Issue Number: 104		January 2014
The liberalisation of gas markets: NetConnect Germany (NCG), GASPOOL (GPL) and a wider EU context European context Gas market liberalisation was established in the UK in the early 1990s, with the creation of the NBP (National Balancing Point) virtual delivery point in 1996 and trade at this market developing from 1997 onwards. But the rest of Europe has been slower in catching up, and the development of the Continental European gas hubs has only really happened since 2005. The UK's gas trading system NBP was the result of more than ten years' of national legislation, privatisation and competition policy. Other EU countries have only more recently started to change how they trade gas, and from the 2000s these countries have favoured the development of continental trading hubs. However, the progress of these hubs has been hindered by the pre-dominance of long-term contracts which, until recently, were nearly all exclusively priced in connection to oil products. As some of these contracts begin to end or are re-negotiated, we are beginning to see a transformation of how gas is bought and sold in Europe. Figure 1: European gas hubs and gas exchanges[1]. The catalyst underlying the development of a system of trading hubs in Europe is related to a chief goal of the European Union energy strategy. The European Gas Target model provides a vision of 2014 and beyond, and aims to create an integrated market for gas in the EU and facilitate 'the creation of a well-functioning EU market, consisting of national or cross-border interconnected entry-exit zones with virtual trading points' (hubs)[2]. This will provide an 'entry-exit' system where natural gas ownership can change easily and where it can be bought or sold. The aim is that the driving force behind the price of gas will not be the price of oil, but the supply/demand for gas. This will therefore mean that the prices of gas will be competitive, and less related to the influences of the giant market players. This is part of a wider move by the EU towards an economic system where there are integrated markets, underpinned by the 'relative law of one price'. This is intended to mean that are equal prices for a certain good. This article will briefly contextualise Germany's newly developing gas-trading hubs, examine their structure, explain how gas is bought and sold, and then analyse Germany's market integration by comparing gas prices between its hubs and other hub gas prices in the EU. History of German gas trading and NCG and GPL Although Germany theoretically fully liberalised its gas market in 1998, effective liberalisation for small and medium customers did not emerge until the EU Directive (2003/55/EC) had been made into national law in 2005 (the Energiewirtschaftsgesetz). Like other EU countries, Germany underwent a new market design which conformed to the 'entry-exit' system outlined by the European Commission[3]. The transport companies, who owned the pipelines, eventually established two companies - Gaspool Balancing Services GmbH and NetConnect Germany GmbH & Co. KG. The companies then merged commercial booking of their pipelines into two market areas. The two major German hubs are NetConnect Germany (NCG), which mostly covers the south of Germany, and GASPOOL (GPL), which covers Northern Germany. There is now a semi-liquid market for gas, though it is still developing. These hubs been classed as 'Transition Hubs' which have started to liberalise and to offer trading products but which yet to show their full potential[4]. It might be surprising that NCG and GPL are not well-developed hubs in Germany. After all, Germany is the second largest gas market in Europe and is well positioned geographically with good infrastructure connections with its neighbouring countries. These characteristics should have given it a head start in being the focus for a North West European traded hub. However, due to its complex gas structure, comprising of 19 zones and having 2 major pipeline systems, progress has been slow, even after a period of rationalisation from 2009-2011. In 2010, the gas market areas in Germany were reduced to 3 high calorific gas and 3 low calorific gas zones. (High and low calorific gas refers to the amount of energy that is released when it is heated)[5]. In 2011, there were two further changes, the first change meant that there was a reduction in the number of zones to