Liberalize Gas Markets to Reduce the Cost of Energy

The market for natural gas was profoundly affected by the wave of liberalizations of the late 1990s. Before then, the industry was dominated by bilateral relations between supplier and consumer countries, both usually represented by state-owned, monopolistic companies. These were long-term contracts which guaranteed security of provisioning to the importing country and limited the financial risk of investment outlays required for gas distribution by imposing payment obligations (take-or-pay agreements) on the buyer, whether a national utility actually used the gas or not. And the price of gas was pegged to that of the main alternative energy input, i.e. crude oil.

Since those times, everything has changed. Yet friction remains in gas markets and thus the need for adjustment. National markets within the UE have opened themselves to competition, with a consequent reduction of the share of final demand met by the dominant company. Wholesale gas markets have developed, with England and Holland taking the lead, which offer, through their liquidity, an venue to secure gas supplies alternative to long-term contracts. Also, pipeline distribution has been complemented by the growth the of LNG market, where methane is liquefied and carried by tankers which can ship gas wherever there is receiving terminal, and this has weakened the bond linking sellers and buyers in bilateral contracts.

Finally, the map of the world market has changed both on the demand side, due to steadily growing Asian gas consumption, and on the supply side, thanks to the development of shale gas, which has turned the US from an importer of natural gas to a potential exporter. However it is yet too soon to speak of a unified global market for gas, in which a single price, net of transportation costs, would rule. Nonetheless, the interaction between the American, European, and Asian markets is stronger than before and prices are increasingly set by the interplay of supply and demand, and gas prices have exhibited market trends often in contrast with those of oil prices.

In this new framework, the EU and Italy have experienced a drop in gas demand, due to the crisis and the development of renewables. This has has translated into a drop in the wholesale price for gas, also due to an increase in the international supply of gas and diminished demand on the part of the US. This trend, however, has not influenced the price that gas importers bound by long-term contracts are paying to gas exporters. To the contrary, indexation with respect to oil has meant that the price for gas has actually increased, since the price of crude has gone up in recent years. This marked divergence in price movements calls for a major overhaul of the existing structure of long-term contracts for the purchase of gas. Take-or-pay and indexation clauses are in fact putting a heavy strain on the balance sheets of companies importing gas.

In the current phase, dominated by excess supply, this means having to resell gas at a lower price than the one paid to exporters, in order not be crowded out by rival supply in wholesale markets. A rapid look at the financial statements of European gas operators shows how much importers have had to bleed for this.

Changing long-term contracts is thus crucial, along with necessity of linking prices to the gas price prevalent on spot markets, and a softening, or even an outright cancellation of take-or-pay clauses, which do not take into account the fact that buyers have alternative sources of energy and provision at their disposal. There are early signs that this is finally happening, as contracts are being renegotiated.

However, the problem of having a secure and steady provision of gas remains. The route to be taken in a liberalized world is not that of long-term partnerships between exporters and importers celebrated by the construction of major transnational pipelines, but the diversification of import sources, either via pipelines or LNG terminals, in order to reduce dependence on a single gas producer. At the same time, the entry of new operators and the development of technical knowledge are to be pursued, in order to reduce the market power of incumbents. However we should be wary about multiplying gas import facilities in Italy, since they are very onerous to build, and given a constant demand for gas, this would translate into unused capacity in pipelines and LNG terminals, thereby increasing the cost of investment.