Preparing for Changes in Market Design

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1 Preparing for Changes in Market Design EMART Conference Didier Lebout, Strategy and Development Director Gazprom Marketing and Trading France Amsterdam, 21 November 2012

2 In this presentation GM&T Ltd: a brief presentation GM&T Ltd: Structure inside the Gazprom company Gazprom Marketing and Trading France Question 1: A European Gas Market without long term contracts? Economic facts LTGC versus CEMP? Question 2: the end of old fashioned oil indexation? Market Commonalities Argue in Favour of Similar Pricing Structures for Oil & Gas The importance of oil indexation Long-term contracts as a "win-win" option for sellers and buyers The hybrid pricing model: a short description Question 3: to align EU with the «US gas model»? Fundamental differences between US & Continental European Pricing Models the specificities of Continental Europe Consequences of the overexposure of spot-market prices to short-term trends: the example of shale gas production in the US Summary: gas price models & contracts Question 4: «golden age of gas» or «age of cheap gas»? - Emerging tendencies in worldwide gas business Global gas balance Europe will stay an attractive gas market Natural Gas has a key role in the European Energy mix in order to achieve the Energy transition at economical costs Diversification of GP marketing routes Gazprom Marketing & Trading France 2

3 GM&T Ltd: A global trader inside the Gazprom Group Natural gas LNG Power CO 2 Carbon emissions credits He Helium & other natural gas byproducts LPG and Crude oil Gazprom Marketing & Trading France 3

4 Gazprom Marketing and Trading France Our landmarks: Company created in mid-2006 First sale to the end user: end of : direct sales to very large end users-monosite : expanding to medium sized end customer market and multi-site large clients : first smart meter installed 2011: development of sales to small and medium clients Total of approx.1bcm delivered in 2010 French sales organization is integrated inside GM&T Energy team active in UK, Ireland, Belgium, Netherlands, Germany,... Gazprom Marketing & Trading France 4

5 Question 1: A European Gas Market without long term contracts? Let s look at economic facts! Long term contracts in the gas business are not an exception it is clearly the dominant case! Except in the US & UK these are countries with numerous indigenous gas producers & marginal gas importation, and with a financial commodity trading tradition all other regions worldwide are dominated by Long Term Gas Contracts (LTGC) ; Even the growing LNG business is at 85% based on long term contracts (and also oil indexed)!. Spot transactions will keep growing in the global gas business, but are a long way off accounting for the biggest volumes, or even becoming price representative (except on arbitrage transactions). The 3rd Energy package is driving EU Energy policy to an internal EU gas market design based exclusively on «commodity exchange/liquid market places» ( CEMP - so called «spot gas») The EU has a declining internal gas production- and whatever the change in the EU energy mix will probably have to import an increasing volume of natural gas up to All existing gas exporters to the EU are handling natural gas to EU based chiefly on long term contracts : Norway, Algeria, Nigeria, Qatar, Egypt, Libya, and Russia there is low chance that this situation will change even if EU internal market rules are drastically changed; Who will take the risk between long term sourcing contracts (10-30 years) up to the EU border and short term wholesale business inside the EU area, based on exchange marketplaces working with short term visibility? The appetite for «spot gas» in the EU is linked to the low level of spot gas prices- it is not an appetite for a market design revolution! The statement of a permanent low spot price level (versus long term) is a risky gamble on a long term basis!! Gazprom Marketing & Trading France 5

6 LTGC versus Commodity Exchange Markets? Don t compare apples and oranges! Don t restrict the variety of your food menu! The model of CEMP is very «fashionable» because it delivers commodity trade instruments If markets are liquid, it gives a lot of arbitration opportunities If market are liquid, it delivers a «fair» price signal (supposed to be based on the balance supply/demand) If markets are liquid and correctly regulated, it gives opportunities for new operators to enter the business and to stimulate competition (supposed to generate the «lowest possible» prices for end-customers). LTGC is NOT a commodity trade instrument, it is an investment vehicle, it is a financial tool for long term project financing: year guaranteed availability of physical natural gas flows from producers to identified delivery points; Yearly take-or-pay obligation + carry forward mechanisms investments in logistic chain are backed-up + flexibility; Large daily free flexibility Oil linked (but sometimes coal, ) with 6-9 months time lag (low price volatility); Regular price level & contract review (generally 3 years) Price level based on a net-back replacement value calculation (competitive replacement price at end-user level minus transportation costs) LTGC and CEMP are not exclusive : they are complementary tools! Gazprom Marketing & Trading France 6

7 Question 2 : the end of old fashioned oil indexation? Market Commonalities Argue in Favour of Similar Pricing Structures for Oil & Gas Oil and gas continue to share many commonalities; price indexation is a natural extension of this Similar exploration and drilling technologies Similar cost structures Increasing convergence in end-use markets World Oil Consumption World Gas Consumption World Gas Consumption Other, 12.5% Other, 12.5% Transport, 5.50% Non-energy use, 16.5% Industry, 9.3% Transport, 61.7% Non-energy use, 16.5% Industry, 9.3% Other, Transport, 48.80% 61.7% Industry, 34.90% Non-energy use, 10.80% Other includes agriculture, residential, commercial and public services, and non-specified uses. Source: IEA. Gazprom Marketing & Trading France 7

