DUtch TTF: To index or not to

When we conduct a tender for gas, some suppliers have used indexation “Title Transfer Facility” (TTF) as a differentiating element of its proposal. Many times, as seeing as something different than what we’re used to, we do not get to see the advantages or disadvantages of this product and return to the famous formula Brent (or derivatives) and exchange rate (€ / $) that still prevails in Spain.

Now in Spain it has been operational since October 2015 an organized gas market managed by the company OMIE, and known as MIBGAS . This new organization is already changing the outlook for the Spanish industry in bidding for gas. It is true that there are not many future products yet, as our European counterparts have, but there is already a daily reference price. A price that the transport network operator used to balance the gas system by buying or selling in the day. This results in certain gas contracts modification regarding volume conditions, causing suppliers to sell off or buy their daily needs on the MIBGAS market. Moreover, emerging associations, as GASINDUSTRIAL are proliferating to convert MIBGAS into a competitive market, as it is the TTF in northern Europe.

With the MIBGAS starting to work, indexated markets such as TTF are reconsidered in tenders. Is it advisable to migrate to a TTF indexation and discard the traditional Brent and exchange rate formulas? This requires analysis of the pros and cons of this market.

Brent is a type of oil that is extracted mainly in the North Sea and sets the benchmark in the European markets, but is directly under the decisions of OPEC producer. The oil organization petroleum exporting countries (a.k.a OPEC) remains as a driver in this market. Their production and export levels are signals that push up or down the price. The problem is that it is an opaque organization and it makes difficult to predict the Brent future.

Returning to the TTF, the counterpart of OPEC in the gas market would be the forum of gas exporting countries (GECF) and it has not the same dominant position. Today there are many hubs in Europe dispelling the possibility that a group of producers will become a driver of a big gas market and create a signal price. In 2014, the market shares in OTC trading and markets were:

In addition, the Brent market, being a reference price not only for Europe, is considered one of the largest financial markets. A market where the number of transactions is increasing exponentially. For instance, the trade volume of one of the largest platforms in Europe was more than double in less than 7 years:

While this high volatility triggers more opportunities, it also represents a higher risk: there are numerous agents involved. Although high participation avoids the existence of a dominant player, this level of participation has made the Brent market a financial market, instead of a raw materials market. The difficulty in understanding a financial market, is that you cannot know the reason of each agent performance. Those agents can alter the Brent value, although there is no fundamental underpinning. In other words, in financial market, changes on price occur because of agents private interests and, generally, for speculative purposes. It is estimated that 60% of today´s oil prices is pure speculation according to Global Research. The increase happened in April the last meeting of DohaAn is an example of how speculators can distort the supply and demand relationship. At this meeting, no major decision was taken, but Brent pushed up to $ 50. A resistance level that was lost after agents unmade their short positions to collect the opportunity profits . Those profits were created by the speculation rumours before the event took place.

This type of market behaviour happens because the Brent market is global, and a large part of the operations do not result in the physical delivery. There are agents holding purchases and sells everywhere to obtain just an economical profits. On the other side, the TTF gas market is characterized by being regional. In Europe there are several hubs where buyers and sellers typically are related to the geographic market place, meaning to be close. In fact, the gas market is still considered a segmented market where each region present its own price lead by their own variables and their own supply-demand scheme. In this regard, an important part of the contracts really lead to the gas exchange at an agreed price. A feature that limits the type of participant in those markets and normally repel investment funds: Already in 2014 banks such as the Deutsche Bank AG decided to withdraw its trading division in commodity markets because they did not obtain the expected benefits and wish to focus on more lucrative sectors.

As a result, the trade volume given in the gas hubs, as the TTF, is 120% lower than the one given in the Brent market. There are less market operations and therefore less liquidity. That’s why there are less pure financial agents in the gas market than in the Brent market. A feature that reduces the number variables to monitorize in order to estimate the price movements. For example, in the short term it seems that gas price is affected by seasonality: increased in price by winter due to a high demand for heating, unlike the summer.

Moreover, in Europe there is a high degree of interconnections via pipelines between hubs around the TTF which caused a correlation of prices. The five hubs with greater convergence in the monthly product 2012-2014 were:

This correlation exists not only thanks to the interconnections but also because those hubs’ regions share gas suppliers, economic cycles, and a high degree of trade between them. So the TTF price references is a convenient index when competing with those regions business as most companies use it. That relation does not occur with companies indexed to Brent. Brent is influenced by macroeconomic and not by the particularities of a region. So, if a company is indexed to Brent while its competitors follow TTF, this company will get different gas costs and sometimes over their competitors if this is indexed to the TTF. For that, the below graph represent the evolution of a Brent exchange rate formula compared to the TTF market for 2017:

As mentioned above, the gas markets like the TTF are less liquid than the Brent market. This may cause that few trades result in a jump in prices on a short period. However, in northern European countries, they have significantly reduced maximum price hit along the year through gas stores. Underground gas storages are filled in summer to provide enough gas in winter when demand overcomes the capacity of piping systems in order to avoid sharp increases in the price:

However, a falling demand combined with the new gas supply vessels of Liquefied Natural Gas (LNG) have reduced the spread between winter and summer prices from 8 euros / MWh in 2010-11 to 1 -2 euros. This is below the storage costs of many European operators, who are between 4 to 8 euros. The gas storage profitability is currently questioned in an oversupplied market. European member country are considering to subsidize them so to maintain the necessary safety volumes. In May of this year, the French government announced that it was seeking financial support mechanisms to the falling prices of storage.

Increasingly, to rely more on LNG seems to be the future path because of the attractiveness of their prices (more competitive than the gas purchased by pipeline) and the independence given as you access a wide range of producers. According to Cedigas, the gas international association, LNG imports increased by 10.2% over 2015 in Europe. In north-western of Europe, where gas markets are more liquid than other parts of the region, net imports of LNG increased significantly and expanded the portfolio of suppliers, including Qatar, which diverted LNG to limit Asia oversupply. In the UK, the South Hook terminal received about 20 % more liquefied natural gas (all from Qatar), meaning an increase in net imports to 9.4 Mt. Besides, in Belgium and the Netherlands net imports rose, respectively, to 2 Mt and 0.7 Mt.

If the LNG becomes the main source of gas markets, prices hubs will be more influenced by the global supply and demand for LNG lanscape. Events like “Fukushima” or countries growth like Brazil, could rapidly rise LNG prices and hence the price of TTF. Therefore, LNG is a double edged sword that can eliminate one of the attractive price TTF. It could become less regional and therefore less manageable as it will be affected by a greater number of exogenous parameters, both in demand and supply, the region in which it is used as a reference for purchase. According Cedigaz in 2035 LNG will represent 53% of interregional gas transactions:

To recapitulate, to assess whether or not indexed to TTF, it should be noted that the market TTF:

There is not an organisation with the size of the OPEC whose behaviour cannot be predictable.
It is less liquid than the Brent market and with less activity of financial entities.
It is regional and correlate with the other interconnected hubs not only physically but economically and commercially.
Through gas storage the hit price are lower as well as the range of quotes.
It can be applied as a transitional step to Migbas.

However, penetration of LNG can modify the characteristics discussed.

Marta Merodio | Energy Consultant