatrach from Algeria. In the consuming countries, (predecessors of) companies such as RWE, E-ON Ruhrgas, Wingas, Gaz de France, Distrigas, Eni, Gas Natural or others were the receivers of these deals. This deal-making implied heavy political interference, as ministers were often directly involved in the negotiations. A famous example is the Belgian minister Willy Claes negotiating the contract that brought Algerian gas to Distrigas in Zeebrugge. The traditional companies in the consuming countries built the network infrastructure necessary to receive, store and distribute the natural gas. When the continental European markets were liberalized, they were forced to create separate grid companies to run this infrastructure. This ‘unbundling’ is supposed to create the necessary independence of interests to allow third parties an open and unbiased access to the grid infrastructure. Such third party access is a necessary condition for gas market liberalization to be a success.

Last week, traders in the continental European markets had complaints regarding that third party access. They specifically blamed lack of transparency regarding available storage and transit capacities for the slow development of continental European Hubs such as Zeebrugge in Belgium, TTF in the Netherlands or NCG in Germany. And indeed there are some solid reasons why transparency regarding storage and transit in these markets is low. The first reason is that some of the infrastructure is still in the hands of certain market participants. The big German gas suppliers are also the owners of the large storage capacities in Germany. The second reason is the fact that many capacities have been blocked by historical rights of certain suppliers. Unlocking these capacities is a difficult exercise. Many years ago, the governments supported companies making long term contracts for the supply of gas. Can those same governments make those contracts obsolete by taking away the capacities that those companies need to honor these contracts?

The underlying difficulty is that it proves extremely hard to transpose the English gas market model – without or with limited long term contracts – to the continent. An important reason for this is the difference in pricing models. The long term contracts have pricing based on oil prices. The Hub markets function with gas-to-gas pricing. It is supply and demand of natural gas that sets the gas price (which is much more logic). Since the summer of 2009, the Hub prices have dropped far below the oil indexed prices. If this trend continues, the holders of historic supply contracts face a huge problem. They will have the obligation to take gas from the producers at higher oil-indexed prices than the Hub prices at which they can sell in their home market. It is therefore understandable that they are not very enthusiastic in developing the Hub markets. Therefore, developing liquid and transparent continental Hub markets is the main challenge for European natural gas market policymakers.

Filed under: Belgium, Energy policy, France, Germany, Natural gas, the Netherlands, UK

What if the UK runs out of power?

When I started working in energy procurement consultancy ten years ago, the UK was always cited as an example of how energy markets should be organized. Anglo-Saxon liberalism had inspired policymakers on the other side of the Channel to create open energy markets much faster than their continental colleagues. It is therefore startling for me to find an article in this week’s Economist with the title ‘Britain’s energy crisis: how long till the lights go out?’ (http://www.economist.com/opinion/displaystory.cfm?story_id=14167834). Apparently, liberalization English-style, shouldn’t be considered as being so exemplary after all.

It is indeed true that the UK is heading for trouble as for its energy supply. Power plants are not built quickly enough to deal with rising demand due to:

-        The nuclear path being blocked for a long time due to a political decision for nuclear phase-out,

-        Investment in coal-fired power plants also difficult due to the ambitious carbon dioxide reduction targets,

-        slow development in renewable energy due to planning restrictions and lack of coherent policy.

This leaves only investment in gas-fired power plants open as a possibility. And we do observe that the proportion of gas-fired in the UK’s power production is growing rapidly. The trouble is that this ‘dash for gas’ coincides with a development where the UK is more and more dependent on imports of gas as its own production is in decline. The outlook for the UK power market is grim: under-diversified, overly dependent on imports of electricity and fuel (natural gas). And strangely enough, even if the rest of Europe is actively building new power lines to other countries, the UK is also slow to build import capacity. This brings the prospect of the lights going out uncomfortably near.

I fear that many anti-liberalization forces inside Europe will use the UK example as an argument in favor of less energy market liberalization. The events in the UK power market will be to many just another sign that the Anglo-Saxon model doesn’t work. And these anti-liberal voices have already started to sound louder due to the financial crisis.

We should indeed reflect upon the way we organize energy market if we observe what happens in the UK. It does prove that the neo-liberal adagio that markets should function wholly independent of the policy-making level is not true. The trouble with the UK power market is due to a lack of interest in it by policy-makers. UK politicians have refused to face the problems and to take the policy decisions that were necessary to deal with it. The renewable energy policy is a clear example of this. Tony Blair and Gordon Brown have always sounded very ambitious when it came to greenery. But we simply observe that development of e.g. wind power is dwarfed when compared to countries such as Germany and Spain.

If one thing is made clear from the experience in the power market across the Channel, it is that an energy market needs good policy decisions to function like it should. The long term development of the power supply portfolio is one of those domains where politicians need to do the necessary things. The market in itself cannot deal with that.

Does this mean that we should exchange our Anglo-Saxon economic textbooks for French ones? Should we go in the direction of ‘le dirigisme’ like we observe in the French energy market where the government is involved at every level of energy market decision making? I don’t think so. Too much policy-making can be harmful as well. Just think about EU agricultural policy if you need to get convinced of that. And liberalization of energy markets is not necessarily a failure, just think about the Nordpool market in the Scandinavian countries. The trouble in the UK’s power market shows us that we should rethink the roles of private initiative and collective decision-making, of economics and politics, in energy markets. Just like we should do it for our financial markets.

Filed under: Energy policy, UK