The EU Gas sector and the snake’s dilemma: shedding skin to survive?
by Ilaria Conti (Florence School of Regulation)
Surviving without gas Long-term contracts: at which price? The ‘gas supply’ perspective
As the European Commission’s « Quo Vadis ? » research project has recently highlighted, gas Long-Term Contracts (LTCs) in Europe are dying out. The push towards more open and competitive markets, to hub-indexed gas price formation and spot trading, made long term contracts increasingly less necessary as European gas markets gained in transparency and liquidity.
This may not sound like breaking news. In fact, since the financial crisis of 2008–2009 and the constant decline in gas prices, fewer and fewer European companies felt comfortable signing new long-term commitments with external suppliers. More frequently, existing contracts have been renegotiated, and price converted from oil-indexed to hub-based.
On the other hand, if the perspective is –as it seems — that all gas long-term contracts currently in place are due to expire by 2036, then it is more than legitimate to inquire and assess which consequences this change might entail and how gas actors in the European market can make the best use of this transitory period.
The FSR focused on this topic during a policy workshop in May, the end of the Long-Term Contracts (LTC’s) era.
As explained by Markus Backes, DG Energy, in our interview, we need to distinguish between capacity and commodity Long-Term Contracts — the former linked to the transportation of gas, the latter having to do with gas intended as raw material.
But what’s the real problem with the end of the long-term contracts era?
All in all, the termination of LTCs is due to significantly reduce the amount of gas capacity imported to Europe. Which consequences will this reduction have? Will there be an issue with security of supply for (some) European countries?
While security of supply is less perceived as a real threat at the moment (both because of low gas demand and of availability of alternative sources ), the reduction of physical flows from outside Europe is expected to have an impact on revenues for gas TSOs.
Therefore, directly linked with the LTCs termination issue is the debate on transportation tariffs. Will TSOs be obliged to increase transportation fees, or is this a non-issue since lately most of capacity bookings are done via automated platforms (such as PRISMA) and therefore TSOs revenues will only be marginally affected by this further reduction?
The gas tariffs Network code entered the implementation phase in March 2017, and Florence School has largely debated on gas transportation tariffs in that context.
The ambitious achievement of a Single gas market for Europe is not so far from completion (see FSR Topic of the Month March 2017), however the debate on how to build truly cost-reflective tariffs in Europe might now be re-opened and questioned in this context.
Last but not least, the end of the long-term contracts era might have an impact on gas liquidity, since big part of the current redundant capacity deriving from LTCs is exchanged at European hubs and also used for swaps — which contributes to greater liquidity and narrowing price spreads between hubs. Therefore, one of the consequences we might see with the end of LTCs (and the disappearing of this redundant capacity) is a reduction in liquidity and a misalignment between European gas hub prices (see here).
To conclude, while it’s still unclear whether the end of the long-term contracts era will bring dramatic changes to the status quo of the European gas market, it is now common understanding that actors in the European gas sector will need to keep monitoring the several factors which might be indirectly linked to this issue and have an even greater impact on their business.
The Florence School of Regulation will keep facilitating the open dialogue between all interested parties while monitoring the development of this interesting theme.
The perspectives of gas utilities: which new skin will fit the “utility of the future”?
Gas utilities are facing the double challenge — among others — of decarbonisation and digitalisation, which are the main disruptive elements to the “old business model”.
Before the 2000s, in Europe, vertically integrated energy companies (often monopolies) would supply consumers in a foreclosed market. Then, the liberalisation process gradually opened gas and electricity markets — obliging the former incumbents to unbundling and to a fair competition with new entrants having the same market access rights.
Now, utilities must again face (and get ready for) a completely different scenario — which includes, first of all, the ability and the will to question the existing business model and think about how to respond to future challenges.
Following this theme, the FSR — together with Fondazione Enrico Mattei and Bruegel — organised a very interesting workshop on “ The future of energy utilities” (link to news article). A few months earlier, we supported the launch of a new study written by a team of researchers at the MIT and Comillas Universities titled “The utility of the future”.
While no “magic recipe” can be found in the Conclusions of either event, both were critical occasions of reflection and exchange of views between industry representatives, academics, institutions.
So which are the main challenges in this transformation, leading utilities to shed the old skin and acquire a new one? And which strategies might help them overcome the transition in a less painful way?
If they keep on merely surviving according to the “old business model”, gas utilities are condemned to be more and more confined to the role of simple “backup (to renewables) energy providers” and potentially, in the long-run, to extinction — as this role might even not be needed any longer.
