What Drives Natural Gas Prices?

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1 -A Structural VAR Approach - Changing World of Natural Gas I Moscow I 27th September I Sebastian Nick I Stefan Thoenes Institute of Energy Economics at the University of Cologne

2 Agenda 1.Research Questions 2.Methodological Approach 3.The Model 4.Results 5.Illustrative Examples 6.Conclusion 2

3 Research Questions EUR/MWh NCG Day-Ahead Price Liberalized wholesale market Decline in oilindexation Significant supply shocks NCG Day Ahead in EUR/MWh What are the fundamental drivers of natural gas prices? Which price movements can be assigned to supply shocks? 3

4 Methodology: Requirements and Choice Characteristics of German Gas Market Characteristics of German Gas Market Interdependencies between gas prices, storages, Interdependencies LNG, substitution between among gas alternative prices, commodities storages, LNG, substitution among alternative commodities Exogenous shocks both on supply and demand Exogenous side of shocks the market both on supply and demand side of the market Required Model Features Modelling of the interaction among various variables (no a priory assumptions of exogeneity) Simulation of one-off impacts (via multiplier) Vector Autoregressive Model (VAR) as proposed by Sims (1980) Instantaneous Interaction reflected in reduced form errors:, 0 Lack of economic interpretation Need for structural representation 4

5 Methodology: SVAR and Structural Analysis Structural VAR-Representation Structural MA-Representation... Allows for an economic analysis, since instantaneous correlation is accounted for by A However, A has to be identified (see e.g. Lütkepohl(2005)) Impulse Response Analysis Forecast Error Variance Decomposition elements can be interpreted as responses of the system to structural innovations the jk-thelement of represents the effect on variable j of a shock in the k-th variable that has occurred i periods ago with,, /,,, 5

6 The Model: Data Fundamental Influence Variable Source Temperature induced demand shocks Supply shortfalls HDD-deviation from historical average GMS (DWD) Gas volumes not available to the EU Own calculation Business cycle Brent Spot Crude Price EIA Fuel-substitution ARA Spot Coal Price McCloskey Global market integration LNG-Imports of EU-27 Eurostat Flexibility in demand and supply Deviation from historical changes in utilization rates German natural gas price NCG Day Ahead Price EEX Gas Storage Europe Sample period: January 2008 June 2012 Sample period: January 2008 June 2012 Frequency: Weekly Frequency: (228 observations Weekly for each series) 228 observations for each series 6

7 The Model: Identification HDD Dev. Supply Shortfall Crude Price Coal Price LNG Storage Gas Price HDD Dev. * Supply Shortfall * * Crude Price * * * Coal Price * 0 * * 0 0 * LNG * * 0 0 * * * Storage * * * * 0 * * Gas Price * * * * * * * Notes:Each row of this table indicates an equation in the VAR model with the respective variable as dependent variables and each column indicates the instantaneous impact of the variable in each equation. The denotes that a parameter is estimated from the data and that the model allows for an instantaneous relationship, while a 0 indicates that the according parameter is restricted to zero. 7

8 Results: Impulse Response Analysis 8

9 Results: Impulse Response Analysis Storage flows adjust quickly to changing market conditions Hypothesis of competitive storage operation can not be rejected 9

10 Results: Forecast Error Variance Decomposition Share on Forecast Error 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Forecast Horizon in Weeks HDD Dev Supply Shortfall Crude Price Coal Price LNG Storage Gas Price Forecast HDD Dev. Supply Crude Price Coal Price LNG Storage Gas Price Horizon Shortfall

11 Illustrative Example I: Russian-Ukrainian Crisis Notes: Week 1 refers to the week ending on Friday 1/9/

12 Illustrative Example I: Financial Crisis Russian-Ukrainian gas dispute Notes: Week 1 refers to the week ending on Friday 9/19/2008. The price increase in week 17 reflects the beginning of the Russian-Ukrainian gas dispute in January

13 Illustrative Example II: Libyan Civil War Notes: Week 1 refers to the week ending on Friday 2/18/

14 Illustrative Example III: February 2012 Cold Spell Notes: Week 1 refers to the week ending on Friday 1/27/

15 Conclusions What are the fundamental drivers of natural What are the fundamental drivers of natural gas prices in Germany? gas prices in Germany? In the short-run, gas price crucially affected by weather conditions Gas prices in medium-term horizon driven by business cycle and crosscommodity effects: Coal prices (at least) equally important as crude prices Evidence of efficient storage operations (i.e. smoothing prices) Which price movements can be assigned to supply shocks? Price impact of supply shocks may be overestimated since major shares of price spikes in the respective periods can be accounted for by demand sided variables Further Research Extension to a European scale / other national gas hubs Enrich the model with more accurate data on LNG-imports 15

16 Thank you for participation! Any Questions or Remarks? Sebastian Nick Alte Wagenfabrik Vogelsanger Straße Köln +49 (0)

17 References Brown, S. P. A. and Yücel, M. K. (2008). What drives natural gas prices? The Energy Journal, 29(2): Hall, P. (1995). The Bootstrap and Edgeworth Expansion. Springer Series in Statistics. Springer. Hartley, P. R., Medlock, K. B., and Rosthal, J. E. (2008). The relationship of natural gas to oil prices. The Energy Journal, 29(3): Kilian, L. (2009). Not all oil price shocks are alike: Disentangling demand and supply shocks in the crude oil market. American Economic Review, 99(3): Lochner, S. (2011). Modelingthe europeannatural gas market during the 2009 russian-ukrainiangas conflict: Ex-post simulation and analysis. Journal of Natural Gas Science and Engineering, 3(1): Lütkepohl, H. (2005). New Introduction to Multiple Time Series Analysis. Springer. Maxwell, D. and Zhu, Z. (2011). Natural gas prices, lngtransport costs, and the dynamics of lngimports. Energy Economics, 33(2): Mu, X. (2007). Weather, storage, and natural gas price dynamics: Fundamentals and volatility. Energy Economics, 29(1): Ramberg, D. J. and Parsons, J. E. (2012). The weak tie between natural gas and oil prices. The Energy Journal, 33(2). Robinson, T. (2007). Have european gas prices converged? Energy Policy, 35(4): Sims (1980). Macroeconomics and reality. Econometrica, 48: pp Sims, C. A., Stock, J. H., and Watson, M. W. (1990). Inference in linear time series models with some unit roots. Econometrica, 58(1):pp Zellner, A. (1962). An efficient method of estimating seemingly unreleatedregressions and tests for aggregation bias. Journal of the American Statistical Association, 57(298):

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