three: 2 H-cal and 1 L-cal, and then the last merger created the current set-up of a 2 Market Area system: Gaspool and NetConnect Germany, each with both high and low calorific gas networks which are still being balanced individually. The costs of energy conversion are expected to be 'socialised' by 2016, meaning that the costs are pushed onto the taxpayers[6]. It must be remembered that the German set-up is quite different to the rest of North West European gas markets because both the NCG and GPL are each run by 6 TSOs (Transmission System Operators). The proposed merger, of NCG and GPL, has been recently dismissed by the regulator, BNetzA. BNetzA agreed with a previous report by the TSOs that it would be too expensive to merge the hubs. However, there has been criticism over this decision because it is thought that the estimated costs of the merge have been grossly inflated. Experts think that if the German market cannot unite into one Market Area, this could be a major stumbling block preventing a German hub from becoming the continental European gas price benchmark[7]. And according to the ICIS buyer study which interviewed German gas buyers, many consumers felt that the merge was necessary for a more competitive market[8]. How gas is bought and sold 90% of gas trade in Germany happens 'over-the-counter' (OTC). This means that customers and suppliers agree a set fee by way of traditional contract negotiations. The contracts specify how much gas will be delivered and whether the price is based on current demand or linked to an index. The contracts also specify the level of flexibility, and it is usually an advantage for the customer to buy gas based on levels of current demand. The market participants can also handle the sale and purchase of natural gas via exchanges or brokers. 10% of all gas trade in Germany is handled this way. Traders who wish to sell surplus quantities or buy additional gas can use an energy exchange site, such as the EEX (European Energy Exchange) based in Leipzig, and trade on the spot market for deliveries the next day, or the futures market for deliveries at a later date. There is complete transparency of trade on exchange websites and it serves as a useful reference for pricing between the gas suppliers and their customers. Putting German gas hubs to the test: analysing the pricing of gas, and looking for market integration and efficiency Some analysts suggest that a price indexation based on gas hub trades should be avoided because there could be a manipulation of hub prices by a few large local market players. However, if prices across different gas market places changed closely over time, this would make this hypothesis unlikely. Therefore, a key way to test the success of the gas trading hubs in Germany is to look at the price convergence between the corresponding hubs. If there are signs of market integration, then there should be minimal price difference, although a small difference in levy fees may still be present[9]. A wider and important issue that comes out of this is how well prices of gas in Germany converge with the rest of the EU. For this present article, it is fruitful to compare the German gas markets with the Netherlands' Title Transfer Facility (TTF) as a competitive benchmark, because of its proximity and liquidity to Germany and also compare Germany's hubs with other EU countries. Price convergence between NCG, GPL and TTF Using data from the European Energy Exchange, I have formed a graph (figure 2) which shows a price comparison between the NCG, GPL and TTF, for day-ahead spot market prices in the last quarter. As it can be seen, there is a fluctuation in prices for all market areas in this time period. The degree of convergence between the hubs is strong, although there are some large discrepancies at times. For instance, between 30/10/13 and 09/11/13, NCG prices for gas spiked to about 30€/MWh whilst, GPL and TTF were around 27€/MWh and 26€/MWh respectively. Figure 2: Logarithmic day-ahead spot prices (€/MWh) for the last quarter[10]. Looking at figure 3 beneath, in the second half of 2012 and during the first two months of 2013, the German border price converged more and more with the NBP spot price. This suggests that Germany is beginning to pay for gas imports based on a hub-traded price, rather than an oil-indexed price. The gap between the German border price and the estimations of higher priced