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European gas market set for growth and change in 2011


By Alex Froley


January 19, 2011 - The European gas market is expected to grow in 2011, but faces a year of change as traditional long-term contract arrangements are renegotiated, major new supply routes come into operation in north and south Europe and regulatory arrangements continue to undergo reform.


European gas demand is expected to continue to grow in the future, by around 1%/year over the long-term, according to the European gas industry association Eurogas's 2010 statistical report.


Eurogas sees a key role for natural gas in the future, based on its proven technologies and its environmental friendliness. Gas produces half the carbon dioxide per unit of power that a coal plant would.


The global financial crisis of late 2008 hit the gas market hard, and in 2009 European gas consumption fell around 6%, Eurogas says. But it started to recover in 2010.


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Gas demand picked up around 12% in the first six months of 2010 compared with the same period of 2009, mainly because of a cold winter in 2010 that boosted heating use, but also because of industrial recovery.


Over 2010 as a whole Eurogas believes gas consumption may show a rise of between 6-8% from 2009 levels once the final data is in. A second cold winter already underway may help the figures.


A counterbalance to expected recovery in demand is the possibility of an upgrade to Europe's gas reserves and production potential.


The US market has been transformed in recent years by the rapid growth of unconventional gas production, and the gas industry will be watching eagerly in 2011 for any indications as to how far the experience could be replicated in Europe.


While Europe undoubtedly has shale gas reserves, it is not yet clear what prices they could be produced at, and some commentators point to substantial differences between the European and US environments, such as in population densities and land-rights arrangements, that could limit development.


But exploration is well underway in countries including Poland, Germany and the UK and there is a possibility of significant finds, that at the upper level could provide a major boost to the market.


Contract renegotiation


The biggest commercial issue of post-crisis times has been the divergence of gas and oil prices. While oil prices bounced back rapidly from their post-recession lows, and are now looking strong at around $100/barrel, European gas prices were much slower to recover.


That led to the opening up of a gap between gas bought in the short-term spot markets, and gas bought under Europe's traditional oil-indexed long-term supply contracts, a mainstay of the market for decades.


The widest gap was in 2009, when spot gas was seen as low as 50% of oil-indexed gas. During 2010 the spread tightened, with spot gas closer to 75% of the oil-indexed price, according to Platts indicators, but still offering a substantial discount.


The divergence has led major European utility companies such as Germany's E.ON, France's GDF Suez and Italy's Eni to look to renegotiate their contracts with major producers such as Norway's Statoil and Russia's Gazprom.


The buyers are reluctant to sign up to further multi-year deals that could lock them into paying higher prices than competitors could achieve buying spot gas.


Although adjustments were struck between buyers and sellers in 2010, companies are continuing to look for further changes, with E.ON a key voice for change, and behind the scenes companies will be hard at work on their negotiating strategies throughout 2011.


Klaus Schaefer, CEO of E.ON's gas unit E.ON Ruhrgas, said on December 7, 2010 that "to safeguard the competitiveness of gas and preserve its market share in Germany and Europe, central elements of supply contracts with major gas producers ... have to be readjusted."


The divergence has led major European utility companies such as Germany's E.ON, France's GDF Suez and Italy's Eni to look to renegotiate their contracts with major producers such as Norway's Statoil and Russia's Gazprom.


Few details of the talks are made public, but buyers are thought to want to preserve the security of long-term contracts, while making them more flexible, and closing the gap between long-term and short-term prices.


Options could include more frequent reviews of contracts, discounts to current price formulae or switching from oil-indexation to spot gas market-indexation.


Russia's Gazprom, as the biggest seller in the talks, has been resisting moves away from traditional long-term, oil-linked deals, arguing that long-term contracts provide security for upstream investments, and that the global oil market is a reliable, transparent benchmark.


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