Gas liquidity could be hit as contracts expire, experts warn

06 June 2017 13:58 Source:ICIS
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Gas market liquidity could be hit in the years ahead, as long-term commodity and transportation contracts expire, market experts have warned.

According to a recent study by the European Commission seen by ICIS, all existing long-term commodity contracts are expected to terminate by 2036. The study shows that transportation contracts will halve by 2025, while commodity contracts are expected to show a more linear decrease.

The commission’s forecasts were presented at a workshop in Florence last month. Ilaria Conti, head of gas at the Florence School of Regulation and one of the workshop’s organisers, told ICIS that while it didn’t emerge at the workshop whether all the contracts will be renewed, it was thought to be unlikely.

“It was at least certain that some [contracts] will be renegotiated under different conditions. Some of the existing contracts were negotiated before the liberalisation process started. For example some contracts that were previously indexed to oil will now be indexed to hub prices,” said Conti.

“At the workshop people were looking for some clear signal about energy union policy – what will the role of gas be? What will be the clearest drivers for gas demand? This was high on the agenda as demand will be key to triggering long-term contracts.”

Liquidity

Conti said that one possible consequence of long-term legacy contracts expiring could be a drop in liquidity.

“At present, there is [an] abundance of capacity and commodity available to traders in the form of long-term legacy contracts. As many of these are out of the money, traders are obliged – in order to minimise losses – to buy and sell capacity and be more active on the market. All this contributes to greater liquidity (and narrowing price spreads),” she said.

Conti said that most existing long-term commodity contracts have transportation contracts attached to them.

She added that one way traders make use of these contracts to optimise their portfolios is by conducting swaps, whereby traders with surplus gas or capacity in one market swap it with traders with surpluses in other markets, which brings additional liquidity to the market.

“Traders are currently active also due to these contracts that they need to get rid of. Consequently, it’s possible that, going forward, the role of traders and shippers in the next decades will reduce,” said Conti.

“More importantly, with long-term contracts ending, it is legitimate to question what effect this will have on liquidity and spreads in the future.”

Hub prices

Other sources polled by ICIS said in addition to hitting liquidity, the potential reduction in long-term contracts could lead hub prices to diverge.

“A lot will depend on what happens in the transportation price setting. When people book capacity well in advance, it is a sunk cost. In the new world, an economic decision to move gas will only be made when the price differential between hubs is greater than the transportation charge. I think as a result of this hub prices could diverge,” said one UK-based consultant who helped in the drafting of the EU’s gas network codes.

Doug Wood, chairman of the European Federation of Energy Traders (EFET), also told ICIS that hub prices may have converged in recent years as capacity holders are treating their long-term contracts as sunk costs.

He noted that as a result of this, they are less likely to renew the contracts once they have expired, adding that transmission system operators across Europe will have more uncertain revenue streams. jack.elliott@icis.com


By Jack Elliott