deliveries such as Algerian gas to Italy has been decreasing to less than 4€/MWh in the first two months of 2013, compared to more than 12€/MWh in the example of Russian gas to Bulgaria during 2012. Figure 3: Comparison of EU wholesale gas price estimates[11]. In an important study of European gas hubs by Beatrice Petrovich for the Oxford Institute for Energy Studies, it was shown that Germany was one of the most integrated markets, and that NCG and GPL were the most integrated pair. Petrovich concluded for Europe in general that the gas hubs 'are expressing a competitive market reference and that a necessary condition for efficient pricing has already been met[12].' It should be mentioned that price correlation between different gas hubs does not prove that the hubs are fully-functioning and competitive. There is always the possibility that the prices have still been determined or influenced by the actions of market players. Analysing hub prices in light of market players' influences is a task that is tricky because it is hard to connect market players' actions to price fluctuation. All that can be concluded is that hub price correlation is a sign - but not the proof - of an efficient and competitive market pricing. Conclusion The future of Germany's gas hubs looks promising, even if the merge between NCG and GPL does not happen. There are signs that the gas pricing is becoming more detached from the index of oil pricing and more related to supply/demand. The idea of a 'relative law of one price' is becoming more and more realised in EU gas markets. Researched and written by MJMEnergy Analyst, Nico Cottrell, [1] Patrick Heather, 'Continental European Gas Hubs: Are they fit for purpose?' http://www.oxfordenergy.org/wpcms/wp-content/uploads/2012/06/NG-63.pdf p.4 (accessed 10/01/14). [2] 'Study on Entry-Exit Regimes in Gas', Viewed at , http://ec.europa.eu/energy/gas_electricity/studies/doc/gas/201307-entry-exit-regimes-in-gas-parta.pdf quotation on p.17 (accessed 10/01/14). [3] For more details, see 'Directive 2003/55/EC of the European Parliament and of the Council of 26 June 2003 concerning common rules for the internal market in natural has and repealing Directive 98/30/EC', http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2003:176:0057:0057:EN:PDF (accessed 10/01/14). [4] Heather, 'Continental European Gas Hubs' http://www.oxfordenergy.org/wpcms/wp-content/uploads/2012/06/NG-63.pdf see p.16 (accessed 10/01/14). [5] H-gas is primarily delivered from Norway and Russia. L-gas only plays a small role in Germany [6] Heather, 'Continental European Gas Hubs', http://www.oxfordenergy.org/wpcms/wp-content/uploads/2012/06/NG-63.pdf (accessed 10/01/14). [7] Heather, 'Continental European Gas Hubs', http://www.oxfordenergy.org/wpcms/wp-content/uploads/2012/06/NG-63.pdf (accessed 10/01/14). [8] 'German regulator erases hope of NCG-GASPOOL natural gas market zone merger', http://www.icis.com/resources/news/2013/03/20/9651776/german-regulator-erases-hope-of-ncg-gaspool-natural-gas-market-zone-merger/ (accessed 10/01/14). [9] Due to the ongoing changes of the German TSOs and market zones, consistent and reliable data on transmission charges are not publicly available. [10] Graph created at http://www.eex.com/en/Market%20Data/Trading%20Data/Natural%20Gas/daily-reference-price-index/Natural%20Gas%20Chart%20Chart%20%7C%20Reference%20Price/gas-average-chart/2014-01-08/3m/NCG/GPL/TTF (Accessed 9/01/14) [11] European Commission, Quarterly Report on European Gas Markets, vol. 6, iss. 1, (2013) http://ec.europa.eu/energy/observatory/gas/doc/20130611_q1_quarterly_report_on_european_gas_markets.pdf (accessed 10/01/14). [12] Beatrice Petrovich, 'European gas hubs: how strong is price correlation?', viewed at http://www.oxfordenergy.org/wpcms/wp-content/uploads/2013/10/NG-79.pdf (accessed on 10/01/14). January 2014 MZINE

Issue Number: 103		December 2013
