Thursday, 19 November 2009

Gazprom in Wonderland

As promised, an update on Gazprom’s travails in the European gas market.

The story so far: gas demand in Europe has slumped and the spot price has collapsed, facts that (under the Civil Code contracts used by continental gas buyers) can be adduced to force a renegotiation of prices and/or volumes. The big wholesale buyers are politely bringing this to the attention of Gazprom, their friendly Russian supplier. Gazprom has told them to, err, take a hike, and that their expensive oil-indexed contract prices are here to stay. Now read on...

Gazprom is reluctantly being forced to takes its arguments public. Trouble is, they are truly awful arguments, to wit:

Gazprom has defended oil indexation, saying there aren't trading hubs with sufficient volume to provide better pricing signals than oil products. "The NBP [the UK pricing hub for wholesale gas] handles 15 billion cubic meters of gas a year while Gazprom sold 160 billion cubic meters to Europe last year," said Sergei Komlev, head of price formation at Gazprom Export. "If we used the NBP it would be like the tail wagging the dog".

Unfortunately Cepëж мой друг, the figures are not these at all – you are out by two orders of magnitude.

According to best estimates, trade at the NBP is approx 10 times the amount of underlying UK demand, itself around 100 billion cubic meters per annum. A higher multiple would be preferable, but a churn of 10 is pretty respectable. Hence, price formation here is based on around 1,000 BCM of trade – around 6 times more than Gazprom’s exports. Some tail !

NBP price formation is not beyond technical criticism, but inputs include the dynamics of diverse pipeline gas supplies and LNG; the smaller German, Dutch, Belgian and French wholesale markets are highly correlated to NBP; and it is used as a pricing basis in vast amounts of contracts for traded and delivered gas and a range of derivatives across all of the UK, much of northern Europe, and in the substantial Atlantic LNG trade. It’s a real, meaningful price, reflecting the fundamentals of supply and demand. An ideal candidate for indexing long-term contract prices, obviating the need for future price renegotiations.

Still, Gazprom can rely on plentiful Stockholm syndrome amongst its counterparties.

The International Energy Agency said on Tuesday there could still be a big surplus of gas in the global market until 2015, but an E.ON executive said the IEA was being "a little bit on the pessimistic side".’

Yup that’s E.ON, a buyer, one of Gazprom’s biggest, hoping the surplus won’t last long! When our suppliers start thinking like this, heaven help us consumers.



Blue Eyes said...


I assume that transporting gas by pipe is a lot cheaper than liquid by boat, but surely there comes a point when the cost difference outweighs the price difference?

Unfortunately most of us consumers are a captive market. Heating is not an easily substituted service.

Blue Eyes said...

Whoops I meant the other way around.

Nick Drew said...

upfront (capital) costs of both can be huge - but the operating costs and variable costs of a pipeline are trivial (mostly just some fuel for compressors)

but cost of LNG liquefaction is high (re-gasifying it at the receiving end, not so)

so no-one would build LNG where a pipeline was feasible

the 'sunk costs' thought-processes are not always straightforward in either case

and frequently there are irrational / highly political players at the upstream ends of both systems !

rational wholesale buyers are less plentiful than you'd hope (see post!) but generally speaking the market price is what it is, irrespective of the economics of the producers

(you don't consider the cost of bricks when looking at the price of a house)

the E.ON's of this world get creamed by rational market players in purely trading terms but, hey, they have monopolies ! (well, 'market power' these days because most out-and-out monopolies have been made technically illegal)

Anonymous said...

I've enjoyed your gradual exposes of Gazprom over the last few months, but I have to ask, "Will anything actually be done about it?"

If E.ON et al are of the crazy mindset that you report, are the EU commission as well? All well and good pointing out the flaws, but if they can't be fixed, what's the point? The only outcome atm is that it raises my ire against those pesky ruskies.

Anonymous said...

Nick, since I am not technical, I would ask, is this going to happen, or is it hot air? :-)

Nick Drew said...

anon @ 1:16
The Commission (the outgoing one) was broadly on the side of the angels as regards opening the gas & elec markets, though they were nervous as to how Gazprom should be handled: some say 'Europe should speak with one voice' in Moscow but (a) what would this mean in practical terms for gas buying ? (b) it won't fly in any event, when Germany & Italy each favour solo grovelling

E.ON's interests speak loudly in German politics (but, conversely, E.ON is sometimes used by the German govt as an instrument of foreign policy)

the continentals all have problems stemming from their Civil Code contract models

there is hope if the German gas market can be liberalised, and there are some hopeful signs, I am optimistic (and patient!)

E.ON will need to take a massive hit, though, like BG did in parallel circumstances in the UK in the '90's. (But BG survived, demerged - and thrived ...)

the basic answer, as I've said here before, is to use this window of (temporary) Russian weakness to strike some well-structured long term contracts. This means making them subject to an appropriate common law jurisdiction, e.g. England&Wales, or NY, or Harris County TX.

Nick Drew said...

anon @ 3:44

not an engineer, so my response is also non-technical

IGCC is newish but not entirely revolutionary

I know of no reason why it shouldn't be feasible

it has strong commercial advocates in the UK, some of whom reckon the govt's current policy towards Carbon Capture & Storage (which is about to cost us all an increase in our elec bills if NuLab's Energy Bill gets passed per the Queen's Speech) is biased against IGCC

James Higham said...

For a male, Nick, you don't need the final a on Sirozh.

Nick Drew said...

I thought it was like Sasha, James, but I bow to your superior knowledge and have made the change!