Friday, 28 April 2017

Why would the EU Commission concerns raised about competition in the gas market still hardly helpful to save consumers’ pockets?

It has been over two years since the EU Commission adopted "A Framework Strategy for a Resilient Energy Union with a Forward-Looking Climate Change Policy" on 25 February 2015 as one of major initiatives of the newly elected Commission Team. In short, the main objectives of the Energy Union are to provide EU households and businesses with sustainable, competitive, secure and affordable energy.

In March, this year in Berlin European Commissioner for Climate Action and Energy Miguel Arias Cañete underlined once again the importance of competition in the gas market speaking about completing a competitive, reliable and innovative Energy Union. "In order to make the European energy system more competitive, our objective is to ensure that costs and prices can be gradually aligned towards the most competitive levels," said Commissioner Arias Cañete.

Nevertheless, time has proven that although the EU countries generally share the objectives of the Energy Union and include them into their national energy policy, there remain significant disparities in some of them and even whole regions in in shaping the objectives’ priorities.

On the one hand, all the member states are giving a high priority to sustainable development and climate change mitigation that requires decarbonizing the energy sector. In Central and Southeastern European EU member states, on the other hand, it gives place to competition and security of supplies. This is usually attributed to a high reliance of those countries on the supplies of gas from Russia, which de facto determines the level of competition in the market.

In line with the classical view of gas market development the cornerstone of competition is the assumption that gas buyers should be able to make а well-informed choice based on comparison of prices, terms of delivery and essential qualities of natural gas. Given that the list of the latter begins with the physical state in which gas is supplied to the market. Almost everybody knows that there are a number of options of delivering natural gas from oil and gas fields to market, including pipelines, LNG, CNG and some others. Thus, theoretically, the acceptable level of competitive prices forms in the process of competition between different options for terms of delivery, as well as between supplies of natural gas in a certain physical state and related specific qualities. 

Meanwhile, if after this brief overview of theory our gas consumers return to a current practice to consider the actual presence of competition in the EU gas market they may have the following questions:
- How much are gas buyers and consumers able to be sure that the choice of price formation mechanisms has a significant impact on natural gas import price?
- How has competition between traditional pipe gas and LNG evolved recently in Europe?- Why do gas consumers have to convince themselves that they are paying competitive prices formed by the market but in fact, on average, half of the retail gas price is regulated by the State and local administrations?
Transition from the pricing formula that takes into account inter-fuel competition to market-based pricing principals have not caused noticeable effect yet on retail prices in the EU gas market.Competition between different price formation mechanisms had begun to increase with the development of spot gas trading hubs in northwest Europe from the late 1990s, starting in the UK’s NBP market and then spreading over following decades to Continental European hubs including the Dutch TTF, and Germany’s GASPOOL and NCG.
Since the middle of 2014 less stable and unpredictable oil markets have changed the terms of the competition between price formation mechanisms in favour of growing elements of spot indexation. It would seem that transition to pricing for gas as commodity, independent of oil, will favorably affect the conditions of competition in the market and it will be beneficial for consumers due to lower prices. However, obtaining the independence of gas prices from oil indication has not yet led to their noticeable decrease.
To illustrate this point, we need only compare the charts below displaying retail prices movements (the left side) and the transition to an alternative price formation mechanism (the right side) in Central and Southeastern European EU member states.
As the charts show, in Central European EU member states the linking the price of gas to that of oil for the period from 2005 to 2015 decreased threefold approximately from 87% to 29%. Meanwhile, over the same time period, in the South East Europe countries the extent of the applicability of the price formation mechanism linked to competing fuels remained roughly the same and continued to fluctuate around 40%. In contrast, the price movements in both regions did not reflect the existence of these differences and revealed almost similar picture of retail pricing fluctuations.
Perhaps it suggests that the importance of competition between two price formation mechanisms was exaggerated or at least under the gas market conditions existing in the South East Europe countries, breaking away from oil indexation has not provided yet significant incentives for reducing retail prices for gas.
Don't know why? Obviously, because retail prices for natural gas to a certain extent just have dropped out of traditional competitive market environment to stay under the influence of non-economic motivation at policymaking level that is now dominating in some EU member states.