British gas producers faced with summer of reduced export demand

British gas producers face a summer of meagre profits as demand for their exports is reduced, feeding through to a weak price differential between British and Belgian markets.

The price spread between NBP and Zeebrugge products, commonly known as the basis, is the key driver of exports on the bi-directional Interconnector pipeline. Gas contracts at Zeebrugge are often more expensive than at the NBP during summer, as continental utilities tap British fields in order to refill storage supplies for the coming winter.

The Zeebrugge Summer basis could give some indication as to how British and continental gas prices will compare over the summer. The current financial incentive is greatly reduced as continental utilities turn elsewhere for their gas.

According to trade data reported to ICIS, Summer ’15 at Zeebrugge Beach has traded at a spread to its NBP peer on 57 occasions so far this calendar year, at an average 0.06p/th premium. This compares with 68 front-summer basis trades in the same time last year, at an average 0.17p/th price premium.

If the tight Summer spread is borne out in lower prompt bases throughout the summer, this would reduce shipper incentive to flow British gas to the continent, assuming all other factors remain unchanged.

According to a number of traders, continental utilities are reaping the benefits of long-term contracts indexed to the price of oil that until now have been largely ‘out of the money’ compared with hub prices.

“I guess the market expects continental utilities to utilise or nominate more Russian gas this summer given the expected level of oil-indexed prices in their contracts,” said one analyst at a commodities house who wished not to be named.

Oil-indexed gas for the German market, a key destination for storage injections in the summer, is currently far cheaper that at both British and Dutch hubs, according to ICIS estimates of long-term contracted gas.

ICIS estimates show Russian supplies could be as much as €1.00/MWh cheaper than the NBP Summer ’15 contract and €0.425/MWh cheaper than the same contract at the TTF.

Commodity charge

One key factor driving the basis is the commodity charge on gas entering the British gas system, which has historically created an export bias on the Interconnector, has changed since last year.

On 1 October 2014, the British entry cost rose from 0.0512p/kWh (1.5p/th) to 0.0616/kWh (1.8p/th). As it costs shippers approximately 0.7p/th to deliver gas beaching at Bacton towards Zeebrugge, the Belgian hub remained the more profitable place to send gas even when prompt prices were as much as 0.8p/th weaker than at the NBP.

Since the commodity charge increased at the start of the gas year, the Belgian hub may still draw gas from Britain when prompt prices are up to 1.1p/th below the NBP. One market source pointed to this dynamic to explain why this year’s lower front-season basis could have little impact on British exports to Zeebrugge.

No commercial flex

With current charging and output profiles, many British producers are likely to continue exporting to the continent, albeit at a lower profit, according to market sources.

With output declining steadily since 2000, British gas production has lost most commercial flexibility. A significant amount of gas is produced alongside oil, making it costly to alter production in response to any change in prices.

Southern North Sea gas fields that beach at the Bacton terminal are the most likely to export to continental markets in the summer.

Last summer exports to the continent touched a three-year high of 3.8 billion cubic metres (bcm). This broadly equals the 3.9bcm of gas that entered the system at the Bacton terminal North Sea fields. A great amount is exported directly into the continental market.

Industry predictions are for a stable production profile. This raises the prospect of some movement in prices at the NBP, traders said, with producers facing the choice of exporting at a reduced profit or selling in the British market

“I wonder if the UK gas price will fall so much to encourage exports [given] the amount of LNG set to arrive,” said Nick Campbell, risk manager at Inspired Energy PLC.

“I think currently that is the most likely as Russian gas should be strong into Europe in order to avoid take-or-pay issues,” he added.

Positioning

The Zeebrugge price continues to trade at a discount to NBP. However, looking forward, a trader has suggested significant flows from Bacton can keep downward pressure on prices in the medium term.

Market participants are expected to position themselves in relative value Zee and NBP product spreads and timespreads of these product spreads across the curve, in order to capture perceived value as the market tends towards oversupply in the coming months.

That said, considering strong gas flows into the continent on the back of lower oil-indexed prices in light of a weak crude oil market, going forward the supply-demand balance between Britain and the continent will be keenly studied. Albert Evans, Jake Horslen and Surya Kanegaonkar