Market fundamentals, competition and natural gas prices

03-02-2015 1 Market fundamentals, competition and natural gas prices MACHIEL MULDER University of Groningen, Department of Economics, Econometrics and Finance Authority for Consumers & Markets International Academic Symposium Energy Markets and Sustainability Barcelona, 03 February 2015

03-02-2015 2 Outline 1. Background a. liberalizing European gas markets b. the Dutch gas market c. research questions 2. Explaining price differences 3. Explaining price level 4. Conclusions

03-02-2015 3 Liberalising European gas markets Since the 1990s market places for gas have been developed in various European countries virtual hubs exchanges / Over-the-counter trade Cross-border trade has been facilitated by improving the allocation of existing capacity - more market-based allocations - introduction of secundary markets new connections - with Norway, Russia - LNG-terminals

Dutch market is closely connected to neighbouring markets 03-02-2015 4 http://ec.europa.eu/energy/international/russia/doc/2009_the_european_natural_gas_network.pdf

03-02-2015 5 TTF - Title Transfer Facility TTF (since 2003) is a virtual market place within the highpressure grid The TTF serves as a virtual entry or exit point in the portfolio of a trader The TSO registers title transfers or nominations Trade on the TTF is done through exchanges (APX-ENDEX) and bilateral Over-The-Counter (OTC) contracts

03-02-2015 6 Trading hubs in Europe The Dutch TTF is likely to become the benchmark hub for gas supply to Belgium, the Netherlands, Luxembourg, Germany and France (Heather, 2012)

03-02-2015 7 Market share of TTF has increased strongly

03-02-2015 8 Research questions 1. How integrated is the Dutch gas market with the German gas market? 2. What is the impact of fundamentals on the day-ahead gas price on TTF?

Research topic 1: Explaining the difference in day-ahead gas price on TTF (Netherlands) and NCG (Germany) 03-02-2015 9

03-02-2015 10 Related literature Cuddington and Wang (2006), and Marmer, Shapiro and MacAvoy (2007) Regional markets in the US are isolated Siliverstovs, L Hégaret, Neumann and von Hirschhausen (2005) USA and Japan are integrated (similar long-term contracts and oil-gas indexation) EU and USA are not integrated (US gas prices are more competitive, EU gas prices closer linked to oil) Growitsch, Stronzik and Nepal (2012) NetConnect Germany (NCG), Gaspool (GPL), and Title Transfer Facility (TTF) are reasonably well integrated, but not all price differences can be explained by transportation costs (esp. between NCG and GPL)

03-02-2015 11 Theory In a fully integrated market, price differences disappear as a result of traders using arbitrage opportunities (Stigler and Sherwin, 1985) If constraints between regional markets do exist, prices in these markets may show diverging patterns for a period of time (Marmer et al., 2007)

03-02-2015 12 Focus on NL-GER Connection We analyse the connection between Title Transfer Facility (TTF) and NetConnect Germany (NCG) NetConnect Germany (NCG) was more a trading hub than Gaspool (GPL), but these markets are economically reasonably well integrated (Growitsch et al, 2012; Heather, 2012)

03-02-2015 13 Model 1 Dependent variable is the absolute value of the difference of the maximum day-ahead prices between TTF and NCG U EX-H and U EX-L utilisation rates for export capacity (firm + interruptible allocated daily capacity / total maximum available capacity on the borders) NX is net gas trade (export-import) between the Netherlands and countries C={GER, UK, BEL} Z is a set of control variables (Month and Year dummies, Ukraine dummy, Heating Degree Days)

03-02-2015 14 Results model 1 Absolute value of difference in price levels Mean equation Coefficient Std. Error constant 0.37*** 0.06 U EX-H -0.02 0.04 U EX-L 0.001 0.055 NX GER -0.001*** 0.0001 NX UK -0.00005 0.0001 NX BEL 0.0002*** 0.00004 D_UKR 0.56 0.40 HDD -0.004*** 0.001 Observations 1637

03-02-2015 15 Model Results The utilization of the infrastructure does not affect the absolute value of price differences The gas flows between Nl and Germany reduced price differences The outside temperature positively affects price differences: when gas demand is relatively large due to low temperatures (i.e. high HDD), markets have less difficulties to realize equal prices Seasonal effects play a significant role explaining crossborder price differences, both regarding levels and volatility (price range)

03-02-2015 16 Conclusion topic 1 TTF and NCG have become more integrated over the past years Infrastructure bottlenecks, which existed in the past, do not hinder market integration anymore

EUR/MWh 10 20 30 40 faculty of economics Research topic 2: Explaining the movements in the day-head price on TTF 03-02-2015 17 2007 2008 2009 2010 2011 2012 2013 days

03-02-2015 18 Related literature S.P.A. Brown and M. K. Yücel (2008). What drives natural gas prices? The energy Journal, 29(2): 45-60. F.L. Joutz and J.A. Villar (2006). The relationship between Crude Oil and National Gas Prices. EAI Manuscript, October. International Energy Agency (IEA) (2008). Development of Competitive Gas Trading in Continental Europe. How to achieve workable competition in European gas markets? Paris: OECD/IEA, 2008 P. Heather (2012). Continental European Gas Hubs: Are they fit for purpose? Research report NG63, University of Oxford, The Oxford Institute for Energy Studies.

03-02-2015 19 Method Reduced form model P = F(exogenous demand factors, exogenous supply factors) Demand factors temperature (measured by heating degree days) Price of oil (affecting demand substitution) Supply factors HHI on European level reserve/production ratio Ukraine crises in 2009 and 2012 Data over 2008-2014

Euro/MWh 10 20 30 40 50 60 faculty of economics 03-02-2015 20 TTF price and Brent oil price seem to follow a similar pattern 7/1/2008 1/1/2010 7/1/2011 1/1/2013 7/1/2014 Brent oil price TTF gas day-ahead price Correlation coefficient = 0.69

03-02-2015 21 The R/P-ratio is a measure for the expected depletion of gas reserves and, hence, for the opportunity costs of producing now instead of later Source: BP

0 Euro/MWh 10 20 30 40 faculty of economics 03-02-2015 22 Heating degree days and TTF price 7/1/2008 1/1/2010 7/1/2011 1/1/2013 7/1/2014 HDD - Heating Degree Days TTF gas day-ahead price

.2 HHI (index).22.24.26.28 faculty of economics 03-02-2015 23 Market structure in a Cournot market, price-cost margin is related to concentration HHI based on supply of gas to EU 1/1/2010 1/1/2011 1/1/2012 1/1/2013 1/1/2014 1/1/2015

03-02-2015 24 Results model 2 TTF-day-ahead price Coefficient Standard error (significance) Lag of TTF-day-ahead price 0.96 0.01*** Heating degree days 0.02 0.006** Lag of Brent oil price 0.02 0.004*** HHI 0.74 0.28*** R/P-ratio -0.06 0.02** Dummy Ukraine crisis Jan 2009 0.87 0.41** Dummy Ukraine crisis Feb 2012 2.44 0.78*** Dummies for day of week and month of year Adj. R-squared 0.98

03-02-2015 25 Conclusion topic 2: TTF gas price in the period 2008-2014 is significantly upwards affected by the Ukraine crises positively related to HDD, HHI and the oil price negatively related to the R/P-ratio The influence of the oil price on the TTF gas price is however small, despite the high level of correlation. The influence of HHI is also small Gas price is to a large extent determined by gas market dynamics