Oil And Gas Pricing- Too Close For Comfort?

Separating gas indexation from oil prices would mean that major gas suppliers in Europe would lose income. Therefore they prefer that gas indexing is coupled with oil, ensuring it’s long-term gas supply contracts and bringing it closer to controlling an EU wide natural gas monopoly.

Gas has been indexed to oil prices ever since the 1960s. It was convenient for gas sellers and gas buyers to have ‘certainty regarding both volume and price as the gas was priced in the contracts at the price of the competing fuels’, this has resulted in a lack of ‘gas-to-gas competition’ and higher than necessary prices for consumers, according to Oil & Gas UK Economic report 2011.

Currently, 90% of the gas consumed in Continental Europe is sold under long-term contracts with oil price indexation that have been extended beyond 2030. One of the main strengths of indexing gas price to oil is to have the security of supply, if gas is to be sold at the continental supply hubs, countries need to know that gas will always be there in order not to risk energy shortage. However the recent US shale gas boom has unleashed a new age of cheap gas, which could trigger changes in gas indexation to oil.

Back in 1989 The Monopolies and Mergers Commission found that there was no competition between gas and oil. The decision to keep gas prices reliant on oil comes from the companies’ interests in keeping high gas prices in the spot market. John Huggins, former director of Gas Transportation, British Gas, said: ‘Changing this situation is likely to be a slow process unless there is a shock to the system from a sudden influx of extra supplies into the spot market.’

Recently Ofgem, the energy regulator, has launched investigations into claims that power firms are manipulating the wholesale price of gas. Because the prices are inflated on the wholesale market, the domestic bills are increasing too. Mr. Clark, Financial Secretary to the Treasury at the BBC Radio 4′s Today programme focused on the need to fine the profiteering power companies: ‘ when it’s as serious as this they should be punished very severely.’ However it is not clear how this would benefit the taxpayer since the fine would simply be passed on to consumers through increased bills and there is no mention of customers receiving compensation payments. This approach of dealing with the symptoms of a malfunctioning trading system rather than the causes is by no means a long-term solution.

At the same time Europe’s commitment to implement the third Energy Liberalisation Package, which says that energy supply, production and transmission activities must be separated in order to promote regional solidarity and security in gas supply is being compromised. The EU law requires ‘all energy companies active in the European market to run their supply, transport and sales businesses separately’.

However eight EU countries including Russia (Gazprom), Germany, France refused to start ‘full ownership unbundling’ in which a parent company sells its transmission networks to a different firm. Gazprom, the Russian state owned natural gas producer, is increasing its’ influence in Europe and reinforcing it’s supply chain. Recently during an asset swap with German BASF, Gazprom took over its’ natural gas trading and storage businesses. Separating gas indexation from oil prices would mean that Gazprom, the leading gas supplier to Europe, would lose income. Therefore it prefers to keep the indexing coupled with oil ensuring it’s long-term gas supply contracts and bringing it closer to controlling an EU wide natural gas monopoly.

One major threat to Gazprom’s near monopoly of the EU gas market and the old-world thinking regarding oil and gas indexing is the recent advent of shale gas. Shale gas deposits are evident in many EU countries and could quickly diversify the supply and lead to a rethinking of the pricing structures. The sudden increase in gas output from shale gas could lead to genuine gas- to-gas competition and lower prices for consumers.

Photo Credit:  youtube_user_willtrade4food

Tagged BASF, EU, gas indexation to oil, pricing, Russia, Shale Gas, third Energy liberalisation package