Well before the Covid-19 pandemic brought about a global health and economic crisis, governments in a number of emerging markets around the world announced significant new gas market reforms. These include Brazil’s Novo Mercado de Gás programme, the establishment of an independent pipeline company in China, and India’s recently launched Gas Exchange that reinforces the government’s vision for a gas-based economy.

While the attention of many policy makers today is naturally focused on economic recovery and the design of stimulus packages, the substantial benefits that gas market reforms can bring to economies should not be overlooked.

For example, we estimate that the European Union’s spending on gas imports would have been almost one-third ($15 billion) higher in 2019 under the market conditions that were in place before the liberalisation of European gas markets away from oil-indexation.

In essence, the establishment of liquid wholesale gas markets fosters competition among suppliers, improves the efficiency of resource allocation, and ensures transparent price discovery. This can serve as an anchor both for domestic and import prices, providing an alternative to other pricing mechanisms, such as oil-indexation.

The current crisis and emerging loose global gas market, with ample uncontracted supply of liquefied natural gas (LNG), should be used as an opportunity to fast-track gas market reforms, as they can hugely benefit consumers, reduce import bills and support economic recovery.

As highlighted in our recently released Gas 2020 market report, the current crisis is likely to have repercussions for the medium-term growth potential of natural gas, including demand for LNG. As a consequence, the growth of global liquefaction capacity is expected to outpace incremental LNG demand, resulting in overcapacity.

LNG trade and liquefaction utilisation rate, 2015-2025

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During the same period, contracts covering more than 200 billion cubic metres per year (bcm/y) of LNG are set to expire, with the majority of it destined for markets in the Asia-Pacific region.

Such a situation would leave some LNG producers and portfolio players with growing uncontracted future production and sunk costs. This in turn would exacerbate competition among suppliers – both in the renewal of expiring contracts and for the development of new markets in emerging regions.

Historical experience suggests that loose market conditions can serve as a catalyst for gas market reforms, especially when underpinned by an increasingly diverse and competitive source of supply. Benefits become more immediate both for midstreamers and governments.

In the United States, the implementation of regulatory reforms liberalising the gas market coincided with the oil and gas glut in the aftermath of the 1979 oil shock and the 1981-82 recession. In practice, surplus volumes facilitated the development of inter-state trade and led to greater price convergence.

Similarly, the gas liberalisation and development of trading in the United Kingdom were facilitated by ample supply from the North Sea in the late 1980s and 1990s.

In continental Europe, the loose market conditions in the aftermath of the 2008-9 financial crisis, coupled with the political will to implement the Third Energy Package, led to the development of liquid wholesale gas markets and trading hubs, enabling regional price discovery.

This in turn allowed a gradual shift away from oil-indexation in import contracts towards hybrid- and hub-indexed formulae. These are more reflective of the actual supply-and-demand fundamentals of the importing market.

The transition can be clearly traced in the evolution of import prices of Europe, with the share of oil-indexation falling from above 90% in 2005 to below 25% in 2019. In the case of the European Union, the share of oil-indexed imports is now estimated to be below 20%. 

Evolution of Europe’s gas import pricing mechanisms: from oil- to hub-indexation

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The implications in terms of the overall import bill can be substantial especially in a context of expiring long-term contracts. As mentioned above, we estimate that the European Union’s spending on gas imports would have been almost one-third higher in 2019 under pre-liberalisation market conditions in which oil-indexation prevailed in most import contracts. Moreover, competitive gas pricing can trigger significant environmental benefits by contributing to a more cost-efficient implementation of clean air policies and coal-to-gas-switching in the power sector, and hence reduce the carbon-intensity of economies. 

Both the European and North American experiences show that it takes at least 10 years to establish well-functioning, competitive wholesale gas markets.

Timeline of natural gas markets opening in some major countries and regions

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Given that every energy and gas system is different (in terms of resource endowment, interconnectivity, security of supply and other aspects), there is no single path to the establishment of a more competitive gas market. However, there are a number of factors that should be considered by policy makers and other relevant stakeholders during the market-design phase and the implementation of regulatory measures.

A gas supply system and infrastructure able to meet the average, seasonal and peak demand requirements of consumers is considered an essential element for the creation of a liquid wholesale market.

The regulatory framework should enable market participants to access the gas infrastructure and the midstream flexibility products (such as entry-exit capacity at pipeline interconnections, storage, LNG regasification) on a non-discriminatory, objective and transparent basis. This necessitates the unbundling of the midstream infrastructure from the (typically) vertically integrated incumbent and also the non-discriminatory application of capacity allocation rules, congestion management and balancing procedures.

Network development plans and investment decisions shall reflect on the evolving supply-and-demand patterns of a given gas market. In this respect, the right tariff design –providing the appropriate incentives for investments and for network acces – is of foremost importance.

Operational transparency of the gas system is crucial to mitigate any information asymmetries that might exist between market participants.

Layers of a competitive gas market

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Layer Of A Competitive Market Chart 02
Layers of a competitive gas market
Layer Of A Competitive Market Chart 02

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Market participants need to embrace the challenges and opportunities offered by a liberalised gas market. In the traditional model of vertical integration, wholesale companies act as ‘intermediaries’ between producers and end-users. The wholesalers can simply pass on gas to customers on a cost-plus basis because of their monopolistic or oligopolistic market position. But in a liberalised gas market, utilities, midstream suppliers and trading companies all need to compete with each other both for customers and for supply sources. The elimination of any clauses in gas sales contracts that hinder the resale of gas and/or prevent customers from switching suppliers is crucial to further enhance competition.

A key cornerstone of competitive gas markets is the establishment of a liquid hub. This guarantees that gas is exchanged among market participants in a time- and cost-efficient manner and provides a price benchmark reflective of the underlying market fundamentals.

The churn rate is usually considered as the most important indicator of hub liquidity. It represents the ratio between the total volume of trades and the physical volume of gas consumed in the area served by the hub. A churn rate of above 10 indicates a liquid hub (both TTF and Henry Hub now have churn rates hovering around 100). The hub design should facilitate the development of trading. Market participants’ access to the hub should be provided on a non-discriminatory basis, the licensing procedure should be transparent, and participation fees (if any) should not severely increase entry barriers. The offered product range should be diversified, both in terms of time horizon (day-ahead through month-ahead spot trades – as well as forwards and futures) and in terms of trading instruments (including swaps and options) to allow market participants not only to balance their short-term positions on the physical market but also to manage price risk over different time horizons.

Trading activity in wholesale energy products has to be monitored. This is of particular importance in the early phases of hub development when liquidity is still relatively low and the risk of market manipulation by a dominant player remains high. Moreover, supervision of the market and detection of anti-competitive behaviour play an important role in building trust among participants.

Drawing on international experience and best practices can facilitate the implementation of gas market reforms.

The IEA has been supporting market reform programs for decades through knowledge sharing and by dissemeninating international expertise via white papers, conferences and dedicated work programmes with Member and Association countries.

Recent examples include the IEA’s Gas Market Liberalisation Reform report, which provided key insights from international experiences for China; the Agency’s active support of Brazil’s Novo Mercado de Gás reforms, which passed the lower house of the Brazilian parliament this month; and the recently launched cooperation programme with India on gas markets.

The IEA will continue to play a pivotal role in building dialogue among key stakeholders, facilitating the sharing of international experience and providing thorough and objective analysis to support gas market reforms.