Vicious volatility fosters EU trade [NGW Magazine]

Despite the impact of pandemic-related lockdowns on gas demand, most of Europe’s main gas hubs have shown remarkable resilience with traded volumes extending the growth seen last year.

Increased hedging activity from traders re-adjusting positions in March was one of the key drivers behind the uptake in traded volumes, according to market observers. Traded volumes have also been boosted by high price volatility presenting market participants with profit opportunities. Growth in traded volumes is a strong indicator that market liquidity remains robust with multiple buyers and sellers trading frequently at the main hubs.

In the first quarter of 2020, the growth rate in traded volumes on Europe’s gas hubs was up by over 30% year-on-year, according to the European Commission (EC)’s quarterly gas reports. The amount traded dropped significantly in the second quarter but was still 7% higher than in the same quarter last year.

In the first six months of the year, trade rose by a fifth year-on-year, according to the latest monitoring report from the Agency for the Cooperation of Energy Regulators (Acer). Last year also saw the same proportional increase on the year before.

The traded volumes on Europe’s main gas hubs reached 1.320 trillion m³ in the second quarter, worth €84 ($98)bn based on average spot prices, according to the EC’s report. It said 24 times more gas was traded than was used in the seven member states measured: UK, France, Germany, Italy Netherlands, Belgium and Austria.

The Dutch Title Transfer Facility (TTF) in particular saw more trade this year, despite prices falling to historical lows. The amount traded in the second quarter was up by a sixth year-on-year.

The TTF now accounts for two thirds of the total gas trading in the EU. Its chief rival – the UK’s NBP, Europe’s first and formerly largest gas hub – saw traded volumes decline 23% year-on-year in the second quarter. Uncertainties linked to Brexit and the relative stability of the euro/pound exchange rate are among the reasons why continental traders are flocking to the TTF, according to market observers.

“TTF has emerged to become a liquid continental benchmark, having the advantage of euro-denomination, and benefiting from its good connection to various supply sources and access to seasonal storage as well. On the other hand, a further decrease on the NBP hub signalled a shift from what was once Europe's most liquid market,” said the EC’s report.

The TTF is also increasingly becoming a benchmark for global LNG pricing, and is creeping into some Asian contracts. Chinese oil and gas major Sinopec, for example, sees the TTF as better correlated with global LNG prices than the US’ Henry Hub – the world’s most liquid gas market – the EC noted. 

Traded volumes on the two German hubs – Gaspool and NGC – were up by 4% year-on-year in the second quarter, while Italy’s PSV saw an increase of 5%. 

The rise though cannot mask the fact that demand took a major hit in the wake of the pandemic. In the first half of 2020, EU gas consumption amounted to 203bn m³, down 14bn m³ compared with the same period last year. In the second quarter, gas demand fell by 8bn m³ to 71bn m³. The decline was mainly due to lower industrial activity and lower gas-fired power generation.

Gas demand has shown signs of recovery in the second half of 2020, but with a second wave of Covid-19 restrictions hitting many European countries there is no doubt that 2020 was an overall bearish year for gas and suppliers such as Algeria and Russia will be hoping for a seasonably cold winter with more people working from home. 

Gas demand increased by 3% in the third quarter of 2020, driven by power generation, according to the International Energy Agency (IEA). Cold spells in September and October also supported demand.

Long-term legacy contracts

From now on it seems that hub trading will be boosted further by the gradual expiry of long-term contracts. Shippers have shifted their focus to short-term capacity bookings for a maximum of one year ahead, while long-term bookings are increasingly dominated by upstream players.

“It is true that upstreamers are more active [...] it is because mid-streamers are less active for these longer-term capacity bookings. They want to take less risk and try to focus more on the shorter term,” Acer’s Bart Veerecke told a recent webinar.

More than a third of the EU legacy contracts’ volume in place at end of 2019 will have expired by the end of 2023, while more than 60% of them will no longer be in place by 2028, according to Acer. The shift towards short-term capacity bookings should free up more transmission capacity as long-term contracts typically had fixed, physical delivery points at borders. This will boost competition further.

“More than half of contracted transportation capacity valid at the start of 2020 had been booked before 2015, but in the coming years, expiration of legacy long-term contracts will accelerate and they will almost completely disappear by 2035,” said the market monitoring report. 

The shift towards short-term capacity bookings means that the EU’s network codes - which were designed to harmonise capacity auctions and prevent capacity hoarding - will play an even bigger role than before. The capacity allocation mechanism network code (CAM NC), for example, aims to harmonise capacity auctions rules between member states and standardise cross-border capacity contracts. 

In most member states, according to Acer, long-term capacity contracts have been largely or fully replaced on expiry by shippers booking new shorter-term products that are compatible with CAM NC. Acer noted, however, that it is uncertain if this trend will continue, as LNG could displace some cross-border pipeline flows. Moreover, the current level of natural gas demand is incompatible with EU decarbonisation objectives under the Green Deal, Acer noted.

German market merger

The TTF and NBP are by far Europe’s most liquid hubs, but there are signs that liquidity elsewhere is improving. All eyes are on Germany's two gas markets, GasPool and NCG, which will be merged into one single hub in time for the start of the next gas year, October 1 2021.

This will be the last stage in a merger process that has taken over a decade to whittle the regional networks down to just two balancing zones.

Preparations to facilitate the merger are stepping up ahead of the launch. 

The national energy regulator Bundesnetzagentur recently approved new rules for common transportation tariffs which will apply to the enlarged market.

Market players are hopeful the merger will boost liquidity in the German gas market, particularly in the light of new infrastructure such as Nord Stream 2 and possibly a new LNG regasification terminal in a few years. 

The German power market is already mature and a liquid gas market would facilitate spark spread trading and possibly challenge the TTF's status as continental Europe's single benchmark hub. It would also compete with Baumgarten to become an East-West reference hub for Europe.

The timing of the market merger could suit Germany well as the country is phasing out nuclear power by 2022 and gradually also coal-fired power. This means gas is expected to play a key role in supporting intermittent power supply from wind and solar over the coming decade. 

Persistently high prices for EU carbon allowances and relatively low gas prices are already encouraging fuel switching from gas to coal in Germany. Gas-fired power generation rose by over 10% year-on-year in Q3 2020, while electricity production from coal and lignite dropped 9% and 7% respectively, according to the IEA.