It has been two weeks since the EU Commission proposed to make Europe independent of Russian fossil fuels (well before 2030). The time taken to realize the scale of the initiative has led the EU gas market players to sober realization – if taken to action, this initiative will pose a whole new layer of concerns, which will have to be adopted in the established practice of gas portfolio management.
Besides broad implications in the legal and environmental space, this initiative will primarily hit the metrics of price (volatility and level) and risk (volume and price). This spring has led to natural gas prices hitting record-high values (350 EUR per MWh or $4000 per 1000 m3 on 7 MAR at TTF intraday). And it might not be the limit.
The saga continues. On 23rd March, Russia requested for all gas export payments to the EU in Russian ruble (RUB).
Let’s take a look at how this impacts participants in the EU natural gas market.
- EU’s ambitious goal to reduce Russia’s gas import – currently 155 billion cubic meters (bcm) per annum – by 100 bcm before the end of 2022 can only be fulfilled by radical change of the import sources. And thus – will lead to a structural change of the physical and financial portfolios, along with the pricing policy and the corresponding risks.
- The underground storage (UGS) policy imposition to have all UGS at 90% capacity by 1st October 2022 will be a challenge because it is not feasible on the background of the reduced gas import. And it will also affect the internal transfer pricing mechanisms.
- The requirement to pay the bills for imported gas in RUB will bring in a new layer of complexity of FX exposure.
It is obvious that the new challenges that traders and wholesalers of natural gas in the EU will face have multiple dimensions. All of which will have to be addressed in the near future.
- LNG imports are set to increase by 50 bcm in 2022. Since the soon-to-be-reduced Russian piped gas exports cannot be redirected to the World LNG market, this extra demand will increase the LNG import prices, and accordingly – the EU wholesale gas prices.
- Continuing challenges with LNG import: since the additional 50 bcm will have to be diverted from either Henry Hub based deliveries or Asian-targeted deliveries, there will be a mix of new exposures arising in the portfolios of the EU and the US traders. The EU traders will have to introduce Henry Hub index in their valuation matrix. While the US traders – will have to include TTF to evaluate the market potential of the LNG cargoes. Add on top the oil-indexed Asian LNG, and the complexity of the ‘renewed’ European natural gas portfolio skyrockets in terms of risk and valuation.
- Regarding the increase of piped gas imports, the candidates are Algeria, Azerbaijan, Libya and Norway. The total potential is estimated at eight bcm per year increase, which brings the consideration of gas-oil link and an expectation of increased import prices due to a marginal production cost increase.
- The legal dimension holds relevance because the reduction in imports from Russia to the extent envisaged would take the level of imports to well below the take-or-pay (TOP) levels in the long-term contracts. This could result in high penalties, which again, will lead to an increase of the wholesale gas price.
- Regarding gas storage, we can expect that summer injections will be of 65-70 bcm to bring stocks up to 90 bcm by 1st October 2022. This is 20-25 bcm higher than in 2021. And will inevitably lead to more volatility in pricing as less gas will be available in the summer markets.
- On the FX Note, the ruble so far has been a rarely used currency for the settlements at the EU companies. There are minor precedents in history, including the inaugural Russian Gas purchase, when 80 mcm were taken at NCG hub in March 2019. Besides that, there is no common practice for the EU market participants as per:
- Buying the currency and securing it on corresponding bank accounts for the payment date
- Hedging the currency risks via Futures at available exchanges
- In some cases, a new Exchange membership will be required
- Clear policy with regards to the RUB volatility – it is obvious, that at the moments of contract settlements, when all participants will be cumulatively buying RUB currency, it’s rate will be spiking
While the physical and financial aspect of dealing with the above challenges will be the primary occupation of the procurement and legal departments for the months to come, the trading departments shall turn to the analysis of capabilities that their existing ETRM systems provide. Namely, the following functionality will have to be checked for consistency:
- Transparent representation of physical and financial positions
- Decomposition of the natural gas position exposure into oil products and FX
- Flexible handling of gas storage operations and pricing
- Ability to handle FX products, including RUB
CTRMCloud can help European gas market players with a fast roll-out of a cloud-native environment, in which the above challenges are handled at a high productivity rate.