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GasindexationinEuropeatippingpoint?
29Apr,2013

TheincreasinglevelofgashubindexationinEuropeansupplycontractshasbeenakeyfactorbehindtheevolutionofthegasmarketoverthelast5years.The
momentumbehindhubindexationhasgrownasNorthWestEuropeanhubpriceshaveconsistentlytradedbelowoilindexcontractlevelssincethefinancial
crisis.Thishasactedtobothdevelophubliquidityandtransparencyaswellasopeningupapainfulgapforsuppliersbetweenlongtermcontractcostsand
shorttermretailcontractpricing.

WhilstcomingupwithreliableassessmentsoftheaggregatelevelsofgasindexationacrossEuropeansupplycontractsisverydifficult,thereisundeniable
evidenceofanacceleratingtransitiontohubindexation.Butsimpleassessmentsofthelevelsofoilvsgasindexationoverlookthedynamicsthatensurethatoil
priceswillbeakeydriverofhubpriceformationformanyyearstocome.

CurrentlevelsofgasindexationinEurope

ThechartbelowshowsrecentOIESandReutersassessmentsofthelevelsofgasindexationbyEuropeansupplysource.

Chart1:TwoviewsofaggregateEuropeansupplycontractindexation

Source:TimeraEnergybasedondatafromReutersandOIES(OxfordEnergyForumAugust2012)

AsathirddatapointSocGenrecentlyannouncedthattheybelievelessthan50%ofgassupplieswillbelinkedtooilin2013.
Itisalmostimpossibletogetanaccurateassessmentofgasindexationlevelsandgrowth.Mostofthesupplycontractsarestructurallongtermportfolio
contractswithhighlyconfidentiallysensitive.Typicallycontracttermsandconditionshaveevolvedovertimethroughtheprocessesofrenegotiationandprice
reopeners.

Italsorelativelyeasytopokeholesinthetopdownestimatesabove.Forexample,beforethedevelopmentoftheNBPasaliquidhub,muchofthegascoming
intotheUKfromtheNorthSeawassoldunderlongtermcontractswithstrongcomponentsofoilindexation.Whilethesecontractshavemostlybeende
dedicatedfromthefieldthemselvesandsubjecttomanycontractrevisionsovertime,theystillcontainalargeelementofoilindexation.Asaresultitis
optimistictoassume100%ofgasfromtheUKCSisgaslinked.However,thereisanundeniabletrendofgrowthingasindexation.

Gasvsoilindexationthroughtheeyesofthereopener

Thegasvsoildebatehasbeeninfocusrecentlythroughthelensofreopenernegotiationsandarbitrations.Herethekeyproducershavetakenopposite
positions.

StatoilhavebeenmorewillingtoacceptincreasedlevelsofindexationtoNWEhubsandhavestatedthattheyexpectthemajorityoftheirsuppliesinthefuture
tobehubindexed.Andtheyputtheirmoneywheretheirmouthislastyearbysigninga10year45bcfsupplydealwithBASFprimarilylinkedtotheGerman
hubs.

GazpromandtheNorthAfricanproducershavebeenmorevociferousintheirdefenceofoilindexation.Reopenerdisputeshaveresultedinsomeconcessions
butthesehavebeenfocusedontemporaryadjustmentsofabsolutepricelevels.Gazpromhavebeenveryvocalintheirpublicdefenseofoilindexationand
havegivenonlymarginalconcessionsintermsofincreasedlinkagetogasinreopenersettlementswithmajorNWEsuppliers.Howeveritisinterestingtonote
thatGazprom,throughitsmarketingandtradingarm(GazpromM&T),havesigneda3yeardealwithCentricatodeliver2.4bcmgastotheUKentirelypriced
offtheNBP.

IftheCentricadealisasignofastrategicshiftfromRussia,thenamorerapidtransitiontohubindexationisonthecards.Butratherthanthisbeingan
indicationofastepchangeinposition,itismorelikelytobearesultofGazpromconfrontingthefactthat,giventheprevalenceofgasindexationinUK
wholesaleandI&Ccontracts,itisalmostimpossibletofindabuyerforanoilindexedgas.

Asthecontinentalmarketstransitiontowardsgasindexationasthestandardforpricingsalestolargeendusers,itbecomesincreasinglydifficultforincumbent
supplierstobearmisalignmentsbetweenexposuresintheirsupplycontractsandretailportfolios.Therehasbeenapronouncedshiftoflargegasconsumerson
thecontinentfollowingthelongestablishedUKprecedentandrequestinghubindexedgasasanalternativetostandardfuelandgasoilformulas.

Theinfluenceofoilisheretostay

TheoriginalreasonsforoilindexationaremostlyirrelevanttotodaysEuropeangasmarket.Itisdifficulttomakeacompellingcommercialcaseforthe
retentionofoilindexationasthepredominantpricinginfluence.However,theinfluenceofoilpricesonEuropeanpricingdynamicswillremainformanyyears.
Firstly,thelegacylongtermcontracts(insomecase20+years)thatunderpinmostEuropeanpipelineimportsarestillpredominantlyoillinked.Theflexible
volumes(typicallyabove85%takeorpay)areakeysourceofmarginalsupply,allowingsupplierstomanageoverallportfoliobalance.Thismeanstheywill
continuetohaveadisproportionateinfluenceonhubpricing.

Secondly,muchoftheincrementalsupplywillonlyflowintoEuropeagainstanoillinkedthresholdoropportunitycostalternative.Inthecomingyears,un
contractedRussianproductionpromisestobeakeysourceofincrementalsupplywhichislikelytobestronglyinfluencedbyoillinkedbenchmarks.In
addition,flexibleLNGcargoes(divertiblecontractorspotpurchases)willonlyflowintoEuropeifhubpricesarehigherthanthebestalternativeonanetback
basis.AsianLNGmarkets,whichstillhaveastronglinkagetocrude,arelikelytosetthatalternativeforyearstocome.

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LNGSpotvolatilityandEuropeanpriceformation

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