ICIS view: Gazprom’s price review pledge and the impact on gas hub trading

Gazprom’s central eastern European commitments are part of a piecemeal transition from oil- to hub-based pricing, but it remains to be seen if it will have any impact on EU gas trading

Russian natural gas producer Gazprom has suggested to Brussels a series of concessions regarding its long-term supply contracts to central and eastern European customers which may have the potential to subtly alter trading dynamics at some hubs.

One of Gazprom’s commitments is to allow more frequent price reviews, which would be triggered when the contract price fails to reflect the development of the European gas market and the price at its liquid hubs.

This is not the same as moving towards hub-indexation directly within supply contracts, although it could amount to much the same thing.

The commitment would essentially give contract holders some insurance in the event that oil prices begin to rise but spot gas prices do not follow, increasing the price premium of Gazprom’s supply contracts to prevailing hub prices.

Within Gazprom’s commitment is an implicit acceptance that prices at Europe’s liquid hubs fairly reflect the interplay of natural gas supply and demand fundamentals. Price revisions would effectively correct contractual prices towards the prevailing level at hubs like the TTF, NCG or GASPOOL.

This is not the first concession, however couched, Gazprom has made to hub-based pricing. Hub prices already factor, in combination with oil products, in the Russian supplier’s long-term contracts with other European customers.

Gazprom’s three gas auctions have also let market forces influence its sales price to Europe, since some interested parties no doubt enter their bids based on prevailing spot-market signals.

But the company continues to maintain a preference for oil-linked gas pricing – now with a provision to allow for frequent price renegotiation to keep contracts within an acceptable range of European hubs – instead of plumping for hub-indexation outright.

One might wonder if the extra cost, administration and effort of engaging in frequent renegotiation is worth eschewing hub-indexation merely on principle, if the overall impact on its sales price will be limited.

Hub impact

In any case, there could be the possible impact of Gazprom’s new commitment on hub trading. Oil’s correlation with the gas curve at key hubs is one dynamic that could in theory be disrupted.

As gas and oil are no longer competing fuels for heating, the only physical reason for any correlation is the arbitrage that oil-linked gas contract holders must manage between their gas purchase price and the value of their gas sales at hub-linked prices to end-users, or into the spot gas market itself.

This spread can be hedged, optimised or even profited from, but this means oil-market developments play a role in shaping participants activity at the gas hubs, breeding price correlation.

Less exposure to unfavourable oil-price moves, as seemingly would be the case under the new commitments, should mean less need to hedge and trade at the hubs based on developments in the oil market and therefore less price correlation between the two commodities.

In reality however, any change of this sort depends on the extent to which companies in Estonia, Lithuania, Latvia, Bulgaria and Poland are already engaged in such hedging activity at the key hubs – which, with the exception of the latter, is probably relatively small. Much of oil’s sway over day-on-day hub price moves is also sentiment driven, as many gas traders with no physical exposure will still track oil and take their lead from it in some circumstances.

A second related impact on hub trading could be on liquidity. As companies in the Baltic States, Poland and Bulgaria find their exposure to oil drop, their stake in price developments at liquid hubs like the TTF, NCG and GASPOOL will increase.

It therefore seems logical to expect the companies affected to consider stepping-up or breaking into European hub trading to manage a different sort of exposure. This could be a boon for hub liquidity in the years to come if there is any rise in the number of active counterparties.

One thing Gazprom’s commitments are unlikely to impact is the outright price at key hubs since there is no discernible impact on supply or demand. The spot market will remain driven by global and European gas fundamentals, oil-market sentiment and currency triggers. jake.horslen@icis.com