Will Iranian LNG come in from the cold? Recent breakthroughs in negotiations over Iran's nuclear programme have raised the prospects of Iranian gas and LNG (liquified natural gas) reaching world markets. MJMEnergy Analyst, Nico Cottrell, considers the impact of sanctions on the Iranian gas industry, and possibilities for future development. Benjamin Netanyahu, the Israeli Prime Minister, has described the recent negotiations at Geneva over Iran's nuclear programme as an 'historic mistake'. In contrast, William Hague, the UK foreign Secretary, has said that the deal signals 'good news for the whole world'[1]. A blessing or a curse, the deal will mean that Iran will curb some of its nuclear activities in return for 'limited, temporary, targeted, and reversible [sanctions] relief' which will last for six months and is worth an estimated $7bn (£4.3bn). EU foreign ministers will meet in the next few weeks and the proposal for the relief of sanctions may be approved as early as December 2013. These negotiations have also indicated that a permanent solution to Iran's sanctions will be sought. Whilst sanctions have been a feature of US Iran policy since Iran's 1979 Islamic Revolution, the UN and worldwide bilateral sanctions on Iran are relatively recent. The more recent sanctions were imposed on Iran because of its uranium enrichment programme. Since Iran's nuclear activities began in 2002, the International Atomic Energy Agency (IAEA) has been unable to determine whether Iranian activities were exclusively peaceful, or intended to produce nuclear weapons. These uncertainties over Iran's nuclear intentions have triggered various sanctions from the UN, EU and US since 2006 and particularly in 2010, which were more forcefully felt. The sanctions have hit the country's economy hard: it is in recession and the rate of inflation has been as high as 41.3% in June 2013 [2]. Fereydoun Khavand, an economist and expert on Iran, has said, 'Iran's economy is out of breath' [3]. The sanctions have had a huge impact on Iran's banks and oil exports, reducing the country's revenue by about 65%. Some take this as a sign that the sanctions work and therefore should continue. Others believe that it is unjustifiable to financially ruin a country. One online blogger invoked hyperbole and compared the sanctions on Iran to the extremely punitive 'Treaty of Versailles but perhaps on steroids. [4]' The moderate line is that the sanctions should be relaxed if Iran acts according to the requirements of the deal; if it fails to do this then, as Barack Obama warns, 'we will turn off the relief and ratchet up the pressure. [5]' Geneva negotiations Source: http://previous.presstv.ir/photo/20131016/329709_Iran-nuclear-Geneva.jpg Whilst Iran's economy has been hampered by sanctions since 2006, it has only been the more recent sanctions in 2010 that have severely affected the country's gas industry. EU sanctions in 2010 meant that there was a ban on the export to Iran of key equipment and technology required for the refining and production of natural gas. Soon after the EU sanctions, Germany's Linde stopped selling its LNG technologies to Iran, which is likely to be related to political pressure. And then, in October 2012, the EU banned the import, purchase and transportation of natural gas from Iran. As a result, Iran can only export gas via by pipeline, which is a less lucrative option compared to the export of gas as LNG. In November 2013, The NIGC (National Iranian Gas Company) collapsed and declared bankruptcy with a debt of $4bn. Media reports quote Bijan Zangeneh, Iran's oil minister, that the gas company 'is destroyed.' [6] Are the sanctions to blame? Looking for reasons why Iran's gas industry has failed: are the sanctions a red herring? Some experts have pointed out that there have been longstanding inabilities associated with Iran's gas industry; the sanctions from 2010 were not the key reason for its failure and only served to put the nail in the coffin. Not convinced that the sanctions are the best explanation for Iran's weak gas industry, these analysts look to domestic factors such as costly subsidies and domestic over-consumption; objections to foreign participation; and policy and institutional conflicts. [7] Whilst these are all important reasons that have had an important bearing on Iran's gas industry, this view neglects the fact that Iran's LNG industry had made significant ground in recent years and, prior to the 2010 sanctions, looked hopeful. Iran had two projects with investment from large companies, a national project, as well as preliminary agreements for four other projects. But the sanctions in 2010 ended all but one of the projects. And the remaining project has been suspended for the foreseeable future. Construction of Iran LNG at Tombak Port. Source: http://interfaxenergy.com/images/post-content/iran-lng.jpg What did the sanctions mean for Iran's LNG projects? The sanctions crippled Iran's