Statoil ditches the theory, beating Gazprom in practice
By William Powell in London
February 18, 2013 - Norway's gas exports to the European Union have been displacing Russia’s in a weak market. Perhaps not coincidentally, the state-controlled producer Statoil, which accounts for most of them, has shown greater flexibility in its approach than Gazprom in amending its long-term supply contract terms.
Gazprom typically meets a quarter of European gas demand, with Norway as the second largest.
But last year, Gazprom accounted for more than 12 Bcm of the estimated 16 Bcm decline in European gas imports, “which is an abnormal 75%, in our view, while another big gas supplier to Europe, Norway, in fact increased its deliveries," VTB analysts said in a note.
VTB said Gazprom was going to stick to its strategy on the European market, which left the company with lower (but still not competitive) prices and lower export volumes last year, after an investor’s day presentations that saw Gazprom’s share price hit a three-year low.
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Long term contracts with oil indexation do not reflect the reality of today’s liberalized market. They were drafted in the days when each merchant had a captive market and did not compete with its neighbor.
Today, oil indexed gas is more expensive than hub-based gas, as energy demand has fallen below the levels that the buyers had expected when the contracts were signed, while oil prices have risen.
That mismatch might have been manageable on its own, but there are more suppliers than before in Europe; retail customers are free to move around; and there are also competing fuels cheaper than gas.
The European hubs are some way below the price of purely oil indexed gas, while the BAFA price reflects the coexistence of oil indexed gas with a growing percentage of gas that is traded at hubs. (See related graph: European gas price trends ($/MMBtu)).
Admittedly, the gas at the hubs comes mostly from Russia anyway, but by the time the molecules have reached the hub, in an oversupplied market, they are simply surplus to requirements and that is reflected in the price.
This price difference has also hammered the fortunes of its customers – many of which are the former incumbent national or regional monopolists such as E.ON, RWE, GDF Suez, OMV and Eni.
Take or pay commitments mean that they must pay the oil-indexed price for gas they have not contractually received, until they can negotiate a lower one.
The high price of gas has forced the closure of even their most efficient gas-fired power generating plant and encouraged the greater use of coal -- a perverse outcome in a European Union that is striving to cut its carbon emissions.
Gazprom sticks to its guns
So in this tough environment, producers have had to compete on price. But while Statoil has been busy ‘modernizing’ its contracts behind closed doors with its customers, Gazprom has taken a very different approach.
It has decided to adhere to the ideology underlying long-term contracts, but let its gas exports fall, and then to issue its customers with back-dated credits that reflect the amount of gas at stake, and the length of time their contracts were out of the money. These run into the billions of dollars, in aggregate.
Gazprom refunded $2.7 billion in 2012 and plans another $4.7 billion in potential price cuts this year as it aims to keep its pipeline gas prices competitive with spot prices.
Gazprom has also engaged in a public argument with the Oxford Institute of Energy Studies, which claims that Gazprom is jeopardizing the future of gas in Europe by its rigid adherence to the principle of oil indexation.
Gazprom Export’s pricing group, under the direction of Sergei Komlev, has produced a number of papers explaining the history and the continuing need to use oil indexation to fund upstream production. His most recent, in English, came out in January.
It argues that hubs are too illiquid and shortsighted to generate any kind of meaningful signal; that it is unreasonable to burden producers with both the pricing and the reservoir risk; that in Europe, only the UK’s National Balancing Point is meaningfully liquid; and hub prices are anyway a function of oil indexed prices, so lowering the latter would inevitably lower the former even more; and the production costs of gas and oil are roughly similar, but gas costs about thirty times more to store and transport than oil.
But however compelling these, and other arguments that Gazprom has deployed, may be, they have no calorific value and its customers are simply not buying them.
War of words
Indeed, this failure to meet its customers’ requests could have long-term repercussions for gas itself. Academics Jonathan Stern and Howard Rogers said in an OIES paper published February 11 that Gazprom Export was jeopardizing the future of gas, by pricing it out of the market.
Without a rapid adjustment to hub prices, gas will become a “sunset industry” in Europe, they claim.
Stern and Rogers have consistently said that hubs are the way forward, and oil indexation is no longer rational. Even in Asia, they say, its hold is weakening.
In their latest paper they state that market developments since 2007, "when we first published research on this subject, provide ample evidence that Continental European gas prices are moving inexorably in this direction."
The difference between day-ahead prices at different hubs is now very small. The Italian gas bubble has finally burst, and the oversupply of contracted gas has hit the market. Capacity has been freed up, enabling plenty of participants to trade at the Italian hub and so discover the true price of gas. (See related graph: Long-term vs short-term gas prices (Eur/MWh)).
They said Komlev had confused the relationship between oil and gas price levels with the case for maintaining formal contractual linkage to oil product prices in long term supply contracts.
However, "until genuine competition and substitution between oil products and gas is re-established, there is no case for a formal contractual linkage between oil and gas prices," they said February 12.
Next page: Gazprom insists on making its gas more expensive