At the same time, demand has changed — not only in numbers but also in structure — with the consumer having a much more active role in the energy sector, compared to the past. In fact, not only are consumers able to produce energy themselves (for example via solar panels) but they’re also better informed and proactive when it comes to energy consumption — so much so that we now talk about “prosumers” and “digital natives”.
Therefore, I believe gas utilities should at least ask themselves three questions:
- Decarbonisation in the European gas sector is a reality. In which markets should I invest, so that my gas can still be used as a useful source, and how?
- Increasingly, consumers are seen as key actors. Who are they, and to what extent do I take them into account in my business strategies?
- Innovation-Digitalisation. How digital am I? (how) Should I innovate?
The “new skin”, those gas utilities will necessarily have to wear when facing this new era should cover them from at least these three significant challenges.
At the same time, “promptness” is not the key word in this process. As Mr. Daniele Agostini of ENEL told us in a recent interview “it’s not essential for utilities to adapt fastly, but to rapidly make sure you have the instruments to compete in a fastly changing world”.
The key word is, instead, “flexibility”: flexibility in converting generation assets (where possible), flexibility in revisiting business strategies and alliances, and flexibility and openness towards change and in exploring brand new cooperation possibilities. For example with actors not traditionally belonging to the energy sector: telecommunications, transport, etc. Many companies are already exploring new ways, and Florence School will monitor and discuss the latest initiatives in a workshop in November (more details coming soon!).
Gas companies seem to be on their own in this fight for survival. While the energy policy future remains too opaque for big investments, in this context it’s hard to rely only on markets’ traditional capability to adjust themselves and to adapt to the new reality.
Little help from policymakers, little help from markets. So what’s the role of regulators in this scenario? Can the regulatory framework provide any help in the transition?
The energy regulators’ dilemma: anticipate the future or risk lagging behind?
While the EU Commission wonders where the EU Gas market design “is going” (with its “Quo vadis study”) and as we saw last week, EU gas utilities look for alternative business strategies, energy regulators, the third important actors in the EU gas sector, are currently in search of certainties.
In June this year, the Council of Energy Regulators (CEER) launched an important and very timely initiative to inquire about the “Future Role of Gas from a regulatory perspective” ( “FROG”). The resulting report, which is being drafted with the help of an Advisory Panel of external experts, is due to be published by the end of the year.
While the scope of this study appears broad at a first glance it seems to me that, in this case, regulators bravely adopted the right approach to the dramatic shift of paradigm that is taking place in the EU gas sector.
In fact, what is being questioned at the moment is not only a negligible aspect of the current EU gas system, or the implementation of certain rules in certain countries. With renewable energy massively penetrating the energy market and with technology progressing in electricity storage — among others — in the coming decades it is the future of gas and its usage that would be under threat. With the era of Long-Term coming to an end, gas utilities strive for investment signals from decision makers on which role gas will play in the future energy policy. If we want to think ahead and prevent future difficulties, now is the right time to stop and discuss which possible scenarios lie ahead.
The debate is twofold and includes the use of gas as a commodity and the issue of infrastructure:
- Which use of gas (and which gas? Only natural gas or also biogas?) should we consider in the energy system in the next 20 years? In which sectors (transport, heating?) and functions will it be more significantly present?
- Secondly, how do we facilitate the development of the right new infrastructure needed to support its new usage? And how do we deal with the existing infrastructure, which might need to be decommissioned?
Additionally, the biggest challenge for regulators will consist of identifying the regulatory gaps which exist in this transitional period. They will need to build the missing regulatory links and “bridges” between sectors which were hardly skimming over each other, and where gas is expected to have a future — at least for the next 20 years or so. For instance, gas and electricity in Power-to-Gas applications, gas as a fuel for maritime transport, urban mobility with gas vehicles and so on.
The big challenge will lie, on one side, in finding the right balance between the need (and the temptation!) of anticipating what the future will look like — and, on the other, the danger of lagging behind a fast-changing environment. In the first case, the risk is to make fundamental decisions based on predictions which might turn out to be completely wrong — for example, because of a sudden acceleration in the development of one or the other technology. It was the case with solar panels only a few years ago. In the second case, the risk is to let the energy players work in an outdated regulatory framework, which misses some fundamental pieces to enable a fair energy market functioning.
Of course, nobody can make precise predictions; however, combining and discussing different perspectives still better than sitting and watching changes happening inexorably.
Good luck to the energy regulators, may their shedding of skin be as smooth and as painless as possible — for the benefit of the whole EU gas sector!
