Retrospective: EGM celebrates 20-year anniversary

15 January 2014 15:36 Source:ICIS

In January 1994, the first issue of EGM provided essential and unprecedented price transparency into a very opaque natural gas industry. Twenty years on, EGM founder Patrick Heren talks about the seismic changes in the European gas sector and the role EGM played in promoting liberalised gas markets

The first edition of European Gas Markets was launched 20 years ago this month. It was a very different world from today’s – a world that EGM would play a key role in transforming.

In 1994, the liberalisation of the gas business was in its infancy, and it is fair to say that outside the UK and Germany, the idea of gas-to-gas-competition was derided by most industry experts.

Nevertheless, EGM’s timing was propitious. The idea of market liberalisation was gaining strength, with the two core principles of gas-to-gas competition and equal access to transport and other infrastructure. These principles completely undermined the basis on which European gas industries had been developed.

North American gas had been deregulated in the mid-80s, giving birth to a massive and often volatile spot gas market and, since early 1990, the NYMEX natural gas futures market.

In the UK, the former state monopoly British Gas had been privatised in 1986, but it was the liberalisation of electricity supply that provided the key to open the gas market:

The former state power monoliths were broken up and privatised as four generators and a dozen distributors.

Independent power producers (IPPs) were established, and all of them chose to build combined cycle gas turbines, which required long-term gas supplies.

The dash to supply the IPPs led to an exploration boom in the North Sea.

The government decreed that no more than 90% of output from any new field could be sold to British Gas, which forced the gas producers into the arms of the IPPs.

Price discovery

The key to any market is price, but, despite the US example, few gas industry executives grasped the implications of liberalisation. They especially did not understand that a competitive market would lead to spot trading and spot prices that eventually would become the index.

As a monopsony buyer in the North Sea, British Gas had imposed its own pricing system on gas producers. Typically, a life-of-field contract included a base price with annual or quarterly escalation in line with official inflation indices. At first, there was little change in the overall approach.

In the early nineties, the IPPs signed similarly-structured life-of-field or long-term contracts. That was not surprising as most of the people involved – on either side of the table – had emerged from the generously staffed British Gas Supply Department, and were serviced by the same group of lawyers and consultants.

But as gas began to flow to the first IPPs and independent gas marketers, imbalances necessarily arose. In some cases, CCGTs (combined-cycle gas turbines) were not ready to receive contracted gas supplies, which then had to be sold into the fledgling industrial market.

Spot market development

The first spot deals took place in 1992. By 1993, when I was planning the launch of EGM, several companies – including the aggressively pro-competition Enron – were irregularly trading gas, while Morgan Stanley, always the quickest of the investment banks to support an incipient market, had appointed a gas trader. It was more of a club than a market, and all deals were done bilaterally by telephone, or possibly down the pub.

Traders – actually mostly the people doing deals were either senior executives or operations staff – were happy to talk generalities, but reluctant to reveal prices.

At the time of EGM’s launch, the former British Gas monopoly was gradually being split into three entities, a UK supply arm (now Centrica plc), the British pipeline company (now National Grid Gas), and an international business (now BG plc). The UK supply arm had begun to channel small volumes from the Morecambe gas fields, which it controlled, into the new spot market, providing essential liquidity.

Russian revolution

Across the Channel, something equally dramatic was happening. Although at that stage there was no real move within the EU to enforce UK-style competition, revolution had come, unexpectedly, from the ruins of the Soviet Union.

Gazprom – formerly the Soviet ministry of the gas industry – had taken over the long-term export contracts held by Soyuzgazexport, an agency of the Soviet Foreign Trade Ministry. The bulk of the gas delivered under these contracts was supplied to the Big Three of western European gas: Ruhrgas, Gaz de France and Snam of Italy. The price was linked to oil prices, and was supposed to represent competitive value in the end-markets.

Gazprom, under its first chairman Viktor Chernomyrdin (subsequently Russia’s prime minister), believed, rightly or wrongly, that it was not getting full value for its gas.

It wanted a piece of the “added-value” enjoyed by its trading partners. The problem was, without third party access to the pipelines owned by those same trading partners, it had little prospect of doing so.

In the meantime, the first moves towards market liberalisation in Germany were paradoxically spurred by Gazprom’s direct involvement. German chemical giant BASF had long complained about the cost of feedstock gas supplied by Ruhrgas to its Ludwigshafen petrochemical facility.

In the early nineties, it entered into a partnership with Gazprom, establishing a joint-venture German gas marketing company Wingas, and an international trading company Wintershall Erdgas Handelshaus (WIEH). It also began building a pipeline network within Germany, starting with the Midal pipeline, and a new Russian export line, Yamal-Europe, which would cross Belarus and Poland.

Due to lack of access, Wingas had few sales, but other post-Soviet developments provided opportunities for competition in the former East Germany.

Here, Verbundnetz Gas (VNG), the old gas merchant, had been sold off to various western shareholders, of which the largest, with 35%, was Ruhrgas, and the second largest, with 20%, was Wingas. In a move that caught Ruhrgas and VNG off-guard, Gazprom transferred the VNG sales contract to WIEH, which immediately sought to raise the gas price from the sweetheart level inherited from the old Soviet trade relationship to a level higher than that paid by Ruhrgas, etc.

This manoeuvre took place just as the first edition of EGM was being prepared, and of course it was an excellent lead story. Hoping to learn some more, I rang the boss of one of the protagonists.

“Herr Heren, if you wish to know the prices that all of these companies are paying this month, please phone back in 20 minutes.” He was as good as his word, and the prices of six of the chief gas supply contracts into Germany duly appeared on page 1 of EGM under the headline “German gas war exposes real prices”.

It was part of EGM’s stock in trade that we had a reasonable handle on the changing levels of European border prices, but I could never have hoped for this level of transparency, especially in our first issue.

The tide of competition swiftly transformed the British gas market, with the spot market, as recorded by EGM, giving British consumers the lowest prices in the EU, while the “dash for gas” in power generation meant that the UK was the only nation to meet its Kyoto CO2 reduction target – a fact forgotten by politicians today.

Slow going

Progress on the continent was slow, and real liberalisation took another decade. That was despite the arrival of the Interconnector pipeline, sanctioned in December 1994.

One of the biggest changes since 1994 has been the shift of ownership. Some gas companies have been privatised, others have passed from the control of Big Oil to Big Power: Ruhrgas being the most obvious example.

Twenty years ago, the LNG market was still structured on traditional lines, and it is one of the features of the current market that it enjoys access to flexibly priced LNG – but competes for it with other markets around the world.

In 1994, the industry was stumbling reluctantly into a liberal market forced on it by politicians and regulators. In 2014, a radically restructured gas industry is largely competitive, but politicians and regulators have turned their backs on competition as such, and instead have distorted the entire energy market in order to encourage investment in renewable generation. Gas demand has been depressed and, despite relatively high prices, investment has been stifled.

But the genie of competition is well out of the bottle, and will stay that way whatever the political and economic circumstances. I am proud that EGM played a role in bringing this about. As I wrote in our first issue:

“Although we at EGM pride ourselves on our news-gathering and analytical abilities, readers should be in no doubt that ‘markets’ is the operative word in our title…. In a market where information is still at a premium, we believe that our independence, intelligence and integrity is a guarantee to our readers of the best possible service.” Patrick Heren

In 1994, the industry was stumbling reluctantly into a liberal market

By Patrick Heren