Péter Kotek (REKK) co-authored this opinion editorial.
Following closely the developments in the natural gas market has always been an extremely exciting task. Just recall the unexpected market shifts, technological developments, new recoveries of gas reserves, geopolitics surrounding any major pipeline investment and related security of supply questions which were all keeping tensions high in the last decade.
The topic of this short writing might be less catchy but is at the core of the European legislation: markets and their regulation, with a special emphasis on LNG.
There is no doubt that LNG is playing an increasingly important role in the EU by providing competition in the upstream and contributing to the security of supply. Over the past two years, EU imports of LNG have doubled. LNG share within total EU gas imports rose from 12 per cent in 2018 to over 23 per cent in 2019 and stayed at that level in 2020 despite falling demand due to the pandemic. This increase was driven by relatively low gas prices in competing Asian markets in 2019 and the development of new liquefaction capacity in the United States and Australia, which increased global LNG supply and created a buyer’s market for 2019 and 2020.
As we see from the figure below, LNG inflow to Europe dropped dramatically in the second half of 2020 due to changed price dynamics: Asian prices skyrocketed and attracted LNG to flow to those markets where they can make the largest profit, abandoning the otherwise well-supplied European markets where storages are still at an unusually high level due to previous years injections. As a consequence, European spot prices also increased substantially. The EU experienced that being part of a global gas market can also result in a price increase. The market dynamics works: no surprise that fully booked European LNG terminals utilisation dropped by almost half at the end of the year.
European gas markets are historically supplied by pipeline gas (from the Netherlands, Norway, Russia, Algeria) therefore transmission infrastructure is well developed and the networks are well interconnected. In the integrated EU gas markets wholesale prices are converging on the (more or less) liquid gas hubs. The fact that the EU could absorb huge LNG quantities is the result of a carefully designed and very painfully implemented market design, accessibility due to unbundling, regulated third party access, capacity allocation rules and increased transparency that enabled the development of a well-functioning gas market with price signals.
The market design has been a successful European strategy to address high concentration of upstream suppliers and the concerns of increased import dependency due to depleting fields. The market design allowed for an increased competition of suppliers, where LNG has played an important role by challenging the status quo of the traditional long term supply contract structure of the historical pipeline suppliers and resulted in significant price decrease on the wholesale level for the benefit of European gas consumers.
Europe undoubtfully competes for LNG supply with Asia, however from a very comfortable position. Historical suppliers – especially Russia – have the ability and the infrastructure in place to supply Europe via pipelines with even larger volumes than it did in 2020 – if demand arose. By that, we arrive at a crucial point: how will the European gas demand evolve in the next two-three decades? The ambitious European Green Deal does not provide gas with any bright future in the long run. However, the upcoming decade might still bring a few good years for the gas industry. The long-term perspective does not encourage more investment into infrastructure, so the ones that are in place should be used in the most efficient way. The regulation must ensure that the redistribution of gains is fair and the increased volatility of the markets is acknowledged.
The first question we ask is: are there any market imperfections that we can detect in relation to European LNG terminals?
In a study on LNG market regulatory framework, led by Trinomics the conclusion was drawn, that although there is increasing competition among terminals to attract spot cargoes (inter-terminal competition) and among users of a specific terminal (intra-terminal competition) there is still room for improvement on the regulatory side to allow for even better utilisation of the terminals.
- Terminal capacity allocation problems: most of the primary capacity by the terminals is long term contracted. Short term access is often restricted to registered users, at some terminals there isn’t any capacity reserved for short term bookings. The most common way to allocate primary capacities is first committed first served, which can obscure market signals. Most terminals have rules in place to reallocate unused capacities, but actual reallocation is limited. More transparency as regards secondary capacity allocation would help new entrants to get better access to the terminals.
- Tariff structures and levels vary on a large scale: despite European wide provisions, there are significant differences in the tariffs applied at the regulated terminals. A CEER benchmarking exercise from 2017, which compared tariffs of the terminals, found that tariffs for the bundled service of regasification storage and send out vary between 0.1 to 3.87 euros/megawatts-hour (MWh). If we also added the regulated entry tariffs to the network, the range would be 0.15 to 4.64 euros/MWh. According to terminal users asked in a survey, the second most important factor they consider when selecting a terminal is the tariff (the first and most important factor is the location of the terminal and how liquid the market is, to which it provides access.) More transparency on the calculation methods and some harmonization in principles and structures could allow for a better comparison of tariffs applied and better predictability of future tariffs.
- Information provision and transparency of LNG terminals: the lack of adequate, user-friendly and non-discriminatory information provision on tariffs, available capacities, services offered and contractual terms at some terminals still hinder market access, especially for smaller market parties and new entrants.
- Exempted terminals: exempted terminals can negotiate their tariff rates and are not obliged to publish them, which lowers transparency and leads to an unlevel playing field between regulated and exempted terminals. About 37 per cent of the capacity of the EU terminals (as of January 2020) has been exempted from the regulated third-party access rules (under the Article 22 of the Gas Directive), meaning that those terminals can set their tariffs without regulatory oversight. It must be noted that with the Brexit most of those exempted capacities left the EU. Remaining exempted terminals are the Gate terminal in the Netherlands, Adriatic LNG (Rovigo) in Italy and Dunkerque in France, making up 22 per cent of all EU27 regasification capacities. Their exemptions will expire in 2031, 2034 and 2036 respectively.
- More flexibility in services requested by users: terminals should be incentivised to reflect users needs in a more flexible manner.
- Small scale services: this developing segment – due to its relatively small size – is less interesting for the LNG importers and shippers to supply at competitive prices.
In 2019 and 2020 European terminals absorbed the global LNG oversupply, the current regulatory framework did not hinder the uptake of these volumes. When the price was right, the volumes followed and the well-interconnected European market made use of its vast storage capacities as well. It is a question though if there is any room for regulatory improvement, for instance, should regulation deal with issues such as exemption, transparency or small-scale access?
What should happen to exempted terminals when their exemption expires? Should they work under a negotiated third-party access regime as Frontier suggests in a study commissioned by Gate terminal or should they come under regulation and be part of the regulatory asset base? If regulated and negotiated terminals operate parallel does that harm fair competition between them?
Could a more advanced capacity allocation regime, for example, auctioning of capacities instead of first committed first served – like the one recently introduced in Spain – lead to better results?
Would more standardisation of the products at terminals lead to more competition between terminals via better comparability or on the contrary: would more standardisation lead to rigid structures and less flexible reaction to individual users’ needs?
There is no doubt that more transparency would be beneficial. Should EU regulation leave it to the LNG terminal operators’ voluntary cooperation to develop some sort of an IT platform or should regulation push them into that direction?
Inputs are needed as the public consultation on the revision of the Gas Directive (2009/73/EC) is to be launched soon and the proposals of the European Commission are expected by end of 2021. These questions and much more will be addressed at the online webinar Better access to LNG terminals organised by REKK Foundation on 10 February 2021. The event will bring together think tanks, regulators, traders and infrastructure operators. As natural gas will remain a part of the energy mix during the transition to a decarbonized future it is essential to keep an eye on market functioning.