Analysis: Oil indexation waning, but gas price impact still felt – analysts

Recent negotiations over long-term natural gas supply agreements have seen a decrease in the prevalence of oil-indexation, but the link between the two commodities is still significant.

Historically, long-term gas contracts were oil-linked, causing a high correlation between the two. This type of supply agreement is becoming less popular, with buyers preferring to link contracts to hub prices, but the oil element is still significant.

“Indexation is no longer as high as it has been in previous years,” one TTF trader said. “In past years, many longer term deals – particularly those with the Russians – were heavily linked to the price of oil, but these have been scaled back.”

Analysts agree, with Commerzbank’s Eugene Weinberg telling ICIS: “One should neither overestimate, nor underestimate the significance of these contracts. The quantity may have declined in recent years, but they certainly are still relevant.”

Others, including the Oxford Energy Institute for Energy Studies, which recently published a report on the subject, maintain that while large suppliers, notably Gazprom, publically maintain their support for oil-linked contracts, they have shifted towards hub-based pricing.

“Gazprom’s price-volume strategy is one of the key determinants of the ‘new world order’ in global gas dynamics, and is not straightforward. The company had been in negotiations, often leading to arbitrations, with its European pipeline gas customers under long term oil-indexed contracts from 2010,” the institute said.

It highlights two periods in the negotiation process, the first between 2009-2012 where customers were obliged to pay for minimum quantities with an oil-linked price formulae, but could purchase additional volumes at hub prices.

The second ran from 2012-2014 where oil-indexation remained in the price formula, but it was not the only input and a proportion of the contract was hub linked.

But traders and analysts mostly agree that significant shifts in the price of oil still have a palpable impact on gas prices.

“We’ve been hearing for years that movements in oil is less significant than before, and yes, the impact may be less, but longer term, gas prices still follow oil,” another trader said.

Analysing the correlation

The numbers back up the general consensus, with data compiled by ICIS showing the price correlation on an annual basis between Brent crude and year-ahead Dutch TTF contracts had a statistical significant 0.54 so far in 2014, with a reading of 1 indicating a perfect correlation and a reading of -1 the reverse.

Strongly-correlated commodities like gold and silver give a reading of about 0.8.

As expected, the link appears to be trending lower. In 2011, the annual gas/oil correlation was at 0.69, while in 2012 it was at 0.67. But breaking the trend, 2013 registers 0.339.

The data appears to be most highly correlated during periods of strong directional moves in the oil price, as opposed to periods of range trading. The correlation also weakens in the colder months, when natural gas prices are more strongly influenced by fundamentals.

Many analysts highlight a sentiment relationship between the two, but Commerzbank’s Weinberg points out that oil and gas prices are often driven by the same fundamentals.

For example, weak European demand will affect both oil and gas, whereas a glut of US gas can affect LNG prices, in turn weighing on European gas markets. Eddie van der Walt