8 Oil-indexation is the guarantee of a fair gas price: Gas loses its value when disconnected from oil Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 1,8 1,6 1,4 1,2 1,0 Oil parity 0,8 0,6 0,4 0,2 0,0 BAFA Henry Hub NBP Japan LNG import average Gazprom Marketing & Trading France 8

9 LTGC: a win-win option for sellers and buyers 1. Secure gas supplies For gas consumers 2. Predictable pricing signal 3. Protection against the abuse of any market player 4. Flexibility and services under long-term contracts For gas producers 1. Possibility to plan investments: production and transportation of gas is only reasonable under long-term contracts with off-take obligations (no one would construct a costly pipeline without firm guarantees that it will be filled with gas) 2. A fair gas price Gazprom Marketing & Trading France 9

10 Hybrid pricing model: how does it work? U.S. Pricing Model End-users Distribution Companies Hub Hybrid Pricing Model End-users Distribution Companies Importers Short-term contracts Arbitrage through Interconnector & BBL Hub(s) Producers of all types Long-term contracts Pipeline gas suppliers (3 rd countries) LNG suppliers (3 rd countries) A hybrid pricing model in Europe s gas market 1. Long-term contracts and oil-indexation: leading role, secured supplies 2. Spot-market: balancing role, arbitrage for companies at the margin Closely interconnected, healthy balance between its two components Gazprom Marketing & Trading France 10

11 Question 3: to align EU with the «US gas model»? Fundamental differences between US & Continental Europe Pricing Models the specificities of Continental Europe 1 USA Continental Europe Hub price is a function of total demand and supply Hub prices are a function of multiple examples of arbitrage USA Continental Europe USA Continental Europe USA Continental Europe One price at a level determined by Henry Hub Multiplicity of prices Company supply managers determine the price of gas portfolio Majority of gas is sold on hubs Majority of LT export contracts incorporate diversion clause Small volumes of physical trade on hubs represent primary sales The remaining volumes of gas traded come from LT contracts for pipeline gas High churn ratios Churn ratio below 4 (low, but sufficient for balancing market) Gazprom Marketing & Trading France 11

12 Consequences of the overexposure of spot-market prices to short-term trends: the example of shale gas production in the US U.S. Natural Gas Production and Imports(bcf/d) Federal Gulf of Mexico production (right axis) U.S. net imports (right axis) Marketed production forecast (left axis) annual change (bcf/d) U.S. non-gulf of Mexico production (right axis) Total marketed production (left axis) Source: Short-Term Energy Outlook, November 2012 Gazprom Marketing & Trading France 12

13 Summary: gas price models & contracts (1) Be aware that except the UK & US, the oil index reference dominates the natural gas business: 90% of LNG contracts are oil indexed; Asia, Africa & South America business are pure oil indexed; In Europe, nearly all producers ( Norway, Holland, Algeria, Nigeria, Egypt, Libya, Qatar, Russia) are mostly or completely working with oil indexed contracts. (2) Bear in mind that recent appetite of EU regulators and some EU utilities for «spot» gas indexed reference is due to the low level of spot prices. However, very few European end-customers are ready to sign spot market indexed contracts: balancing gas delivered at day ahead price reference? Flexibility no more included in the contract but delivered at spot market price value? There is large confusion between «price level» (spot price level versus LT contractual price level, «contractual model» (long term contract with TOP principle, availability guarantee & large flexibility included versus short term contracts with no flexiblity and no guaranty of delivery) and «price indexation principle» (oil versus gas index). (3) The relevance of the hybrid pricing model has to be assessed with regards to the European market s own characteristics instead of misapplying North-American conditions: The European market is far from becoming liquid and it will take a long time to build up the infrastructure necessary to change the historical design of the European gas industry; Increasingly dependent on imports. Gazprom Marketing & Trading France 13

14 Question 4: «golden age of gas» or «age of cheap gas»? Emerging tendencies in global gas business Price differentiation between regional areas will keep driving the spot LNG flows and gas project development; LNG role is growing but is only dominant in Asian markets, and will remain marginal in US & Europe; Shipping costs are more and more a key factor Back on the way to «a single global gas market» model? Only if price volatility can be kept under control Gazprom Marketing & Trading France 14

15 Forecasts Prices in USD/ thousands cubic meter Gazprom Marketing & Trading France 15

16 Global gas balance Uncertainties are growing in the global picture of the gas business: Uncertainties about gas importation demand in EU and in USA; Uncertainties about price dynamic; But growth of gas demand is not contested as a solid fundamental Natural gas development will be driven by: Low emission profile of gas versus oil & coal in power generation & domestic heating, but only if spreads are in line with rational factors Growing use of gas in transport Gazprom Marketing & Trading France 16

17 Europe will stay an attractive gas market On a long term basis, Europe is a first class market for the Gazprom Group, with an increasing demand for gas imports. Gazprom Marketing & Trading France 17

18 Natural Gas has a key role in the European Energy mix in order to achieve the Energy transition at economical costs Based on renewable resource options, up to $1500bn (820 bn from EU State budgets) must be invested; under the gas scenario model 500 bn dollars less by 2030, and 850 bn less by Gazprom Marketing & Trading France 18

19 Diversification of GP marketing routes Gazprom Marketing & Trading France 19

20 Thank you for your attention! Amsterdam, 21 November 2012 Gazprom Marketing & Trading France 20

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