Natural gas contract renegotiation trend boosts spot market volumes

07 July 2014 12:29 Source:ICIS
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A greater degree of spot indexation in renegotiated, previously oil-linked natural gas contracts is boosting traded prompt volumes on some of Europe’s most liquid over-the-counter (OTC) hubs, sources have told ICIS.

NBP, TTF and NCG Day-ahead volumes have ticked higher over the past six months compared to the same period last year, fuelled by a spate of contract renegotiations which started around the fourth quarter of last year, market participants said. Only a very small proportion of trade on these contracts is carried out through exchanges.

According to the Energy Contract Company (ECC) which recently published its annual European gas market review, intense price review throughout Europe has led to increasing use of spot markets and also to the increasing use of spot prices in the price escalation provisions of existing long-term contracts.

Sources confirmed companies are taking advantage of relatively cheap spot prices, and increased volatility on hubs since Ukraine tensions started which together are and boosting traded volumes.

Day-ahead volumes at the Dutch TTF hub have seen the most growth, increasing by 13% to 151TWh in the six months to June, while Germany’s NCG achieved a 11% gain to 92TWh. Britain’s NBP Day-ahead volume growth, however, trailed at just 1% to 161TWh, ICIS data showed.

Although the mass-departure of banks from energy commodities affected all hubs, the TTF and NCG were able to offset losses in liquidity through an increase in spot indexation in supply contract renegotiations, sources said.

The NBP has benefited less clearly from the trend in renegotiation from oil price indexation to a spot gas index because most British contracts have been primarily spot-price linked for over a decade already.

German focus

Of the three markets, the NCG achieved consistent volume development over the past three months compared to the same period the previous year.

The most notable period was in the second quarter when volumes jumped by 60% to 17.8TWh in May, and by 50% to 15.7TWh in June. NBP and TTF volumes fluctuated more compared to the previous year.

The divergence between German, British and Dutch traded volumes is because “these renegotiations primarily affect German markets”, one source said. “NBP and TTF are in decline due to the exit of proprietary traders while the German market should see a resurgence led by asset players hedging to [the spot] market rather than oil.”

Traditionally, Germany has lagged behind the Netherlands and Britain on the renegotiation of its long-term contracts but continuing growth in liquidity suggests this pattern is changing.

“The market in Germany is still developing and has not achieved the same liquidity as the TTF and NBP,” another source close to the German market said.

A relaxation in take-or-pay agreements has also helped to boost traded prompt volumes because some companies, which were required to take a certain volume of gas or face a fine, were allowed to delay receipt until a later date.

The presence of these delayed volumes back on the hub is contributing to the boost in traded volume, particularly since oversupply is supporting the extended price spread between cheaper prompt prices and those on the curve.

Flexibility

Another source added that a change in the flexibility clause within long-term contracts is also helping to boost hub liquidity.

Previously, only a few big contracts were linked to long-term prices which offered a lot of flexibility. This meant that short-term needs such as balancing, for example, could be fulfilled within these contracts, a source said.

“But now, there is not the same level of flexibility in the contracts, so players have to rely increasingly on short-term products and that means flexibility is generated through spot trading,” he said.

The growing divergence between prompt and curve prices since the beginning of January has helped to make hedging on the spot more financially appealing.

Prompt prices have been driven lower by a combination of lower demand linked to mild temperatures and oversupply, while curve products have been supported by Brent crude increases linked to on-going tensions in Ukraine, Iraq and Libya.

At the TTF in June, the average Winter ‘14 premium to the Day-ahead stood at €6.72/MWh, according to ICIS data. This compares with June 2013, when the equivalent Winter ‘13 premium to the Day-ahead was just €1.215/MWh.

Renegotiations

Participants have been keen to increase spot indexation to keep their exposure to higher oil-indexed prices, and some big producers have responded by renegotiating these contracts.

Norwegian oil and gas giant Statoil, for example, has made no secret of plans to increase spot indexation. Statoil said in late 2013 that by 2015, 75% of its supply contracts would be hub-based but refrained from specifying the underlying contracts or hub.

And Russia announced earlier this year that the competitiveness of Russian gas had been enhanced through the revision of take-or-pay terms and the adjustment of the contract system to “market conditions”, although the principles of oil-indexation largely remain.

These assertions have filtered through to the market with some leading trading companies renegotiating contracts following successful arbitration hearings.

In June, French incumbent GDF Suez said it expected to reach 60% indexation from an existing 46% position in its long-term supply contracts. The French incumbent had said in February it had renegotiated two-thirds of its long-term contracts over the previous 18 months and that renegotiations would intensify again next year.

Regulator CRE found an increasing proportion of indexation in GDF SUEZ’s contracts was based on PEG Nord. This hub would account for six percentage points of the expected future indexation level of 60%. Indexation on the year-ahead gas period is also becoming prevalent in gas contracts and accounts for three percentage points, CRE said, however it did not specify the underlying hub.

In Italy, gas incumbent Eni signed a final agreement with Statoil on the revision of its long-term gas supply contract ( see ESGM 27 February 2014 ). Eni said earlier this year that by 1 January 2016 it would revisit all of its third party long-term gas supply contracts.

The spate of contract renegotiations is expected to continue over the next three to five years by which time oil indexation within gas supply contracts across north-west Europe is expected to drop to very low levels, according to ECC. Kirsty Ayakwah

By kirsty ayakwah