LNG prospects. Two advanced LNG projects, Pars LNG and Persian LNG, which had planned capacities of 10 million tons per annum (mtpa) and 16.2mtpa respectively, were cancelled due to the sanctions and political pressure put on Iran's international partners. Iran had attracted investment from companies such as Total and Petronas in Pars LNG, and Shell and Repsol in Persian LNG. There were also other LNG projects which Iran had signed preliminary agreements but which did not advance, including Golshan LNG, Lavan LNG, North Pars LNG and Qeshm. There is one other LNG project, Iran LNG, which is 100% owned by Iran's natural gas company (National Iranian Gas company), but it has been suspended for the time being. It was unfortunate that at the moment Iran's LNG projects were about to take off, the sanctions came into play, which thwarted the projects' potential. The future of LNG in Iran The possible removal of the sanctions opens up an interesting question: what might it mean for the future of Iran's gas industry? The recent negotiations will mean that a deal will be struck for six months. But given the complex domestic issues already mentioned, the temporary suspension of the sanctions will not mean that Iran's LNG projects will suddenly gain a second-wind and pick-up where they left off before the deadly sanctions in 2010. Things have dramatically changed since then; to say just a couple of reasons: Iran's national gas company has gone bust and will take years to recover, there will probably be a gas shortage over the next few years, and the economy is in pieces. The future of LNG in Iran will depend on the outcome of the negotiations which will take place in six months' time. If Iran successfully meets the conditions and requirements of the EU, and wrangles a long-term solution that includes the removal of sanctions, then this will give a more promising context for Iran's gas industry. It will boost Iran's economy but, more significantly, it will open up the chance of outside investment and give the country access to the latest LNG technology. Conclusion: Doubt remains Even if the sanctions are permanently removed, it is extremely difficult to know whether foreign companies will still want to invest in Iran after the failure of its LNG projects in 2010. The chief concern is that Iran might break its promises and receive sanctions again. This could mean that investors would lose hundreds of millions of dollars. What is clear is that before Iran can attract investment, it must re-gain the trust of the EU and US, as well as the foreign investors. For many companies, there might be 'safer bets' for their investments, and in the next few years, this might even take the form of the new Floating LNG vessels. [8] Ultimately, the future success or failure of LNG in Iran lies in the hands of foreign companies. And for many the risk will probably be too great. [1] 'Iran agrees to curb nuclear activity at Geneva talks', http://www.bbc.co.uk/news/world-middle-east-25074729 (accessed 9/12/13). [2] 'Iran Inflation Rate', http://www.tradingeconomics.com/iran/inflation-cpi (accessed 9/12/13). [3] Cited by Farnaz Fasshihi, 'Iran State Gas Company Faces Collapse, Hit by Sanctions', http://online.wsj.com/news/articles/SB10001424052702303755504579206103448476892 (accessed 9/12/13). [4] 'Iran Sanctions Oil Embargo vs. Treaty of Versailles', http://www.dailypaul.com/202556/iran-sanctions-oil-embargo-vs-treaty-of-versailles (accessed 9/12/13). [5] Iran agrees to curb nuclear activity at Geneva talks', http://www.bbc.co.uk/news/world-middle-east-25074729 (accessed 9/12/13). [6] Farnaz Fasshihi, 'Iran State Gas Company Faces Collapse, Hit by Sanctions', http://online.wsj.com/news/articles/SB10001424052702303755504579206103448476892 (accessed 9/12/13). However, there is some dispute over this: the Iranian deputy oil minister gas denied claims that the NIGC has gone bust: http://www.iraniangas.ir/Site.aspx?ParTree=11131E&LnkIdn=192575 (accessed 9/12/13). [7] David Ramin Jalilvand, 'Iran's gas exports: can past failures become future success?' Oxford Institute for Energy Studies, esp pp. 13-22. http://www.oxfordenergy.org/wpcms/wp-content/uploads/2013/06/NG-78.pdf (accessed 9/12/13). [8] See 'LNG: Will it float? A short report on planned Floating LNG (FLNG facilities around the world, 2013-2023', http://www.mjmenergy.com/MZINE/2013/november13art.html (accessed 9/12/13). December 2013 MZINE